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Gold Bull Market Is Nowhere Near the Top

Commodities / Gold & Silver 2009 Dec 19, 2009 - 02:19 AM GMT

By: The_Gold_Report


Best Financial Markets Analysis ArticleThe U.S. dollar has reigned as the world's reserve currency for more than 60 years. That's a real anomaly in the history of paper money, according to Stansberry & Associates Investment Research founder Porter Stansberry, but the dollar's days on the throne are numbered. With a sea-change in the monetary system on the horizon—and drawing ever-nearer as more and more U.S. creditors turn toward hard assets and away from paper dollars—he tells The Gold Report in this exclusive interview that the world is approaching a return to "at least a de facto gold standard." Porter does not recommend bullion as "insurance" (because that suggests hope for the dollar when there is nothing to pin hope on) but rather as "the perfect natural money."

The Gold Report: As someone who invests in many sectors, Porter, what major trends are you watching in the global economy?

Porter Stansberry: The major trend is a switch in central banks' recycling of dollars. As you know, the United States has been a net debtor to the world each year since 1976, I believe. We've put a huge amount of dollars out into the world and those dollars have to be recycled in some way.

Up to this point, central banks have been buying mostly U.S. Treasuries. Over about the last 10 years they organized so-called sovereign wealth funds (SWFs) and have been buying trophy properties mostly, but also some operating U.S. businesses as a way to recycle those dollars. The most interesting thing I've seen in a very long time is that suddenly some central banks have decided to begin to exit the dollar system by using trade surpluses to buy gold instead of either U.S. Treasuries or U.S. assets. I happen to believe that this is a sea-change in the gold and monetary system that will ultimately result in a return to at least a de facto gold standard.

I know my view is pretty far outside the mainstream, but historically, paper monies don't last. Our paper money, which has been exclusively a paper system—not backed by any precious metals since 1971—is getting long in the tooth and U.S. creditors are beginning to seriously doubt its sustainability. At some point, they will say, "This is ridiculous. We're not going to let you pay us back in dollars that you print. We're going to dump our Treasuries and buy gold because you can't print it." Gold has always been the stable basis of money and credit because it's very difficult to produce and it's timeless. It isn't consumed, it doesn't rust. An ounce of gold mined 10,000 years ago is very likely still in circulation today.

TGR: Granted, the U.S. dollar is the reserve currency, but could a single currency drive the whole world to return to a gold standard?

PS: If you want to understand how one currency could replace the U.S. dollar as the global reserve currency, look into Gresham's Law. Historically, bad money always drives out good. Accordingly, if a central bank anywhere in the world sets up its currency to be backed by any kind of hard currency, it would cause people all around the world to desire that currency for their savings, rather than dollars.

The Swiss don't do it anymore, but suppose, for example, that China decided to back all of its currency in silver. That would make a big difference in the market for dollars in particular because there are so many excess dollars around the world that have to be purchased every year that it would displace the dollar very quickly. All you would need is a country with a large role in global trade deciding to establish a currency based on a hard commodity standard, whether gold or silver or a bi-metal standard. Those standards historically have always been very respected.

Then as soon as you have a hard currency standard, people will begin to hoard that currency and dump the dollar. For example, the U.S. bi-metal standard in the 1800s undervalued silver relative to gold. Within about 10 years—from 1810 to about 1820—no silver coinage was left in the country. That happened in the 1960s as well, by the way. At that time, the face value of silver coins in circulation, the pre-1964 quarters, for example, was lower than the value of the metal. So they disappeared from circulation almost overnight.

The same thing would happen were another currency to be made more secure—with backing from gold or silver, for example—than the dollar. People would begin to hoard that currency and dump the dollar.

I believe that's what we're beginning to see with the central bank purchases of gold. It may be hard to believe, but it's true, that central banks have been net sellers of gold since the end of Bretton Woods. It's really an anomaly that for 35-plus years, there has been no challenge to the dollar standard. There's never been a time before in human history that the world reserve currency wasn't backed by gold or by a combination of gold and silver.

TGR: Is there enough gold in the world to return to a gold standard?

PS: Not enough, perhaps, to return to the earlier standard of $35 per ounce of gold. There are far too many dollars out there to make that conversion work. Clearly, the exchange rate would have to differ dramatically. Estimates I've seen say that if you divide the U.S. gold reserves by the total number of Federal Reserve base money, you get something $6,000 per ounce of gold. It just needs to be a new hard standard that the either the central bank begins to enforce or you abolish the central bank and set up state banks or private banks based on a firm foundation of gold.

