Today's Best Bargain in Gold

It's time to get smart about gold.

Given the well-documented risks for further devaluation of the U.S. dollar going forward, I submit that some exposure to precious metals must be considered a prudent component of any well-balanced asset portfolio.

Which form that exposure takes -- whether it's a bullion instrument like SPDR Gold Shares (NYSE: GLD  ) , a single mining equity ETF like the Market Vectors Gold Miners ETF (NYSE: GDX  ) , or a more customized basket of equity holdings -- is a decision all investors must make for themselves.

Likewise, the scale of one's allocation to gold and/or silver must be tailored to an individual's own degree of confidence in the long-term upward trajectory for precious metals.

I am not here today to advocate a given formula for precious-metals exposure. My only aim is to ensure that Fools have given ample consideration to their own precious-metals exposure strategy.

I have reason to be hopeful about this, since 96% of respondents to a recent Motley Poll agreed that "Gold is money, and paper money is more impaired than ever before. Gold will continue to shine." For those intent upon scrutinizing the global macroeconomic landscape, and how it relates to the outlook for gold and silver prices, I offer the array of articles hyperlinked above and below.

The Fool community has been actively discussing gold and silver for several years running, and members are well-versed on the topic. Diverse perspectives are not only present, but celebrated. Newcomers are strongly encouraged to approach the Motley Fool CAPS community through the CAPS blogs with any questions or ideas they may have about this sector.

Where we stand today
Following an 18-month corrective phase, gold entered a new chapter in its multi-year bull market when prices finally broke through key resistance at the previous nominal high of $1,033 per ounce in early October 2009. The metal rocketed to a fresh high above $1,220 just two months later, prompting this Fool to raise some cash by parting with some shares of highfliers like IAMGOLD (NYSE: IAG  ) for a likely corrective pause. Thereafter, a counter-cyclical dollar rally triggered a reversal that so far has shaved more than 10% from both gold and silver prices, and a prompt retracement of 33% from IAMGOLD shares.

With all the attention paid to junior miners of late, Fools may be surprised to discover that the Market Vectors Gold Miners ETF has actually fallen slightly further than its junior miner counterpart since this reversal took hold on Dec. 2. A strong relative showing by junior New Gold (AMEX: NGD  ) -- amid near-certainty that the El Morro project in Chile will be fast-tracked toward production by one of two determined major miners -- has etched a powerful counterpoint to weakness among fellow juniors, like the 35% collapse in shares of one of my favorite primary silver miners: Coeur d'Alene Mines (NYSE: CDE  ) .

Although I believe that multiple mining names are resplendent with golden prospects, the mid-tier and major miners in particular have fallen sufficiently from recent heights to warrant reinvigorated buying interest. With the possibility for near-term weakness notwithstanding (if metal prices continue to slump), shares of major miner Goldcorp (NYSE: GG  ) offer superb growth prospects following a pair of pending strategic acquisitions. Fools already know my top choice for silver.

Yamana simply gleams
However, weighing the combined criteria of deep value, long-term production growth potential, and a high-quality operation with favorable ore and cost metrics, Yamana Gold (NYSE: AUY  ) takes the nod from this Fool as the best overall selection within the gold mining sector at this particular stage in the bull market.

With combined proven and probable reserves of gold, silver, and copper in the ground carrying a present market value of about $62 billion, Yamana's modest $8.19 billion enterprise value is astonishing by comparison.

Incredibly, Monday's closing share price of $10.53 was first achieved by the stock in April of 2006! Although Yamana's share count has ballooned by 283% over the intervening period, massive value was generated by a corresponding 272% increase in gold reserves alongside an 80% surge in gold prices. More amazing still, the period in question also witnessed more than a tenfold increase in annual production -- from just 112,506 ounces in 2005 to 1.2 million GEOs in 2009. As if on cue, Yamana announced a positive construction decision for the Ernesto/Pau-a-pique project Tuesday morning, as well as an optimized mine plan for the exciting Agua Rica copper/gold project in Argentina.

These shares have appreciated 169% since I proclaimed that "Yawanna Have Yamana" back in October of 2008, but still remain 47% below their all-time high. Either Yamana Gold was among the most overvalued stocks in the equity universe back in 2006, or it's a screaming value today. 

You be the judge: Vote in our Motley Poll, and share your thoughts about this struggling mining stock in the comments section below.

Fool contributor Christopher Barker's selection of Yamana Gold for his silverminer CAPS portfolio has outperformed the S&P 500 by roughly 132 percentage points since November 2008. The stock has earned four stars out of five, with more than 3,500 investors expecting further outperformance. Join the free Motley Fool CAPS community today, and share your own outlook for Yamana Gold.

Christopher Barker can be found blogging actively and acting Foolishly in the CAPS community under the user name TMFSinchiruna. He tweets. He owns shares of Coeur d'Alene Mines, IAMGOLD, New Gold, and Yamana Gold. The Motley Fool has a gilded disclosure policy.


