Archive for March, 2010
The U.S. is in Danger of Hyperinflation
The U.S. Government reported a budget deficit of $220.9 billion for the month of February 2010. The government took in $107.5 billion and outlaid $328.4 billion. This is pretty staggering. We are on track to another $1 trillion dollars in debt in the first seven months of fiscal year 2010. To put $1 trillion dollars into perspective; if you stacked $1,000 bills tightly it would reach 67.9 miles high! I have read that even if the government taxed every American at 100% of their income the budget would not be balanced.
The federal debt is currently over $12 trillion and growing. With the currently low interest rate environment our interest payments on the debt are roughly 10% of tax revenue. As our interest payments increase in size the more of our tax dollars are taken away from other areas of spending. Consequently as rates will have to rise as inflation sets in, the interest payments on the debt could easily shoot up to the 25% range. Which means more borrowing, it is a vicious circle.
The current debt figure does not include Social Security or Medicare. Including these two items the debt is estimated by some experts to be somewhere between $55 and $80 trillion. The government is spending money that it doesn’t have everyday. It has become completely normal to do so. The more money the government has to create, the more inflation the dollar will see. Once all of these dollars hit the system inflation will tick higher and higher.
Inflation is when too many dollars are chasing too few goods. To make it simple, when no one wants dollars because they view them to be weak, they will spend them on goods today rather than wait until tomorrow. This speeds up the velocity of money (for an example of this look at Zimbabwe hyperinflation on youtube.com). The Zimbabwe government began printing money at will to cover their debts and this snowballed until their currency finally collapsed in April of 2009. Now their citizens are panning for gold just to buy food.
Foreign countries like China, Russia and Brazil have already begun taking measures to divulge themselves of their dollar reserves. If the U.S. continues on the path of printing money excessively, ultimately countries around the world will speed up this process. As these dollars come home to the U.S. inflation will pick up and possibly create hyperinflation. Those who own gold and silver have protection. If you look at the hyperinflation that took place in Weimar Germany from 1919 to 1923 you will find that an ounce of gold went form 170 Deutsche Marks to 87 trillion Deutsche Marks. Those that owned gold were able to buy essential items. Those that owned Deutsche Marks watched their wealth disappear very fast.
Will New Healthcare Bill Affect Gold Prices in the Future?
I have been asked many times in the past week or so about how the new healthcare bill will affect gold prices in the future. There is no direct correlation between government debt and gold prices. Gold is a free floating instrument with no direct ties to the dollar, meaning they are not pegged. However when the dollar falls in value, gold will rise in price due to this fall, because gold is priced in terms of dollars.
Government spending is what most people are afraid of and rightfully so. The government is spending money at an alarming rate. To put this into perspective, it took 204 years for our debt to reach $1 trillion; we will create another $1 trillion more debt in the first seven months of 2010. The more debt the government piles on the more unsustainable it becomes. At some point these debts have to be paid, refinanced or defaulted on. The healthcare bill is estimated by the Congressional Budget Office to cost the U.S. $940 billion over the next 10 years. But let’s put that number into perspective. When Medicare was passed it was estimated to cost $12 billion dollars for the first 25 years. The actual cost was $107 billion. A miss estimate of 791%! My point here is this; do you really think the healthcare bill is going to cost what they are estimating? Probably not. It will probably cost us much more that $940 billion.
So how does this relate to the price of gold? The more debt we create, the more our foreign creditors become fearful that they will never get paid back on the money we owe them, which in turn makes them not want to buy our debt, which puts further pressure on the dollar. People are putting money into gold primarily because they are scared about the dollar loosing value, or worse, a complete collapse. As more and more people are putting their money into gold the more valuable it becomes.
Therefore, as the government adds more debt to our balance sheet, whether through bailouts, healthcare reform or the like, the dollar becomes less and less attractive to the foreign countries we depend on so much. It has become customary for our government to spend money it doesn’t have. This is inflationary and in my opinion will continue to fuel the gold market for years to come.
