Gold: God’s Currency – Part II

This article was originally written in April 2003 for RC Peck’s Fearless Wealth’s Newsletter.

The market has been acting a bit strangely the past week or so. I’ve noticed a lot of speculation taking place, both to the up side and to the down side. Stocks are running way past their normal moves and falling much farther than would be expected. Are the Main Street stock speculators getting a bit itchy? Perhaps, but the trend of the market is still up, including the topic of this week’s newsletter—Gold: God’s currency.

If you have some time on your hands, and you’d like to look back into the history of gold, you’d see some correlations with its long-term rise and fall. One that might stand out is the inverse correlation between the price of gold and our government printing money. Since the printing of money has a direct correlation with the price of gold, let’s start there.

The US dollar as we know it has been around for about 32 years. Yes, we were using the dollar long before that, but 32 years ago is when our government decided to take the dollar off the gold standard. The gold standard system guaranteed that all dollars in circulation were backed by America’s gold bullion reserves at Fort Knox, Tennessee. But that’s no longer the case, and you can thank Nixon and the Vietnam War for the detachment.

You see, we (America) needed money to pay for the Vietnam War and we couldn’t get enough if our dollar remained on the gold standard. So Nixon unpegged the dollar from gold and turned on the printing presses (which led to inflation, but that’s a story for another time).

Today the US dollar is “fiat” money. Fiat money is basically any currency printed by a government as legal tender that is not redeemable for gold or other commodity and lacks economic value except that which the printing government gives it. So basically, fiat money is worth what others are willing to pay for it.

The problem with fiat money is that governments can print as much as they want, when they want, without asking anyone. This is not a good scenario for you and me, but it can be mitigated if we as investors have gold as part of our portfolio.

Flashback to 1970: The US was in the middle of a very unpopular war on the other side of the world. It was in a small foreign land few people had heard of. The enemy was invisible. And our country didn’t really have the money to pay for it. Fast forward 32 years: We are fighting a war on the other side of the world, in a small foreign land few people had heard of, against people we can’t see—and it’s really expensive.

What happens when our government needs money to pay for what it can’t afford? Does it have to dig up the money? No. Does it have to stop spending? No. All our government has to do is turn on a printing press, which is certainly less costly than spending $270 to mine an ounce of gold. All they have to do is move a decimal point on a computer in some building; they don’t even have to print more money, though they indeed do that as well.

Printing money is such a big part of how our government works that at the end of 2002 (October) Ben S. Bernanke, a member of the Board of Governors of the Federal Reserve System, made a statement in response to a question about deflation. The question was about what the Fed was going to do to counter deflation, if and when it starts (I believe it has started already, but that too is another newsletter). Bernanke’s comment was, “We have an invention called the printing press, and if need be, we’ll turn it on.”

In other words, the money sitting in your money market account is going to be worth a whole lot less after the US gets through printing a whole lot more dollars. Bernanke’s comment set off a pretty big chain of events. In a very short time gold shot up $65 an ounce and the US dollar index lost 7%.

Printing money whenever the Fed decides it needs to brings up a question: “How much has the value of the dollar fallen over time?” I’m glad you asked. A dollar in 1900 was worth a dollar. That same dollar today is worth 7 cents (Department of Labor Statistics).

And do you know why the dollar is worth 14 times less today? Because the US government hasn’t taken any lessons from DeBeers. Instead, it just kept increasing the money supply. So much so that in 1900 there was $34 of cash in circulation per capita, compared with $2,075 of cash in circulation per capita today, an increase of 61 times! That should make you fall off your chair.

The government cranked out 60 times more dollars over 100 years and yet the dollar has only fallen 14 times during that century. Not bad. Still, that should make you stand up and ask, “How can I preserve my hard-earned money?” Now we’re talking. How about putting part of your money in Gold?

In 1900 gold cost $19 an ounce. Today, an ounce of gold costs $360. The price from 1900 has increased by a factor of 18. As I said before, during the same period the value of the dollar dropped by a factor of 14. Are you following me? The value of gold increased by a factor of 18 while the value of the dollar decreased by a factor of 14.

Which one of these holds its true value? Gold. Obviously. In 1900 an ounce of gold bought a man a nice suit, and in 2003 an ounce of gold can still buy a man a nice suit. GOLD HOLDS ITS VALUE, especially when we go to war and print money to pay for it.

Gold holds it value because the US Fed (or any other government) can’t “print” more of it. Plus, gold is not someone else’s liability. You are not buying someone else’s government debt, which means that governments can’t mismanage it. Gold cannot be inflated away. God did a good job with gold. If there were no other reason to buy gold, that would be enough, but there’s more.

Gold coins leave no paper trail. Gold can easily travel over borders, it can be stored easily, and it has the same value in downtown San Francisco as it does in downtown Istanbul. Gold is the world’s only inflation-proof currency, and everyone accepts it. The only other inflation-proof commodity I know of is diamonds.

Let’s take a look at the two easiest ways to buy gold:

1 – Gold mining stocks
2 – Gold mutual funds

Gold mining stocks are a great place to start. I suggest you look at the bluest of the blue of gold mining stocks. If you own zero gold, this is where to begin. The company I’m going to tell you about doesn’t hedge its gold mining production (“hedge” means it doesn’t sell future mined gold for a set price, it sells the gold for whatever the market says it’s worth at the time of production). All you need to know is that this company does not hedge its gold production and will experience a rising stock price when gold itself rises.

The name of the company is Newmont Mining Corporation (NEM). Its stock value has increased about 60% over the past two years.  As I said, this is the bluest of all the gold mining companies in the world, and for even the blue chip of gold companies to be up 60% in two years is no small feat.

One more issue to keep in mind about Newmont: when people wake up to the fact that they need to have gold in their portfolios, guess where their money managers and brokers are going to look? Newmont, baby! That has supply and demand ramifications. A lot of attention is going to be on a few sets of stocks. Can we say bubble?

If you don’t want to buy an individual stock you can click on www.morningstar.com and investigate its gold sector mutual funds (Morningstar is an independent company that ranks mutual funds and stocks according to its own metrics). One of the best funds I have found is managed by Evergreen, whose ticker is EKWAX. Check them out. And while you are on the Morningstar site, look at its competitors too.

Lessons:

  1. Gold holds its value when compared to the US dollar. Compare the value of gold over the last 100 years to the US dollar and you can see why gold is essential to your portfolio.
  2. Wars and the printing of money have a tendency to increase the value of gold over the short term. Right now we are in both.
  3. Buy gold now so that when the world wakes up to it you can feel like the person who bought technology stocks in 1995 and sold them in 2000.
  4. The US dollar is flooding into the market, which will drive up the price of gold.
  5. To being prudent and smart.

With regards,
RC’s Signature