10th anniversary articles - bmg group inc. 10 year book of articles web.pdf · employ any hedging,...

r Portfolio Diversification Myths: Why Pension Funds Need to Rethink Their ion is Outperforming Mining Stocks Gold is Money Ensuring the Quality of x Myths about Gold Platinum: Dark Horse, Bright Future Precious Metals: onceptions 2004 Empire Club Investment Outlook 2003 President’s Message

ARTICLES10TH ANNIVERSARY BOOK OF Ten Years of Articles and Outlooks

Nick Barisheff

I n t r o d u c t i o n

We are pleased to present a collection of 15 articles and outlooks by

Nick Barisheff, president and CEO of Bullion Management Group Inc.

The articles were previously published in magazines or periodicals, or

delivered as speeches. Nick has been a regular contributor to magazines

like Resource World, Investor’s Digest and Benefits and Pensions

Monitor. In addition, he has spoken at the prestigious Empire Club

Outlook luncheon for the past five years consecutively. His most recent

address is included in the collection.

These commentaries cover a wide range of topics, from how to buy and

store precious metals to why precious metals will continue rising in price

for years to come. With something for everyone, from those just beginning

to plan their future to the most sophisticated market expert, Tenth

Anniversary Book of Articles deserves a place on every investor’s bookshelf.

Ta b l e o f Con t e n t s

Annual Report President’s Message | March 2004 7

Gold Myths and Misconceptions | October 2004 11

2005 Outlook for Gold | January 2005 19

General Motors, the Stock Market and Gold | April 2005 27

Precious Metals: Critical Diversifier | November 2006 35

Platinum: Dark Horse, Bright Future | March 2007 41

Six Myths About Gold | November 2008 51

2004‐2009 Pompous Prognosticators Revisited | July 2009 59

Ensuring the Quality of Precious Metals Purchases| December 2009 63

Gold is Money | March 2010 67

Why Bullion is Outperforming Mining Stocks | July 2010 77

Three Dominant Factors Will Impact Precious Metals | April 2011 85

Portfolio Diversification Myths | May 2011 103

Gold and Fiat Currency: Forty Years Later | August 2011 109

Why Rising Debt Will Lead to $10,000 Gold | January 2012 113

2 0 0 3 Annu a l R e p o r t :

P r e s i d e n t ’ s Me s s a g e

M a r c h 2 0 0 4

The concept of The Millennium BullionFund was formed in 1997 when

my own research led me to the conclusion that equity markets were

forming a bubble, and that economic conditions were about to

deteriorate. My research indicated that the next bull market would be

in commodities, and particularly in precious metals. Throughout my

30‐year career in the investment business, I have always maintained

that precious metals are a vital component of an investment portfolio.

However, the investment form had to be actual physical bullion, not a

paper derivative such as a futures contract, or an equity interest in a

mining company. Although investments in commodity futures and

mining stocks were available both directly and through mutual funds,

there was no cost‐effective, convenient way for Canadians to purchase

and hold gold, silver and platinum bullion. Moreover, bullion could

not be held in RRSPs or other registered plans.

After further legal research and three long years of negotiations with

the Ontario Securities Commission, The Millennium BullionFund�

received approval for Ontario in January 2002, and after further

negotiations with the remaining provinces and territories, it received

complete Canadian approval in May 2003. For the first time, Canadians

could now fully diversify their portfolios and hold gold, silver and

platinum bullion in their RRSPs.

The Fund’s structure echoes the unique characteristics of bullion.

Unlike traditional financial assets, the value of bullion can never

8 10th Anniversary Book of Articles

decline to zero. Unlike bonds, bullion is not someone else’s liability,

and unlike stocks its value is not based on anyone’s promise of

performance. In order to maintain these unique characteristics, the

Fund was structured with a fixed investment policy of purchasing

equal amounts of each metal. As a result, unit prices are primarily a

function of bullion prices alone, and do not depend on the trading skills

of a portfolio manager. The Fund’s mandate does not allow it to

employ any hedging, or to lease its bullion holdings. The legal

structure of an open‐end mutual fund trust ensures that liquidity is

equal to that of the bullion itself, and that no third party can have any

claim against Fund assets. Because units are priced at Net Asset Value

on a daily basis, no premiums or discounts can impact their value.

The importance of holding precious metals in an investment portfolio

has been largely forgotten during the equity bull market of the past

twenty years. Traditional asset allocation theory, as represented by the

investment pyramid, advocates higher risk, less liquid assets at the top,

with lower risk, more liquid assets at the bottom. Typically, precious

metals and commodities are placed at the top of the pyramid, while

cash equivalents are at the base. While placing commodity futures

contracts at the top of the pyramid is appropriate, fully allocated

physical bullion should form the foundation of the pyramid. For 3,000

years precious metals have been the most liquid, universal form of

money throughout the world. They still are.

An effectively diversified portfolio should contain at least five percent

in physical bullion at all times. Futures contracts, options and mining

equities belong in a different asset class, with percentage holdings

based on individual investor objectives and risk tolerance. Unallocated

bullion, like pool accounts and certificates, can form part of a portfolio’s

cash component, but would not form the foundation.

This asset allocation model benefits the investor because precious

metals have an inverse relationship to other assets, like stocks and

bonds. Holding bullion reduces portfolio volatility and improves

returns during normal market conditions. During periods of economic

stress bullion acts as portfolio insurance, growing in value and

effectively offsetting losses in other asset classes. For added protection

in turbulent economic times, bullion allocation should be increased to

at least 10 – 20 percent.

9

Diversification is just as important within the Fund as for individual

investors. Internal diversification is achieved by holding not just one

precious metal, but all three. Gold, silver and platinum each have

unique characteristics, and share dual roles as both industrial

commodities and monetary assets. The Fund’s investment mandate

requires it to invest equally in each metal.

This strategy reduces volatility within the Fund because the metals are

valued for different attributes: gold primarily as money; silver as money

and as a commodity; platinum primarily as a commodity. During

economic expansions, commodity demand for silver and platinum will

likely be greater than for gold. During economic downturns, monetary

demand for gold and silver will increase. Because two‐thirds of the

Fund’s holdings will perform well regardless of economic trends,

volatility is minimized and long‐term returns are maximized.

Owning units of The Millennium BullionFund provides all the

advantages of holding physical precious metals in a registered plan,

with the added value of cost‐effective purchasing, insurance and

storage. This provides investors with one of the best wealth protection

strategies available. As an added benefit, there is every indication that

we are in the early stages of a long‐term precious metals bull market

that could result in tremendous gains for unitholders.

2003 Annual Report: President ’ s Message

Go l d My t h s a n d Mi s c o n c e p t i o n s

O c t o b e r 2 0 0 4

Gold. Casually mention the word to a group of investment‐minded

friends and colleagues and watch as it inspires a visceral reaction, since

people either love gold or hate it; there arenʹt many who feel ambivalent

toward it. Those who love it realize that gold has been the ultimate

store of wealth for over 3,000 years, while various paper currencies

have come and gone. Those who hate it maintain that gold is an archaic

relic, no longer relevant in a world where the majority of business

transactions are carried out with a few clicks on a computer keyboard,

and money is nothing more than a digital entry on a computer.

Or is the antagonism toward gold because they realize that a rising

gold price makes them uncomfortable? Subconsciously the disbelievers

may sense that a rising gold price is like an economic barometer

forewarning of a coming financial storm.

Since 1971, when Richard Nixon ended convertibility of the US dollar

into gold, various myths and misconceptions have been circulating,

influencing peopleʹs opinions and resulting in a number of unfounded

myths that have dogged the yellow metal.

MYTH: GOLD IS HIGHLY SPECULATIVE!

The importance of holding precious metals in an investment portfolio

has been largely forgotten during the equity bull market of the past

twenty years. Holding precious metals in a portfolio can provide three

distinct benefits: speculative gains, hedging and wealth preservation.


However, many investors and their advisors focus only on the

speculative aspect and treat gold as if it was an industrial commodity

like copper or zinc.

Traditional asset allocation theory, as represented by the investment

pyramid, advocates higher risk, less liquid assets at the top, with lower

risk, more liquid assets at the bottom. Typically, precious metals and

commodities are placed at the top of the pyramid, while cash

equivalents are at the base. While placing commodity futures contracts,

options and exploration junior mining companies at the top of the

pyramid is appropriate, fully allocated physical bullion should form the

foundation, or base.

While futures contracts, options and mining equities can provide

leveraged speculative opportunities, they belong in a different asset

class along with percentage holdings based on individual investor

objectives and risk tolerance. They also carry much higher risks, and

have been known to decline to zero. Unallocated bullion, like pool

accounts and certificates, can form part of a portfolioʹs cash component,

but should not form the foundation as they may become illiquid and, in

certain circumstances, could lose their value completely. Fully

allocated, segregated bullion is not someone elseʹs promise of

performance, nor is it anyone elseʹs liability. It cannot decline to zero.

An effectively diversified portfolio should contain at least five percent

in physical bullion held on a fully allocated, segregated basis at

all times. This asset allocation model provides effective hedging,

benefiting the investor because precious metals have a negative

correlation, or inverse relationship, to traditional financial assets like

stocks and bonds. Holding bullion reduces portfolio volatility and

improves returns during normal market conditions. During periods of

economic stress, bullion acts as portfolio insurance, growing in value

and effectively offsetting losses in the other asset classes. For added

protection in turbulent economic times, bullion allocation should be

increased to 10 ‐ 20 percent.

MYTH - CENTRAL BANKS NO LONGER NEED TO HOLD GOLD AND HAVE SOLD OFF THEIR HOLDINGS!

The Central Bank of Canada has ignored thousands of years of

monetary history and bought into the archaic relic view, and has sold off

nearly all the gold it held in its foreign exchange reserves. From a peak

13

of 1,023 tonnes in 1965, Canada now holds only 100,000 ounces of gold

valued at $45 million. This places it in 77st place, below third‐world

developing countries such as Bangladesh, Guatemala and Tunisia.

This sell off has contributed to an impression within Canada that other

central banks are also divesting themselves of gold, but statistics

compiled by the World Gold Council show that official global reserve

holdings of 36,575 tonnes in 1971 have declined by only 0.4 percent

annually to 31,736 tonnes in July, 2004. Gold sales by Canada,

Australia, Britain and Switzerland, among others, were offset by gold

purchases in France, Germany, Japan, China and Taiwan. Recently

Argentina has been buying 10 ‐ 12 tonnes per month to shore up the

value of its currency.

The Bank of England also accepted the archaic relic label, sold half of

its gold reserves at the very bottom of market, and purchased

interest‐bearing US treasury bills. Since then, the US dollar has lost

about 30 percent against the British pound, while gold has increased by

approximately 30 percent in British pounds. Gold and silver have

successful 3000‐year track records as portable stores of wealth, whereas

paper money does not. Although the US dollar is considered by

many to be the most stable currency, it has lost approximately

80 percent of its purchasing power since gold convertibility was

eliminated in 1971.

MYTH - GOLD IS NOT A GOOD INVESTMENT!

Although fully allocated gold bullion is not an investment per se, its

long‐term performance has been more than commensurate with risk.

Goldʹs decline from its 1980 peak is often cited to support the poor

investment performance myth but, when measured from a cyclical

peak, any investment will take many years to break even. The DOW

did not recover to its 1929 high until 1954. By that time, many of its

original stocks had completely disappeared and were replaced by

alternatives. Fifteen years following the peak of Japanʹs NIKKEI, it has

only achieved approximately 25 percent of that peak.

In fact, on a cumulative basis since 1971, gold has outperformed the

DOW. Goldʹs rise from $35 per ounce in 1971 to its recent $415 level

amounts to a 1,086 percent increase versus the DOWʹs 1,046 percent

increase from 868 to 9,950 today. In the past four years, goldʹs

performance has dramatically outperformed that of equities. While

Gold Myths and Misconceptions


gold has increased 63 percent, the DOW has lost 13 percent and the

tech‐heavy NASDAQ is down 62 percent.

