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Gold isn’t an investment, gold is money.  If gold goes up 100% or 150% you really aren’t ahead, but you can keep up with rising prices.

That’s the general perception of gold.  But, as in all things, there is an exception to the rule.  I’m going to tell you a story now, one that will show you how to take advantage of gold’s rise in a way far more beneficial than merely “treading water.”

In late 2004, we finished paying off our mortgage on our home in St. Louis Park.  This was the first time in our 40-year marriage that we had no debt.  We bought a bottle of Champaign to celebrate.  No more house payments!  This was great.

However, we were also very close to building a new house.  Just a few months after being debt-free, I took out a million dollar plus loan to start construction on a new house in Deephaven.  From no debt to over a million dollars in debt just like that.  This was a real shock for Susan.  She read Richard Russell every day and had a great deal of confidence in what he had to say – and Russell was saying the thing to do was eliminate all debt.  How could we justify this?  We had enough assets (primarily gold and silver, but for the sake of this discussion let’s just say it was all gold) that could be sold and the proceeds used to pay cash for the new house.  Why not follow Russell’s advice, sell the gold, pay cash for the house and have no debt?  That is the question I had to wrestle with.

At the time, gold was $500 an ounce.  I would have to sell 2000 ounces of my gold in order to buy the house without a mortgage.  But my belief in gold and confidence that the bull market had a LONG way to go convinced me that it was foolish to sell the gold at that time and that the debt wasn’t a bad thing (sorry Russell).

Let’s fast-forward to this summer and “assume” gold is $2,000 an ounce.  That number makes the math easier.  This summer I sell 500 ounces of gold and pay up the mortgage – not 2000 ounces that was required in the fall of 2005.  Since I have a 10-year, fixed-rate, interest-only loan, I will have to pay it up or re-finance it in the fall of 2015.  Sinclair’s target for gold by then is at least $3,500.  If I hold off until the note comes due, I should be able to pay up the loan with less than 300 ounces of gold, leaving me with a PROFIT of 1,700 ounces.

Yes, there was a monthly mortgage payment (all interest) that cost me $840,000 over the 10-years, but I was also able to write most of it off on my taxes.  And of course there will be a 28% tax on the gain when I sell the gold, but all in all, I was far better off holding onto the gold for a decade, paying the interest on the loan and the taxes on gold’s gain.  If it takes 300 ounces to pay off the loan, factoring in the 28% tax, I have to sell around 400 ounces to also cover the taxes.  The 1600 free ounces times $3,500 is worth $5,600,000.  Now that’s a pretty hefty profit that was generated by using the bank’s money to finance our home.

I would say that I did just a bit better with the gold than treading water.  But didn’t I start this discussion saying that gold was just supposed to keep me even with rising prices?  Yes I did, or more accurately that’s what Richard Russell said.  The exception to the statement is using low interest debt to lock in a price (in this case, of my home) and then pay it up with cheap dollars that you accumulate as gold rises.  Now’s a good time to take another look at Russell’s chart, that I showed you in Monday’s newsletter.

1974 to —

2001 — 50.8%

2002 — 24.8%

2003 — 19.5%

2004 — 5.35%

2005 — 17.77%

2006 — 18.36%

2007 — 32.34%

2008 — 5.14%

2009 — 24.3%

2010 — 29.8%

2011 — 14.2%

2012 — 9.6%

Do you see those percentages up there in that column? Do you know what they mean? They represent the year after year loss of purchasing power in Federal Reserve notes (“dollars”) in terms of gold. You may not have noticed the loss of purchasing power in the dollars that you earn and own, because the annual loss has been subtle and gradual. The above are official figures. Actually, I remember buying one-ounce gold coins in 1974 for $70 a piece. Based on that price, that’s a multiple for gold of 23.9 from 1974 to the present.
– Richard Russell, The Dow Theory Letters, January 7 2013

According to Russell’s figures, since 2005 the dollar has lost over 150% in purchasing power.  Put another way, the million-dollar home was purchased for $400,000.  But how do you buy a million dollar home for $400,000?  You do it like I did it.  You use the bank’s money instead of selling your gold, and then, down the road, you sell the gold and pay up the house with “cheap devalued dollars.”

That’s how I did better than merely staying even.  The cost of the house, the bank loan, stays constant.  Gold rises (because we are in a bull market, the rise is far greater than usual).  The “profit,” pays for the house.  This “profit” is represented by Russell’s chart.  Actually, my gold rose from $500 to the current price of $1,650, which is a rise of 330%, not the 150% Russell’s chart implies.  I guess that’s the “compounding” effect – the extra double is a result of compounding each years gain on top of the previous gains, for nearly a decade.

The moral of this story is that if you use the bank’s money now, and hold onto your gold, you will come out way ahead.  You still have to make the monthly mortgage payment, but each year, as inflation eats away at the dollar, that monthly payment is easier to make than the year before.  The payment is fixed, it stays the same.  I earn more every year, and the gold goes up more every year, but the pay-off number stays the same.  I’m sure glad I didn’t listen to Russell and pay cash for our Deephaven home.  I’ll deal with that in the fall of 2015.

Oh yeah, Russell also pointed out that he bought one-ounce gold coins in 1974 for $70 a piece.  That’s a multiple of 23.9 from 1974 to the present.  In 1974 I sold a mint 1902 Luger Carbine with matching stock for $1,500.  Six weeks ago one just like it sold for $51,750 at the Rock Island Auction.  That’s a multiple of 34.5 from 1974 to the present.  This is a fair example that shows over a longer timeframe, gold does indeed hold onto its purchasing power.

Pictured below is a cased 1902 Luger Carbine with stock and accessories that will be in the next Rock Island Auction this May.  Note the “American Eagle Crest” on the chamber.  This one was meant specifically for sale in the U.S.  It will take more than $51,750 to buy it.  But doesn’t it “look nicer” than a pile of 30 Gold Eagles?

The model 1902 Luger Carbine was a variation of the 4 ¾” Model 1900 Luger. It has an 11 ¾” barrel, adjustable sight up to 300 meters, a European walnut wooden forend and attachable matching shoulder stock.  This turned the Luger into a rifle/carbine.  The story goes that Georg Luger made it especially for Kaiser Wilhelm who loved to hunt deer on his estate, but had a crippled arm and a regular rifle was difficult for him to hunt with.  The factory made 2,500 of this model and they were sold all over the world.  It is usually the “center piece” in any high quality Luger collection.

Very high quality and rare collectables, like the Luger pictured above, do hold their value over time – like gold does.  But you have to own “the best.”  The same can be said for ocean front real estate in desirable locations.  If you store a chunk of your wealth in things, instead of dollars, you will avoid much of the stress of future inflation.  Gold is more liquid than the Luger Carbine or real estate.  That is one of its greatest benefits.  Gold is money (really it is – the BIS recently gave gold the same Cass 1 status as dollars and will now be a favored bank reserve).

This lovely gun is a reminder to me just how much buying power the dollar loses over time.  As the saying goes, it’s easier to make money than to keep it.  True – unless you “keep it” in gold or silver coins, high quality real estate or top-notch collectables.  All of them will hold value over time.