Read/Post Comments (11) | Recommend This Article (39)

Comments from our Foolish Readers

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  • Report this Comment On January 27, 2010, at 8:09 PM, jlanganki wrote:

    What are the net present values? That's all that matters.

  • Report this Comment On January 28, 2010, at 1:14 PM, XMFkmoney wrote:

    The problem with this argument is that gold isn't tied to inflation, it's tied to fear and now speculation.

    What currency is the dollar going to be devalued relative to? So everyone starts using Euros or Yuan, how does that make gold more valuable?

    What confuses me most, is that your advice isn't even to buy gold. If you are really talking about world currency devaluation, your advice is to buy worthless pieces of paper which represent ownership in something related to gold. If we really have massive currency devalution why would those worthless pieces of paper suddenly be worth anything? What exactly are you going to cash them in for?

  • Report this Comment On January 28, 2010, at 5:28 PM, XMFSinchiruna wrote:

    XMFkmoney,

    Gold is 'tied' to nothing. Gold is no more tied to fear or speculation than it is to your shoelaces.

    The USD is the most significant of the impaired western fiat currencies due to its reserve status, and the proportion of global derivatives denominated therein places it in an extremely precarious position. The USD, the Euro, and the GBP are each structurally impaired to a severe degree, but the scale of deficit spending and the specter of fiscal largess that will be employed to combat further deleveraging places the USD on particularly unstable ground.

    As the USD devalues, gold as denominated in USD rises. As fiat currencies writ large come under increasing strain from the $600 trillion derivatives monster, then gold as denominated in all fiat currencies rises.

    I can not be certain, but my guess is that you have never considered gold as a currency. In my experience, those who grapple most with the relationship between dollar weakness and gold strength misunderstand what gold is.

    Consider Alan Greenspan's definition: "Gold still represents the ultimate form of payment in the world". Gold = money. The USD was devised as a proxy for gold, and was later divorced from gold in a grand global experiment in unbacked fiat currencies. Once Fools understand that gold in fact stands still while the paper currencies shuffle around it every which way, then they are better equipped to correctly interpret the gold market.

    You toss around a notion of mass abandonment of the world's reserve currency as if it would not be a game-changing event for the global economy. We have seen reserve currency transitions through history ... they are not smooth. That is far beyond the scope of this article, but since you brought it up ... :)

    If you understood from this article that my "advice isn't even to buy gold", then you have not dutifully explored the dozens of links that I went to great lengths to amass for the benefit of my fellow Fools, and you have misunderstood my message in a very fundamental way.

    Your final questions lead me to conclude that you have not carefully thought through the impacts of currency devaluation upon equity markets. Amid currency devaluation, equities can offer better protection than bonds because nominal share prices correct for inflationary currency movements over time.

    I am happy to answer any further questions you may still have. I get that gold is misunderstood by many, and my sincere wish is to help people understand this rather complex market more fully.

  • Report this Comment On January 29, 2010, at 2:31 PM, XMFkmoney wrote:

    "As the USD devalues, gold as denominated in USD rises."

    This is where the crux of your error lies. It's an error of fact, not reasoning.

    In theory, as the dollar becomes worth less, things should cost more. That is actually pretty true of things with value. Bread, for example, never drops in price.

    In 1980 the price of gold was over $600 an oz,

    In 2000 the price of gold was under $300 an oz.

    Over that time period a dollar in 1980 was worth 0.44 dollars. So, from 1980 through 2000 your statement of fact is simply untrue.

    Now, 1980 was a high for gold, but that's besides the point. The price of gold fluctuates while the dollar gets increasingly devalued over time. There is something else going on with gold other than some sort of relationship to the dollar.

    So, empirically the foundation of your argument isn't true. It's not even true recently. The huge rise in gold price actually corresponded to several months of deflation.

    I have absolutely thought of the value of equity markets during devaluation. Owning Gold or gold stocks isn't any better a way of protecting yourself from devaluation than owning technology stocks or energy stocks or real estate or anything but cash.

    The error in reasoning is that there is some future in which gold can again have value as a currency.

    I was giving you the benefit of the doubt in not believing there was going to be a total collapse of all world currencies. To put it more clearly, my question was, if your gold stocks suddenly go from $100 to $100,000 because all the currencies become devalued and we have to transition to something else, presumably gold, what exactly are you going to tell your broker, who is somehow still in business, when you decide it's time to cash in on your brilliance, "Write me a check"? What currency will you ask for? Will it go into a bank account? Will you just trade that stock directly for food at the grocery store?

    And, assuming you're really going down this road, if gold somehow became the a new non-governmental currency and you owned a large company pulling this cash out of the ground would you even consider honoring your stock obligations? How exactly do you plan on enforcing that contract?

    As far as I can tell, gold supporters have to hold a lot of very weird and inconsistent beliefs about what the world would look like in which gold becomes valuable.

