As one of my colleagues recently reminded me, gold and miners are the kinds of things you want to invest in during periods of high inflation (most recently, Greenspan's real estate bubble). But when we are faced with deflation and economies around the world are crashing, suddenly the U.S. Dollar doesn't look so bad and gold falls out of favour. This is a popular viewpoint, as evidenced by a rising U.S. Dollar and declining gold-in-dollars price.
Don't let that chart of gold (in U.S. Dollars) mislead you into thinking that gold is now weak. Gold is very strong against the British Pound, Canadian Dollar, Australian Dollar, and Euro. In just about all of these charts, gold is in a strong multi-year uptrend and currently testing its 200 day moving average. There certainly is no technical breakdown in gold.
The one (or two) exceptions of course are the U.S. Dollar and Japanese Yen. Gold priced in these currencies looks not quite as strong.
To put it another way, gold is strong but the Dollar and Yen are currently even stronger.
When looking at the global context and not just the USA, gold is still very much in favour.
I agree that gold mining stocks are not a good investment during the current period of deflation. I have sold all of my gold miners.
But whether physical gold is worth holding, now that is a different matter!
The big reason to hold physical gold, as I see it, is that the value can not evaporate to zero – this is very different from wealth stored in bank accounts, mutual funds, stocks, and bonds. Sure, the value of gold can decline, but it will not vaporize.
All of the common methods of wealth storage, most of them paper/electronic in nature, are very susceptible to catastrophic declines or total loss. A bank account balance is only as good as the bank's solvency. A bond's value is only as good as the issuer's solvency and the proper record-keeping of the bond by your broker. A mutual fund's value is only as good as the underlying vehicles, their liquidity, the honesty of the manager, the honesty of the broker, the segregation practices of the broker, and the securities lending practices of the broker. Those are way too many factors for my comfort.
All of this may have been considered somewhat academic before the financial crisis began, but now we've seen all the proof we need: banks are collapsing all over the place. Bonds are becoming worthless as issuers collapse. Various hedge fund and derivative investments are getting wiped out when the counter-party or custodian collapses. The big one we haven't seen yet, but I fully expect, is the collapse of various mutual funds and ETFs due to practices of brokers and counter-parties. I have long predicted that catastrophes in securities lending will eventually lead to very surprising losses in mutual funds and pension funds.
OK, so gold's value can not be wiped out by an issuer defaulting, an investment bank collapsing, or a central bank desiring it to become worthless. This tangible property is not unique to gold, of course. Real estate, oil, and other commodities are all tangible wealth store vehicles. Of these however, gold is the easiest to store, maintain, trade in a liquid market, and has a high value per unit mass.
Many investors take comfort in the “cash” portion of their portfolios. Unfortunately, most investors probably do not really hold cash but a series of promises or instruments emulating cash. Here are some examples of dollars being held by an investor:
Cash in a checking or savings account. Unfortunately, your bank is likely de facto insolvent. All it will take is a revaluation of their off-balance sheet assets, or a run on the bank, to reveal that your “account balance” is in fact meaningless and not backed with cash. You may then go to the FDIC or CDIC for your money, but unfortunately deposit insurance covers a shockingly small percent of total insured deposits and the FDIC's Deposit Insurance Fund is running down to nil. Nobody has your money.
Cash in a money market fund. We saw the problem with these things and commercial paper. Money market funds synthesize cash/dollars by holding corporate obligations and other suspicious paper. Under stress, these instruments become untradeable and their value declines. Some money market funds will simply become illiquid, meaning that although they represent dollar balances they can not actually be redeemed for dollars. Money markets are promises, not cash.
Cash in a t-bill money market fund or treasuries fund. This one might surprise you... you're just about positive this is good quality cash right? Take a closer look. Take a look at the fund's annual report and the securities lending buried among the notes. TLT, which sounds like a treasury bond fund, actually consists of less than 60% treasuries (as revealed by my own analysis). Even t-bill funds such as BIL and SHV turn out to actually be significantly composed of money market obligations. Many t-bill money market funds have corporate paper and derivative exposure, not to mention repurchase agreements and other factors which actually introduce counter-party credit risk. Good luck figuring them out, the professionals have no clue either. You can't even trust t-bill funds.
I hope that the events of the last few months have demonstrated that I am not exaggerating these points. We have after all seen runs on the bank and money market funds breaking the buck. Other risks I mention have not materialized yet in public knowledge, but I assure you they are just around the corner.
Although I am bearish on the US Dollar and fiat currencies, I acknowledge that dollars are an important asset to hold in the form of treasury bills and paper notes. But unless you directly hold t-bills or paper cash notes, I don't think you're really achieving the safety and advantage of cash.
Deflation brings us collapsing banks, collapsing investment banks, widespread defaults and a multitude of failures within the financial system including the collapse of countries (such as Iceland). Fiat currencies can hardly be considered “safe”. Which nation will implode next... the United Kingdom? Spain? The United States of America?
Assuming for a moment that the USA will remain solvent, yes it's reasonable to build cash reserves. You should save up cash. But the nature of this cash storage is of utmost importance. Bank accounts, money market funds, and even treasury and t-bill funds are susceptible to collapse. (As a general rule: the more bankster middlemen between you and your money, the greater the risk of loss and theft.)
Physical gold can not collapse to zero value, and that's why I love it. I happily acknowledge that cash and dollars have a lot going for them, but it's incredibly difficult to safely store those dollars. Also, if the USA does turn out to go the way of Iceland, dollars will become worthless no matter how safely you store them.
Those are the reasons that gold is still worth holding during times of deflation.
I noticed that there are a couple silver bullion fund IPOs being launched in Canada. Details are sparse, but I'll pass on what I know. These appear to be directly competing products.
The first is “Silver Bullion Trust”, a new closed-end trust from the Central Fund of Canada people and based in Ontario, Canada. CIBC World Markets will conduct the share and warrant offering. Regulatory documents are here:
Along the lines of Central Fund's other funds, the new Silver Bullion Trust aims to provide an exchange-tradeable investment representing ownership in physical silver bullion stored on a segregated basis in a Canadian chartered bank. The prospectus describes the intention to hold 1,000 ounce international bar sizes and the requirement that the trust hold at least 95% of total net assets in physical silver bullion.
The second new IPO is the “Claymore Silver Bullion Trust”, also a closed-end fund. This fund is from Claymore Investments, Inc. and a number of investment banks are selling the product. Regulatory documents are here:
The prospectus describes a rationale of providing unitholders with “exposure to physical silver bullion” along with a currency hedge of U.S. Dollars against Canadian Dollars. The portfolio of the fund will consist of physical silver bullion (stored mostly in Canada but also in London and New York), and cash or “other assets” in accordance with the objective of replicating the price of silver bullion, presumably mirroring the price of silver into CAD currency.
The Claymore IPO seems to be coming along faster. I have not performed any kind of detailed analysis, but I can already warn you about one thing: the Claymore product has warning signs. They are not very clear about actual physical silver content of the fund, and the wording of “replicating performance” means that they will use derivatives and other instruments to synthesize performance of silver without actually fully holding silver. The Claymore fund will use derivatives to hedge currencies, which from what I know of the industry means using over-the-counter traded currency swaps. This introduces counter-party risk into the fund. Although the hedging seems like a good idea on the surface, in practice it's a messy process that adds derivatives risk to what should be a simple silver bullion fund.
- Perpetual Bull