Gold Investing Info

A lot of goldbugs believe the soaring US deficits mean inflation is inevitable. While I tend to agree, which is why I’m investing in silver and gold, we have to remember that this is not a guarantee. Just look at the Japanese experience.

Many compare the current US economic slowdown to what occured (and is still occuring) in Japan. In the 80’s, a massive real estate boom occurred in Japan. Much like ours, excessive leverage and speculation led to unwarranted real estate values, primarily in the commercial sector. The ensuing bank crisis resulted in a recession and deflation that still occurs to this day. The Nikkei stock index had its all-time high on December 29, 1989, when it was at 38,957.44. Today, the Nikkei index stands at about 9800. You got that right. Over the course of 20 years, it fell 30,000 points, which was about 77%. Yikes!

The Japanese were slow to lower interest rates, but they eventually did so, and interest rates are still near 0% in Japan today. The government also wasted a lot of money via various fiscal policies, building the typical bridges to nowhere. Japan’s debt is now 180% of GDP, though both short and long-term interest rates are near zero and no inflation has occurred.

The big difference between Japan and the United States though may be the Japanese savings rate. While public debt exploded, Japan never had a debt issue in the private sector. Japanese private sector savings simply got swallowed up by the growing government debt. People were happy essentially getting 0% on their money. That turned out to be a better investment than putting the money in the stock market. With the highest corporate tax rate in the world and a mountain of other taxes and regulations, Japanese business has been in a state of lethargy for decades now and there’s no going back.

What does this mean? I am not saying Japan-style deflation is inevitable. In fact, I doubt it will occur. No two disasters are ever exactly alike and the biggest difference between us and Japan is that they have savings and we don’t. Their budget deficits were also the result of one-off governmental fiscal policies moves, whereas our impending disasters are due to structural flaws with our entitlement systems.

This means we cannot count on the bond market to be so benevolent to our long-term bonds. The massive supply glut of US bonds, the potential for structural deficit issues (meaning our deficit consistently surpassed economic growth, even in ‘normal’ times), and the lack of private sector US savings means that bond rates may go up. In this case, if everyone can loan to the US government at 6-7%, the stock market will collapse since people can get solid returns with ‘no risk’ in US treasury bonds, and the cost of borrowing for corporations and individuals will be unbearable.

Many believe that in this case, the Fed will choose to expand its ‘quantitative easing,’ essentially printing money to fund the deficit. Again, this isn’t guaranteed, as the Fed may refuse to do so and force politicians to balance the budget.

Inflation is a potential with our deficits, but it’s not guaranteed. It could be that the government succeeds at simply destroying the economy long-term, much like the Japanese did, in a deflationary moment by gobbling up all of the private sector capital. The Fed may not print that much money.

To make money off of a disaster, you need to not only predict economic doom but also know HOW the doom will occur. That is the problem in this environment. We can point to policymaker mistakes and claim they will make society worse off. But to make money off of this, you need to know exactly IN WHAT WAY society will be worse off.

Over the past couple of months, silver has been on a complete tear. In the past month, the SLV is up 28%. Compare that to 7.6% for the S&P and 10.8% for gold.

Needless to say, I’m pretty happy about this. As I wrote earlier, I had been piling into silver due to potential stagflation prospects. But is the rise in silver due to this or other reasons? Honestly, I have no idea.

While silver has been up, treasuries have gone down. Investors now are demanding higher yields from the US government. Some believe this is due to the collapse of fear in the marketplace. In the fall, treasuries had unbelievable demand due to everyone wanting a safe haven, and now that people are feeling more comfortable, treasuries are being bid down. I’m not so sure that is true. Treasuries have been consistently selling off since the year began, even in the face of the 25% drop in the market over the first few months.

The bearish explanation on why treasuries are falling is due to people’s fear about the dollar (another explanation for silver going up) and fears of inflation/debt monetization (another reason for silver to go up).

Those that are bullish on the economy may believe silver had just been oversold and was due for a bounce: the gold-silver ratio was way out of whack earlier this year. Another explanation is that all commodities are up due to prospects of economic growth. The USO is up 27% over the past month as well. Silver has many industrial uses, so it is climbing along with other commodities.

It’s not clear what the reason is, but we’ll likely find out over the next couple of years what truly will be driving the price of silver in the near-term.

There are a variety of ways to own gold. A favorite among goldbugs is to own the physical bars. This is the purest way to own gold. Unfortunately, this has downsides, the main one of which is that you have to store it. If you store it at home, it is at risk for theft. If you put it into storage, you have to pay for the storage and there is always the issues of risk with the storage party.

One favorite way to own gold is through the GLD ETF. This ETF is a holding company which owns gold. Purists do not like the GLD since you technically do not own any gold yourself; you merely hold a derivative of an ETF that holds gold. So if, for whatever reason, the ETF’s gold holdings do not turn out to be as much as advertised, you are out of luck. Such sort of paranoid thinking was merely laughed at a few years ago, but as we have seen with the counterparty risk with Lehman Brothers and these other investment banks/hedge funds, it is not something to laugh at anymore.

Another way to make a gold play is to buy gold mining stocks. This avoids the counterparty risks/theft issues outlined earlier. However, it’s not a pure play on gold’s price. Gold miners do well of course when gold is higher in price, but some gold miners are more sensitive to price than others. Because of this, it is important to research the companies and tell how they would be affected under various pricing scenarios.