  • Report this Comment On January 30, 2010, at 10:15 AM, Intrepid11 wrote:

    1933 - gold = $35/oz Congress demonetizes gold

    1966 - gold still under $50/oz

    1973 (I think!) - President Nixon closes the gold window; my wife and I were in Nairobi and banks and hotels refused to accept US dollars to buy local currency and gold runs up over $150., falls back, then runaway inflation in the late 70's early 80's takes gold to over $650. from where it then soars below $300. where it remains through the entire 1990 decade, touching $250. People simply forgot that gold IS the only real money because world currencies were relatively stable, despite modest inflation = devaluation of currencies. Fear has rekindled broad awareness of precious metals and particularly gold as a store of value = money. But that is only one aspect of gold, the market is another which is why the price does not vary directly with the value of the US dollar, the Euro or Sterling.

    It happens that I have in my modest personal investment account a significant holding of Coeur d'Alene Mines, a stock that I have traded both before and after the 1 for 10 reverse split; CDE has basically remade itself in the last two years, expanded its silver holdings and mining activities dramatically, finally had a positive ruling by the Supreme Court that permitted it to open its Kensington gold mine in Alaska and simultaneously improved its balance sheet by raising cash and converting large amounts of long-term debt into equity. I have now determined to make CDE a long-term holding since I believe that from here, its silver and gold holdings can only appreciate, whatever world markets and economies do. CDE's price will doubtless vary from time to time, out of synch with the price of silver. But I do not want to be caught out of the stock by external events and a market run.

    I also plan to buy gold bullion when the price seems right, probably below $1,000./oz. No interest in ETF's.

  • Report this Comment On January 31, 2010, at 11:37 AM, XMFSinchiruna wrote:

    XMFkmoney,

    I appreciate the friendly debate:

    Your interpretation of gold's performance relative to the USD relies upon a cherry-picked timeframe. Cherry-picking as your starting point the biggest price spike in modern history will of course yield your desired result. I would counter with an objectively more salient historical moment to render a test of performance in gold vis-a-vis the USD: the termination the dollar's peg to gold, and the subsequent closing of the international convertibility to gold at about $35. And this isn't exactly taking the discussion back into the stone age ... we're talking the early 1970s here.

    Additionally, your measures of dollar devaluation over time are not my measures by any means. You appear to rely upon official inflation data, which has been systematically understated through carefully massaged metrics for decades. I highly recommend a subscription to 'shadowstats' for a more reliable measure of the dollar's pitiful performance as a store of value since the abandonment of Bretton Woods.

    You claim above that no correlation exists between gold's recent strength and the dollar, which you conclude again via CPI. You are again tracking the wrong metric. Might I suggest a look at the USDX as a measure of the dollar's purchasing power vis-a-vis the world's leading currencies? Here's a chart:

    http://1.bp.blogspot.com/_tq4bCFqe0sA/Sw1XEIath9I/AAAAAAAAA6...

    Finally, we have an apparent disconnect between us in the very paradigms with which we approach the nature of currency devaluation and inflation/deflation. It may be a Keynesian / Austrian divide, but I need not delve into such semantics to make my point. I believe that many people confuse asset price deflation as an absence of inflation, but in an environment of quantitative easing and deep-seeded fiscal imbalance, you have inflation (i.e. loss of purchasing power abroad) through a ballooning money supply even as unfortunate economic conditions precipitate falling prices domestically. This is a classic definition of stagflation, and a scenario which I have discussed at length among these pages. (see my comments to Anand's article here: http://www.fool.com/investing/international/2009/04/23/is-us.... I continue to view stagflation as the most likely scenario looming for our economy, and I worry for those who are solely concerned with deflation as expressed through CPI (or even worse, through estimations of eroded wealth as somehow counteracting changes in the money supply)

    "The error in reasoning is that there is some future in which gold can again have value as a currency."

    With all due respect, your error in reasoning is in presuming that gold is not presently a currency. Gold is money. You conveniently ignored that portion of my response above in which the former darling of the Keynesians expressly confirms as much. I made no mention of a return to a gold standard or anything of the sort... I spoke only of currency devaluation .. not currency collapse, so I will respectfully leave your last paragraphs alone as lying outside the boundaries of a helpful addition to this important debate.

    So, clearly we have a wide philosophical divide between us. We employ disparate measures of inflation, we possess competing paradigms for interpreting monetary phenomena, and we are inclined to focus upon different timeframes to measure gold's historical performance as a store of value. I don't suppose we'll ever bridge that divide, which is fine ... if everybody agreed then perhaps we WOULD have a bubble. :) People must weight the arguments and decide for themselves ... the information is out there.

    "As far as I can tell, gold supporters have to hold a lot of very weird and inconsistent beliefs about what the world would look like in which gold becomes valuable."

    Back at you: :)

    As far as I can tell, gold bashers have to hold a lot of very weird and inconsistent beliefs about what the world would look like in which the U.S. dollar becomes valuable.

    Thanks again for the discussion, and Fool on!