Common Date Gold Coins
Common date gold coins are also referred to as Generic gold coins. This is due to the quantity of coins that exist in the market place. These coins are readily available and are traded as like-kind units instead of as a specific coin. Therefore they are less expensive than the better date/rare gold coins. The value for common dated coins is primarily derived from the gold content and values tend to ebb and flow with the spot price of gold. The value for better dated/rare gold coins is determined by quality, rarity and availability. The gold content in better dated/rare gold coins is a secondary factor in the value.
Common date gold coins are available in $1, $2.5, $3, $5, $10 and $20 denominations. This is not the value of the coin but rather the denomination assigned to it when it was originally minted. Gold prior to 1933 was set at $20 per ounce, so a $1 coin was 1/20 of an ounce and a $20 coin was one full ounce. Common dated coins come in the Indian Head design from the $1 to the $10 issues, and then the design changes to the $20 Saint Gaudens design. Liberties are available in all denominations. The most common $20 Liberty is the 1904 Philadelphia mint and in the $20 Saint Gaudens it is the 1924 Philadelphia mint.
Generics are typically slabbed in plastic holders in the higher grades in the same way that rarer issues are. They can range now days in the $20 Saints and $20 Liberties anywhere from $1,400 to $6,000 depending on the grade and particular dealer.
Common date gold coins are typically used for their gold content plus a small numismatic premium which makes people feel as though they will not be confiscated. I have read that the Patriot Act III requires the value of a coin to be at least double its gold content to be considered non-conficateable, but I am not positive if this is absolutely true. If this is the case then some common dated coins would not be exempt from confiscation.
Common date gold coins can be a great addition to any well diversified coin portfolio, however it should be noted that rarer issues have performed better in the past.
Sight-Seen vs. Sight-Unseen
When acquiring rare gold coins it is important to understand the difference between sight-seen and sight-unseen coins. If a dealer attends a coin auction and fifty 1903P $20 Liberties in MS63 are up for sale, a dealer may make a bid on those coins sight-unseen. This bid will typically be much lower per coin than if that same dealer were to be able to sit with each coin and examine them. This could be a difference of hundreds of dollars bid on each coin, even when the grade is the same on every coin.
Nicer coins fetch more of a premium. If a customer wants the cheapest coins available, he or she can expect the lowest quality coins. The better the quality the more money a coin will cost. In other words you get what you pay for.
For better dated rarer issues, these coins do not trade on a daily, weekly or even monthly basis. These types of coins trade when a buyer and seller get together. A dealer will pick up that particular coin sight-seen and turn around and retail it to a customer sight-seen. This coin will fetch a higher price than a sight-unseen coin. This coin would be something that a collector would be proud to own and that the dealer would want to buy back at a later date.
Sight-unseen prices do not represent value; they represent quick-sale wholesale prices. At an auction one might see sight-unseen bids at around $1,400 on a particular coin and yet the sight-seen bids may be in the area of $1,700-$2,000. Therefore sight-unseen bids would be taken when a dealer needs quick money. When a dealer sells nice coins they command sight-seen prices. These coins are of the highest quality and thus command the highest prices when being sold back to a dealer. When a dealer knows what he or she sold to a customer sight-seen, he or she should be willing to buy them back at the same level of quality.
What is important to understand is that some companies will sell coins at sight-seen prices but then buy them back at sight-unseen prices. This could mean hundreds or even thousands of dollars based on the coin that is being sold back. Therefore it is important to choose a dealer that will buy coins back at sight-seen prices.
What are Certified Gold Coins?
Certified gold coins are coins that have been graded by a professional coin grading company. The two best known and respected grading companies are Professional Coin Grading Service (PCGS) and Numismatic Guarantee Corporation (NGC). In fact, most buyers of gold coins prefer to acquire coins from these two companies.
What coin grading companies do is authenticate, grade and guarantee coins. PCGS has been around since 1986 and have graded over 11 million coins. When a coin is sent to PCGS for example, it is graded by two separate graders. The first grader authenticates the coin and then assigns it a grade. The coin is then redistributed to another grader who goes through the same process. If the coin does not receive the same grade by both graders then it is given to a third grader to break the tie.