As for the future, gold is poised to outperform equities. The DOW:gold

ratio has averaged 10:1, peaking at 44:1 in 2000. Today, the ratio has

dropped to 24:1 and has decisively broken below the 200‐day moving

average. A number of respected analysts expect to see a 1:1 DOW:gold

ratio, as occurred in 1980 and in 1935. The only question that remains is

will the ratio be 1:1 at 6,000, 4,000 or 1,000?

MYTH - PRECIOUS METALS ARE TOO VOLATILE!

The myth that gold is volatile simply does not stand up to scrutiny.

While mining stocks, particularly junior exploration companies, are

highly volatile, gold bullion is not. According to a study by the World

Gold Council, the volatility of the DOW during the past ten years has

been 16.13 percent as compared to 12.55 percent for gold.

The volatility of mining stocks, particularly during bull market cycles,

can afford tremendous trading profits. It is critical to have either a

knowledgeable advisor or to become proficient in technical analysis.

Some traders use trading profits to augment their bullion holdings.

MYTH - MINING STOCKS AND BULLION ARE EQUALLY EFFECTIVE AS PORTFOLIO HEDGES!

One of the most prevalent misconceptions is that holding gold mining

stocks is preferable to owning bullion. However, the decision between

gold mining stocks and bullion is not an either/or decision. Each asset

has a different place in the investment pyramid, representing different

objectives and different risk/reward relationships. Fully allocated

bullion is used for long‐term wealth preservation because it maintains

its purchasing power and also acts as a hedge against economic crises.

Mining stocks, precious metals mutual funds, futures contracts and

options are used for both speculation and investment during bull

market cycles, but are subject to market, management, financial, labour,

geopolitical, environmental and hedging risks.

Another misconception is that bullion is positively correlated to mining

stocks with both rising and falling in unison it is not. In the crash of

1929, Homestake Mining, the largest and oldest gold producer in North

America, initially declined with the rest of the equity market, but

recovered while equities continued down. Unless investors were both

15

knowledgeable and had staying power during that time, a hedge using

mining stocks would have failed. In the crash of 1987, mining stocks

declined more than general equities. Bullion, however, maintained a

positive position with less than 20 percent volatility.

During bull markets, mining stocks initially tend to outperform bullion.

However, as the bull market progresses, bullion tends to outperform

mining stocks. In the 1970s, Homestake achieved a 900 percent increase,

whereas gold more than doubled that level at 2,300 percent. When a

rising gold price signals a non‐confidence vote in the countryʹs fiat

currency, the flight to its safe haven status can result in dramatic gains.

MYTH - MINING STOCKS ARE MORE LIQUID THAN BULLION!

The belief that mining stocks offer superior liquidity over bullion is

another popular misconception. Total aboveground gold is estimated

at $1.7 trillion. On an average day, a net of $6 billion of physical gold is

traded among the members of the London Bullion Market Association

in London alone. This does not include gold futures trades on the

commodities exchanges, or retail investment purchases, or jewelry. On

the other hand, the total market capitalization of all global mining

stocks is less than $150 billion. The most liquid and largest gold‐

producing company in the world is Newmont, with a market

capitalization of about USD$20 billion. It trades about $200 million

shares per day, representing a turnover of about one percent of its

market cap. Even if this turnover rate is applied to all mining stocks it

would equate to about $1.5 billion, or one‐quarter of the gold bullion

traded in London alone.

In addition to higher liquidity due to higher market size and higher

trading volume, gold bullion is accepted as payment globally, whereas

a mining stock certificate would have little if any value in many parts of

the world. There is a difference between liquidity and convenience in

purchasing the investment. The purchase of physical bullion may be

somewhat time‐consuming and inconvenient for a retail investor

compared to placing a trade for mining stocks. However, as the

precious metals bull market progresses, new investment vehicles will

come to market that will provide equal convenience for purchasing

bullion as is currently available for mining stocks.



MYTH - THE PRICE OF GOLD AND SILVER HAS BEEN IN DECLINE DUE TO LACK OF DEMAND!

With all the attention on the latest high‐tech stocks, the price declines in

gold have been attributed to lack of demand. Surprisingly though,

gold, has experienced supply deficits for more than a decade

amounting to over 22,000 tonnes.

How can the price of a commodity decline in the presence of a

supply deficit?

Basic economics tells us that a supply deficit causes prices to rise, but

that hasnʹt happened in the case of precious metals. The fanfare that

always accompanies central banks sales gives the impression that these

sales have made up the deficits. However, net central bank sales only

account for a small part of the deficit. The balance of the deficit has

been made up through the practice of leasing, creating an artificial

supply that acts to suppress prices.

Central banks lease out gold to bullion banks at low interest rates.

Bullion banks, in turn, lease the gold to mining companies and hedge

funds that sell the bullion and invest the proceeds in higher yielding

investments. Calling this practice leasing is a major misnomer. In the

case of the mining companies, it is more accurate to refer the practice as

covered short selling and in the case of the hedge funds, it should be

called naked short selling. In both cases, the artificial supply that

suppresses prices will be a major contributor to the coming price

increases as these entities are forced to buy bullion at market price to

mitigate escalating losses and cover their short positions.

Although there is some controversy about the total amount of leased

gold, the estimates are between 192 million and 800 million ounces.

Any sharp price rise in either metal will have a slingshot effect, caused

by a massive short‐covering demand that cannot be filled with even

several yearsʹ worth of mine production. This will greatly magnify any

increased investor demand and put extreme upward pressure on prices.

For 3,000 years precious metals have maintained their purchasing power

and have been the most liquid, universal form of money throughout the

world. Since 1971, both the Canadian and US dollar have lost

approximately 80 percent of their purchasing power while gold has

enjoyed an increase. In 1971, for example, a new car could be purchased

17

for $3,500 (100 ounces of gold) and a starter house in the suburbs for

$35,000 (1,000 ounces of gold). Today, 100 ounces would buy two new

cars and 1,000 ounces would buy two houses or an estate in the country.

If investors take the time to examine why they have a negative bias

towards gold, and can accept that what they believe to be true may be

myth or misconception, even the naysayers may realize the important

contribution precious metals can make to a portfolio and how they can

both increase and preserve their wealth in the coming decade.


Th e Ou t l o o k f o r Go l d i n 2 0 0 5

J a n u a r y 2 0 0 5

As Presented at the 2005 Empire Club’s

Annual Investment Outlook—January 6th, 2005

It’s January, the beginning of a new year, and the time when

economists, analysts and even astrologers like to prognosticate about

what lies in store for the next 12 months.

With respect to gold, opinions on the price vary from $400 to $500

dollars per ounce for 2005. These opinions presume that current

conditions will remain relatively stable, and if they do the $400 ‐ $500

range is reasonable. Since the range is quite broad, a review of some

history, and an examination of some current trends may be helpful in

gaining additional insights.

First, it is important to realize that the 70% rise in the price of gold since

2001 is not because of any supply/demand imbalance, as an industrial

commodity. Merely speculating on the price of gold ignores its other

benefits and relegates it to a commodity with no more stature than

copper or pork bellies. But gold has an important monetary role,

as confirmed by the billion ounces still held by Central Banks, and by

the clearing turnover of $6 billion daily by members of the London

Bullion Market Association.

Although various paper proxies and gold derivatives can provide

trading opportunities, they may not provide the wealth preservation

and hedging benefits of bullion itself. In order to achieve these benefits,

gold holdings must be in the form of fully allocated, segregated bullion


with reliable custodial arrangements. Since mining shares and other

gold proxies are either someone else’s liability or promise of

performance, they may not provide these benefits at a time when they

are needed most.

Wealth preservation has been an attribute of gold bullion, and it is the

reason gold has functioned as money for over 3,000 years. Although

gold prices in local currencies may have fluctuated during both

inflationary and deflationary periods, gold has maintained or even

increased its purchasing power in both instances.

Gold’s ability to preserve purchasing power was discussed in detail in

an essay written in 1966 by none other than Allan Greenspan, entitled

Gold and Economic Freedom.

We have all heard that you could always buy a man’s suit with an ounce

of gold. I can remember that in 1971, the price of a basic car was about

$2,500, or 71 ounces of gold. Since then, the dollar price of the car has

increased 5‐fold to $14,000, but for the same 71 ounces of gold, you can

now buy two cars. This relationship holds true for real estate, oil, and

the number of ounces to purchase the DOW, where the cost in gold

ounces has either remained the same or decreased over the last 30 years.

The same cannot be said for paper currencies. Throughout history,

currencies have come and gone as they were inflated away by

emperors, kings and politicians. Since 1971, when the US abandoned

gold convertibility, the purchasing power of both the Canadian and the

US dollar has declined by over 80% due to inflation.

Because of wealth preservation and hedging benefits, gold bullion

cannot be viewed like other portfolio holdings.

The hedging benefits of bullion are achieved because gold is negatively

correlated to traditional financial assets such as stocks and bonds.

These hedging benefits become particularly pronounced during periods

of economic stress. When you compare how poorly stocks, bonds,

real estate and currency performed relative to gold during recent

currency crises in Russia, South East Asia and Argentina, these benefits

become apparent.

The old Wall Street saying ‐ “Put ten percent of your money in gold and

hope it doesn’t work”, is particularly applicable today.

21

Often when I mention this saying I am asked what it means. Why would

you hope it doesn’t work? Aren’t you in the precious metals business?

Over the long term, a portfolio allocation of at least 10% to physical

bullion reduces overall volatility, improves returns and provides a form

of portfolio insurance. With our investment portfolios, we would all like

to maintain an optimistic outlook, hoping that the economy will

continue growing and our investments continue appreciating. However,

since financial markets are cyclical, it is only prudent to maintain some

portfolio insurance, in the form of bullion, in case markets move against

us. Even though we pay for house insurance year after year, we would

still rather that our house does not actually burn down.

Unlike traditional insurance or other hedging strategies, bullion is an

asset rather than an expense. It has a price floor approximately equal to

the cost of mining it. Unlike stocks and financial derivatives, the value

of bullion cannot decline to zero.

Because of the recent equity rally, many investors feel that the worst is

over and there is no longer a need to diversify and hedge. However, an

increasing gold price is like a financial barometer warning of an

impending storm.

Is the storm over, or are we actually in the eye of a hurricane?

Leaving aside the impact of natural disasters, terrorist attacks and wars,

are the economic conditions that have contributed to a rising gold price

still relevant as we go forward into 2005 and beyond?

Are the financial vulnerabilities arising from a mortgage‐induced

realestate bubble still present? Are the concerns expressed by both

Warren Buffett and Alan Greenspan about the $200 trillion of

derivatives exposure still present? By historical measures, are equity

markets fairly valued? Will the looming peak in oil production and

increasing global demand cause a continuous rise in the price of oil,

thus impacting global economies and industrialized societies?

But the worst threat of all comes from the continuous increases in the

money supply through the expansion of credit, at all levels. Simply

put, there is an ever‐increasing amount of paper money chasing a

limited supply of physical bullion. Unless corrected, the inflationary

growth of the money supply, federal budget deficit, trade deficit and

The Outlook for Gold in 2005


current account deficit will cause the US dollar to plunge in value while

the gold price climbs. In looking forward to 2005 and beyond, we need

to determine whether it is realistic to expect that this credit growth will

be stopped or even reduced.

Today, the annual increases in the US federal budget deficit are greater

than the total federal government debt was in 1971. This is an alarming

trend. Even during reported budget surpluses in 1998 and 1999, total

government debt still grew year after year to the current level of

$7 trillion. The US is now paying over $300 billion in interest to holders

of federal debt. If this rate of increase continues, eventually annual tax

revenues will not be enough to even service interest costs.

Notwithstanding that the US Dollar Index has declined by over 35%,

the trade deficit grew to a staggering $600 billion in 2004, and now

totals nearly $5 trillion cumulatively. The phenomenon of a growing

trade deficit during a currency decline is without historical precedent.

We don’t have to look far to find the reason for this anomaly. Since the

US has outsourced a great deal of its manufacturing and is dependent

on commodity and energy imports, the trade deficit has become an

ongoing systemic problem. For the past 60 years the US has enjoyed

special privileges because of the dollar’s reserve status and the

willingness of foreigners to invest in US dollar assets.