  • Report this Comment On January 31, 2010, at 12:27 PM, topsecret10 wrote:

    In continuing the rant on the possibility of the US entering a stagflationary environment, as was hinted by Alcoa's (AA) quarterly report (see "Is My Warning of the Risks of a Stagflationary Environment Coming to Fore?"), I have decided to graphically illustrate the historically most successful inflation hedges. For those "gold bugs" who have never ran the numbers, gold offers less inflation protection than your house does. The same goes for WTI crude and probably most other categories of oil.

    The number one inflation hedge appears to be apartment buildings, followed very closely by other classes of commercial real estate, with MSCI emerging markets coming in a close second. I can assure you that the supply/demand imbalance, credit environment, fundamental and macro situations will prevent apartments (oversupply and softening rents from condo conversion competition among other things, driving up cap rates) and most CRE from taking off anytime soon. The short to medium term direction for most of that stuff is down (see CRE 2010 Overview for the 42 page white paper).

    So, if the traditional inflation hedges do not point to inflation, but input costs are going up while real assets are deflating, what do we have?

    From " Economic contractions AND rising prices, dare Reggie utter the "I" word - Enter a global phenomenon", we get:

    Stagflation is an economic situation in which inflation and economic stagnation occur simultaneously and remain unchecked for a period of time.[1] The portmanteau "stagflation" is generally attributed to British politician Iain Macleod, who coined the term in a speech to Parliament in 1965.[2][3][4] The concept is notable partly because, in postwar macroeconomic theory, inflation and recession were regarded as mutually exclusive, and also because stagflation has generally proven to be difficult and costly to eradicate once it gets started.

    Economists offer two principal explanations for why stagflation occurs. First, stagflation can result when an economy is slowed by an unfavorable supply shock, such as an increase in the price of oil in an oil importing country, which tends to raise prices at the same time that it slows the economy by making production less profitable.[5][6][7] This type of stagflation presents a policy dilemma because most actions to assist with fighting inflation worsen economic stagnation and vice versa. Second, both stagnation and inflation can result from inappropriate macroeconomic policies. For example, central banks can cause inflation by permitting excessive growth of the money supply,[8] and the government can cause stagnation by excessive regulation of goods markets and labor markets;[9] together, these factors can cause stagflation. Both types of explanations are offered in analyses of the global stagflation of the 1970s: it began with a huge rise in oil prices, but then continued as central banks used excessively stimulative monetary policy to counteract the resulting recession, causing a runaway wage-price spiral.[10]

    John Maynard Keynes wrote in The Economic Consequences of the Peace that governments printing money and using price controls were causing a combination of inflation and economic stagnation in Europe after World War I. Stagflation was also a very serious macroeconomic problem in the 1970s. In contrast to central bank responses to the oil price spike of the 1970s where similar policies were pursued on both sides of the Atlantic, the 21st century began with America going one way to fight recession and Europe going the other way to fight inflation

    http://seekingalpha.com/article/182378-deflation-inflation-o...

  • Report this Comment On January 31, 2010, at 12:48 PM, XMFSinchiruna wrote:

    topsecret10,

    Even worse than cherry-picking convenient timeframes in order to prove a point, some fail to indicate a timeframe at all, which at first glance is the problem with the analysis you pasted above. Without any chronological context, that analysis is worth about what you paid for it. :)

  • Report this Comment On January 31, 2010, at 1:01 PM, topsecret10 wrote:

    I agree.... Although I do believe that this author Is In the same camp as you are On Stagflation. " Inflation is expected to be tame. Stagflation is the threat". TS

  • Report this Comment On January 31, 2010, at 1:06 PM, topsecret10 wrote:

    Stagflation or Deflation?

    by: James Conrad September 09, 2008 | about: GLD / Those who bought shares in GLD, SLV, as well as interests in other inflation hedge investments, have been confused by recent reports which predict so-called “deflation”. Some claim that the world is “deleveraging” and this will cause the dollar to rise in relation to other currencies, and the price of virtually everything else to drop. Many of these pundits point to an alleged “drop” in the M3 money supply, in August, to support such allegations.

    In these prognostications, however, they ignore the $750 billion dollar per year U.S. current account deficit, and a combination of public and private foreign debt which now amounts to over $9 trillion U.S. dollars. Both the current account deficit and the overall foreign debt will rise now that the dollar has been increased in value in relation to other currencies. The reduction in the nation’s oil bill is a relatively small part of the current account deficit, and cannot make up the difference, as ever more financially strapped Americans buy more and more from deep discounters, like Wal-Mart (WMT) and Costco (COST), who stock their stores with cheap foreign imports. Indeed, these two were about the only retailers to see increased August sales.

    For those who believe the money supply is falling, let me show you a chart, which tracks the M3 money supply. The thick blue line is the increase in money supply in percentage terms, whereas the thinner, black line is the absolute amount of M3. As you can see, M3 has remained steady at about $13.3 billion. The only thing that turned down, in August 2008, was the percentage increase. Contrary to deflation theory, the money supply is NOT falling.

