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Palladium is back over $800, silver is just below $30 and gold is moving in on $1,400 again.  With a close above $30 and $1,400 I think we can say this latest down draft is over.  A few more days – maybe by next week?  We’re close now.

Although I would usually publish this Email in the Mail Bag section, I think it is important enough to merit comment in the opening of the daily.

Dear Mr. Schectman,

I read you everyday…I have been accumulating  gold and silver bullion for 3 years now, and hold approximately 20% of investable assets in bullion and 10% in mining stocks.

Then I read something like this (Green is a well regarded Guy) and start to have tiny little doubts.

Could you to you tell your readers why you think Green is so very wrong?

Sometimes I feel like I should just stop listening to CNBC, or reading Fortune, Barrons,etc….they just don’t get it….or they don’t want us to get it. Right?

Any comments on this would be greatly appreciated.

Thank you Sir.
Warmest regards,”
Jeff K

Jeff is referring to the following article: My comments are inserted in red

But gold has more than tripled in the past five years and quintupled over the past 10 years. Gold bugs say it will go much higher, but there are good reasons to be skeptical…

The Runaway Gold Train

Gold is a wonderful hedge against inflation and economic calamity. And since we recently experienced a full-blown financial crisis, it’s natural that gold prices spiked. Actually, gold performs better in deflation than in inflation when it takes on the roll of an asset that can’t default.  I have written about this before.

But why is it still climbing? Things are getting better, not worse. The risk of a catastrophic meltdown has lessened considerably over the past year and a half. True, but that is the same position that my friend “Dr. J” took in yesterday’s daily.  Better does not mean good, it simply means not as bad and from the depths we are coming from, we have a long, long way to go.

And inflation? The CPI has dropped from 2.7% at the end of 2009 to 1.2% at the end of 2010. Inflation is not a near-term threat.
Doesn’t Mr. Green read John Williams?  Inflation is NOT 1.2%, it’s more like 8%.  And let us not forget, the real definition of “inflation” is NOT the rise in the CPI, it is an increase in the money supply, which is shown in the second graph of the Fed’s MZM.

“Expect that to change,” the gold bulls insist. They predict that higher inflation is just ahead because commodity prices are rising, the Fed is printing money and Congress is spreading it around with a fire hose. And why not?  The Fed IS printing money and Congress IS spending it.

But there are significant disinflationary forces at work right now, too…

The Factors That Could Stall Gold’s Price Rise

1.      The real estate meltdown, which is far from over: Most Americans’ biggest asset is their home and as values continue to slide, it will make homeowners even more reluctant to spend.

2.    High Unemployment: Traditionally, inflation moves higher during periods of higher wages and benefits. But with one in 10 workers on the sidelines, that’s not a significant threat. The real inflationary threat comes from what Jim Sinclair refers to as “cost push inflation.”  The debasement of the dollar is leading the way to higher prices, not the “pull” from increased demand.  Notice the “push” versus “pull” catalyst here.  Mr. Green has this wrong.

3.    The Fed: Despite how often you’ve heard it, the Fed is not “printing money.” This is a myth. The amount of currency in circulation isn’t changing. The money supply hasn’t changed in any significant way. The Fed is buying Treasury securities to lower long-term interest rates and stimulate the economy. I believe this policy is unwise and unnecessary, but it hasn’t proved inflationary – and it could be revoked at any time. Yes, the Fed is buying Treasuries, but they are creating the money used to purchase them and the money is then injected into the economy by the Treasury.  It is “borrowed” into existence.  That number is expected to reach $1.5 trillion in 2011 and it will be used to help balance the budget.  Once again, this will weaken the dollar which is very inflationary since it will lead to higher prices on our imports.  Hasn’t Mr. Green noticed the record highs reached in the Commodity Index and oil over $90 a barrel?

4.    Gold Price Projections: The way that some gold bulls forecast future prices is ridiculous. Under the best of circumstances, gold is tough to value. It doesn’t pay interest like bonds. It has no earnings or dividends like stocks. It can’t house you or provide rental income like real estate. So how do you project where gold should be trading? Let the market value gold.  It is shouting, loud and clear, that gold is worth more in every currency.  Gold has become the currency upon which all others are now measured.  Why not ask “how does one value the dollar?”  The dollar is backed by nothing but (Treasury) debt.  Yes, it may be difficult to value gold but the trend is crystal clear and has been for the past 10 years – it takes more dollars to buy gold because the dollar is losing value, gold isn’t rising.