The US Current Account deficit now stands at over $650 billion, and

represents about 6% of GDP. But what has this got to do with the price

of gold? This ratio is the highest since 1929. Most economists consider

5% a critical level for current account deficit/GDP ratios. In the past,

when third‐world countries reached that level, a currency crisis followed.

COULD THE US BE THE NEXT ARGENTINA?

This credit expansion has led to a total US debt of $34 trillion ‐ over

300% of GDP ‐ the highest level in history. In addition, we need to add

$55 trillion in unfunded pension liabilities and Medicare obligations.

In all, this mountain of debt requires that the US borrows about

$80 million per hour, and absorbs over 80% of the world’s savings.

Here is a startling fact – it now takes $7 of new debt for every

$1 increase in GDP. How much confidence would you have in a

corporation that needed to borrow $7 annually just to increase its gross

revenues by a dollar? Clearly this can not go on much longer.

23

No wonder Alan Greenspan recently warned that “foreigners’ appetite to

continue to invest in the US may not be adequate to fully sustain the expected

growth in the net indebtedness of the US”.

Translated into English, his statement means that eventually foreign

investors will stop lending the US any more money.

No one knows for certain when that day will come. It may be next

week, or several years from now. You may think that it can not happen

in the US, but history gives us numerous examples of excess debt

leading to a currency collapse. Unless there is the political will to

reduce or eliminate the current mountain of debt, the day of reckoning

must eventually come. The longer it is postponed, the worse it will

ultimately be. Since politicians are not known for their ability to control

their spending and are not elected on platforms that propose

unpleasant financial medicine, it is difficult to imagine that the steps

necessary to fix the problem will be taken.

Canadians need to pay attention to these issues as well. While I have

focused on increases in the US money supply, you may be surprised to

know that the Canadian money supply has risen at twice the rate of the

US. Because of the fractional reserve banking system and global fiat

currencies, the US has exported credit bubbles to the countries that run

a trade surplus with it. In Canada, we are particularly vulnerable to the

state of the US economy and its monetary policy. We depend on the US

to buy our exports, and US dollars represent 50% of our currency

reserves. Canada is now the only G8 country without any gold bullion

to back its currency.

Bearing this in mind, is it likely that the Canadian dollar will maintain

its recent gains against the US dollar?

Up to this point, we have simply assumed a continuation of current

conditions. Maybe the US and the global economy will “muddle

through”, and business will continue as usual. But is it really prudent

to maintain a long‐only bias in your portfolio and assume that the

longest‐running bull market in history will continue for another

20 years? After all, markets are cyclical ‐ not linear. A 10% allocation to

bullion for its hedging and wealth preservation benefits seems more

than justified.



However, if one of the previously mentioned vulnerabilities

experiences a trigger event, then bullion may provide impressive

capital gains over and above hedging.

Since February 2002, the US Dollar Index has declined 35%, wiping out

$3 trillion for foreign investors. If the dollar continues to decline, the day

will come when the world will no longer be willing to increase their

US dollar holdings. The US Federal Reserve will then be faced with a

no‐win situation: increase interest rates dramatically, or let the dollar fall.

If foreign investors get nervous and start selling some of their 10 trillion

dollars’ worth of US dollar holdings, it may create a descending spiral

of further dollar declines coupled with financial asset declines. If that

happens, the line between hedging and capital appreciation will

become blurred. In the 1970’s, a loss of confidence resulted in the

US dollar declining 70% in German marks and Swiss francs. Gold,

however, experienced a 2,300% increase.

Historically, a reliable indicator for the trend direction of gold and

equities is the DOW:Gold ratio. When the ratio increases, it is a good

time to be overweight equities and when it declines, it is better to be

overweight gold. The ratio was 1:1 in 1935. In 1980, when gold was

$850 and the DOW was 925, it again approached to 1:1. The ratio

peaked at 43:1 in 2001, but has steadily declined to its current level of

25:1. Richard Russell, publisher of the DOW Theory Letter since 1958,

predicts that the DOW:Gold ratio will once again be 1:1. The question

is, will both gold and the DOW be at… 1000, 2000, or 5000?

As far‐fetched as these possibilities may sound today, they may in fact

come to pass. In 1989, investors would have found it hard to imagine

the 80% decline in Japanese equities that ensued over the next 13 years.

Equally difficult to foresee in the early 80’s, when the NASDAQ

was 400, was its rise to 5000. In 1971, when gold was $35 an ounce,

no one imagined the 23‐fold increase that gold would experience over

the next nine years.

We now appear to be entering the second leg of the precious metals

bull market, a time when institutions and hedge funds are beginning to

invest in physical bullion. Because of the tremendous market‐size

disparity between financial assets and precious metals, bullion prices

would rise dramatically if a minute percentage of global investors

allocate 10% to bullion.

25

While there is $50 trillion in global financial assets, there is less than

$1.5 trillion in above‐ground gold, less than $1 billion in above‐ground

silver and practically no above‐ground platinum.

Eventually there may even be shortages. You can not simply print

more bullion to meet demand. New mines take 5 – 10 years to bring

into production.

In 2005 whether the price of gold will be $400 or $500 does not really

matter. Would it have mattered whether you bought the NASDAQ at

400 or 500 in the mid‐80’s?

It is only important that you did not buy at 5,000.

No matter what the price turns out to be in 2005, it is still wise to put

10% of your money into gold… and hope it does not work.


Gen e r a l Mo t o r s ,

t h e S t o c k Ma r k e t a n d Go l d

A p r i l 2 0 0 5

If the saying “As goes General Motors so goes America” holds true then

it doesn’t look very good for America or for the stock market.

In a March 16th profit warning GM announced that significant

weakness in the North American automotive business would lead to a

loss in the first quarter and full yearʹs earnings would amount to just

one fifth on the companyʹs December 2004 expectations.

This stunning revelation caught many people by surprise and

prompted investors to drive down GM’s share price 10% in that one

day. GM’s share price is down 44% from a 52‐week high of US$50.04 to

its current low of $29.37. From itʹs market high of $93, in May 2000,

GM shares have lost 69% of their value. This indicates that GM is in

serious trouble and may prove to be an important turning point for the

entire stock market.

What does GM’s financial vulnerabilities tell us about the future of the

stock market and the price of gold?

While most people think of GM as a car company 80% of its 2004

earnings came from GMAC, its financial division. While the auto

divisions posted losses the finance division provided all of the profits.

GMAC doesnʹt just do auto financing; in fact the majority comes from

consumer credit, insurance and mortgage financing. This division

provided GM with most of its profitability. Just as with GM, the

financial industry was responsible for 50% of corporate profitability in


the US. With rising interest rates and the prospect of increasing defaults

by overleveraged consumers this is likely to change dramatically in the

near future.

This financing activity is clearly masking the problems plaguing its

automotive operations. Apart from competitive market factors for car

sales, foreign competition, rising commodity and labour costs, and

rising oil prices, the areas of greatest concern are GMʹs underfunded

pension liabilities and corporate debt. In 2003, GM faced the largest

pension fund shortfall of any US corporation ‐ $25 billion, requiring it

to float an extraordinary $17.6 billion bond issue, bringing its long term

debt to over $300 billion. This still left GM with a deficit of over

$50 billion in its health care fund. The magnitude of this becomes more

apparent when you consider that GMʹs market capitalization is now

just $16.6 billion.

GMʹs pension woes are not likely to improve. In a report for The Detroit

News Auto Insider Ed Garsten states that GM currently provides health

and income benefits to 461,500 retirees and their surviving spouses. As

of October 2004 GM retirees and their dependents outnumbered the

company’s active workforce by three‐to‐one. This imbalance will

continue to grow as more and more retirees are supported by fewer

and fewer workers.

GM’s employment and pension woes are not isolated issues restricted to

its corporate boardrooms. GM’s problems point to and underscore greater

systemic issues that could one day choke the life out of tomorrow’s

capital markets and cause havoc for the West’s financial system.

Pension underfunding is a global problem that is particularly

pronounced in the US due to the underfunding of Social Security. In

2004, the US Federal government posted the highest budget deficit in

history‐ $412 billion. However, its total indebtedness rose by

$11 trillion to $46 trillion largely due to underfunded social security

and Medicaid obligations. The magnitude of this liability comes into

focus when one considers that the 2004 annual increase is equal to the

entire GDP of the whole country. It translates into $350,000 per worker

and since both couples work in most families, this represents a $700,000

liability per family.

29

In 2003, 70% of US corporate pension plans were underfunded by

$278 billion with estimates for 2004 exceeding $400 billion. The Pension

Benefits Guarantee Corporation, that insures the pensions of over

44 million American workers, incurred a record net loss of $12 billion in

2004 increasing its liabilities to $62 billion on $39 billion in assets,

resulting in a deficit of $23.3 billion. The CATO Institute, a policy

research group estimates that the agencyʹs shortfall may top $50 billion

in the next ten years. If the economy experiences a decline due to rising

interest rates or rising oil prices the number of corporate bankruptcies

could increase dramatically. Given the precarious financial position of

GM, it could be one of them.

During the ‘90s bull market most pension plans were in surplus.

Companies were able to add surpluses to their operating income

thereby distorting price/ earnings ratios. After the market decline in

2000 many defined benefits plans became underfunded. Today, the

picture is still distorted as pension funding obligations are based on

overly optimistic portfolio returns, resulting in a much higher level of

underfunding than is being reported.

As an example, prior to its bankruptcy, Bethlehem steel reported

that its plan was 84% funded when in fact it was only 45% funded.

This resulted in a $4.3 billion liability that the Pension Benefits

Guarantee Corporation had to assume. Robert S. Miller, Chairman and

CEO of Bethlehem Steel told Bloomberg News: “I hope other

companies are ready for this, because many of them, including some

automakers, aren’t going to be able to outrun their pension liabilities.

At some point, the great sucking sound of pension and health care

liabilities just overwhelms your ability to raise capital or invest in new

plants or equipment.”

Like many other members of the S&P 500, GM projects an expected rate

of return of 9% on its pension assets. Such exceedingly optimistic

assumptions served to increase GMʹs operating profit by $8.7 billion in

2001 and $8.1 billion in 2002 even though pension assets posted losses

of $5.3 billion in 2001 and $5.4 billion in 2002.

These pension liabilities may ultimately cause a decline in the entire

stock market. Since 360 of the S&P 500 companies have defined

benefits pension plans these obligations will negatively impact earnings

as more profits will have to be diverted to pension plans. As lowered

General Motors, the Stock Market and Gold


profits negatively impact share prices these will, in turn, result in greater

pension deficits due to the fact that these company’s pension portfolios

are invested in each other’s stocks. This can become a descending spiral

of pension deficits, leading to reduced earnings that in turn lead to

lower stock prices, that lead to even greater pension deficits.

With the stock market starting to trend down, long term bonds yielding

under 5% and treasury bill yielding 2.7% it is hard to imagine how an

assumption for a 9% rate of return can be achieved without adding

significant risk. Rather than improve, the situation is likely to get much

worse. By 2011 approximately 100 million US workers or roughly the

entire population of Japan will have retired from the workforce.

Economists agree that this event will have marked consequences for

both the US economy and its capital markets. Unfortunately,

economists also agree that the effects of this massive retirement wave

will be for the most part negative.

In addition to the pension and health care liabilities GM’s debt is also of

concern and is symptomatic of the high consumer, corporate and

government debt levels. US corporate debt grew to new highs of over

$9 trillion, representing 84 percent of GDP. These high debt levels are

significant when you consider that the Federal Reserve has stated it

intends to continue to raise interest rates, and that equity markets are

overvalued by all traditional measures. The combination of decreasing

consumer spending and increased debt service costs will ultimately

translate into slower growth, a contraction in earnings and reduced

profit margins. This will all translate into declines in stock prices.

GM’s total consolidated debt was $301 billion on December 31, 2004.

To put this into perspective this is almost as large as Canada’s entire

Federal Debt of about $363 billion. It is larger than the value of the US

gold reserves of 512 million ounces, worth about $217 billion at

$425/ounce gold.