    The downward adjustment of the rate of increase is probably the result of a coordinated dollar intervention, by central banks, which has been ongoing between late July, 2008 to early September, 2008. In spite of the blip, however, the long term chart shows that U.S. dollar money supply (even before considering credit derivatives) has grown well in excess of losses from the so-called “credit crisis”. These losses will total $1 trillion, according to the IMF, but I estimate them to be closer to $2 trillion. As I will soon explain, the value of work, represented by this lost money, has been gone permanently, and cannot be replaced.

    The combination of the M3 money supply, plus all credit (including bank, consumer, commercial, and estimated real estate loans) is known as “total money”, and it is probably the most accurate way to view whether or not economic policy is inflationary or not. It is the measure of the total amount of money floating about in the economy, after fractional banking expands the basic inputs of M3. Total money has increased by what can only be described as an explosive force. Since the beginning of August, 2007, it has leapt from about $35 trillion to reach about $43 trillion dollars by the end of August, 2008, an increase of about 23% in one year. Here’s the chart:

    It bears noting that M3 must now be obtained from independent economists, like John Williams of www.shadowstats.com, and www.nowandfutures.com, because the Federal Reserve has chosen to stop publishing it. The Fed claims that it is to expensive to calculate M3, and the effort does not justify the “utility.” However, the underlying data continues to be collected and published. All they would need to do is run a spreadsheet calculation on small personal computer. Total cost = very close to $0.00, not including the incremental cost of whatever paper might be used to print it out in physical form.

    Is this huge expense too much for the Federal Reserve? Or, is there another reason they don’t want to publish the numbers anymore? Is the refusal to publish M3 yet another aspect of the Orwellian double-speak world that the powers in Washington DC and on Wall Street want to impose upon us? The Federal Reserve obviously wants to hide how much liquidity they are flooding into the market. One thing is sure. The explosion of total money will result in an explosion of inflation. It must. The relationship is mathematical. Double-speak cannot change the laws of physics.

    As discussed in my prior article, The Great Dollar Pump of 2008: A Doomed Central Bank Intervention, the U.S. government sold 6 billion euros from the emergency exchange rate stabilization fund [ESF]. The proceeds from this sale must have been used to buy approximately $1 trillion worth of derivatives. Essentially, the $6 billion will be used to “pay interest” on this huge derivative position, so as to take dollars temporarily out of those that are circulating. This has temporarily pumped the value of the dollar, and reduced the value of commodities because they are denominated in dollars.

    The ECB and the Bank of Japan, no doubt, have contributed to this effort, and, in all, several trillion dollars were probably taken out of circulation. The hope is that a few months of upward momentum will alter public perception and break the back of anti-dollar, pro-gold, pro-everything-but-the dollar, sentiment. The idea is to have a steady but slow dollar devaluation, not the kind of rout that was taking place in early July, 2008.

    Henry Paulson, no doubt, planned carefully for the socialization of Fannie (FNM) and Freddie (FRE), months ago. The event was well organized, and he was clearly not caught off-guard by a finding by the Morgan Stanley team that the two GSEs were misstating their capital reserves.

    Dollar intervention has been carefully timed to neutralize the socialization event, first by pumping up the dollar beforehand, and, later, by countering the hordes of people who were selling the dollar in the morning of September 7, 2008. That is why we saw the dollar collapse, temporarily, in the early morning trading, on Monday, and, then, subsequently, rebound to a strong positive showing, as New York currency trading got under way. Without this intervention, the dollar index would have collapsed to about 60 by Monday, September 7, 2008, and negative feelings about the dollar would have become so entrenched that no amount of intervention might have been able to offset it.

    The dollar manipulation has been painful to many innocent investors, but it has managed, yet again, to put off the day of reckoning. The temporary refusal of trends will allow favored institutions, and friends of those in power, to exit dollar and other paper money denominated assets, and buy hard assets at a cheap price. In 2005, another temporary intervention propped up the dollar and slowed its long term decline. The effect lasted less than a year. But, back then, the credit crisis was not yet perceived by market players.

    Now, people are well aware of the irresponsible actions of our government in concert with Wall Street. The effect of the latest dollar manipulation, therefore, will be much shorter. Active intervention must end very soon, because, if central banks continue to restrain the U.S. dollar money supply, much past the end of August/beginning of September, they will tip the balance, and throw the world into a new Great Depression. Bernanke’s writings make it clear that they are keenly aware of that.

    It is important to understand certain basic economic principles before we can understand what is happening. We must first abandon abstraction, and look carefully at each thing, so that we can see it for what it really is. By tossing the jargon and the code words, we will be able to tune into reality, past the loud din of market chatter.

    First of all, the strength of all economies are based upon the amount and efficiency of the productive work done. That is the key to economics. “Work” is any productive activity by individuals or groups of people, who perform useful tasks that benefit society in some way. “Money” is the credit people get for that work. It is a form of “stored work”. It can be used to compel other work, from other people, in the future, to pay you back for the work you did, in the past. The work I do today will provide credits with which I can buy someone else’s work, tomorrow.

