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The precious metals have been on a tremendous upleg as I predicted. But for the past few years I have
maintained that gold and silver are about average value and sometimes a
little expensive. In other words, they are no where
near as cheap as they were at the beginning of this secular bull market in
1999.
Then my ears perked up when I heard Marc Faber on CNBC say, “I think
maybe gold is cheaper today than it was in 1999 when it was $252.”
Is Mr. Faber’s subjective valuation of gold
rationally optimistic, delusional or just plain insane?
HOW TO
VALUE GOLD AND SILVER
When I am looking to buy or sell an asset, whether
real estate, stock, bonds or precious metals, I generally use the 200 day moving average
to determine its relative price and give a quick determination of whether it
is cheap, average or expensive. On RunToGold
I even have key ratios where one can easily view the DOW:gold or DOW:silver
ratios based on the spot price or 200 day moving averages. I find these
extremely helpful to get a quick assessment of current market ratios.
Despite being extremely bullish about silver and
understanding the silver backwardation
implications on the silver price I have
nevertheless been extremely cautious because of the overstretched 200 day
moving average; based purely on technicals silver
looks very expensive and due for a correction to around $30. But these are
just techniques and do not get to the fundamental issues. They are only as
good as their underlying premises.
Many financial professionals struggle with valuing
gold. This is because traditional valuation techniques and strategies focus
on discounted future cash flows, discount rates, interest rates, risk-free
rates, real returns, ROI, IRR, WACCs, etc. Distilled simply they base all of
their premises and conclusions on a faulty premise: The 10 year US Treasury
is the risk-free rate.
As a result, most people including almost all the
gold bugs I know keep their balance sheets, income statements and cash flow
statements using the FRN$ or Euro as the numeraire.
Even among gold bugs I know it is only myself and Anthem Blanchard who seem to keep regular
financial statements denominated in gold as the numeraire.
The truth of the matter is that the benchmark for
‘risk-free’ is subjective and a decision every investor
should make for themselves. What one uses for a numeraire
is a completely different issue from what one should buy, sell or hold, etc.
Plus, one should be acutely aware of return-free risk. Here are a few of the
factors that persuaded me to use gold as my prime numeraire:
1. Gold, an element in the periodic table, is a tangible physical asset
with a constant definition.
2. There are large above ground stockpiles of gold which results in low
relative changes in size and those changes are largely predictable.
3. Gold is a current asset with significant financial liquidity
properties. It belongs in the cash portion of the balance sheet.
4. Gold has value in itself, is not subject to counter-party risk and
can never become worthless.
5. Gold has a long-term relationship with other
commodities. Professor Jastram in The Golden Constant explained on page
130,
As we have said, the purchasing power of gold
depends on the relation of commodity prices to gold prices. A close scrutiny
of this relationship over time discloses an affinity of a curiously
responsive character. It could be called the ‘Retrieval
Phenomenon’, meaning that the commodity price level may move away
higher or lower, but it tends to return repeatedly to the level of gold.
6. When feeling insecure about the financial and economic conditions one
can always pet their gold. Go ahead, pet your platypus.
SWITCHING
ONE’S LENS
Viewing the financial and economic world through the
prism of the FRN$, Euro, Yen, Pound, etc. leads to gross distortions. Due to
the gold price suppression scheme one’s vision is
only slightly improved, and definitely not to 20/20, by viewing through the
lens of gold as numeraire. But the one-eyed man is
the dodgeball God when playing among the blind.
To be honest, I do not really care if people
disagree with how I assess value; I just kick their bum in the market and am
rewarded with the purchasing power. It reminds me of what one of my banker’s said about 10 months after we had closed on
an acquisition, “You sure underpaid for that business.” My
response was, “We were buying, right?” Duh. Plus, the seller
named his price so he got exactly what he wanted!
In nature, atrophy is the natural order of
things. The fiat
currency and fractional reserve banking system has resulted in a
concave financial prism that results in a financial inversion. The natural
order of things would have a negative, not positive, interest
rate. Perhaps most shocking when one begins to perform this initial
paradigm change is to see what I like to call the inversion of interest
income; store of capital expense.