GM is a benchmark bond issuer, being the world’s third largest

corporate borrower with $114 billion in outstanding bonds. Much of

that debt may soon fall below investment grade status among the most

influential credit rating agencies, relegating the once venerable GM to

“junk bond” status. Since the recent announcement the yield on GM’s

euro denominated bonds have soared to 9.59%. Fitch Ratings recently

31

lowered its ranking on GM to one step above junk, while Moody’s said

that it may lower its rating to one step above junk or high yield status.

Dominion Bond Rating service had lowered its rating on GM last week

to two levels above junk status with a negative bias. What will happen

to global bond markets if GM’s bonds go into default?

With borrowing costs surging to their highest level in almost two years,

increasing pension shortfalls, declining auto sales, reduced credit

demand and increasing default risk the earnings picture looks bleak for

both the auto and financing divisions. Instead of a $2 billion positive

cash flow for 2005 GM now projects a $2 billion cash shortfall.

GM’s troubles have immediate ramifications for today’s stock markets.

This is due to the size of GM, its role in the North American economy

and the place it enjoys on its representative index. General Motors

Corporation is one of the 30 “blue chip” companies that comprise the

Dow Jones industrial Average. These 30 companies represent just two

percent of all listings on the stock exchange, but account for 25% of the

daily trading volume of the New York Stock Exchange.

The popular belief that a diversified portfolio of stocks and bonds will

provide long‐term capital preservation and growth is simply not true

during bear markets or during periods of rising interest rates. For full

diversification, portfolios need an allocation to tangible assets,

including precious metals in order to provide negative correlation to

financial assets, and to offset any declines. While North American

investors have participated in the longest and highest equity bull

market ever during the past twenty years, it is important to understand

that this period was not the norm ‐ nor is it likely to be repeated over

the next twenty years. Today, most investment portfolios are not fully

diversified and are at risk of capital loss.

A secular bear market could last for a decade and wipe out any gains

achieved during the bull market. The 1920s bull market took the Dow

from 66 in 1921 to 381 by September 1929, and the ensuing decline took

it down 89% to 41. The current bull market started in 1982 at 777 and

reached a peak of 11,750 in January 2000. The rally in 2003 is typical of

a bear market rally similar to the 1930 rally in the US, and the 1980 rally

in the Japanese Nikkei Index. Will this bear market repeat what

previous secular bear markets have done? Will the ensuing decline

take the Dow below 777?



If a secular bear market is coupled with rising interest rates then GM’s

pension problems, as well as the pension problems of many of the

S&P 500 corporations, could lead to insolvency. GM’s pension plan has

a traditional split of 55%‐60% equities, 30%‐35% bonds and 10%‐15%

other assets. There is no mention of any allocation to precious metals

to provide portfolio insurance and to help offset losses that these

assets may suffer.

While many retail investors and pension fund managers believe in

the buy‐and‐hold strategy, it does not work during a bear market.

Many of the baby‐boom generation will not live long enough to even

break even on their investments during the coming bear market.

Many corporations with underfunded pension liabilities may face

bankruptcy long before this strategy delivers the necessary returns to

fund their pension obligations. Investors in the Dow of 1929 had to

wait 30 years just to break even in inflation‐adjusted terms. Japanese

investors who held stocks in the Nikkei are still down 71 percent,

15 years after the 1990 high.

Rather than buying and holding, investors need to consider the benefits

of reallocating portfolio holdings during cyclical trend changes. Apart

from the fundamental vulnerabilities for traditional financial assets,

it is important to understand the cyclical nature of markets. As asset

classes move through individual bull and bear phases, investors should

adjust portfolio allocations in order to maximize long‐term growth. A

portfolio overweight in a bear‐phase asset class can result in huge

losses requiring decades to recover from.

With respect to equities and precious metals, an important indicator for

portfolio adjustments is the Dow:Gold ratio. An increasing ratio, such

as that experienced from 1921 to 1929, from 1933 to 1968 and from 1982

to 2000, indicate that portfolios should be overweight in equities.

Declining ratios, such as those experienced from 1929 to 1933, 1971 to

1980 and 2000 onward, indicate that portfolios should be overweight in

gold. In 1933 and 1980 the ratio came close to 1:1, while in 2000 it

reached its highest level of 43:1. Since then, it has declined to 25:1 and

is trending lower. This indicator suggests that since March 2000

investors should have been allocating higher percentages to precious

metals and smaller percentages to equities. Will this ratio again be 1:1,

as the bear market in equities continues and the value of gold increases?

33

As the outlook for financial assets deteriorates, the importance of a fully

diversified portfolio with an overweight position in precious metals

will become increasingly more critical. Although no one knows for

certain the impact of rising oil prices, the risks posed by derivatives and

high debt levels, and the threats posed by overvalued equity and real

estate markets, there is more than enough justification to consider an

overweight position in bullion. Apart from a portfolio allocation of

5 percent in bullion during all market conditions, an overweight

position of at least 10 percent is essential today.


P r e c i o u s Me t a l s :

C r i t i c a l D i v e r s i f i e r

N o v e m b e r 2 0 0 6

Gold is on the rise. It recently surpassed $630 per ounce, an increase of

more than 145% from its low of $254. As of mid‐2005, it has increased

approximately 30% in all currencies, and is no longer simply reflecting

US‐dollar weakness. Media coverage attributes these increases to

supply shortfalls, geopolitical concerns, rising oil prices, inflation fears

and US financial imbalances. The reports typically focus on trading

implications, since most investors and analysts think of gold as a short‐

term speculative trade in an industrial commodity. Platinum and silver

have both outperformed gold since 2000, but they have received little

attention. There is, however, an important reason why investors should

pay attention to precious metals: strategic asset allocation.

Strategic asset allocation ensures a fully diversified investment

portfolio by properly balancing asset classes of different correlations in

order to maximize returns and minimize risk. While many investors

believe their portfolios are diversified, they typically contain only three

asset classes ‐ stocks, bonds and cash. Real estate, commodities,

precious metals and collectibles rarely form part of most investorsʹ

portfolios. Containing only three asset classes out of seven, such

portfolios are clearly not adequately diversified. Precious metals

provide effective diversification and improve returns, while at the same

time reducing volatility during both bear and bull markets. The old

Wall Street saying, ʺPut 10% of your money into gold and hope it

doesnʹt work,ʺ still holds true today.


The validity of this old adage was recently confirmed in a June 2005

study carried out by Ibbotson Associates. Bullion Management Services

Inc. commissioned the study, entitled ʺPortfolio Diversification with

Gold, Silver and Platinum.ʺ Rather than examine the fundamental

reasons behind the current bull market in commodities, it addresses the

fact that relatively little research has been done on the role of precious

metals in strategic asset allocation. Particular attention was spent on the

correlations of precious metals with traditional asset classes, and how

this relates to diversification. Importantly, the Ibbotson study did not

take into account the various drivers currently contributing to rising

prices. Instead, it used current (low) CPI statistics, and projected a

continuance of similar performance for equity and bond markets.

Low correlations between asset classes are the basis for diversification.

Many investors believe their portfolios are diversified if they contain a

mix of stocks, bonds and cash. Unfortunately, correlations between

traditional asset classes have been on the rise resulting in portfolios that

are not adequately diversified. From 1926 to 1969, the correlation

between annual total returns for US stocks and bonds was an attractive ‐

0.02. Recently, US stock and bond market correlations have increased.

This tendency is reflected in the 10‐year rolling correlations from 1970

through 2004 that ranged from ‐0.03 to 0.80. The uncertain diversification

benefit, in combination with attractive returns observed in other asset

classes, drives the vigor with which opportunities in non‐traditional (or

alternative) asset classes have been pursued in recent years. The primary

method for improving the risk‐return characteristics of the efficient

frontier is to expand the opportunity set of available asset classes.

Ibbotsonʹs study examined a 33‐year time period from February 1971 to

December 2004. While there is data available for gold and silver that

predates 1970, it is less pertinent because the US dollar was still

convertible to gold at that time, and the price of gold was fixed. After

US President Richard Nixon closed the gold window on August 15,

1971, the price of gold was allowed to float.

Although there is some debate on what constitutes an asset class, it is

generally agreed that there are capital assets such as stocks, bonds and

real estate, consumable assets such as commodities and store‐of‐value

assets such as currency and fine art. The fact that precious metals are

both consumable assets and store‐of‐value assets is not well understood

by the investment community. While the three constituents are all

37

precious metals, gold and silver have a long history as monetary assets

and are often viewed as a safe harbor during times of crisis or high

inflation. Conversely, during an economic expansion, the commodity

demand for silver and platinum is thought to increase.

Since an investment in mining stocks does not provide a direct

exposure to precious metals, the study focuses on a direct, physical

investment in an equally weighted portfolio or composite of gold, silver

and platinum bullion. Ibbotson constructed an equally weighted

composite index using gold, silver and platinum bullion, and referred

to it as the Spot Precious Metals Index (SPMI). Ibbotson used this Index

as a proxy for the precious metals asset class.

Over the entire 33‐year period, the three equity asset classes outperformed

the other asset classes. The overall performance of the SPMI was closer to

that of the fixed income asset classes. The SPMI outperformed both cash

and inflation. For over 11 years (May 1973 to August 1984) the SPMI was

the top‐performing asset class, with the longest run of any of the asset

classes. During the low inflation period, the SPMI had the lowest

compounded annual return. During the high inflation period, the

compounded annual inflation rate was 8.62%, and the SPMI had the

highest compounded annual return of 20.83%. For the period studied,

precious metals provided a substantial hedge against inflation.

While the standard deviation of the SPMI is quite high in isolation,

according to modern portfolio theory it is the interaction of asset classes

with each other that provides diversification. Of the 33 years of annual

data, there were nine years during which US large‐cap stocks had

negative returns. During these nine years, the SPMI had the highest

average arithmetic return.

Of the 33 years of annual data studied, there were six years that the

equally weighted portfolio of traditional asset classes had negative

returns. The average arithmetic return of the portfolio of equally

weighted traditional asset classes for these six years was negative 3.5%.

For the same six years, the average arithmetic return of the SPMI was a

positive 13.4%. Precious metals provided positive returns when they

were needed most.

Of the seven asset classes, precious metals is the only one with a

negative average correlation to the other asset classes. It is also worth

noting that, excluding cash, precious metals is the only asset class with

Precious Metals: Critical Diversifier


a positive correlation coefficient with inflation, which is further

evidence that precious metals act as a hedge against inflation.

HISTORICAL CORRELATIONS (1972 - 2004)

The historical efficient frontier with precious metals is superior to the

historical efficient frontier without precious metals. With the exclusion

of the maximum return asset allocation, including precious metals in

the opportunity set improved the risk‐return tradeoff over the entire

historical efficient frontier. Importantly, the allocation to precious

metals does not come at the expense of any single asset class, but rather

it comes from a reduction in several asset classes. This suggests that the

unique risk/reward profile of precious metals makes them a useful

diversification tool in strategic asset allocation.

Based on the historical efficient frontiers, Ibbotson found that including

precious metals moderately improved the efficient frontier. Allocations

ranged from approximately 0% to 9%. Based on the forward‐looking

resampled efficient frontiers, asset allocations that include precious

metals have better risk‐adjusted performance (as measured by Sharpe

39

ratio) than asset allocations without precious metals. Investors can

potentially improve the reward/reward ratio in conservative, moderate,

and aggressive asset allocations by including precious metals with

allocations of 7.1%, 12.5%, and 15.7%, respectively. These results

suggest that including precious metals in an asset allocation may

increase expected returns and reduce portfolio risk.

ASSET ALLOCATIONS

While there are many paper proxies for precious metals that can

provide trading opportunities during a bull market, the hedging

benefits and protection against Fat‐Tail events such as a currency crises

or derivatives accident may only be available if actual bullion is held.

Many precious metals investments are simply counter‐party liabilities

and not an actual investment in bullion. In the event of a counter‐party

default, the benefits of bullion may not be realized at exactly the time

when they are needed most. From a strategic asset allocation point of

view, therefore, it is critical that fully allocated, segregated and insured

gold, silver and platinum bullion is held.

Precious Metals: Critical Diversifier

P l a t i n um :

Da r k Ho r s e , B r i g h t F u t u r e

M a r c h 2 0 0 7

As president of The Millennium BullionFund, I am often asked, ʺWhy

does the Fund hold platinum? Why not just gold and silver?ʺ

Platinum provides a number of benefits to investment portfolios.

