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Gold at Its Tipping Point?
(December 13, 2002) Gold closed Friday at $333.20, up another 2% in a week's time. Bush names a new Treasury Secretary, Scuds are intercepted, the dollar swan-dives, stocks are lower, stores are empty, North Korea steps up its nuclear program, Kissinger steps down, Cardinal Law steps down, and Trent Lott steps into it big-time. We explore gold's ‘tipping point' with some large numbers.
Gold as an investment gets no respect. And after its 20-year debacle from 1980-1999, does it really deserve any? Gold in that period of time fell off of everyone’s radar screen, and for good reason. During those two decades, your money was much better off in the stock market, or bonds, or in a money market fund. For that matter, stuffing cash under a mattress would have outperformed owning gold during those two distinctly un-Golden decades.

But as gold slowly increases in price, as it has over the past two years, it’s like a sleeping giant finally waking up. To start with, people notice a little activity, but he’s been asleep for twenty years, so no one even remembers the last time he was up and truly acting like a giant. He stirs, slowly at first, and when he finally raises his head up, people start to recognize him. Then when he sits up and opens his eyes, the public once again sees how really big the giant is and start to remember how powerful he once was.

But, to continue our little fairy tale analogy, people didn’t recall what that giant was capable of doing when he stood up and really got moving. And after his 20-year nap, younger people didn’t know, and older people had forgotten, that giants are real, and have been for thousands of years.

Just like today, when many people are too young to remember that gold is real, and has been for thousands of years. And gold always wakes up when there is something wrong with the currency in circulation. Whenever there is a perceived weakness in the form of money that the government is circulating, when there’s a suspicion that there’s no actual economic value behind that money, then people start to convert their currency assets to gold.

This flight-to-gold process starts slowly at first, gradually increasing until it reaches its tipping point, at which point everyone races in the same direction at once.

In the year 2000, Malcolm Gladwell wrote a book entitled The Tipping Point, subtitled, "How Little Things Can Make a Big Difference." His book has nothing to do with gold, or money, but bear with us just a moment.

In this book, he explores how changes occur in our society, and what social mechanisms are actually involved in the spread of the ideas, behavior, products, and ‘messages’ which come to be adopted. The process of the spread of new things in a society he attributes to social epidemics.

“…(T)he best way to understand the emergence of fashion trends, the ebb and flow of crime waves, or, for that matter, the transformation of unknown books into bestsellers, or the rise of teenage smoking, or the phenomena of word of mouth, or any number of the other mysterious changes that mark everyday life is to think of them as epidemics. Ideas and products and messages and behaviors spread just like viruses do.” –from the Introduction, page 7.

These epidemics spread from the ideas and behavior of a few early-adopters and mavens, then spread outward among others, often suddenly and unexpectedly, until a ‘tipping point’ is reached. At the tipping point, everyone starts to catch on, and finally what was once unknown or unfamiliar becomes a commonplace in a given society.

In the United States at this time, the idea of gold ownership is at a pre-tipping stage. Gold ownership is totally outside the sphere of common experience in this country. You won’t hear about gold from your financial planner, your banker, your attorney, and certainly not from your stockbroker. It is almost entirely “off the screen” as far as most people are concerned when it comes to their investments.

But, gold is being looked at by a growing number of people as a smart alternative for some of their assets. And as these people acquire gold, they spread the word to others in their circle of family, colleagues, and friends. Many of our clients tell us that the very idea of gold ownership was introduced to them by someone they know, a “maven,” in Gladwell's term, whose opinion they hold in high regard.

This process will gradually lead to an increasing acceptance of gold as a financial alternative - an alternative to the dollar, particularly here in the U.S., which is home to most of those trillions of electronic dollars out there.

Last week, one straw on the dollar-camel's back was the loss of a Treasury Secretary who once proclaimed, "I believe in a strong dollar, and if I decide to shift that stance I will hire out the Yankee Stadium and announce that change in policy to the whole world."