TGR: With gold at $6,000, the doom-and-gloomers say the government would confiscate it from private investors. Is that a legitimate concern?

PS: You wouldn't want to underestimate the perfidy of the government. I have no doubt that the government will need to increase revenues substantially to avoid default on either debt or social welfare promises. How they will increase those revenues, I can't predict. It seems unlikely that they'll be able to effectively increase revenues by raising taxes because it just doesn't work. People will find ways to reduce their income to avoid the taxes or simply leave the country. So I wouldn't be surprised at all to see some kind of a land grab or an asset grab. I don't believe it will focus on gold because there just isn't enough privately held gold in the country to make a real big difference in revenues. I think they'll go after something else, perhaps a tax on net worth, which I've seen discussed in Congress already.

TGR: If central banks accumulate enough gold and if a major economic power moves to gold, how long would it be before we have a de facto gold standard?

PS: I don't think it would take very long at all. And in reference to a de facto gold standard, you can look at the European Central Bank. Of all the central banks in the world, it's really the only one that has been reducing the size of the balance sheet over the last couple of years. It's doing so because the Germans, in particular, have a memory, a recent history, of hyperinflation. They greatly fear hyperinflation so they're keeping the balance sheet relatively sound compared to the others.

That's why you've seen the Euro go so high against the dollar and why lots of people around the world demand Euro-based contracts. Brazilian Supermodel Gisele Bundchen, who's married to New England Patriots quarterback Tom Brady, is the highest-paid model in the world and she was supposedly insisting on Euros in her contract instead of dollars.

Speaking of Brazil, there's a country that may be strong enough to influence a global gold standard. It has almost no gold reserves now, but I think that in the next 12 months Brazil will buy enormous amounts of bullion. I also think you're going to see the same thing from countries in Asia, particularly South Korea and China. I'm telling you, it won't take very long to set off a firestorm of panicked gold buying by the world's central banks.

TGR: The other metal that people consider a basis for exchange is silver, which you touched on earlier. Do you think if we move away from fiat currencies into precious metals, that silver will continue in that vein as currency?

PS: I certainly do, and I think that's actually the best way for people to speculate on a change in the global monetary system. Historically, when there's been demand for monetary silver, silver traded at roughly a ratio of 1/15th the price of gold. The ratio does change slightly over time, going from 14 up to maybe 16.

But any time you have a monetary standard in which the ratio is set by fiat, you end up having a problem in that monetary system; so I would oppose any kind of mandated silver ratio. Given the market dynamic, it will tend toward 1/15th the price of gold. The silver ratio is between 50 and 60 now, so you'd have an enormous amount of leverage to the upside if there were to be a sudden demand for silver as a monetary base.

TGR: Would we need to see the beginnings of the conversion to gold as a monetary base to have silver rush up?

PS: There is no doubt in my mind that as central banks begin to abandon the dollar, there will be an enormous amount of monetary demand for silver and the silver ratio will plummet. If you look at all of the monetary crises over the last 100 years, any time that there has been even a whiff of a collapse of the dollar, the silver ratio has soared.

TGR: In our last interview, one of the nuggets of advice you gave was "don't buy if other people are." With ads to buy gold coins on commercial television now, isn't that a signal that other people are buying?

PS: I can't deny that there is more public interest in gold than I have ever seen in my career and, of course, the price of gold is the highest it's been during my career. I would much rather have built the portfolio of gold investments starting 10 years ago than now. It would be difficult to consider allocating a large amount of capital to gold at the moment.

On the other hand, a lot of the advertisements we see are not selling investors gold, but instead are asking people to send their old junk jewelry in exchange for some cash. To me, that's more evidence of people fleeing from the dollar than a sign of a top in gold prices. I don't think we're anywhere near the top in gold. That's because the key players in the gold price are central banks and it's only been in the last six months that they've even begun to buy gold. So this bull market for gold has a lot, lot further to run.

TGR: As you look at gold and silver investments, how do you evaluate the difference between actual bullion and equities?

PS: I don't consider the equities a gold investment. Gold equities are stocks in operating businesses that have depleting asset bases and very low margins. They're mostly very lousy businesses, and it's a very competitive commodity business. A whole different expertise is required to analyze the gold companies, and some people are very, very good at it. I would point to John Doody, an economist and publisher of the Gold Stock Analyst newsletter as one example. He has it all down. He's studied the relationship between gold stocks and the price of bullion for the last 30 years.