Including all three precious metals means portfolios can achieve full

diversification within the precious metal group and experience reduced

volatility, thereby improving overall performance. Although there are

other precious metals such as palladium, rodium and iridium, only

gold, silver and platinum have dual roles as monetary assets as well as

industrial commodities.

While many investors think of precious metals as merely commodities,

their monetary roles can at times be the driving force for price

increases. While gold and silver have been used as money for over 3000

years, platinum is a relative newcomer. The first platinum coins were

issued in Russia in 1828. Over the next 18 years, the Russian

government minted over 500,000 ounces of platinum and introduced to

the notion that platinum was not just a commodity but, like gold, also a

store of value. Today most mints offer gold, silver and platinum coins.

All three metals have the necessary attributes to function as money.

Platinumʹs name comes from the Spanish expression for ʺlittle silverʺ.

The Conquistadors first introduced platinum to Europe when they

brought it back, along with plundered gold and silver, from the New

World. During the nineteenth century platinum became much sought‐

after for jewellery, and was the metal of choice for many royal houses.


Platinum is the rarest of the precious metals and its price reflects this.

It takes a massive amount of ore ‐ approximately 10 tonnes ‐ to produce

a single ounce of platinum, and the extraction and refining processes

are both costly and time consuming. Excavating ten tonnes of ore takes

6 months of labour‐intensive mining, often in dangerous conditions at

mines that can be several miles deep.

Total annual world production is about 7 million ounces, a mere 10% of

the worldʹs annual gold production of 76 million ounces, and less than

1% of the worldʹs annual silver production of 416 million ounces. All

the gold ever mined would fill an area the size of a 3‐metre high tennis

court, while all the platinum ever mined would hardly fill 25 cubic feet,

or the size of a crate used to ship automobiles.

While the media is starting to notice that gold and silver have jumped

to new 25‐year highs, there has been little or no mention of platinum,

even though its rise has been even more spectacular. On November 21,

2006 platinum soared to an intra‐day high of $1,350 per ounce,

smashing through its previous all‐time high of $1,070 reached in 1980.

In contrast, the previous highs attained by gold and silver ($850 and

$50 respectively) are still some way off. Also largely ignored is the fact

that platinumʹs percentage increase of 190% from the beginning of 2000

has surpassed silverʹs 150% rise and goldʹs 120% rise. Surprisingly,

there is little or no mention of platinum prices in the mainstream press.

43

Even though platinum has surpassed its 1980 high in nominal terms, it

still has a long way to go before reaching its inflation‐adjusted high of

$2,630. Since demand for platinum applications keeps growing while

mine supply remains relatively fixed, the price of platinum is likely to

exceed that inflation‐adjusted high.

Platinum: Dark Horse, Bright Future


The quiet bull market in all three precious metals ‐ gold, silver and

platinum ‐ is important to investors. A portfolio cannot be fully

diversified if it only contains a mix of stocks, bonds and cash because,

since 1969, stock and bond correlations have been increasing. Precious

metals are the most negatively correlated asset class to traditional

financial assets such as stocks and bonds. When they fall, precious

metals tend to rise and vice versa, so precious metals act like portfolio

insurance. Today, every portfolio benefits from an allocation of at least

5% to precious metals in order to reduce volatility and risk.

LIMITED SOURCES OF SUPPLY

Platinum is in a secular bull market strongly supported by

supply/demand fundamentals. Supply is limited and hard to excavate.

Total world reserves that can be economically mined are estimated at

3.5 billion ounces by the US Geological Survey. Unlike all other metals

and oil, platinum deposits are limited to only two main areas of the

world. Due to the distinctive characteristics of platinum deposits,

geologists consider it unlikely that significant new resources will be

found. South Africa and Russia are the richest sources, with South

Africa accounting for about 78% of total annual world production, and

63% of the worldʹs reserves. Russia accounts for about 13% of total

annual world production. North and South America are less important

sources. Unlike gold, there are no large above‐ground supplies of

45

platinum. Any interruption of mine production, because of political

instability or labour turmoil, for instance, would catapult the price into

orbit. The cost of mining in South Africa has climbed recently because

of strength in the rand, and the increased cost of oil. Russian

production suffered during the transition period before and after the

collapse of the Soviet Union, but new investment in modern plants and

equipment could dramatically boost output.

In 2006, total mine supply was 7 million ounces, with South Africa

producing 5.4 million ounces and Russia 895,000 ounces. While North

America produced 365,000 ounces, it consumed 1,085,000 ounces. Since

1997 demand has exceeded mine supply by 8,285 million ounces,

resulting in above‐ ground stocks being depleted by 2,590 million ounces

during the period. Recycling provided another 5,695 million ounces.

INELASTIC DEMAND

Demand for platinum has increased from about 2.6 million ounces in

1975 to 7 million ounces today. Unlike gold, over 50% of the platinum

produced is consumed (destroyed) in industrial applications. Platinum

is indispensable for many industrial uses because of its unique physical

and chemical characteristics, which make it suitable for many different

applications. Platinumʹs catalytic properties, inertness, durability,

electrical conductivity, and high melting point are useful in a variety of



industrial applications, while its rarity, strength, and beauty make it a

popular choice for jewellery. Demand for platinum is inextricably

linked to economic growth, so future demand from emerging

economies will likely challenge current production capacity.

Approximately 30% of products manufactured today either contain

platinum or use it in production.

CHEMICAL PROCESSING

Platinum is used as a catalytic agent in the processing of nitric acid,

fertilizers, synthetic fibers and a variety of other materials. It can be

recycled following the catalytic process, making demand somewhat

volatile. However, platinum is an essential ingredient for many

catalytic processes and there are few satisfactory substitutes.

ELECTRONICS

New uses for platinum in electronics are discovered almost daily.

Currently, it is used in thermocouple devices that measure temperature

with high accuracy; thin‐film optical coating and temperature systems;

wires and electrical contacts for use in corrosive or high‐voltage

mediums; magnetic coatings for high density hard disk drives and

some of the new optical storage systems.

47

GLASS

Platinum is used extensively in glass production, because its hardness

and high melting point make it ideal for difficult high‐temperature

processes. It is also widely used in fiberglass production. The recent

introduction of glass fiber communications technology is a new and

powerful driver for demand. Although glass production is currently a

relatively small component of total demand, it is a high‐growth area.

PETROLEUM

Crude oil refining is a growth area for platinum, alongside economic

expansion in Asia. While other technologies that perform crude oil

separation do exist, the processes using platinum are the most

environmentally friendly. As new refineries are constructed and older

one are updated, platinum use in petroleum refining will rise accordingly.

JEWELLERY

Platinumʹs scarcity and beauty make it top choice for expensive

jewellery. Its hardness and durability mean it can be used in extremely

pure form, resulting in more secure stone settings. It resists oxidation

and discolouration. Its brilliant luster makes diamonds in particular

more luminous, but also enhances the beauty of all precious stones.

Platinum is hypoallergenic, making it the metal of choice for those who

suffer reactions to other materials.

AUTOMOTIVE CATALYSTS

Platinum, along with palladium, is in great demand by the auto

industry, which soaks up 33% of annual supply. Since 1999 auto

catalyst demand has more than doubled, largely because platinum has

a unique ability to control and remove harmful engine emission by‐

products. The importance of platinum within the auto industry will

continue to grow as governments around the world worlds ecologically

responsible governments demand greater levels of emission control,

and future demand could increase exponentially, along with price.

Diesel engines, already extremely common in Europe and Asia, are

becoming increasingly popular in North America. Currently only

platinum can be used for diesel auto catalysts, and only platinum can

be used in third‐world countries where sulphur levels in the fuel

exceed acceptable limits.



Diesel cars now account for more than 50% of the market in Europe,

where many models include soot filters that employ platinum as well

as oxidation catalysts. European auto catalyst demand is expected to

increase by 15% to 2.25 million ounces in 2007.

In North America many light diesel trucks will have catalysts fitted for

the first time in 2007, and platinum use in larger trucks is also expected

to increase. Platinum consumption by North American automotive

industries is expected to rise by 5% in 2007 to 1.5 million ounces.

FUEL CELLS

Manufacturers are experimenting with fuel cell power plants for

electric cars, creating a new use for platinum that could substantially

increase demand. Fuel cells use platinum to catalyze a chemical

reaction using hydrogen that creates electrical energy, but generates no

harmful emissions.

INVESTMENT CASE

According to recent data from Platinum Today, the vast majority of

investors ignore precious metals entirely, and hold portfolios that are

not diversified and are therefore exposed to economic downturns,

financial crises and inflation. Of the investors who do have an

allocation to precious metals, most concentrate on gold, while a few

more include silver. Many believe that an allocation to mining stocks

provides the required diversification. Although mining stocks often

track the price of the metals, there are times, such as during the market

decline in 1987, when mining stocks decline by a greater margin than

the broad equity markets even as the price of gold rises. Consider that,

in the 1970s, the price of gold itself outperformed Homestake Mining

49

shares by a factor of two. Few investors have an allocation physical

platinum, the best‐performing precious metal.

Where platinum is concerned, there are few stocks to choose from. The

major producers are South African stocks such as Impala Platinum, and

Anglo‐American Platinum. North American producers such as

Stillwater Mining and North American Palladium are primarily

palladium producers with some by‐product platinum production.

According to a study by Wainwright Economics, a Boston‐based

investment research and strategy firm, platinum is the leading indicator

of inflation. While gold and silver lead inflation by 12 months, platinum

leads by 16 months. This was confirmed in the current bull market

as the rise in platinum prices started in 1999, while gold and silverʹs

rise began in 2001.

According to David Ranson, president of Wainwright Economics,

ʺThe only asset class that is better than gold as an inflation hedge is a

basket that includes silver and platinum.ʺ


S i x My t h s a b o u t Go l d

N o v e m b e r 2 0 0 8

Gold. People either love it or hate it. There aren’t many who feel

ambivalent toward it. Unfortunately, gold is deeply misunderstood by

investors, and that misunderstanding is hurting their portfolio returns.

Many in the investment community trot out the old myths about gold:

that it is a bad investment; that it is very risky; that it is not a good

inflation hedge. But is there anything behind these assertions? If

investors take the time to examine the facts, these commonly held

beliefs simply do not stand up to scrutiny. It is precisely because these

myths have become so prevalent that gold is still undervalued. Once

the general public realizes these beliefs are not valid, the price of gold

will be much higher.

MYTH 1: GOLD IS A BAD INVESTMENT

A frequently cited argument is that since it peaked at $850 per ounce

(all amounts in U.S. dollars unless otherwise noted) in 1980, gold’s

return has been poor compared to the major stock indices. However,

that peak price was a short‐lived, single‐day aberration. Investors who

avoided the mania phase and purchased gold one year earlier in 1979 at

its average price of $306 per ounce also avoided any significant losses

during the subsequent bear market. The performance of different asset

classes varies from cycle to cycle. The previous cycle from 1968 to 1980

saw the Dow Jones Industrial Average remain flat with significant

volatility, while gold increased by 2,300 percent. In the current cycle,

which began in 2002, gold has posted a compounded return of

14 percent, while 15 of the 30 Dow components are negative.


Many studies compare gold to equities over peri‐ods as far back as the

1700s. But these studies ignore the fact that gold’s price was fixed until

1971. Prior to that time, gold was money and not an investment.

Interestingly, virtually none of the stocks listed in the 1700s still exist

today. Instead, the returns of major indices such as the Dow are boosted

by the removal of bankrupt companies and poor performers, which are

replaced by high performers. Three of the 30 companies that made up

the Dow in 2000 have since been replaced.

From a strategic portfolio allocation viewpoint it is easy to see why

Ibbotson Associates, one of the world’s most highly regarded asset

allocation specialists, determined that holding between 7.1 percent

and 15.7 percent in precious metals bullion reduces portfolio volatility

and improves returns.