    Anything that serves as a storage medium for work value is money. Historically, the most common money has been gold and silver. In some societies, however, money took the form of pearls, or even seashells. In modern times, money has mostly consisted of little slips of paper which we call “currency”. The slips of paper derive their value from the ability of the governments that issue them to compel work in exchange for the paper. This is the concept of backing paper money with the promise of the “full faith and credit” of the government.

    The value of paper money is dependent on whether or not people trust that the government can compel people to do work in the future, in exchange for the particular pieces of paper that the particular government chooses to print. Paper money is, therefore, called “fiat” money because its value arises out of the fiat power of the government. The government says it has value, and, therefore, it does. The value of things like seashells, pearls, gold and silver, in contrast, is derived not from government fiat, but, rather, from the desire of people to possess rare or beautiful items.

    “Debt” is created when someone with more stored work-value (money) than he needs, lends it to someone who has less than he needs. In exchange, the person with less money pledges to pay back the loan with his future work. Future work is eventually converted into stored work (money), and is paid back to the lender. Borrowers take loans from lenders because they want to obtain something of value to them. The thing of value, however, does not have equal value to all people. It will almost always be much more valuable to the borrower than to the lender.

    Take a house, for example. The bank can’t live in a house, so its value is far higher to the borrower than to the bank. That’s essentially why banks lose money when they foreclose on houses. Banks must do work to get rid of the borrower, and, then, later, to find someone else for whom the house has value. Since work is money, banks lose money on foreclosures.

    Now, because so many people bought houses with a promise to pay back more work than they can really do, the banks are forced to lose stored work (money) by taking back a lot of houses. New borrowers, having seen what happened to the first borrower, don’t want to promise more work than they can really do. So, they tend to make lower offers. In addition, because so many houses are becoming available at the same time, each one has become less rare and, therefore, less valuable to a potential new buyer.

    In short, when a borrower takes more debt than he can afford, it really means that the borrower’s future work is not valuable enough to pay off what has been lent to him. Conversely, when a lender gives money to a borrower, and the borrower defaults, it means that the lender will lose the value of some of stored work (money) it has lent out.

    That is what is happening now, in the so-called “credit crisis.” Banks made a lot of stupid loans, and borrowers cannot afford to pay them back. A lot of fraud occurred at the same time, with Wall Street telling everyone that the borrowers were more capable people than they really are. Investors paid for mortgage-backed bonds with stored work (money).

    But, huge inefficiencies in work allocation have occurred. Fools and corrupt people, running the financial system, have transferred trillions of dollars worth of previously stored work, to people whose labor is of insufficient value to return it. In the process, bankers were busy skimming money (stored work), in the form of outsized salaries, bonuses and stock options. In short, the stored work of society, which came from a host of hard working honest decent people, was consumed by a combination of manipulative high living Wall Street executives who frittered it away on extravagant living, and average Joe’s who just aren’t willing or able to generate the quality or quantity of work needed to pay their debts.

    The government can try to replace the physical units of work storage by printing new money. But, printing units of storage (dollars) doesn’t replace the lost work. New money can be used to store new work, but if the government prints it fast, as it has been doing, a big increase in the money supply means that the remaining amount of previously stored work will be worth that much less. Excess money supply growth means that each unit of work will be represented by a larger number of money units. Thus, each unit of money will be worth less. This creates inflation, because less work is chasing after the same amount of goods and services.

    A lot of society’s work effort, over a term of years, has been lost through corruption and economic inefficiency. It will never return. You cannot replace it simply by printing money, which are simply storage units and not work itself. Instead, in order for the economy to recover, society must accept the losses, prosecute the guilty, and start working harder to create full, rather than inflated, new units of stored value.

    The only way to motivate people to recover from a downturn like the one we are now in, is to be honest with them, which is the opposite of the tactics that are being taken by Congress and the Bush Administration. Ben Bernanke, the FMOC, Hank Paulson, and the U.S. Treasury have not taken the honest route. Instead, they have decided to print more money, in the hope that the complexity of the economy will confuse the majority of people. The hope is that by manipulation of the value of the dollar, in relation to other paper money, with the help of other central banks around the world, everyone will be so confused that they will, somehow, not realize that a lot of value has now been stolen from the system, and will never be returned.

    Let’s take a look at a chart showing the link between the money supply and inflation from as early as 1910 to the present. As the money supply increases, real inflation increases with it. Real inflation is represented by the dark black line, which is the true consumer price index, reported by John Williams of www.shadowstats.com, after removal of the hedonic and geometric lies that the government now inserts into the numbers. John Williams recalculates CPI, using the government’s pre-1982 formula. This harmonizes all the numbers, and corrects the current government numbers, back to a time before it began lying about inflation. The relationship between higher money supply and higher inflation will never change, regardless of falsifying the numbers to make it seem that way.