After the coin is graded it is sonically sealed in a tamper proof container and given to one last grader for inspection and quality control. The coin cannot leave the facility without at least two graders agreeing on the grade. Inside the case are the details on the coin. The label will give the date a coin was minted, the location of the mint, the quality score as well as a serial number.
All gold coins are graded on a scale from 1-70, with 70 being perfect condition. Gold coins that are graded can be very old up to modern issue bullion coins. Some collectors enjoy grading their modern issue bullion coins in hopes that one day they will be worth much more.
Back in the old days gold coins were kept in bags in vaults. If they never went into circulation they would receive a grade of mint state today. Typically the lower in the bag a coin was the more scratched and dinged it would be and vice versa. The bottom coins in a bag would get a score in the low 60’s and those on the top of the bag would receive scores more towards the middle to upper 60’s.
When diversifying a portfolio with certified coins it is important to understand that rarity as well as quality plays a roll in the value and strategy of each coin. The higher the grade, typically the more valuable the coin will be. The rarer the coin the more valuable it will be. Coins will vary in rarity within each grade. Choose each coin carefully for your goals and objectives.
What are Numismatic Gold Coins?
First let’s define numismatic in two ways, the academic definition and the government’s definition. The academic definition is how Webster’s Dictionary defines it, and that is, of or relating to currency. Wikipedia defines it as the study or collection of currency, including coins, tokens, paper money, and related objects. So numismatic is the study of coins and paper money. It can also be applied to anything that is related to currency, like the study of bartering systems of the old days when people used items of value for trade, like cowry shells. Numismatists are experts in the area of coinage and paper currencies. This is typically important if you are a collector of coins. Numismatists can be very helpful in assembling large collections of gold coins.
What is important to the gold coin industry and gold investors alike is the government’s definition. The government’s definition is what has kept certain coins from being confiscated throughout history. This excerpt was taken from executive order 6102 which dealt with the confiscation of gold bullion in 1933: All persons are hereby required to deliver on or before May 1, 1933, to a Federal reserve bank or branch or agency thereof or to any member bank of the Federal Reserve System all gold coin, gold bullion and gold certificates now owned by them or coming into their ownership on or before April 28, 1933, except the following: Gold coin and gold certificates in an amount not exceeding in the aggregate $100.00 belonging to any one person, and gold coins having a recognized special value to collectors of rare or unusual coins. So to the government any coins that have rare or special value to collectors that are rare or unusual were exempt from confiscation. Therefore any gold coin that a person owned that had value that exceeded the actual value of the gold content, could be considered numismatic. This premium above the physical gold content is called the numismatic value.
This is the importance for investors in the gold market today. In order to be considered numismatic, the coins must be more valuable than the gold it contains. This can become a fine line though. No one really knows how much more valuable they have to be. So could gold Swiss Francs be considered numismatic because the come at a slightly higher premium than bullion? No one knows for sure. But it is widely accepted that Liberties, Saint Gaudens and Indian heads are considered numismatic coins and would be exempt from future confiscations. This is one reason why so many people like these types of coins, they are considered to be non-confiscateable.
If you are a collector then the academic definition is probably more important to you because you are a student of rare coins. If you are an investor the government definition is probably more important to you because you want your money to be as safe as possible.
Swedish Bank Analysts Gold Predictions
Commodity analysts from Swedish bank SEB AB said in a report that “the continuation of current debt factors combined with longer-term dollar skepticism are all likely to fuel demand and limit downside risk for gold prices.” (03/02/10, Business Week, Gold Gains in New York on Alternative Investment to Currencies)
This quote was found in Business Week two weeks ago and it points to something important. Gold is building steam! More analysts are coming out regularly in favor of long-term gold price increases.