For example, if you have a batch of bananas or wheat
you would not expect there to be more of higher quality tomorrow merely by
the fact of putting them in a pile. In most cases, wealth does not just
magically create and organize itself. In fact, most rational people would
assume there would be less wealth because the bananas or wheat would spoil.
So likewise with gold; there is a storage expense and insurance instead of
earning interest. Most people forget that interest is supposed to compensate
for risk which has largely been cartelized and resulted in tremendous moral
hazard that will be meted out under economic law with systemic collapse.
If you had 3,800 gold ounces, about $1,000,000 of
value, in 2001 and wanted to store the capital until 2007 you could choose
among many different tools. Let’s assume you chose an interest bearing
checking account and GoldMoney.
The monthly store of capital expense for the bank account is about $1,500
while about $500 using GoldMoney
. I
should probably run the numbers to see if the fiat currency and fractional
reserve banking system has gotten more expensive since 2007 but this is what
Mr. Faber is asserting.
THE CURRENT
VALUE OF GOLD
Over the past
40 years, the world economy has attempted to leave gold’s orbit through
the world reserve currency rocket of the FRN$ but it has ran out of fuel before
reaching escape velocity and therefore been unsuccessful which has resulted
in The Great Credit Contraction that has
only just begun a few years ago with capital burrowing down the liquidity
pyramid. The regression theorem reversed.
A tremendous portion of the liquidity pyramid,
particularly with derivatives, has been created since 1999. Looking just at
high-powered currency, the adjusted monetary base, relative to gold gives an
interesting valuation metric. Supposedly the United States government has
261.5 million ounces of gold in Fort Knox. Despite the gold having not been
audited in over 50 years and rampant corruption, inefficiency, misstatements,
lies and omissions by the United States and other governments on countless
topics we will assume for the sake of argument that they really do have the
approximately 8,000 tons of gold.
 
This chart from the Federal Reserve Bank of Saint
Louis shows there was approximately $500B of adjusted monetary base in 1999
and about $2.5T in March 2011 with a corresponding 5.8x increase in the price
of gold relative to FRN$. This places a ratio of adjusted monetary base to
gold in 1999 of $1,912 and in 2011 of $9,478.
Reasoned analysis for Mr. Faber’s valuation
comes into focus. As Mr. Robert Landis asserted at GATA’s
2005 event, “Any rational person who continues to dispute the existence
of the rig after exposure to the evidence is either in denial or is
complicit.” GATA asserts that central banks have only 1/2 to 1/3 of the
gold they claim which would yield a ratio of $28,434.
After
all of the worldwide quantitative easing and competitive devaluation of the
last few years what are the adjusted monetary base ratios of the ECB, Bank of
England, Korea, China, Japan, etc. relative to their minuscule gold holdings?
As Alan Greenspan said to the Council of Foreign Relations,
“Fiat money has no place to go but gold.”
CONCLUSION
For the
last several years I have thought that gold and silver were about average
valued based on the current market conditions and their liquidity. But after
hearing Mr. Faber’s assertions that gold may be cheaper now than in
1999 and analyzing the changed market conditions such as the rise of the digital gold currency GoldMoney,
increased gold hypothecation via JP Morgan, tremendous increase in the
adjusted monetary bases of central banks around the world, failed quantitative easing policies, the
exacerbation of the Greater Depression , lack of access to
knowledge and facts concerning the true state of affairs which is exemplified
by Bloomberg taking the Federal Reserve to the Supreme Court and negative
business and entrepreneurial environment due to increased government
regulation and taxation therefore I may be changing my view on the underlying
valuation of the precious metals. Despite the massive secular bull market
they may actually be getting cheaper!
The
current metals prices may seem high in nominal terms but what is unseen is
the change in fundamental value of the FRN$. I hate owning the precious
metals because of the store of capital expense. I would much prefer to own a
wealth generating business or real estate. But for now I will continue to buy gold, silver, platinum and palladium
only because I do not see any other better alternatives and the difficulty in
discerning the financial and economic landscape because of the twilight zone
induced effects from quantitative easing. In other words, when the crystal
ball is clouded just hunker down at the liquidity pyramid’s tip.
Trace
Mayer
RuntoGold.com
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