Gold thrashing: let’s talk sense

One of the world’s foremost gold stock pickers, John Hathaway of Tocqueville Gold Fund, has increased the Fund’s holdings to 12.5% “physical gold,” i.e. bullion (or possibly bullion plus coins).  2% more of his Fund is in cash, as is routine.  The rest is in gold mining companies traded on various stock exchanges, mostly the NYSE or AMEX: Rangold, Goldcorp, Ivanhoe and Newmont comprise another 25% of the Fund.

Leaders all.  Yet, Tocqueville has dropped more than 50% from its highs.  Hathaway, always a cool customer in the best of times, makes the point that there is no place to go but up, for gold stocks.  We agree, IF the dollar remains a viable currency.  Which it surely could, in the short run.  In the race to junk status, the Euro is likely to win, as debtors race to their nearest dollar sources to pay down what they owe.  But the dollar’s turn will come, and we surmise that if and when Hathaway agrees, his Fund will move increasingly into bullion. 

Here’s Hathaway’s two-paragraph summary in the latest Tocqueville Quarterly Report:

“The collapse of the world financial order had been front page news for several weeks.  Gold bullion had been firm throughout the panic, but the gold shares have been swept along in the general downdraft of equities.  On October 10, 2008, the ratio of the XAU (Philadelphia Stock Exchange Gold and Silver Index) to the gold price was about 12%, the lowest level in the history of the index relative to the gold price.  ON this measure alone, gold stocks appear extraordinarily cheap to us.

“We continue to believe the rapid changes in the world financial order will ultimately benefit the gold bullion price.  And, since gold mining shares are claims on gold in the ground and options on the future price changes of gold, we anticipate they will benefit as well.  Gold and gold shares delayed response to these events is disappointing, to say the least, but we have never seen a fundamental backdrop as favorable for a substantial rise in bullion and share prices as the current one.”

A Trillion Here, A Trillion There

“Since the close of 2002, developing country central banks have absorbed more than $2 trillion in this fashion.  This is debt that, under a gold-based monetary system, the United States could probably not have incurred.  Living so grandly beyond our means, we would have raised the suspicions of our creditors, who would not unreasonably have begun to exchange their paper dollars for the gold that stood behind them.  The loss of gold would have cut short our high living.

“Our foreign creditors accepted dollars in payment for their goods and services — and then obligingly invested the same dollars in America’s own securities.  It’s as if the money never left the 50 states.”

“In the past two weeks, governments in Asia, Europe and the U.S. have effectively nationalized vast swaths of banking.  Central banks have ramped up their money printing.  In the past week alone, the Fed’s balance sheet swelled by $179 billion, to a grand total of $1.77 trillion.  In announcing such radical measures, intervening governments never fail to invoke confidence.  They say they must restore it.”

— James Grant, Wall Street Journal  10/18/2007

Lunacy Week

 ”On the first score, in responding to pleas, particularly from banks and their kin, Uncle Sam is pulling out as many stops as he can.  It’s hard to get a decent handle on what this enormous effort adds up to since it seems to grow daily by leaps and bounds and because it has assumed so many different guises, from purchasing or guaranteeing billions worth of wasting assets to massive loans and outright investment.  (Which makes you wonder whether the powers-that-be keep discovering new problems or they have only the foggiest notion of what they’re doing.)

“But the sum is incontestably staggering, like approaching a couple of trillion dollars and counting.  And if you toss in the capital transfusions that the French, Germans, Brits et al. are also pumping into the wobbly global financial system, the already burgeoning total swells to numbers not dreamed of in your worst nightmares, something like $3 trillion.”

—Alan Ableson, Barron’s 10/20/2008

Right Now

“How bad will the storm get?  This from Nouriel Roubini, Professor of Economics at the NYU Stern School of Business:

‘The crisis was caused by the largest leveraged asst bubble and credit bubble in the history of humanity where excessive leveraging and bubbles were not limited to housing in the US but also to housing in many other countries and excessive borrowing by financial institutions and some segments of the corporate sector and of the public sector in many and different economies: an housing bubble, a mortgage bubble, and equity bubble, a bond bubble, a credit bubble, a commodity bubble, a private equity bubble, a hedge funds bubble are all now bursting at once in the biggest real sector and financial sector deleveraging since the Great Depression.

‘At this point the recession train has left the station; the financial and banking crisis train has left the station.  The delusion that the U.S. and advanced economies contraction would be short and shallow — a V-shaped six month recession — has been replaced by the certainty that this will be a long and protracted U-shaped recession that may last at least two years in the U.S. and close on two years in most of the rest of the world.  And given the rising risk of a global systematic financial meltdown, the probability that the outcome could become a decade long L-shaped recession — like the one experienced by Japan after the bursting of its real estate and equity bubble — cannot be ruled out.

‘At this point the risk of an imminent stock market crash — like the one-day collapse of 20% plus in U.S. stock prices in 1987 — cannot be ruled out as the financial  system is breaking down, panic and lack of confidence in any counterparty is sharply rising and the investors have totally lost faith in the ability of policy authorities to control this meltdown.’”

—The Daily Reckoning, 10/15/2007

The Gold Index

Two cheapest gold coins (in premium over spot price):

Austrian Crown

Mexican Peso

Availability of either on the actual open market today:

Next to nil

Quotable Notables

          “Our former colleague James Grant, that most literary of financial writers, ably catalogued these cycles in a 1992 book called Money of the Mind: Borrowing and Lending in America from the Civil War to Michael Milken.  He followed 120 years of inhalations and exhalations of credit, providing fascinating tales of banking ineptitude along the way.         

          Reviewers said the book should be required reading for bankers, but of course the industry never got the message.

          Jim didn’t suggest that the story would end with the excesses of the Milken era, and we understand that he has a new book coming out called Mr. Market Miscalculates: The Bubble Years and Beyond.  Buy it.

          A more solemn irony is that the Bretton Woods agreement was no model of multipolarity or world concord.  It was dictated by the United States.  It reflected the astounding dominance of America in the world economy right after World War II.  The U.S. accounted for 40% of global economic output and had at least 80% of the gold reserves.  Only the dollar was credible enough to be pegged to gold; other currencies could be pegged to the dollar.  Thus, the U.S. became the world’s creator and judge of money.

          The U.S. eventually abused its power to create the world’s money, flooding the globe with unwanted dollars in such profusion that it couldn’t redeem them for gold.  In 1971, it admitted that, went off the gold standard and left the world and itself with no restrains on the creation of money and credit.”

—Thomas G. Donlan, Barron’s, 10/27/2008 

“But there’s a major difference between now and the 1930’s.  During the ‘30s nobody had dollars.  Dollars were scarce as frog’s teeth.  If you did have dollars in the ‘30s, nobody doubted their value.  Today I doubt the viability of Federal Reserve Notes (dollars).  I wonder what they’ll be worth a few years from now.  Fiat currency is “fool’s money”.  It’s only money because some government says it is.  All fiat money is a function of debt and confidence.  There’s only one currency that represents intrinsic wealth (no debt) on its own.  And it’s gold.  If you can’t understand that, you’ll never understand why men over thousands of years have fought, explored, and died all in the never ending search for gold.”

— Richard Russell, Dow Theory Letters, 11/7/2008