What they say is that the U.S. debt factors are creating gold demand. The U.S. debt is currently around $12.5 trillion and rising rapidly. The U.S. government last week reported a record monthly budget deficit for February 2010 of $220.9 billion and is predicting a budget deficit of over $1 trillion dollars per year for the next 9 years. It is looking like a balanced budget going forward is going to be impossible. The White House is projecting that the interest payments on the debt will reach $500 million per year by the year 2014. The National Inflation Association wrote that “We are now at a point where if the U.S. government taxed Americans 100% of their income, the tax receipts generated would not be enough to balance the budget. Likewise, if the U.S. government cut 100% of its spending including defense, but kept paying Social Security, Medicare and Medicaid, we would still have a budget deficit.”
As far as long-term dollar skepticism is concerned, all we need to do is look at the deficits. All of this money is being “printed” which is what is causing international concern about the U.S. Dollar, and rightfully so. If we look at just a few examples, Germany 1919-1923 and Zimbabwe most recently, these currencies hyper inflated until they finally collapsed.
If the debt in the U.S. continues to climb and we continue to print money at will, internationally the dollar will continue to loose its status as the world’s reserve currency, inflation will set in at a much higher pace and gold prices will continue to rise. Limited downside risk to gold due to these factors will continue as the support level on gold will continue to get stronger, making price drops less likely and less severe.
Concerns about inflation and a possible dollar collapse are the primary factors fueling demand for gold in addition to price increase speculation and will likely continue to be the primary driving factors for years to come.
Gold vs. U.S. Debt
I received an interesting piece of data this morning so I thought I would share it. The spreadsheet ultimately compares government debt with the amount of reserves in gold we have in the U.S. Treasury. The amount of gold owned by the treasury has remained constant for many years at 261,498,899.32 ounces. The really interesting figure is how much the price of gold would have to be per ounce in order to monetize the debt.
In 1980 the total amount of liquidity in the market was $1.4 trillion (that includes government debt, NYSE Market Cap, Corporate Bonds and M1) of that number the government debt total was roughly $80 billion. The 1980 high close on the spot price of gold at the time was $825 per ounce. If the government was to monetize the debt (pay it off) with gold in 1980 it would have only needed to do that at $297.90 per ounce. So in terms of gold to debt ratios, spot gold was overvalued at the $825 closing high.
In 1989 the total amount of liquidity in the market was $3.12 trillion, of that number the government debt total was roughly $144 billion. The spot price of gold at the time was $416 per ounce. If the government was to monetize the debt with gold in 1989 it would have needed to do that at $553.35 per ounce. So in terms of gold to debt ratios, spot gold was slightly undervalued.
In January 2010 the total amount of liquidity in the market is $25.8 trillion, of that number the government debt was roughly $12.4 trillion and rapidly growing. The spot price of gold is currently $1,110 per ounce. If the government was to monetize the debt with gold today, the spot price would need to be an amazing $47,239!
Since we know that wealth never disappears, it merely shifts location. And we also know that, so far in this trend that when investors have become nervous about cash they have shifted their wealth from cash, to stocks or bonds. When they get nervous about stocks they shift to bonds or cash. When they get nervous about bonds they shift to cash or stocks. Therefore, so far in this trend cycle, when investors get nervous they have been shifting from paper to paper. We also know historically, that ultimately this will change and the flight to safety will be to hard currency assets ie. Gold and Silver.
Number one, look at the amount of increased liquidity (money) in the market over the last 30 years, from $1.4 trillion to $25.8 trillion. That is a lot of money. I am not suggesting that all of that wealth will shift this way since it is most likely that once the flight picks up enough steam, those currently liquid markets will most likely become illiquid. But if the 80/20 rule applies that would be $5.16 trillion shifting in the physical metal direction. Almost twice the entire market cap in 1989! And remember, we’ve not taken into account all of the markets, just those four. Number two look at how much the debt has increased, we are in deep trouble here with no signs of stopping. Keep in mind that this number doesn’t include Social Security or Medicare which experts estimate to bring the debt to somewhere between $55 and $80 trillion and growing! And that debt must be addressed one way or another. Lastly look at the fact that if the government was going to monetize the debt with gold they would likely need to confiscate bullion in order to have a more meaningful total number of ounces since the government holdings have never been audited and studies done by GATA suggest we actually hold far less than what we say we have.