I would tell you for most people the answer is to avoid gold stocks altogether and simply hold bullion. If I'm even halfway right about central banks abandoning the dollar and buying gold over the next several years, the price of bullion is going to go up considerably. Then you wouldn't need the extra leverage that was possible in the gold stocks to do well. Likewise, you can avoid all the risks of buying the wrong ones or getting into a period of time when gold stocks underperform the metal. And that does happen from time to time.

TGR: Many equate gold with an insurance policy and hold about 10% of gold in any portfolio. Given the situation we're in with currencies and the central banks, are you suggesting more than that?

PS: That's an interesting question. You buy insurance to cover yourself if the unlikely occurs. Homeowners insurance, for example, protects you if your house burns down or if you are robbed or something really unusual and terrible happens to your home. Most people never make a major claim on their homeowners insurance. They might have claims, but most people's houses don't burn down.

But to say that bullion is insurance is misleading because there is no doubt that today's paper monetary standard will fail. There is no doubt. It's not a question of "if" but "when." You're seeing all the signs of a monetary collapse, where enormous debts are made because paper currency is very flexible and can be expanded. Those debts can never be repaid.

This is always how paper monies collapse and that's exactly what's happening to the dollar today. You can view bullion as insurance if you think it's unlikely the dollar will collapse. But the dollar is collapsing now, so I wouldn't describe gold bullion as insurance. I would say that it's natural, sound money and that everyone should consider their own personal net worth in terms of gold bullion. That's how I measure my own net worth, that's how I advise other people to do it.

TGR: So 10% isn't enough?

PS: Talking about allocation is like asking, "How wealthy do I choose to be?" I keep all of my savings in gold bullion—no dollars, no Treasury bonds—and try to add to my savings hoard every year regardless of the price. If the dollar has an intrinsic value of zero, what is an appropriate price for gold bullion? In terms of dollars, there would be no cap, so pricing it in dollars is impossible. So I just advise people hold their savings in gold and to own as much as they can reasonably afford.

TGR: Is your gold bullion in physical coins or in some sort of ETF or something like Turk's GoldMoney?

PS: A year ago, I did recommend Market Vectors Gold Miners (NYSE:GDX) , which is the ETF of gold producers. At that time, the spread between the value of their gold production and the current bullion price had never been wider, so it was simply recognition of the fact that gold stocks were really cheap relative to bullion. Because I was bullish on gold anyway, it made sense to take that arbitrage opportunity.

But generally speaking, I don't know enough about the certificate programs or digital receipts to know whether it would be wise to do that. It would take a lot to convince me, because in my mind, gold is the perfect natural money. How can you improve on it? I don't believe you can. I am much more comfortable simply owning the bullion, which is perfectly transportable, perfectly divisible, doesn't rust, and is no one else's liability.

TGR: But you pay a premium to get the physical versus buying through an ETF.

PS: It's interesting that you bring that premium point up. There is a premium to buying gold because you have to pay a brokerage fee. If you buy real estate, car or other kinds of asset, you expect to pay some kind of a fee. I've paid premiums ranging from between 1% and 3%, and I always buy whatever the dealer happens to have plenty of to get the lowest possible premium. So the premium has never been a problem for me.

I don't believe that buying certificates is a way around the premium, either. It may appear to be in the literature, but I just don't believe it. Fees for shipping and handling and so on have to be paid somewhere in the transaction. But more importantly, assuming that you're taking delivery of gold in the United States, I would tell you that the size of the premium will be a very accurate measure of the power of Gresham's Law.

When the U.S. Mint stopped producing buffalo coins last year, the premiums on bullion delivery went way up from around 2% or 3% to as high as 8% or 10%. That's because gold is fleeing the United States and the Mint is apparently the only convenient and easy way to get gold coins into the country. That's a sign of future higher gold prices and also a sign of future currency controls. I think the market is judging very accurately that there is a move away from the dollar and that the U.S. government will attempt to stop people from not only buying gold in the future, but also from gold leaving the country.

TGR: Do you think they're that smart?

PS: Smart would be simply to institute a new gold standard at the current price and lower taxes dramatically. Then the economy would boom and the problems of the last bubble would be worked off very quickly. So they're not smart, but they are rapacious. There's no doubt that when the dollar really begins to crack, when China comes out and says they're going to sell a trillion dollars worth of Treasuries and they're going to buy gold, and the price of gold goes to $10,000 an ounce and you get three Euros to the dollar, you're going to see emergency measures to support the dollar. This has already happened in our history and it's happened with lots of other paper standards—Great Britain, for example. In the near term—over the next three to five years—the U.S. government will be forced to support the dollar via currency controls, making it impossible to take dollars out of the country and putting strict limits on who (and how much) is allowed to buy commodities. Buying gold will certainly be made illegal.

