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Business Observer Thursday, Oct. 29, 2009 12 years ago

It's unavoidable: Gold to go up, up, up

When you combine all the factors that affect the price of gold, you can't reach any other conclusion: The price will continue to rise.
by: George Rauch Staff Writer

When you combine all the factors that affect the price of gold, you can't reach any other conclusion: The price will continue to rise.

In June 2003, we said that a hike in the price of gold was unavoidable. Gold was then priced at $380 an ounce.  

“Statistics indicate the minimum price for gold should be $1,700 an ounce and that price levels of $3,000 to $5,000 an ounce are not unreasonable. The economics associated with gold clearly favors a greater gain over the next 10 years than can be seen in ownership of other investments.”

In July 2005, our Market Watch said gold was the only cheap investment. Gold was $450 an ounce at that time. We said: “Gold experts believe gold will obtain a value of at least $1,500 to $3,000 an ounce in the next five to 10 years.”

In April 2007, we said gold was still underpriced. The price was $700 an ounce. “Under present day circumstances,” we said, “$2,500 an ounce to $5,000 an ounce is a realistic price for gold.”

Here we are today with gold at $1,024 an ounce. One must wonder whether further gold price increases are possible.  

Consider a series of facts about gold:

• Declining purchasing power of the dollar. A 1913 dollar, the year the Federal Reserve System was created, will now purchase less than 2% of what it would in 1913. That is 1/50th of the value of the 1913 dollar.
Looked at another way, in 1913 gold was $20 an ounce. Now consider that $20 an ounce times 50. That's $1,000 an ounce — the approximate price of gold today.

As long as inflation continues, we can conclude that gold will rise in concert with the depreciation in the purchasing power of the dollar.

• Demand for gold is increasing. For the first time in decades, central banks are not selling gold; they are accumulating gold. Additionally, China has entered the market and is the number one producer of gold and the number one consumer of gold. Less than 2% of newly mined gold is added to the world's gold supply each year, so increases in demand by huge buyers such as China, or central banks, can influence the price of gold on the upside.

• The math of our monetary system is forcing gold to increase in price. In the 1930s and the 1940s, every bit of the U.S. money supply (M-3) could be redeemed in gold. Every single dollar obligation was covered by specie. This is what the Constitution required then: “All public debt will be settled in gold and silver species.” (Section 10.).

The Founding Fathers wanted debts settled in gold and silver species because that rule prevents government from getting out of control financially. When a public debt could not be satisfied, services would cease or be cut down to a point where the services could be paid for. This was one of the checks and balances placed in the Constitution to limit the growth of central government. Each ounce of gold in the U.S. money supply represented $20 worth of obligations outstanding. 

Today, every ounce of gold in our money supply represents $59,000 of U.S. monetary obligations. It is easy to see with increasing U.S. indebtedness, persistent inflation and unfunded liabilities how math alone will push up the price of gold.

In 1949 the United States had 36 million tons of gold backing our money supply (M3). That amount has been pared down over the years to 8.2 million tons, less than 25% of what we owned half a century ago. The transfer of gold to other countries is a transfer of power. Let's not forget the golden rule:  “He who has the gold, rules!”

The world's largest gold producer, Barrick Gold Corp., will soon issue $3.5 billion in new stock. It will use the funds to close out its hedge book (which means buying back “gold short positions” used to hedge their inventory). Barrick is investing $3.5 billion in gold at these prices, presumably because it does not think we will see these prices again soon, if at all.

• Current bank “profits” are clearly suspect. Profits are largely from the “carry trade” which is all based upon debt. The “carry trade” works as follows: Banks borrow from the Fed at less than 1% and purchase treasury bonds, for example, which yield more than 1%, thereby booking the profit.

Mathematically, interest on the treasury bonds are paid by the federal government, which is borrowing money from the taxpayers to pay interest on the treasury bonds owned by the banks. It is a complete paper profit, and it's a scam.  

Government, Wall Street and the Fed are all complicit in this scheme, and they know that what they are doing would bankrupt a business. Businesses cannot continually borrow money by making a few computer entries like our government does. We are using government funds to bolster the earnings of banks at our expense.

The U.S. money supply's approximate 236 million ounces of gold are worth about $250 billion as compared to our M3 money supply of about $14 trillion. (They quit publishing our money supply statistics about two years ago, so we must now make an educated guess at the amount of our own money supply!)

Even though gold was $252 in 1999, and it now exceeds $1,000 an ounce, the public is still not a big buyer of gold. Various investment funds have begun to take positions in gold and in gold stocks. But when more funds focus on gold, and the public catches on, there is likely to be an upward spike in the price.

What's more, China is now encouraging Chinese citizens to purchase gold. China has a high rate of savings, and a diversion of savings to gold would affect world gold markets.

In 2001, when President Bush was elected, gold was selling at $285 an ounce. With gold at $1,024 an ounce, the U.S. dollar has been devalued against gold by more than 70% since 2001!

It's hard to see how upward pressure on the price of gold can possibly be relieved with increasing government obligations paid for by debt. Debt undermines the value of the dollar, and the loss in the value of the dollar goes hand-in-glove with increases in the value of gold.

Bottom line: (1) If you believe the government will get it together, don't buy gold because over time it will go down in value. (2) If, on the other hand, you feel the promised “change” we are experiencing with the new administration means “business as usual” with more taxes and more government, gold should gain dramatically in value.

Carpe Diem.

George Rauch is CEO of Bradenton-based General Propeller and a resident of Longboat Key. He can be reached at [email protected].

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