Since all the gold that has ever been mined is only 161,000 tons and fits into two Olympic sized swimming pools. You can guess the impact on gold if this $5.16 trillion wall of wealth shifts into physical metals. And since the physical metal has already begun to become scarce on the markets as the 2nd tier wealth began to shift from paper gold (ETF’s and stocks) into the physical. This would likely send rare gold coins to new heights as money would flow into this asset class.
Interest Rates vs. Gold, Stocks and Real Estate
If we look at history we can draw some interesting conclusions from interest rate cycles and how they affect the gold, stock and real estate markets. Typically when interest rates are on the rise gold tends to rise with it and vice versa. Typically when rates are falling stocks and real estate rise and vice versa.
For example, interest rates rose from 1.75% in 1965 to a peak of 15% in 1980. During that same time frame gold went from $35 per ounce to a peak of $850 per ounce. That is a 2,300% increase. During that same time frame the DJIA was stagnant, from 856 in 1965 to 857 in 1982.
From there rates fell from 15% to where they are today at 0-.25%, which created an historic bull market in stocks, with the DJIA at 857 in 1982 to 11,722 in 2000. The historically low interest rate environment started in 2002 just after 9/11 and continued to fuel the stock market up to 14,100 in 2007. During this historically low interest rate environment the real estate market boom ensued. This created a huge bubble which has long since burst and is continuing to do so. The reasons why low rates create stock and real estate market booms is due to increased liquidity. In addition more real estate can be purchased with lower rates, and stocks increase with investment capital inflows when not competing with higher rates on other investments. While interest rates were falling so was the price of gold, which went from $850 in 1980 to $252 in 1999.
So what does all of this mean to gold prices in the future? Well if history repeats itself and gold rises during times of rising interest rates, then one must ask themselves only one question: are rates going higher in the future? I believe rates will have to come off of their historic lows; in fact they only have one way to go since they are at 0% right now. When the economy does start to recover the Fed will have to raise rates in order to slow the flood of cheap money in order to battle inflation.
Why has gold risen during this low interest rate environment? This is due to short-term world economic problems, with people and institutions seeking safe haven from the dollar and other fiat currencies. Thus the demand has increased while supplies are diminishing and worldwide output is slowing down. People worldwide are buying gold bullion and rare gold coins for preservation of capital and growth.
Rob McEwen comes out with his Projections on the Gold Market
Rob McEwen, Chairman and CEO of U.S. Gold and founder and former CEO of Gold Corp the second largest gold producer in the world was interviewed by Bloomberg on January 12th 2009. He has been on the record since March of 2006 saying that gold will reach $2,000 per ounce by the end of 2010. He also states that he believes that gold will hit $5,000 per ounce somewhere between 2012 and 2015.
He sites as his reason for this rapid run up in the price of gold will be due to the governments around the world printing money at a high rate. Mr. McEwen thought that the bull market would have ended by now, but people are starting to see gold as money, a currency that trumps all others. This new demand has fueled the fire further than he thought it would. He is so strong on gold rising that he advises that gold mining companies do not hedge.
In my opinion, Rob McEwen could be right. Gold is in a bull market, and typically bull markets end with a blow-off top in the third phase. We have not seen that third phase yet, so we could see very sharp and dramatic price increases during that time frame. It is undeniable at this point that the U.S. Government is printing money at an alarming rate. Some experts speculate that they have doubled the money supply in under a year’s time. Anytime money printing is done in this fashion it puts extreme pressure on inflation which in turn puts upward pressure on gold. Look at what gold did in the 1970’s, when inflation was running high, gold grew from $35 per ounce to $850 per ounce.
All assets run in cycles so we very well could see gold hit $2,000 per ounce this year. I think it will depend on how the economy performs this year and how much confidence is instilled in the American people. Many have said that the hole has been dug and that the dollar will ultimately collapse like all other fiat paper currencies have. If that is the case gold could go much higher than even $5,000 per ounce. But let’s hope that doesn’t happen, because if it does we are in a lot more trouble than any of us want to be.