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Looking Ahead to a Penny on the Dollar
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(October 9, 2012) Gold prices have surged over 12% since mid-August, as sentiment towards the shiny yellow metal has shifted dramatically. Blame what is now being called QE-Infinity and the dimming possibility of any serious effort to reduce America's growing deficit. As gold approaches $2,000, we begin to see the possibility of the dollar becoming, in essence, a penny.
Gold is back from the wilderness. There were moments during the summer, as prices lurched down towards $1,500 a troy ounce, when investor began to question whether the decade-long bull market in the precious metal had ended. “Gold was boring for a long time,” says a hedge fund manager. No longer.”- "Investors Make Swift Grab for Gold", by Jack Farchy, Financial Times, Oct 6,7/2012.

In dollars, gold’s price touched $1,795 last week, still about $100 shy of its record set n August of 2011. But in terms of both the euro and Swiss franc, gold is more expensive than it has even been. The only negatives for gold seem to be lower demand figures in India and China over the second quarter of 2012, but slackened demand there has been more than made up for by a 158 tonne increase in exchange traded fund gold since the first of August.

A portent of higher gold prices also comes from taking a technical look at gold’s price chart, as Farchy points out in his FT article:

Even the charts appear to be aligning in gold’s favour. The metal’s 50-day moving average recently rose above its 200-day moving average - a formation known among chartists as a ‘golden cross’ – seen by many as a powerful bullish signal technically.

Bill Gross of the world’s largest bond fund, Pimco, brought up gold in his October investment letter in the context of possible outcomes should the US not began to shrink its expected deficit, and soon:

It’s well publicized that the U.S. has $16 trillion of outstanding debt, but its future liabilities in terms of Social Security, Medicare, and Medicaid are less tangible and therefore more difficult to comprehend. Suppose, though, that when paying payroll or income taxes for any of the above benefits, American citizens were issued a bond that they could cash in when required to pay those future bills. The bond would be worth more than the taxes paid because the benefits are increasing faster than inflation. The fact is that those bonds today would total nearly $60 trillion, a disparity that is four times our publicized number of outstanding debt. We owe, in other words, not only $16 trillion in outstanding, Treasury bonds and bills, but $60 trillion more. In my example, it just so happens that the $60 trillion comes not in the form of promises to pay bonds or bills at maturity, but the present value of future Social Security benefits, Medicaid expenses and expected costs for Medicare. Altogether, that’s a whopping total of 500% of GDP, dear reader, and I’m not making it up. Kindly consult the IMF and the CBO for verification. Kindly wonder, as well, how we’re going to get out of this mess….Unless we begin to close this gap, then the inevitable result will be that our debt/GDP ratio will continue to rise, the Fed would print money to pay for the deficiency, inflation would follow and the dollar would inevitably decline. Bonds would be burned to a crisp and stocks would certainly be singed; only gold and real assets would thrive…”

When considering the purchase of gold as a hedge against the further debasement of the dollar, two things are usually true: gold seems expensive when you buy it, and that price seems cheap a few years later. That is the true signal. The ‘noise’ comes in the seemingly random fluctuations in price of gold versus the dollar.

A short story: In 1931, my great-grandfather, a farmer in Meriwether County, Georgia, lost his life savings of $4,000 when the bank failed, as did many banks all over the country during the Depression.

I heard that story when I was young. And my grandmother learned a lesson from her father’s experience, because she never kept a dime in any bank. $4,000 was about the price of a new Cadillac when I first heard the story, so it was an impressive amount of money to my young mind, but certainly not a vast fortune.

Or was it? In 1931, the United States was still on the gold standard, and every dollar was backed by nearly one-twentieth of an ounce of gold at the official price of $20.67 per troy ounce. So, what my grandfather lost when the bank failed was about $4,000 measured in ‘gold standard’ dollars, a measure that bears no relation to the watered-down paper that we call ‘dollars’ today.

Imagine if in 1931, my great-grandfather had a premonition about what would happen to his local bank. He might have made a trip to town, and withdrawn the money from his account in the form of then-circulating U.S gold coins. His $4,000 then was about 200 ounces. Those piles of gold coins would be worth about three hundred and sixty thousand ($360,000) when calculated in today’s dollars. In terms of the ultimate measure, gold, $4,000 in 1931 dollars became $360,000 in 2012 dollars.

So, in thinking about what has happened to the value of our dollar over the past eighty years or so, it might be helpful to keep this in mind: gold prices have risen about 12.5% since the first of August, and over 500% in the past eleven years. Should the dollar collapse another 15% in value versus gold, an ounce of gold will trade for $2,067. It will then take $100 to buy the amount of gold that $1 did in 1931.

Our current dollar will then be worth a gold-standard penny.

 

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