    The U.S. Treasury is now pledging to print $200 billion dollars to bail out Freddie Mac and Fannie Mae. This alone will increase the money supply exponentially, when it is multiplied through the miracle of fractional banking. William Poole, former President of one of the regional Federal Reserve Banks, who was critical of Freddie & Fannie for many years, and resoundingly ignored, says that it will cost a minimum of $300 billion to bail them out.

    That calculation is conservative. I estimate that the total loss will be closer to $600 billion, or 10%. Independent analyst, Chris Whalen, at Institutional Risk Analytics, estimates that the FDIC will eventually pay out $500 billion in replacing deposits lost at hundreds of failing banks.

    The Federal Reserve has converted some $450 billion worth of highly default prone mortgage paper into cash by compromising and polluting its own balance sheet. Congress has given away $150 billion in a so-called “stimulus plan” for its constituents, and Barney Frank and other Democrats are pushing for another cash giveaway. When all these giveaways are multiplied by the fractional nature of our banking system, the M3 money supply increases exponentially. And, the process is continuing.

    Ben Bernanke fancies himself a student of the Great Depression of the 1930s. He has spent most of his academic life studying it, writing papers about it, and talking about it. In a 2002 speech, given on the 90th birthday of famous economist, Milton Friedman, for example, Bernanke stated:

    Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve System. I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again.

    He continued that speech by quoting from a statement by Milton Friedman, made many years before. Friedman has stated that it is theoretically impossible to have deflation in a fiat money based economy. So long as the government has a printing press, and enough helicopters, free money can be dropped from the sky and that would prevent deflation. Bernanke would eventually live to regret repeating that statement because it gave him his pet name, “Helicopter Ben”, and this name has stuck to him, like glue, ever since.

    The last time America saw real deflation, was at the time of the Great Depression. In the old days, of course, we were not supposed to have had a fiat money system. Supposedly, the value of the dollar was based upon the value of gold. People said, in those days that “the dollar is good as gold”, because the government was legally liable to trade each dollar, for the sum of 1/20th of an ounce of pure gold.

    But, the gold standard was a lie. The dollar was never really tied to gold. This big lie would come back to haunt us, as the cause of the Great Depression. Lying, stealing and speaking falsely causes lack of confidence in the system, and confidence, or lack thereof, is the ultimate cause of booms, busts, recessions and depressions.

    In spite of the alleged gold standard, during the 1920s, the government printing press began to go wild. They started printing far more paper dollars than could be redeemed in gold. As you can see, in the charts above, inflation resulted. The price of houses and stocks boomed. But, the out-of-control inflation that we fear today didn’t start until 1933. In 1933, each U.S. dollar was still worth 40 of today’s dollars, because that is approximately what 1/20th of an ounce of gold costs today. Since 1933, however, when President Franklin Roosevelt ended the convertibility of U.S. dollars to gold, and forcibly confiscated private gold held by U.S. citizens, the dollar has depreciated by 40 times, and inflation has increased by a similar amount.

    Debt levels in the 1920s were helped along by the U.S. Treasury and Federal Reserve, who expanded the U.S. money supply at the surging of Wall Street interests who wanted the stock market to surge, much like today. Eventually, the party ended, however, as it always does. The Federal Reserve had been created in 1913 to prevent panics. Yet, on October 29, 1929, now known as “Black Tuesday”, the worst panic in history happened. The stock market crashed back down to earth.

    It didn’t all happen on one day, of course. The stock market made a huge temporary recovery, and people actually spent more money in the first half of 1930, than they had in the first half of 1929. But, by the second half of 1930, things began deteriorating again. Consumers tried to keep up their payments on debts accumulated in the 1920s, and they stopped spending. To make matters worse, a severe drought took hold in the agricultural heartland, now known as the “dustbowl days”. It took fully 3 years of deterioration, from 1929 to 1933, for the Great Depression to gain its stranglehold on America.

    Many people, including Ben Bernanke, have speculated as to what caused the Great Depression. Nobody knows the answer. Our Fed Chairman believes that the U.S. money supply was not “elastic enough.” He thinks the crash was caused by debt-deflation and constraints, imposed partly by the gold standard, on the ability to expand the M2 money supply. He believes that reliance on cheap credit in the 1920s fueled short term growth, but that huge numbers of businesses and people were thrown into default when the money supply contracted and price deflation happened.

    In fact, consumers and businesses drastically cut spending to keep up debt payments, and this reduced demand for new goods. Manufacturers stopped hiring workers and fired them instead. Unemployment grew until it reached 25%. Depositors worried about the safety of their bank deposits, and began withdrawing money en masse. There was a generalized bank run, and banks began to collapse. A huge number of people tried to convert their dollars to gold, but, because the Federal Reserve had allowed the money supply to grow far in excess of what could be redeemed, back in the 1920s, it was forced to allow the money supply to shrink by 1/3 between 1930 and 1933, as people redeemed their paper dollars for gold.