MYTH 2: GOLD IS NOT A GOOD INFLATION HEDGE

The arguments against gold as an inflation hedge are usually based on

calculations arising from the intra‐day price spike in 1980. While gold

did not keep up to inflation using daily prices from 1980 to 2002, the

annual average gold price has kept up extremely well since 1971, when

the price was no longer fixed, Figure 1. During the same timeframe, the

U.S. dollar lost about 80 percent of its purchasing power. In fact, all the

world’s major currencies have depreciated by significant amounts due

53

to continuous excessive increases in the money supply. The impact of

this devaluation on real returns is significant.

Conversely, gold has not only maintained its purchasing power but

increased it against all major currencies. It will continue to do so as long

as the world’s central banks keep increasing the money supply by a

greater percentage than their country’s GDP growth.

More importantly, gold maintains its purchasing power not only

during inflationary periods, but also during deflationary periods. An

extensive study, published by Roy Jastram, analyzed the purchasing

power of gold in England and the U.S. from 1560 to 1976. Jastram

concluded that gold held its value remarkably well over time. The

purchasing power of gold and precious metals actually increases

during deflationary periods because other assets decline in price by a

much greater amount than precious metals do.

As central banks continue to accelerate the pace at which money is

printed, inflation will increase, and the purchasing power of paper

currencies will decline. This will result in more and more astute

investors fleeing to the safety of gold. As a con‐sequence, goldʹs price

should rise far in excess of the Consumer Price Index and the true

inflation rate. In order to protect portfolios from rising inflation,

Wainwright Economics concluded that an all‐bond portfolio would

need an 18 percent allocation to gold, silver and platinum, while an

all equity portfolio would need 40 percent just to stay ahead of inflation.

MYTH 3: GOLD IS A RISKY INVESTMENT

Risk means different things to different investors. A pension fund may

perceive risk as a failure to meet its liabilities, whereas an asset

manager may view risk as a failure to meet its benchmark. Most

investors, however, associate risk with a loss of their capital or

underperformance of their investments in comparison to their

expectations. ʹRisk comes from not knowing what you are doingʹ according

to Warren Buffett.

There are many kinds of risk: currency risk, default risk, market risk,

inflation risk, systemic risk, political risk, interest rate risk and liquidity

risk. While all of these apply to financial assets, many do not apply to

gold bullion. Physical bullion is not subject to default risk, liquidity

risk, political risk, inflation risk or interest rate risk. In the rare

Six Myths About Gold


circumstance of strong currencies, gold may be subject to short‐term

currency risk and, at times, to market risk. Unlike financial assets,

however, gold bullion cannot decline to zero. Gold is the only asset that

can protect wealth from non‐diversifiable systemic risk.

Volatility or standard deviation are often used as measures of risk, and

gold is considered to be quite volatile. However, when annual

compounded returns are plotted against standard deviation, the

individual Dow stocks are all more volatile than gold, and all but two

of the Dow stocks had poorer performance than gold, silver, and

platinum over the past eight years. Figure 2.

Returns are important, but even more important is to compare

risk‐adjusted returns. Clearly, an investment that has higher volatility

may still be attractive if the returns are appropriately higher.

Nobel prize‐winning economist William Sharpe devised the most

commonly used measure of risk‐adjusted performance: the Sharpe

Ratio. This ratio measures the amount of excess return per unit of

volatility. The interpretation of the Sharpe Ratio is straightforward: the

higher the ratio the better.

Bullion is unlikely to suffer underperformance risk in the near future.

Demand for gold, silver and platinum is increasing for both commodity

and monetary attributes, while annual mine production is declining.

55

As the price of oil continues to rise due to production declines and

increased demand, inflation will accelerate. As central banks increase

money supply at accelerating rates, the purchasing power of currencies

will continue to decline. As these two major trends interact with each

other, the price of gold will continue to rise.

MYTH 4: GOLD DOES NOT PAY DIVIDENDS OR INTEREST

The Bank of England used this argument to justify selling half the

countryʹs gold holdings at the bottom of the market in 1998. It wanted a

ʹsafeʹ investment, one that would generate interest, and it chose U.S.

treasury bills. The gold was sold for under $300 per ounce. In the

months following that sale, the price of gold tripled, and the value of

the U.S. dollar lost 30 percent against the British pound. The currency

exchange losses plus the opportunity cost resulted in billions of pounds

in losses, significantly offsetting any interest income the Bank might

have received.

The same is true for bond investors. In an inflationary environment, the

ʹrealʹ or inflation‐adjusted interest rate they receive is often negative.

Gold, like any other asset that sits in a vault, will not earn interest or

dividends, but neither is it at risk. No asset class generates income

unless you give up possession and take the risk of not getting it back.

However, goldʹs capital appreciation is many times greater than the

prevailing interest yields, while not being subject to any of the risks that

interest‐bearing investments are subject to. For a comparative analysis

of holding bonds versus a systematic withdrawal program for BMG

BullionFund units, seewww.bmgbullion.com/bondsvsbullion

MYTH 5: GOLD IS AN ARCHAIC RELIC

Gold is often referred to as an archaic relic with no monetary role in

todayʹs modern digital society. Several facts contradict this view. The

worldʹs central banks still hold 29,000 tonnes of gold in their reserves.

Gold, silver and platinum trade on the currency desks ‐ not the

commodity desks ‐ of the banks and brokerage houses. The turnover

rate of physical gold bullion, between the nine members of the London

Bullion Market Association, currently averages $24 billion per day.

Trading volume is estimated at seven to ten times that amount. Clearly,

gold is still trading in its traditional role as an alternative currency.



MYTH 6: MINING STOCKS ARE BETTER INVESTMENTS THAN BULLION

While mining stocks can generate impressive returns during an

uptrend in precious metals prices, they do not always outperform

bullion. It is unfair to compare junior mining companies to bullion

because of the huge disparity in risk. While successful junior miners

can generate impressive returns, over 90 percent of precious metals

discoveries never become productive mines. A better comparison

would be the larger producers. While mining stocks have outperformed

bullion during the early stages of this bull market, gold bullion has

outperformed the major mining indexes since March 2007. Figure 3.

Mining stocks tend to be significantly more volatile and risky than

bullion, and during sharp market declines they tend to follow the broad

equity markets downwards ‐ even if the price of the metal is rising.

During the late stages of the bull market of the 1970ʹs, mining stocks

underperformed bullion. In order to adequately compensate investors

for the higher risk, mining stocks would have to outperform bullion.

CONCLUSION

Investors who take the time to carefully evaluate the benefits of bullion

will realize that these commonly held myths do not hold up to scrutiny.

Those investors stand to reap significant rewards. Investors who

believe these myths are missing out on the opportunity to add an asset

57

class that diversifies portfolios, protects against inflation, and may

provide better returns than traditional assets, such as stocks and bonds.

Under a worst‐case scenario of systemic risk, bullion may be the only

asset that holds its value. As these myths are dispelled and the price of

bullion rises, as many mainstream analysts predict, informed investors

will benefit from purchasing bullion at todayʹs undervalued prices.

When the public at large becomes fully educated with respect to

precious metals, it will bid up the price. Considering that global

financial assets are estimated at over $180 trillion, while total global

above‐ground gold is only $4 trillion (and above‐ground bullion is less

than $1.5 trillion), a massive wealth transfer event is likely to occur. It is

interesting to note that even a 10 percent switch from financial assets

to gold would result in a 450 percent to 1,200 percent increase in the

gold price.

The BMG Special Report: ʺThe Six Biggest Myths About Goldʺ is

required reading for sophisticated investors and advisors. This report

provides a more detailed and technical evaluation of the six myths.

Please visit www.goldmyths.com to download the report.


2 0 0 4 ‐ 2 0 0 9

P ompo u s P r o g n o s t i c a t o r s R e v i s i t e d

J u l y 2 0 0 9

In 2001, Colin Seymour published an article entitled 1927‐1933 Chart of

Pompous Prognosticators. In it, he documented the many Depression‐

era assurances given by politicians, economists, financial experts and

the media to the public, protesting that everything was fine and there

was nothing to worry about. Meanwhile, the stock market would

decline by 92%, the US dollar would be devalued by 40%, real estate

would drop 30% and unemployment would soar to 25%.

Today, we have a similar situation. Politicians, economists and the

media are assuring the public that everything is fine. But governments

around the world are frantically borrowing trillions of dollars to fund

bailout and stimulus plans, the stock markets have lost over 40% of

their value, real estate over 50%, and unemployment is approaching

10% in most major countries.

2004

1.“The ability of lending institutions to manage the risks associated with

mortgages that have high loan‐to‐value ratios seems to have improved

markedly over the past decade.” – Alan Greenspan [February 2004]

2005

2. “Home sales are coming down from the mountain peak, but they will level out at

a high plateau, a plateau that is higher than previous peaks in the housing cycle.”

– David Lereah, Chief Economist, National Association of Realtors [December 2005]


2006

“I don’t know, but I think the worst of this may well be over.” – Alan Greenspan, [October 2006]

2007

4. “The fallout in subprime mortgages is ʺgoing to be painful to some lenders,

but it is largely contained.ʺ – Treasury Secretary Henry Paulson [March, 2007]

5. “The impact on the broader economy and financial markets of the problems

in the subprime markets seems likely to be contained.” – Ben Bernanke [March 28, 2007]

6. ʺThis is far and away the strongest global economy Iʹve seen in my business

lifetime.ʺ – Treasury Secretary Henry Paulson [July 12th, 2007]

7. “In todayʹs environment, it is virtually impossible to violate rules.” – Bernie Madoff [November 2007]

61

2008

8. “Over the next few months, existing‐home sales are expected to hold fairly

steady as indicated by pending sales activity, then rise later in the year and

continue to improve in 2009.” – National Association of Realtors [January 2008]

9. “Although recent data suggest that the probability of a recession in 2008 has

increased, CBO does not expect the slowdown in economic growth to be large

enough to register as a recession.” – US Congressional Budget Office [January 2008]

10. “I donʹt think weʹre headed to a recession.” – President George W. Bush [February 2008]

11. “I donʹt anticipate any serious problems of that sort among the large

internationally active banks that make up a very substantial part of our

banking system.” – Ben Bernanke [February 28, 2008]

12. “No! No! No! Bear Stearns is not in trouble.” –Jim Cramer, CNBC commentator [March 2008]

13. “The worst is likely to be behind us.” – Henry Paulson [May 2008]

14. “Despite a recent spike in the nationʹs unemployment rate, the danger that

the economy has fallen into a ʺsubstantial downturnʺ appears to have waned,” – Ben Bernanke [June 9, 2008]

15. “Fannie Mae and Freddie Mac are fundamentally sound. Theyʹre not in

danger of going under.... I think they are in good shape going forward.” – Barney Frank, chairman of the House Financial Services Committee

[July 2008]

16. “We have no plans to insert money into either of those two institutions.”

(Fannie Mae and Freddie Mac) – Henry Paulson, [August 10, 2008]

Pompous Prognosticators Revisited


17. “My own belief is if we were going to have some sort of big crash or

recession, we probably would have had it by now.” – Canadian Prime Minister Stephen Harper [September 2008]

18. “Weʹre probably somewhere pretty close to a bottom.” – Fund manager Barton Biggs [September 2008]

19. “The fundamentals of our economy are strong.” – US Senator John McCain [September 2008]

20. “We remain committed to examining all strategic alternatives to maximize

shareholder value.” – Lehman Bros. CEO Dick Fuld, before bankruptcy [September 2008]

2009

21. “It’s a huge bull market rally.” – Jim Cramer, CNBC [June 2009]

Just as Seymour’s Pompous Prognostications proved devastating for

those investors who remained complacent due to those false

assurances, today’s investors would be wise to educate themselves on

the real risks and vulnerabilities they face today. In order to preserve

their wealth over the coming years, investors need to make wise,

informed decisions, stop being complacent, and avoid following the

false assurances of politicians and financial experts. With countless

risks and vulnerabilities facing the world, the next 20 years will not be

the same as the last 20 years.

Sources: FederalReserve.gov, BusinessWeek, CNBC.com, Realtor.org, Marketwatch.com, USA Today, Washington Post, Reuters, Associated Press, Bloomberg, BBC.com, TimesOnline.

