Within the inflation debate, few investment topics stoke such contentious discussions as gold. Whatever Fools think about the metal, they hold those views strongly. As the relevance of gold in the context of macroeconomic developments grows even clearer, I offer this consolidated treatment of the top 10 reasons to hold gold through the next several years.
1. Awash in a sea of trillions
First, retire the notion that gold is a commodity. With its pedigree as an ancient and universally recognized physical store of value, gold is held by central banks as a reserve currency. Gold remains a crucial anchor for the planet's relatively short-lived and frankly unimpressive experiment with unbacked fiat paper money. While paper money can become encumbered by debt, obligations, and the ravages of a printing press, gold cannot.
Still clinging to its role as the de facto reserve currency of the world, the U.S. dollar continues to provide the clearest indications of gold's trajectory. The present bull market for gold and silver began not when Bear Stearns crumbled, but back in 2002, when the U.S. dollar index (USDX) abruptly reversed course, shedding 40% of its purchasing power before rallying in 2008.
Fools seeking to place gold's roughly $1,000 price-level in context are reminded that since that mark was first reached in March 2008, the U.S. fiscal response to the crisis has ballooned to more than $13.5 trillion in pledged or potential outlays. The Congressional Budget Office sees $9.3 trillion in total budget deficits through 2019, bringing the debt-to-GDP ratio to a whopping 82%. This scale of indebtedness not seen since World War II erodes confidence in the underlying currency, and triggers a most unfortunate domino effect, contracting the nation's credit line as dollar-denominated debt assets lose their appeal.
The housing meltdown was not the true epicenter of the global financial crisis -- merely the trigger. The unregulated expansion of derivatives to more than $1 quadrillion in notional value represents the single greatest scourge upon humanity ever devised by the financial industry. Warren Buffett was absolutely correct to call the products of this leveraged market "financial weapons of mass destruction."
Whether as originators or counterparties, banks are heavily exposed to derivatives. I believe that the $587 billion in potential derivative losses conceded by the five largest U.S. banks last year -- including Citigroup (NYSE: C ) and Bank of America (NYSE: BAC ) -- is merely the tip of the iceberg. And I view the stress test as little more than a public relations blitz that permitted the banks to raise capital through equity offerings at elevated share prices. Of course, derivative losses will not be contained to just the banks, as even Berkshire Hathaway (NYSE: BRK-A ) shareholders can attest. To understand why gold will move higher, Fools must study the implications of this monumental house of cards.
3. The declining domestic revenue base
For the first time in 26 years, the U.S. Treasury ran a monthly deficit during the month of April, when tax revenues come pouring in. With unemployment and underemployment on the rise, and corporate earnings impaired, the Treasury faces a contracting domestic revenue stream, just as spending is going stratospheric. One might conclude that tax rates will have to rise as a consequence, but that sets up a negative feedback loop of its own. The takeaway here is that Americans have a reduced capacity to fund government spending.
4. The slippery slope of quantitative easing
Simply stated, quantitative easing occurs when a nation funds the creation of new money by purchasing debt directly from its own central bank. For nations like Zimbabwe, such policies have not ended well. The U.S. officially embarked upon quantitative easing with a plan to purchase $300 billion in Treasury securities. Given stated government spending objectives, the declining domestic revenue base, and a reduced appetite for U.S. debt abroad, the printing press may just be warming up. For major holders of U.S. debt, including China, quantitative easing is an unwelcome development, and it contributes to an emerging crisis of confidence in the world's reserve currency.
5. The longer-term dollar decline
Part II will look more closely at the dollar's reception on the world stage. For now, with the dollar smacking a four-month low against the euro, the unfortunate outlook for the greenback provides an appropriate bookmark that incorporates each of the points above.
With the balance sheet of the Federal Reserve exploding into unchartered territory, a national debt of $11.3 trillion (and climbing fast), and printing presses running hard to pump liquidity into a veritable black hole of toxic derivatives, the U.S. dollar has deteriorated quite frankly into a structurally impaired currency. Financial gurus like Warren Buffett, Nouriel Roubini, Jim Rogers, and Peter Schiff all share concerns either about the dollar, or for the consequences of inflation. Foreign central bankers have also expressed their concern. Since the dollar and gold move inversely over the long term, gold offers protection from this currency decline.
Four ways to hold gold
Physical bullion is the most straightforward vehicle for gold exposure, and the American Precious Metals Exchange (APMEX) is a reputable source, in this Fool's view. The majority of investors appear enamored of gold bullion ETFs, but I have consistently recommended the Central Fund of Canada (AMEX: CEF ) instead. High-quality gold miners like Yamana Gold (NYSE: AUY ) and Agnico-Eagle Mines (NYSE: AEM ) offer leverage to gold price appreciation, while a royalty company like Royal Gold (Nasdaq: RGLD ) incurs less operational risk. As the dollar folds, the bold hold gold.