    Bernanke believes that if sufficient “liquidity” had been supplied, in the form of emergency lending to key banks, bond buying on the open market, and so on, the depression might have been averted. Aside from being tight friends with many executives at the big banks, that is why the FMOC has sent a flood of cash from taxpayer’s pockets to the coffers of America’s big banks.

    Deflation is impossible under a Bernanke-led Federal Reserve. Things are very different now than they were back in the 1930s. Money expanding policies are in full swing. Depositors are not worried about losing their money in banks. Even as I write this, many are taking CDs at what they see as “good” rates, from banks close to failure, like Washington Mutual (WM), Wachovia (WB), Key Bank (KEY) and others.

    Depositors believe in the FDIC insurance fund. People are not converting dollars to gold. They can’t. The government admits its dollars are backed by nothing but empty promises. We make no pretense to being on a gold standard. When a bank goes under, the dollars on deposit are immediately replaced. Replacement dollars will be printed if needed. The new dollars will look exactly the same on electronic spreadsheets, though they will now be worth far less, because the stored work that backed the ones that have been lost, has been frittered away. With each new dollar printed, the dollar loses rareness. There will be more dollars chasing after the same amount of goods, and services. That is the essence of inflation, not deflation.

    Contrary to popular fancy of those who say the U.S. government is rock-solid, the United States of America went bankrupt in 1933. It didn’t walk into a courtroom, and ask a judge for mercy, like individuals do, when they file bankruptcy. But, it declared bankruptcy nonetheless. It defaulted on its most basic promise to the American people and the world. It failed to make good on its legal obligation to convert dollars to gold.

    Instead, in 1933, President Roosevelt outlawed private ownership of gold, and forcibly confiscated all gold held by private citizens. This was the ultimate treachery of a deadbeat debtor. It was the act of a totalitarian dictatorship, not a democracy. But, by the time it happened, the government was bankrupt. It could not convert dollars to gold. There just wasn’t enough gold. The entire “gold standard” was all a big lie. By 1934, the dollar had depreciated by government fiat, by 75% in relation to gold. Because our dollars are no longer backed by any gold at all, they will now depreciate by much more, as the money supply keeps rising.

    When it became clear that the gold standard was a big lie, confidence was destroyed. That is what caused the Great Depression. Ben Bernanke simply doesn’t get it. Instead, he’s got it backwards. Economic downturn is not created by mathematical fluctuations in money supply. Economic booms and busts are a function of human emotion. When people were lied to, repeatedly, and they see their stored work, in the form of money (which was gold) stolen from them, they lost faith in the government, and in the economy. They became depressed, and rightfully so.

    The Wall Street bankers, who siphoned off money in the 1920s, and urged the Treasury to print more dollars than could be redeemed for the promised gold, caused the Great Depression. This same type of greed filled person is also the cause of our current problem. Wall Street bankers, such as Henry Paulson, should have no place within the halls of government.

    Distrust toward society, government and banks, and, yes, even bank’s distrust of one another, arises from lack of confidence which, in turn, arises out of repeated lies. If the money supply, back in the 1920s, had been composed purely of gold dollar coins, in different denominations, each dollar being equal to 1/20th of an ounce of gold, as promised, we would never have had a Great Depression. Instead, we would have seen a mild recession, with people pulling back for a while. People would have hoarded their little golden coins, for a while, and, then, after feeling a bit better about things, they would have started spending them again.

    The government no longer maintains a pretense that each dollar is equal to gold. That makes it very easy to pump up the money supply. The powers that be, in our modern world, think the same as their counterparts thought, back in the 1920s. They think that by lying to us, they can change the course of economic history. It is not true. Lies breed resentment and fear, and, no matter how carefully the lies are concealed, eventually people learn the truth.

    Bailouts for billionaires and socialism for the rich are not policies that inspire confidence. Instead of feeding capital to productive business, the new dollars of our exploding money supply are supporting incompetence. Inefficient use of capital does not save an economy from collapse. Flooding an economy with money, when there is no sentiment to use it productively, simply reduces the value of the units of money, creates irrational demand, and induces massive inflation.

    The best longer term investments in this environment will function as a hedge against inflation, so long as they are not subject to the inefficiencies that are being inserted into economy. Therefore, the stock market is a bad bet.

    Gold, agricultural land and food products are good bets. Food products are usually perishable, however, and highly volatile. In ancient times, gold was the most stable of all things. But, now precious metals are highly volatile, in the short and even medium term, because of repeated government interventions and staged manipulations on the futures markets. This volatility will be minimal, however, over a longer term of 3-6 years, and the price should rise sharply.

    Agricultural land is less manipulated, and less volatile, and repeatedly produces harvests without regard to temporary price increases or decreases of perishable commodities. But, land is already very expensive in most countries in which political risk is low.

  • Report this Comment On November 05, 2010, at 9:19 AM, Maksani wrote:

    A very academic discussion...good thing I didnt waste my time and money on a college degree. Looking at the price of Yamana Gold stock in Nov..several months after the January article, I would have to conclude that Christopher Baker lost the argument documented above.

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