That’s the $6 million-dollar question…

The Problem With Predicting the Price of Gold

For example, I hear bulls talking about record deficits and the problems in the eurozone and so forth. Indeed, these are serious issues. But they may prove deflationary instead of inflationary. How the heck does it tell you what the price of gold should be? It tells you a lot – because governments are debasing their currencies (creating more and more) in order to fight the deflation.  Once again, Mr. Green ignores the effect of the watering down of currencies which is what is pushing up the price of gold in all the major currencies.

If gold were currently trading at $3,000 an ounce and these same problems existed, would that mean gold should be trading at $4,000, or $5,000, or $10,000? Who can say? After all, the world’s economic problems are no secret and the markets have had plenty of time to absorb the news. Yes, it could be trading at $4,000 or $5,000 or $10,000.  Yes, gold and the Dow could also trade at 1 to 1 again, as they did in 1980 and 1930.  Why is it important to know what the high will be?  It will be what it will be and it WILL BE HIGHER.

Some analysts point out that gold was trading for $850 an ounce in 1980 and if you just adjust for inflation, the price should be around $2,300 today. But that’s just guesswork gussied up with charts.
That’s not guesswork.  It is common practice in any market to use an inflation-adjusted high, from the previous all-time high, as a “guide” to where gold should be.  We do it with commodities, oil and other items all the time.

Gold has often underperformed inflation for decades, as it did between 1980 and 2000 when it rather spectacularly lost 70% of its value. How can you be sure that won’t happen again?
Gold’s bull market of the 70s ran into a brick wall BECAUSE Volcker raised interest rates to 20.5% (Prime) and the high rates being offered, above the rate of inflation, made gold less desirable to hold.  Now, interest rates are scraping zero, well below the rate of inflation which makes gold very desirable.  2000 was the peak of the stock market bubble which was about to come tumbling down.  Owning gold then was off the radar screen of most investors, because they were waiting on Dow 30,000.  Since 2000, gold has outperformed the Dow by a factor of nearly five.  So, neither the high interest rates of 1980 nor the lure of a bull market in stocks exists today.

I’m not saying it will happen. But I am saying that – while the next move in a bubble is anyone’s guess – looking back five or 10 years from now, this is likely to be viewed as yet another investment mania. (Bear in mind that in 2005, investors made up 16% of the demand for gold. Today, it’s more than 40%.) At some point, gold probably will be in a bubble, but it is not now.  The real bubble is the US Bond market.  When interest rates can’t go down (they are at zero now) then they can ONLY GO UP and when they do, the bond market will collapse. Even bond maven, Bill Gross (PIMC) acknowledges this fact.   Also, if you wish to give Jim Sinclair some credit here, he maintains that when gold hits a peak this time, it WON’T FALL AS IT DID IN 1980, but the price will be locked in and gold will be used as part of a new world reserve currency at that high price.

If you pile into the barbarous relic at these prices, you may get the same shellacking that Internet investors and real estate speculators got a few years ago.Barbarous relic, indeed!  Mr. Green is sounding like a Keynesian. This “Barbarous relic” has managed to rise from $20 an ounce to nearly $1,400 an ounce.  Gold is still holding its value rather well. History will regard the “Dollar” as the curiosity or relic.  It will fail, as have all other paper currencies have.  It has already lost over 95% of its value in the last 90 years.

My advice? Keep 5% to 10% of your portfolio in high-quality gold shares as a hedge against inflation and potential economic calamity. That’s better than nothing, but I say it is too low.  Shares are more than a hedge against inflation.  Most of the high quality shares are up hundreds of percent while the Dow and S&P are going nowhere.  They have been a fantastic investment and the gold (and its little sister, silver) has been the best performing asset class for over a decade and running.  Commodity bull markets generally last for around 20 years.  This one is young and has years left to go.

But if you own gold purely for speculative purposes, do yourself a favor: Take profits now. Gold (physical) is a core holding, and not for speculation.  It should be bought, set aside and not sold.  Not if gold is rising or if gold is falling.  It is your financial insurance. You don’t sell your insurance.

This article should not cause my readers any anxiety.  It is exactly what one would expect to come from Wall Street’s paper bulls and gold bears.  There is nothing in this article that you should be worried about and the arguments it presents are old and stale.

David Schectman
Miles Franklin