TGR: So get your gold now.

PS: Get it now or pay a much, much higher premium for it, assuming you're still allowed to buy it.

TGR: You've made it clear that you look at equities entirely differently from having gold, but you did mention China. Not only is China building its gold reserves, on the road to becoming the world's leading retail buyer of gold and encouraging its citizens to own gold, but also gold production continues to rise in China while many other top-producing countries are in decline. Last year, China's gold production exceeded 9 million ounces of gold—more than any other country. Against that backdrop, what opportunities for investors do you see in Chinese mining?

PS: I'm clearly very bullish on the amount of central bank buying of gold over the next decade. If you look at the central bank holdings of gold, the first thing that jumps out is how little gold the major emerging market countries have as a portion of their reserves. China has $2.2 trillion worth of foreign exchange reserves and gold accounts for only 1.6%—a very small percentage. Brazil has less than 1% of its foreign currency reserves in gold. Korea has almost no gold. Hong Kong has no gold, period.

These are very large economies with very little gold backing their currency, so a run on the dollar would make their currencies and their economies suffer. I expect them to move into gold in anticipation of that eventuality. When that happens, there's obviously going to be a large demand for gold. Equally obviously, China is better off if they're able to produce it internally. Otherwise, they'd have to buy it on the world markets.

If you look around to see who's mining gold close to China, there's the big Ivanhoe Mines Ltd. (NYSE:IVN, TSX:IVN) discovery in Mongolia, for example, and the world's largest gold mine is currently Grasberg in Indonesia— Freeport-McMoRan Copper & Gold, Inc. (NYSE:FCX). I think we'll continue to see China on its quest for hard commodity resources. So good equity investments will focus on providing hard commodity resources. Certainly, gold is one of those resources. They're going to need it because they'll need money and they won't be able to trust the U.S. dollar.

TGR: You mentioned Mongolia and Indonesia. Doesn't China itself have some of the biggest gold mines?

PS: China has an enormous amount of gold resources internally as well. Our mining analyst, Matt Badiali (also editor of our Resource Report), has covered several of the different equity securities that are mining gold in China. I have actually toured several gold mines in China myself, but I just don't know enough about those particular equities to talk about them intelligently, and I don't personally recommend gold stocks in my newsletter. Analyzing gold stocks is a real specialty and I don't devote enough time or resources to doing it myself.

TGR: Any other comments for our readers?

PS: No, I think the story is told. It's mostly a story of central banks now buying and the reason they have to buy is that the dollar is falling apart.

After serving a stint as the first American editor of the Fleet Street Letter, the oldest English-language financial newsletter, Porter Stansberry put out his shingle at Stansberry & Associates Investment Research, a private publishing company. Celebrating its 10th anniversary this year, S&A has subscribers in more than 130 countries and employs some 60 research analysts, investment experts and assistants at its headquarters in Baltimore, Maryland, as well as satellite offices in Florida, Oregon and California. They've come to S&A from positions as stockbrokers, professional traders, mutual fund executives, hedge fund managers and equity analysts at some of the most influential money-management and financial firms in the world. Porter and his team do exhaustive amounts of real-world, independent research and cover the gamut from value investing to insider trading to short selling. Porter's monthly newsletter, Porter Stansberry's Investment Advisory, deals with safe value investments poised to give subscribers years of exceptional returns, while his weekly trading service, Porter Stansberry's Put Strategy Report, shows readers the smartest way to book big gains during the ongoing financial crisis.

Want to read more exclusive Gold Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Expert Insights page.

1) Karen Roche, of The Gold Report, conducted this interview. She personally and/or her family own none of the companies mentioned in this interview.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Avalon Rare Metals; Revett Minerals, Goldcorp.
3) Michael Berry—I personally and/or my family own the following companies mentioned in this interview: Senesco Technologies, Goldcorp, Quaterra Resources, and Galway Resources.
I personally and/or my family am paid by the following companies mentioned in this interview: Revett Minerals.

The GOLD Report is Copyright © 2009 by Streetwise Inc. All rights are reserved. Streetwise Inc. hereby grants an unrestricted license to use or disseminate this copyrighted material only in whole (and always including this disclaimer), but never in part. The GOLD Report does not render investment advice and does not endorse or recommend the business, products, services or securities of any company mentioned in this report. From time to time, Streetwise Inc. directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.

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