It appears that Mr. Hathaway is a proponent of "Free Gold". "Free Gold" is the term given to the concept whereby gold and fiat currency coexist. In such a scenario, gold serves as a store of wealth and currency is used as a convenient means of conducting everyday transactions.
While one may say, "That's the way things are today.", that is not the case. Gold is not free to express it's true value. Central Banks have been on a campaign to sell their gold holdings into the open market, thereby depressing the price of gold and stifling the measure of inflation.
Additionally, bullion banks have leased gold to private entities at a lease rate of incredibly low levels of interest. The private entities, in turn, sell the gold (causing the price of gold to drop) and use the proceeds for other investments that pay a higher rate of return than the cost of the lease. Later, they buy gold at the lower price and return it to the bullion banks. This is known as the gold carry trade.
This practice fell out of vogue as global interest rates declined over the last five years and, to no surprise, there has been a coincident increase in the price of gold over the same time period.
From the link:Capital flows into gold under one scenario only: when the lack of investment returns elsewhere, the desire for safety, and the ascendance of a risk-averse psychology at large converge.
In other words, investors come to gold through a process of elimination. It is an odyssey of discovery and realization that investment vehicles thought to be potentially rewarding are in fact filled with hazard and adversity. The current gold cycle began with the collapse of the Nasdaq bubble. The collapse eliminated investor passion for highly speculative equities with little or no operating history trading at absurd valuations. That was five years ago and marked the beginning of a secular downturn in credit. The Nasdaq peak represented the culmination of a credit cycle that commenced in June 1982, when 30 year treasuries were priced to yield 13.92%
The high water mark of the credit cycle, in our opinion, should be measured not by the quantity of debt outstanding, as some would argue. Surely, the Fed's energetic effort to prop up the post 2000 economy has resulted in significantly more debt outstanding than before the Nasdaq crash. Instead, the apex of the credit cycle must be identified in a less quantifiable manner. It is the degree of fantasy present in investor expectations as to future returns. The fact that there is more General Motors paper outstanding than five years ago is not due to GM's improved credit standing or a heightened level of expectations for returns. Obviously, the reality is quite the opposite. A most useful objective measure of credit excess (and fantasy) is the ratio of the Dow Jones Industrial Average to the price of an ounce of gold. The DJII traded at 40x the price of an ounce of gold in 2000. Today, that ratio is 24x. At the bottom of credit cycles in the previous 100 years, that ratio was more or less 1x. A rising gold price merely anticipates future downgrades in financial assets of all stripes, including equities, debt, and currencies.
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The global market cap of mining shares is about $100 billion. Investing in shares is subject to a long list of risks including geopolitical, cost pressures, labor disruptions, mine accidents, and environmental lawsuits to name a few. However, the greatest risk by far is share dilution by financially unsophisticated managements. Over the last two years ending December 31, 2004, the share count for the entire industry rose 33%. Is it any wonder that the shares and share indexes have lost some momentum in light of the additional supply? We wholeheartedly support the scathing comments of Graham French speaking at a mining conference in April of this year: "This industry is so blas? that 90 percent of capital raising is done without consulting shareholders." We would add that the industry consumes huge quantities of capital on which it generates poor returns. It cannot afford to take its shareholders for granted.
While we favor gold shares in most instances over the metal because they offer leverage to the gold price, we can understand why risk-averse investors looking for the protection of gold without the risk of mining would prefer the metal itself. Gold entails no business risk, only the possibility of overpaying. In our view, the potential pool of risk averse investors is considerably larger than the share oriented risk tolerant investor group. Physical gold comprises an asset class at least 10 times that of the mining shares. Therefore in time, it seems reasonable to expect the ETF and similar initiatives to have a market cap proportional in size to the underlying disparity.
The recent weakness in the gold shares is a good proxy for investor sentiment. It is at rock bottom. This is confirmed by the Hulbert Gold Newsletter Sentiment Index which has recently matched record low readings. The May 23rd Market Vane sentiment gold barometer was 61% bulls, the lowest since 57% on May 13, 2004 when gold was $379. The bullish consensus was in the 40's in April '03 when gold was $320. The peak recent reading was 83% in October of 2004 when the gold price was slightly below $430.
The dollar price of gold bullion is trading within 3% of a seventeen year high, despite negative sentiment. Over the past five years, the dollar gold price has increased 50% vs. a 16% decline in the S&P 500 and a 18% decline for the trade weighted dollar. Swooning sentiment while gold trades within a few percentage points away from a seventeen-year high? Sounds like a bull market to us. It is the nature of every bull market to take along as few as possible. The recent shakeout, which began in earnest in early March, has done an excellent job of chilling investment sentiment. The early stages of all bull markets are characterized by widespread skepticism. Gold remains in a multiyear bull market that will last another decade. The deflowering of the euro represents a major milestone along the way.
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We believe that the divestiture of gold reserves by central banks (at a measured pace, of course) offers the possibility of the eventual privatization of gold. There could be no better monetary outcome for the private sector than for all gold to be removed from central bank vaults. Citizens would then be free to choose how to hold their wealth, as they did before legal tender laws became the standard. We have no doubt that sufficient buying power exists through the exchange of questionable paper assets to support a bid much higher than the current dollar price. Would it be possible for gold instruments such as the ETF and Bank Receipts to coexist with fiat currencies? We may be witnessing the dawn of just such an outcome. In a free market for both, gold would offer the superior alternative for capital preservation, while fiat currencies may periodically offer a more convenient medium of exchange.
Nearly sixty years ago, Beardsley Ruml (Chairman of the New York Fed) wrote: "The necessity for a government to tax in order to maintain both its independence and its solvency" is no longer true because of the "vast new experience in the management of central banks" and "the elimination, for domestic purposes, of the convertibility of currency into gold." (American Affairs, Jan. 1946) These few phrases foreshadow the sixty year evolution of the Federal Reserve from a traditional central bank into a central planning agency. (See our web site article "Beardsley Ruml's Road to Ruin," November 2004) Convenient though government sponsored currencies such as the dollar and the euro may be, they are first and foremost tools of government policy and serve the interests of the private economy as an afterthought. The dichotomy of monetary interest between the public and private sector will be exposed as the current secular credit contraction runs its course. It will culminate in a grass roots mandate for sound money, and will be expressed as a dollar gold price well into four digits.
WSC