We also saw the dismissal of White House economic advisor Lawrence Lindsey, who made the mistake (among others) of going public in September of this year with his estimate that "War with Iraq would cost the U.S. between 1% and 2% of US gross domestic product (about $100 billion to $200 billion)." The fault in those figures may be that they're too low. Thomas Friedman in his column in the New York Times (December 8th, 2002) puts the cost of an Iraqi war at a round $1 trillion. Of course, everything's more expensive in New York City.

And, let's not forget Federal Reserve Board governor Bernanke's remarks before the Economists Club just last month:

"But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services…"

Individually, none of these occurrences mean that much. But each one rings a bell with someone, somewhere. With each visible instance of official neglect of the fragile abstraction known as the dollar, a few more people come to the realization that the era of low gold prices is just about over.

A slight increase in demand can exert a lot of leverage in a world in which only some $25 billion worth of gold is mined every year,while the number of dollars extant runs into the trillions.

Let's take a look at some truly astronomical numbers that put a mere $25 billion worth of anything totally in the shade.

In the U.S. the total aggregate money supply as measured by the Fed's M3 is some $8.33 trillion dollars as of October 2002. This is the Fed's broadest money supply number, and includes such things as money market funds and banks parking their money overnight with one another. $8.33 trillion is about 333 times the value of all the gold mined in the world last year. It's also more than six times the value of all the gold mined in the world since the beginning of human history (call it All the Gold In the World, or AGIW -that's about 125,000 tons held by governments, banks, and private citizens in the forms of bullion, coins, and jewelry, worth about $10.5 million per ton at today's price).

So let's take the more restricted money supply measure known as M1. Now, M1 is basically just our country's 'walking around' money - cash and checking accounts - and according the Federal Reserve Board it totals $1.1996 trillion as of October this year. That narrow measure of ready cash in this country is about 48 times the value of all the gold mined, worldwide, in 2001. Or, to put it up against AGIW, if everyone holding US dollars would just open up his or her wallet and/or checking account, at today's prices that would purchase some 85% of all the gold in the world.

The above humongous numbers are impressive, but they ignore the worth of things such as stocks, bonds, real estate, and other assets. Let's take the US stock market, with a total market capitalization of some $11 trillion. That number is 440 times the value of annual gold mine production worldwide – for that matter, the market currently values the total of US stocks as worth more than eight times the value of All the Gold in the World. That’s an awful lot of faith to put in US corporations and their CEOs.

As an example, let's take a look at one of America's most profitable companies. It’s common knowledge that the Microsoft corporation has been a virtual “goldmine” for years, but that’s a pitiful understatement. In fact, there’s never been a goldmine worth anywhere near it. Microsoft's current market capitalization ($296 billion) is four times the market capitalization of all the gold mining companies in the world put together.

Putting the current Microsoft valuation another way, with some $25 billion worth of gold being mined every year, the shares of Microsoft in total are worth more than eleven years of world gold production. In essence, the gold and stock markets are saying that the corporation Microsoft is worth:

- About 29,000 tons of gold, or,

- Three-and-a-half times the US Treasury gold reserves,or,

- Nearly one-quarter of AGIW - All the Gold in the World.

That's quite a valuation for a software company that first went public 16 years ago.

Now all this may sound like we’re comparing apples to oranges. And in a way, we are. But the simple point here is that the amount of dollars and dollar-denominated assets in existence is several orders of magnitude larger than any measure of gold you might think of, whether it be annual production, US reserves, or even the sum total of all the gold mined since the dawn of human history (AGIW).

The tipping point for gold demand cannot be predicted. As Gladwell writes (Endnotes, page 161), "Tipping Points are moments of great sensitivity. Changes made right at the Tipping Point can have enormous consequences."

It is exactly in times of economic uncertainty, when US and worldwide investors become wary of US stocks and the US dollar, that events start to tip in favor of the old reliable safe harbor, gold itself.

Let's go back to that figure of $11 trillion - the total market cap of US stocks. If only 1% of that sum was to be invested in gold at today's prices, it would take over four years’ production from all the gold mines in the world to fill the order.

If anything remotely like that were to happen, we'd quickly find how plentiful dollars are, and how scarce gold.


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