Gold & Silver: How High & Why? -- A Lesson in Real World Economics 101, by Al Martin

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by Al Martin

Gold & Silver: How High & Why? -- A Lesson in Real World Economics 101

(9-20-10) Bloomberg reported that "Gold climbed to a record for the third time this week as investors stepped up demand for a haven from financial turmoil." (Sep. 17, 2010) So why has Gold become the safe haven of choice for investors who have become disenchanted with the stock market and the empty pronouncements by public officials, i.e., no Obama peaches 'n cream trucks on the horizon?

There has been an enormous increase in what's called "retail demand" (public demand) for Gold, or what is called "dumb money" demand in the industry -- people who are buying it simply because it's going higher.

Bloomberg reports, “All the debt and deficits are so high, the only perceived way out of this mess is a global synchronized devaluation of all fiat currencies,” said Michael Pento, a vice president at Euro Pacific Capital Inc. in New York." This is true.

But Pento also says, “Gold is replacing the dollar as the world’s reserve currency.” This, however, is not true, since Gold is not going to become a reserve currency. Gold is, however, going to become a benchmark that global currencies now become priced in.

A "benchmark" refers to this -- how many Dollars, how many Euros or how many Pounds Sterling does it take to buy an ounce of Gold? The fraction is now being reversed. As a matter of fact, you now see some investment banking houses will quote cross-rates between the Dollar, Euro and Pound, etc. and Gold. This is expressed in a fraction.

This in itself is a major shift in thinking, and it has taken place because Gold is now being looked at as the ultimate benchmark to price other currencies. Since Gold is the "ultimate currency," it thus becomes the ultimate benchmark into which paper currencies are now going to be priced.

So has Gold been decoupled from its usual role as an industrial metal? The role of Gold is changing. Even though Gold's principal "usage" and "demand" is still industrial and commercial, it has taken on a new financial role that it didn't have before -- as a benchmark for which other currencies and other assets will be priced. Why? Because Gold is now considered to be the planet's sole fixed benchmark asset into which all other commodities, fiat currencies and other non fixed assets can be priced.

This is the change and preparation for economic collapse. Asset classes which had previously been considered to be a fixed asset class, like real estate, securities, and government bonds are no longer considered to be "fixed" assets. The one exception is US Treasury Bonds.

According to Bloomberg, Egon von Greyerz, a managing partner at Matterhorn Asset Management says that the price of Gold may climb as high as $10,000 an ounce. On the other hand George Soros told Reuters that Gold has become “the ultimate bubble”-- even though he's buying it as well.

When you look at the price rise in Gold, it would appear to be in "bubblicious" territory. It could pull back at any time, since it's technically over-extended and it is due for some sort of a rest because the change in thinking necessary to support Gold prices is not yet universal. There are still many George Soroses in the world who look at Gold as simply another commodity. If you look at Gold simply as another traded commodity (which in the last analysis, it still is) it is overbought on a short-term basis. That is definitely true. You cannot say that the Dollar has depreciated anywhere near enough to support the current Gold price. The Soroses of the world that point that out are correct.

However Gold is in a transition, so these Wanton Bullish Shills who predict astronomical prices for Gold are simply using assumptions that are not yet valid.

The Bloomberg piece also claims that "Gold is still far below its inflation-adjusted high after a record rally, and at least one indicator suggests the precious metal won’t approach that peak any time soon…Gold would have to rise above $2,435 an ounce to exceed its high from three decades ago, based on the CPI’s current reading."

Gold Shills always like to point out the so-called "inflation adjusted value" of Gold. The problem is that the "inflation adjusted value" of anything assumes a constant supply in terms of how much of the stuff is coming out of the ground (new mine supply) and how much existed at any time vs. demand. The Shills' favorite line is referring to "inflation adjusted" since 1980. The problem is that total Gold production on the planet now is 4 times as high as it was in 1980 -- on an annualized basis.

In other words, in 1980, the planet's total production of Gold was 1640 metric tons. In 2010, the planet's total production of Gold will be approximately 5640 metric tons.

The safe haven psychology and the "fear bid" governing the price of Gold is overshadowing all other considerations. The "fear bid" tends to overshadow everything else because it creates a knee-jerk reaction, particularly among the Unwashed, which are people who look at Gold as the ultimate currency.

Public opinion polls conducted by Barrons and Investors Daily point out a dangerous trend, I think, in Gold. A greater number of people, the Great Unwashed, buy Gold under the assumption that it's going to be used as actual currency. They also believe that all paper currency is going to become worthless and nation-states will break up into little disorganized fiefdoms, and the Gold you have in your coffee-can in the back yard -- that’s what you're going to live on. Unfortunately that is still the predominant opinion among the Unwashed who buy Gold.