E n s u r i n g t h e Qu a l i t y o f

P r e c i o u s Me t a l s P u r c h a s e s

D e c e m b e r 2 0 0 9

There have been a number of articles on the Internet about tungsten‐

filled gold bars, as well as fake and counterfeit coins being in

circulation. As precious metals prices continue to rise, there will be

more and more scams involving precious metals that will prey on

individuals trying to save money on the purchase price or storage costs.

This is false economy, as well as a risky approach that could result in a

complete loss of their investment instead of having precious metals

preserve their wealth.

Precious metals do not sell at a discount. Any metals offered at a

discount will either not meet good delivery standards, have illegal

source backgrounds or are to be delivered at a future date. Purchasers

should remember that it is much easier to create fake or counterfeit

coins and bars than it is to create counterfeit paper money. The

potential profitability for criminals is very tempting as tungsten, which

closely matches the density of gold, sells for about $49 per kilogram, a

fraction of the price per ounce for gold. At Bullion Management Group

(ʺBMGʺ), we receive many offers to purchase bullion at a discount, and

simply dismiss all such offers as not being credible. Very low storage

fees are also suspect, as they typically involve pooled accounts that may

not be backed by bullion, or the bullion is leased to third parties.

BMG deals exclusively with ScotiaMocatta, a division of The Bank of

Nova Scotia, for all of its bullion purchases. Records trace bullion

transactions in London back to the 17th century with the formation of


the oldest original member of the market, Mocatta & Goldsmid, in 1964.

It was, however, the introduction of the London Silver Fixing in 1897

and the London Gold Fixing in 1919 that marked the beginning of the

marketʹs structure and of the co‐operation between members that has

created the marketplace as it is today.

The growth in the number and type of market participants in the early

1980s, combined with the introduction of the Financial Services Act in

1986, brought about the formation of the LBMA in 1987. Mocatta &

Goldsmid was purchased by The Bank of Nova Scotia in 1997.

ScotiaMocatta is one of the eleven market‐making members of the

LBMA while BMG is an associate member of the LBMA.

The rules established by the LBMA mean members can trade bullion

between themselves without concern as to the quality or the purity

of the bars. Daily Turnover, the net difference in trades among LBMA

members, is in excess of US$37 billion for gold and US$5.45 billion

for silver. The actual volume is estimated at 7‐10 times the Daily

Turnover amount.

The LBMA sets the rules for good delivery bars. In January 2004, the

LBMA introduced Proactive Monitoring of the refiners on the

Approved List, an important initiative which further enhances the

reputation of the List and the refiners on it. Prior to the introduction of

Proactive Monitoring, a refiner only had to demonstrate its refining and

assaying ability at the time of its application for admission to the List.

Regular monitoring of those on the List ensures that the stringent

requirements for joining the List continue to be met.

The monitoring system necessitated the appointment of Supervisors (to

witness the dip‐sampling operation that provides samples for testing

by the LBMAʹs Referees). The monitoring operations are carried out

approximately every two months.

If a refiner produces both gold and silver, it is tested for both metals at

the same time. Gold refiners that only produce and sell ʺfour‐ninesʺ

gold may elect to be monitored by assaying a set of reference samples

(ranging in fineness from .995 to. 9999) sent to them by the LBMA.

These samples have been produced and crosschecked to the highest

standards by the panel of Good Delivery Referees.

65

If the LBMA receives a complaint about the quality of bars produced by

a refiner, it investigates the complaint and carries out a bar examination

if necessary. If the complaint appeared justified, the LBMA writes to

the refiner asking it to ʺstand behindʺ its bars by making appropriate

restitution to the customer.

Bars traded by LBMA members are maintained within a ʺChain of

Integrityʺ. This refers to a traceable chain of custody among trusted

trading partners where bullion bars are accepted at face value without

an assay test. COMEX rules specify an official ʺchain of integrityʺ for

COMEX GOLD contracts. The LBMA maintains a list of acceptable

member refineries that meet certain membership requirements and

have passed assay tests. Bullion products from these refineries will

generally be accepted by other members of the LBMA at face value

without further assay testing. However, the LBMAʹs chain of integrity

is purely informal. When purchasing bullion products the face value

can generally be accepted if the product can be shown to have

remained in the custody of a certified bullion repository since its

manufacture by an acceptable refinery.

Responsibility for the regulation of the major participants in the

London bullion market lies with the Financial Services Authority (FSA)

under the Financial Services and Markets Act 2000. Under this Act, all

UK‐based banks, together with other investment firms, are subject to a

range of requirements including capital adequacy, liquidity and

systems and controls.

Introducing bars into the LBMA system requires the sale or deposit of

the bullion with an LBMA member. Documentation may be required in

order to comply with Anti‐Terrorism and Money Laundering legislation

such as FinCen in the USA, NCIS in the UK, JFIV in China and Hong

Kong and FINTRAC in Canada. The identity of the bar owner needs to

be established and confirmed, as well as the source of the bars.

If the documentation and the background checks passed scrutiny, then

all bars coming from outside the Chain of Integrity are re‐assayed and

re‐cast to Good Delivery standards at the cost of the owner. For bars

coming directly from an acceptable refiner, or from another LBMA

member, spot checks are made to confirm weight and purity.

Ensuring the Quality of Precious Metals Purchases


In some instances, typically bars from ʺDeep Storageʺ from central

banks, bars that meet acceptable purity and weight but that do not meet

Good Delivery Standards for physical appearance are also required to

be recast. The LBMA clarified their position for ʺDeep Storage Barsʺ in

a press release in 2007.

In addition to the checks and balances provided by LBMA and the FSA,

BMG receives sales confirmation documentation for every bar

purchased from ScotiaMocatta. This documentation details the refiner,

the weight to three decimal places and the purity to three decimal

places. In addition, The Bank of Nova Scotia, as Custodian, provides

detailed inventory lists of all the bars held in storage. The physical

inventory is verified annually by KPMG as part of their audit for both

BMG Funds and BMG. These lists, for both the bars and the Funds, are

posted on the BMG website.

As a result, purchasers of either the BMG Funds or the BMG

BullionBars program are assured that all bars purchased meet Good

Delivery Standards.

As a result of these checks and balances it is highly unlikely that fake or

counterfeit bars would ever enter the LBMA Chain of Integrity. Should

it be discovered that a bar did not meet Good Delivery Standards or

was not of the stated purity or weight, The Bank of Nova Scotia and the

LBMA would intervene to correct the situation in order to meet the

representations in their sales documentation.

For more information on purchasing and storing physical bullion

please download our free report at: www.howtobuygoldreport.com.

Go l d i s Mon e y

M a r c h 2 0 1 0

In a speech I recently gave at The Empire Club of Toronto , I referred to

gold as the ʺanti‐currency.ʺ Gold is not and never has been a currency.

Gold is something entirely different and far more valuable. It is money.

CURRENCY VERSUS MONEY

Most investors confuse money and currency, but they are not the same

thing. Money is defined as a medium of exchange, a unit of account and

a store of value. For centuries, money referred to coins made of rare

metals (gold and silver) with intrinsic value, and to notes backed by

precious metals.

Currency, while it is a medium of exchange, is not a store of value. It

only derives its value by arbitrary fiat , government decree and hence

the term “fiat currency”. Paper banknotes represent money but they are

not money. They are simply promissory notes whose long‐term “value”

or purchasing power depends entirely on the fiscal and monetary

discipline of the government that issued them.

And therein lies the problem. In an era of massive fiat currency

expansion by profligate governments across the globe, today’s

currencies are depreciating in value faster than yesterday’s news.

Fortunately for precious metals investors, gold and precious metals

have risen in value, and will continue to rise in value against all

currencies because they have once again resumed their historical role as

stores of value: money.


THE DECLINE OF THE WORLD’S CURRENCIES

“Currency debasement isn’t a recent phenomenon. For decades,

governments around the world, through their central banks, have been

creating money out of thin air to cover their excessive spending and

mounting debt. Investors have for the most part accepted this subtle

form of taxation, because it seemed to have little personal impact. But

appearances are deceiving. Investors are discovering that the value of

their dollar‐denominated assets has actually declined a staggering

82 percent since 1971 (not coincidentally, the year the US cut its link to

the gold standard). Figure 1 tells the story.

THE MEDIA ARE USING THE WRONG MEASURING STICK

Every day, the media (via currency traders) informs Canadian investors

about the latest price of the Canadian dollar in US dollar terms, while

US investors compare the US dollar to a basket of the world’s major

currencies. But this information gives investors surprisingly little

insight into the true value of their portfolios. If we started measuring

the world’s currencies against money (i.e., gold), investors would be

horrified at the stark decline in the value of all currencies. Most

investors’ portfolios are heavily weighted towards currency‐

denominated financial assets (stocks and bonds), but few realize that

the true value or purchasing power of their portfolios is declining every

single year because of currency depreciation.

69

THE RATE OF CURRENCY DECLINE IS ACCELERATING

Since 1913 (the year the US Federal Reserve was established), the US

dollar has lost over 95 percent of its value. The US and Canadian

dollars have lost 82 percent of their value since 1971, as noted earlier.

But the rate of currency decline is now accelerating.

In the past ten years alone, the US dollar, the Canadian dollar, the UK

pound and the euro have collectively fallen 70 percent in value if

measured in real (currency‐debased) terms. In other words, when they

are priced in terms of gold (Figure 2).

IT’S ALL ABOUT THE (FIAT CURRENCY) MONEY SUPPLY

Not too long ago, all the world’s major currencies were backed by gold

because it was a universally recognized store of value. The gold

standard imposed fiscal and monetary discipline, since each country

had to hold enough gold to equal the amount of money in circulation.

But not any longer. Government spending around the world is

exploding, and (fiat currency) money supply, along with government

debt in the world’s major economies, is exploding along with it. But

nowhere in the world has spending become more out of control than

the US (Figure 3), where the monetary response to last year’s financial

crisis is creating yet another bubble, and this time it will be the bubble

to end all bubbles.

Gold is Money


COUNTRIES ARE INCREASINGLY AT RISK OF SOVEREIGN DEBT DEFAULT

“In the process of saving a few ‘too big to fail’ corporations and their bond

holders, policymakers are greatly increasing the risk of sovereign defaults.” – Puru Saxena, editor/publisher, Money Matters

The risk of massive and widespread sovereign debt default has never

been higher. “Official” US government debt has soared to 90 percent of

GDP, while multi‐trillion‐dollar budget deficits for the next several

years will send that number soaring. Japan, the world’s second‐largest

economy, was recently put on credit watch. Its debt is twice total GDP,

yet its newly elected government has announced much higher

spending for 2010. The UK’s 2009 budget deficit will be over 14 percent

of GDP, adding to a net debt that will reach 56 percent of GDP this

year, 65 percent in 2010 and 78 percent by 2015.

Spain, Italy and Portugal are facing major fiscal deficits, as is Eastern

Europe. Dubai is billions in debt and its prize jewel, Dubai World, is

bankrupt. Greeceʹs credit rating has been slashed, and its debt is

forecast to reach 130 percent of GDP. And then there is Iceland, whose

debt had exploded to seven times GDP before the global meltdown.

The country’s banking system has now collapsed, its currency is deeply

devalued, its real estate market has imploded and the country is in a

full‐blown economic depression.

71

THE INCREDIBLE SHRINKING DOLLAR

As the world’s reserve currency, the US dollar is a proxy for the rest of

the world’s currencies. The dollar’s decline is a direct reflection of

America’s deepening financial troubles, exacerbated by a ravaged

banking system that, by 2010, may see over one thousand banks

insolvent. In 2009, the US incurred a budget deficit of $1.4 trillion, and

its debt rose by $1.9 trillion due to off‐budget expenditures. These off‐

budget expenditures alone were more than the 2008 budget deficit. At

the end of 2009, America’s total debt was over 100 percent of GDP.

In their attempt to reflate the bubble‐driven economy, President Barack

Obama, Fed Chairman Ben Bernanke and Treasury Secretary Tim

Geithner have decided to add to this financial house of cards. Instead of

raising taxes or cutting expenditures, they have decided to borrow their

way out of the problem and have the Fed create money out of thin air,

which will almost certainly create another bubble. This bubble will

make the others pale by comparison and will help destroy the US

dollar. The dollar may be the world’s reserve currency, but China and

other countries are not only questioning its status, but also actively

campaigning for greater use of alternative currencies.