As long as that is the predominant opinion, there becomes a problem for future price rises in Gold because the more time that passes that everything does not fall apart and Gold does not becomes the only exchange medium that’s worth anything, the more people that bought it based on that premise become disillusioned. Then if they have a profit in it, they'll begin to sell it.

Another sign that Gold has not completed a transition period is that central banks and other financial institutions that hold Gold are still net sellers -- and not net buyers.

This is the way Gold has to be considered -- who's buying it? The price is rising based on who's buying it. The Smart Money is buying it understanding that Gold is becoming and will become in the future the financial benchmark upon which all currencies are priced. Thus you want to own Gold because as the value of those currencies depreciates, the price of Gold has to go up. The price of Gold has to move in the opposite direction.

It is no longer a question of inflation. This is the old Bullish Shills' argument, and it doesn't work anymore because the planet's economy is deflating.

So what's the difference between Smart Money and Dumb Money --if it’s all getting poured into the market and making the price of Gold rise? As we have seen in the past, when the expectation, or the reason the Unwashed are buying Gold doesn’t pan out and they have a profit in it, they will readily turn into sellers. This has been consistently the case since 1980. When the planet's economy is still being held together, 10 or more years later, when we're not back to horses and wagons, and the Gold buyers doubled their money and the reason they bought the Gold isn’t panning out, they will sell and take their profits.

And what will happen as all the fiat currencies are measured by this benchmark of Gold? This is a time when all governments are in a race against each other to depreciate the value of their currencies. That's why all the banks are moving to a quantitative easing, repurchasing their Treasury instruments, forcing down interest rates and expanding their money supplies, or their balance sheets, in order to depress the value of their currency.

This is a race to the bottom, as it were, in order to cheapen their currencies as much as possible. They are doing so because a cheaper currency and lower interest rate gives them the ability to service debt longer than they would have otherwise. They all recognize that a global economic collapse is coming.

The mandate among the G-20 nation states then becomes -- how do you stretch that out as long as possible and gradualize the global economic decline going into a planetary collapse?

One of the ways you can gradualize that decline is by cheapening currencies, thus reducing the cost of ever-increasing governmental debt service -- a process known as "debt monetization." If you are then looking at Gold as a benchmark of value, as the fixed benchmark asset into which other currencies are valued, whether the price of Gold rises or not depends not so much on how those currencies depreciate, but how much transactional volume there is in those currencies. In other words, how many other assets are being purchased with those currencies?

Just as we've said before, inflation doesn't happen in a vacuum. Inflation is not simply caused by printing money. Even the Unwashed are now beginning to understand.

How much the price of Gold rallies isn’t going to be a function of how much paper currency is printed necessarily or how much it declines in value. Since Gold is the fixed benchmark asset, the fiat currencies or what the price of Gold will be sensitive to, is what is the defacto exchange value of that currency, when you use that currency to buy a basketload of groceries or to buy a house or an acre of land.

And what about Silver? The Dumb Money also believes that Silver, like Gold, is going to be one of two mediums of exchange -- when we're back to horses and wagons and fiefdoms and castles, run by Old Republican Scamscateers (who will have the gold-plated wagons and the Clydesdales, by the way.)

You don’t see any Smart Money buying in the Silver. There are some central banks that continue to hold Silver, like the Bundesbank, as well as some South American and Asian nation-states. But they're continuous sellers of it.

Silver is not going to become any reserve currency either. The principal buyers of Silver are Joe Six Packers, who get suckered into this idea by the Silver Shills that Silver is the poor man's Gold. They tell them that you get more leverage in the Silver because you can buy more ounces of it than you can of Gold -- for the same amount of money. They tell them that it must be a better buy. In fact, however, Silver's financial demand has not increased, and indeed it is continuously decreasing.

Silver however is only playing catch-up with the Gold, so now we're approaching all-time highs in the Silver; we're only about 50 cents away from the all-time highs. Last Friday, you could see Smart Money coming in and putting on short positions on the Silver. This $21-22 level has been the place, where Silver has fallen back from before. Therefore, for Silver to get above $22 an ounce, a fundamental change in economics would be required, like a sudden sharp decline in global GDP and the value of paper currencies. Or a sudden interest by governments of making Silver some sort of secondary financial metal, which isn’t there.

On the other hand Silver does have speculative moves that last a number of months, but not years. However when you say that, look at where the price of Silver was 3 months ago and look where it is now. We've already had a tremendous move. How much of a move will there be when we're already at all-time highs? Silver is not a financial metal, and it is not going to become a financial metal.

Also Silver is not particularly sensitive to currency fluctuations. It would appear to be but that is only because it tends to be a tag-along metal with the Gold. But in the real world Silver is not going to become a new financial metal and in the real world, the commercial and industrial demand for Silver, which is even a bigger factor in the value of Silver than Gold, is steadily decreasing.

Plus the total amount of physical supply -- no matter what the Silver Shills say -- is increasing. The Silver Shills will point out that new mine production has actually fallen, while demand is rising. But what the Silver Shills never tell you is what the total available supply for sale is. That is not comprised of new mine silver coming out of the ground. It's also combined with the enormous inventories of Silver that sellers have, like the Bank of India with its 2 billion ounces of Silver. The Bank of Malaysia and Bank of Indonesia are also consistent sellers of Silver. In South America the Bank of Peru is a consistent seller. The Silver Shills also don’t like to point out the 10 billion of ounces of surface supply of refined Silver that is always available for sale -- and it will come into the market as prices rise.

Gold is a must-have -- particularly for the Unwashed -- because it is a fixed asset and it will be the key fixed asset upon which currencies are priced in the future, But you're not buying it for the Republican fiefdoms of tomorrow where you're going to barter that Gold for a loaf of bread. That’s nonsense.

You must understand the reason you're buying Gold. You're buying it in physical form, so you can take it to an exchange house and exchange it into an ever increasing amount of paper currency in the future. You're not buying it to exchange it for a loaf of bread. You're buying it so you can have an ever increasing amount of paper currency to buy that loaf of bread whose cost as expressed in paper currency will continuously rise.

In other words, this is not the classic definition of inflation, but deflation. We saw in the 1930s where deflation ruled the planet and currencies continued to deflate in value yet prices continued to rise. Then as now, deflation was the watchword of the day.

In other words, you're not buying Gold necessarily as an investment because future price increases of Gold are uncertain…

Unless you're a trader. For instance, everybody was a buyer above $1280 in the December contract. We saw the Gold move up and it's getting a little tired, but if you don’t have the ability to trade it as in trading Gold futures, then what you should do is simply hang onto it in physical form, or an ETF that has physical delivery.

Joe SixPackers shouldn’t be buying into Gold ETFs as they’ve become the new substitute for the old domestic common stock mutual funds. But Joe is buying commodities because that's what he hears from Jim Cramer every day that Joe's got to hold commodities even though Joe doesn't know the economic dynamics that separate an ounce of Gold from a bushel of Wheat.

Remember inflation is dead, even though Joe has been infused by Gold Shills that you have to hold Gold for inflation. You're not holding Gold as a hedge against inflation because inflation is dead. The planet is in deflationary cycle

Gold has been in an orderly advance and it's not in a bubble. The problem with Gold is that the Gold Shills will tell you that Gold is a deep liquid market. It isn’t. Gold is a rather thinly-traded market. There are not billions of dollars in transactions in Gold everyday, or billions of Gold held by an investment house, or any one party.

It should be noted that a little selling in Gold can create an exaggerated movement in price -- both up and down. The problem with Gold at current levels is that you have an awful lot of Smart Money, holding Gold since it was at $800-900, which has a large unrealized profit in it. If Gold does not move higher, those who are long Gold and have a substantial profit, will sell the Gold to nail down the profit

The Smart Money also knows that Gold is not particularly liquid. The Smart Money knows that increased taxation on capital gains both in the United States and globally is coming. They have fewer havens to escape those capital gain taxes.

So watch out because Gold has a political aspect here. Watch out for what's coming in the United States -- if the Obama Regime is successful in extending Bushonian tax cuts only for the middle class and excluding the rich.

If that happens, you're going to see markets reverse. This will pressure stock markets and commodity markets because the Republican Rich who own the majority of commodities and equities are going to be sellers in a hurry…

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* AL MARTIN is an independent economic-political analyst with 25 years of experience as a trader on NYMEX, CME, CBOT and CFTC. As a former contributor to the Presidential Council of Economic Advisors, Al Martin is considered to be a source of independent analysis for financially sophisticated and market savvy investors.

After working as a broker on Wall Street, Al Martin was involved in the so-called "Iran Contra" Affair as a fundraiser for the Bush Cabal from the covert side of government aka the US Shadow Government.

His memoir, "The Conspirators: Secrets of an Iran Contra Insider," (http://www.almartinraw.com) provides an unprecedented look at the frauds of the Bush Cabal during the Iran Contra era. His weekly column, "Behind the Scenes in the Beltway," is published weekly on Al Martin Raw.com, which also publishes a bimonthly newsletter called "Whistleblower Gazette."

Al Martin's new website "Insider Intelligence" (http://www.insiderintelligence.com) will provide a long term macro-view of world markets and how they are affected by backroom realpolitik.

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