Gold is Money


INVESTORS ARE DEMANDING REAL MONEY

Where are most investors putting their cash? It should no longer be in

stocks. Key stock indices like the Dow Jones Industrial Average have

been flat to negative in nominal terms since the end of the last century.

But if the Dow is priced in gold (in other words, money) as opposed to

depreciating dollars (in other words, fiat currency), its decline is far

more dramatic. As Figure 4 shows, the Dow:Gold Ratio is not only in a

downtrend, the downtrend is steepening which is a continuing

indicator to move from equities to bullion.

Global creditors who currently hold trillions of dollars’ worth of dollar‐

denominated financial assets are dumping them to preserve their

wealth. That is why gold bullion, along with its precious metals

cousins, silver and platinum bullion, have been consistently keeping

their value against financial assets (Figure 5).

CENTRAL BANKS ARE BUYING GOLD BULLION

India recently bought 200 metric tonnes of gold bullion from the International

Monetary Fund for $6.7 billion. Russia has recently added 120 tonnes of

bullion to its reserves, while China has steadily (and surreptitiously)

increased its gold bullion reserves from 600 tonnes in 2003 to 1,054 tonnes

today. China is even urging its people to put five percent of their savings into

gold and silver because it is so worried about the dollar. And because trillions

73

of dollars of its reserves remain in US dollar‐denominated assets, China’s

central bank will be diversifying into gold for many years to come.

The world’s central banks know that gold is primarily a monetary

asset, not a commodity. That’s why a growing number of them are

quietly diversifying out of US dollars and adding to their 29,000

tonnes of gold reserves.

In its 2010 Precious Metals Outlook, Scotiabank noted that “seeing the

value of the dollar steadily erode must be a nightmare for large US

creditors such as China, Japan, South Korea, Russia, the oil producing

countries and Sovereign Wealth Funds (SWF)...

MAJOR INVESTORS ARE DIVERSIFYING INTO GOLD

It is not just governments that are dumping dollars for bullion. A

rapidly growing number of sovereign wealth funds (including China

Investment Corporation) are participating, as are major institutional

investors. Hedge fund manager John Paulson, who made $3 billion in

2008 by shorting subprime mortgages, recently took a multi‐billion‐

dollar position in gold as a hedge against inflation. Northwestern

Mutual Life Co.’s CEO Edward Zore said his company purchased

$400 million in gold (the first time in its 152‐year history) because “the

downside risk is limited, but the upside is large. We have stocks in our

portfolio that lost 95 percent. Gold is not going down to $90.ʺ

Hedge fund manager David Einhorn, through his Greenlight Capital

fund, has sold gold ETFs in order to invest in longer‐term and lower‐risk

gold bullion because of current US economic policy. Lone Pine Capital

significantly increased its stake in gold this year. Perhaps of even greater

interest to the unwary investor is a survey of US hedge fund managers

by London ‐based Moonrake r Fund Management :

90 percent (20 of the 22) of the hedge fund managers surveyed admitted

they had bought physical gold for personal investment. These

sophisticated investors know something that the average investor

doesn’t: that the global policy response to the financial crisis will not

only devalue the world’s major currencies, it will decimate the US dollar.

“Both China and America are addressing bubbles by creating more bubbles

and we’re just taking advantage of that.” – Lou Jiwei, Chairman, China Investment Corporation

Gold is Money


MANY INVESTORS STILL VIEW GOLD AS A COMMODITY

Individual investors are not so farsighted – yet. Because most of them

have only experienced one kind of market – a 25‐year bull market in

stocks – many still think gold is just a commodity like copper, zinc or

pork bellies. But gold is far more than that. It has a 3,000 year history as

money; for much of that time, it was the universal medium of exchange

because of its divisibility, portability, rarity, beauty, malleability and

indestructibility. Despite today’s negative sentiment, gold is not a

speculation or a barbaric relic. Gold is money. Gold retains its

purchasing power year after year, as Figure 6 shows.

Forty years ago it took 66 ounces of gold to buy a compact car. Today it

takes only 14 ounces. If you had put your money in gold instead of

dollars, the same car would actually be 79 percent cheaper, because

gold keeps its value. Houses, stocks and virtually every other asset on

earth would also be cheaper if bought with physical gold.

THE MORE INVESTORS LEARN ABOUT BULLION, THE BETTER FOR THEIR PORTFOLIOS

If you are already a bullion investor, now is the time to add to

your portfolio. If you are new to investing in bullion, now is the time to

start dollar‐cost‐averaging into bullion. I encourage investors to learn

as much as they can about bullion and about the markets in general.

A good place to begin is the Learning Centre section of our website

(www.bmgbullion.com). It offers a comprehensive look at the economy,

money, markets and bullion investing, and provides a variety

of thought‐provoking articles written by experts in the field of gold

and precious metals.

75

ʺWe have a market‐friendly Fed injecting a lot of liquidity in the system

which will set us up for another bubble economy. Excessive monetary

accommodation just takes us from bubble to bubble to bubble.ʺ – Stephen Roach, chief economist, Morgan Stanley

GOLD IS MONEY

Gold is money because it cannot be created out of thin air by

government decree. Unlike bonds, gold does not represent someone

else’s liability and, unlike stocks, gold does not rely on someone else’s

promise of performance. Gold is money because, unlike currencies,

impatient monetary policymakers cannot change its value. The rising

gold prices we have experienced for the last eight years do not signal a

bull market in precious metals, but rather a vote of decreasing

confidence in the future value of paper currencies.

Currency‐denominated financial assets are a disaster waiting to

happen. The current economic rebound is a mirage, being entirely

dependent on something artificial and unsustainable: massive

government spending. A new crisis is building out of unprecedented

fiscal and monetary mismanagement. Fortunately, smart investors can

protect their wealth from the coming storm. The true level of risk has

not been priced into the markets. The time to shelter your wealth from

the storm is now. And there is no safer investment on earth than

bullion, because bullion is and always will be money.

1Gold Outlook for 2010

Gold is Money

Why Bu l l i o n i s Ou t p e r f o rm i n g

Min i n g S t o c k s

J u l y 2 0 1 0

If the investment choice is between mining stocks and physical bullion,

it is essential to remember that these are different asset classes with

entirely different risk/reward attributes. Mining stocks and bullion

perform quite differently when the global economic environment is in

turmoil, as is the case today. Banking crises, trillion‐dollar deficits and

the accelerating depreciation of many of the world’s major currencies

do not create positive conditions for equity markets, which is why

investors are fleeing to the safety of physical bullion.

BULLION IS A SAFE HAVEN DURING TURBULENT TIMES

This flight to bullion was confirmed during the stagflationary 1970s.

Figure 1 shows that while Homestake Mining, the shares of the largest

North American producer at the time, increased by an impressive 800

percent during the 1970s, physical gold increased by 1,500 percent,

during that same time period. While it is true that many junior mining

companies outperformed both bullion and Homestake in the 1970s,

producing impressive returns for their shareholders, many other

juniors faded into obscurity, resulting in painful losses.

The volatility associated with junior mining companies versus blue chip

producers and physical bullion makes them a purely speculative

choice. However, if you have a high risk tolerance and a good advisor,

then a small allocation to junior mining companies may be appropriate,

especially those with established ounces in the ground. Juniors with a


new discovery can generate substantial capital gains, but they are still

highly speculative investments and can be very volatile.

BULLION OUTPERFORMS MINING STOCKS DURING FINANCIAL CRISES

While mining stocks can generate impressive returns during an

uptrend in precious metals prices, they do not outperform bullion

during times of crisis, as in the financial meltdown of 2008, for example.

79

Figure 2 shows the relative performance of the XAU mining index

against gold bullion. When global economic conditions deteriorate,

investors inevitably seek a safe haven for their wealth, rather than more

speculative investments. As can be seen in Figure 2, gold maintained its

strength throughout the turmoil, even as financial markets and mining

stocks (as represented by the XAU Index in purple) declined.

Blue chip gold stocks like Goldcorp and Barrick Gold can be good

investments because, unlike juniors, they are less likely to wither away

to nothing and frequently offer dividends. But timing is crucial because

producers can also be quite volatile. Other precious metals investment

options might include mining ETFs which holds a basket of gold

producers, but be prepared for a daily roller coaster ride. Regardless of

the type of investments chosen, every investor’s portfolio should be

diversified with precious metals.

BULLION HELD ITS OWN DURING THE 1987 MARKET CRASH, WHILE MINING STOCKS FELL

During sharp market declines, such as the 1987 stock market crash,

mining stocks tend to become correlated to the broad equity markets

rather than the price of bullion. Figure 3 shows the comparative

performance of mining stocks, gold bullion and the Central Fund of

Canada (CEF), a closed‐end fund that holds gold and silver bullion,

during the crash. As the chart shows, mining stocks declined more than

Why Bullion is Outperforming Mining Stocks


the Dow even though the price of gold was rising. The exchange‐traded

Central Fund behaved like an equity even though it holds bullion.

While mining stocks have significant appreciation potential beyond the

price of bullion, they are leveraged plays on bullion prices, and like any

form of leverage they carry a variety of risks. In addition to stock

market volatility and deteriorating economic conditions, potential risk

factors include: geopolitical issues, environmental issues, management

skills and performance, business model, financial strength, mine life,

production costs and efficiencies, increases in operating and energy

costs, hedging policies and exploration success.

GOLD BULLION IS NOT AN INVESTMENT

Many investors jump on the gold bandwagon without taking the time

to assess whether they are savers seeking wealth preservation or

speculators seeking capital gains. Mining stocks, especially juniors and

exploration companies, tend to be for speculation, while bullion is

about wealth preservation. But physical bullion should not be viewed

as an investment. An investment is defined as an asset that is expected

to produce earnings or capital appreciation at a later time. Bullion does

not pay dividends, income or interest, and should not be held,

primarily, for capital appreciation. If bullion isn’t an investment, what

is it and why does it continue to rise in price?

81

GOLD IS MONEY

Gold is primarily a monetary asset. It has been a universal medium of

exchange and store of value for three thousand years, and it backed

every major world currency until the twentieth century. The reason for

gold’s “rise” to prominence in recent years has little to do with the

metal itself; it is occurring because gold provides the ultimate

protection against economic mismanagement and currency destruction.

In an era of rampant currency creation, gold has resumed its historical

role as money. For a full explanation of this phenomenon, go to: “Gold

is Money” (www.bmgbullion.com/document/682).

THE “CASH” COMPONENT OF EVERY PORTFOLIO

Because gold and other precious metals do not depreciate in the long

term, it should replace the depreciating “cash” component of every

investor’s portfolio. Physical, allocated bullion is the foundation of the

precious metals investment pyramid (Figure 4) and, given current

conditions, it offers more safety and security than government bonds,

T‐bills and other traditional cash components.

GOLD IS THE ANTI-CURRENCY

In an era of fast money and currency destruction, bullion is real money.

Central banks are buying bullion, hedge funds and other institutional

investors are buying bullion. And the world’s largest creditor – China –

is diversifying out of dollars and buying bullion.

“When the price of gold moves, goldʹs price isnʹt moving; rather it is the value

of the currencies in which itʹs priced that is changing.” – John Tamny, Economist, H.C. Wainwright Economics

Most investors’ portfolios are heavily weighted in currency‐

denominated financial assets (stocks and bonds), but few comprehend

the extent of their purchasing power loss. The numbers in Figure 5 may

help put things in perspective: in the past ten years, the US and

Canadian dollars, the UK pound and the euro have, collectively, fallen

more than 70 percent in value if measured in that universal unit of

money, gold. In effect, investor portfolios have lost 70 percent of their

purchasing power. Currency destruction, while it is accelerating, is by

no means a recent event, however. Since 1913 (not coincidentally the

year the US Federal Reserve was formed) the US and Canadian dollars

have lost a staggering 96 percent of their value. Is this trend likely to

come to an end? Not in the foreseeable future.



SOVEREIGN DEBT GROWS, BUT GREECE IS NOT THE PROBLEM

The debt problems in Europe in general, Greece in particular, Japan and

the UK should be of grave concern to all investors. As the crisis widens

and deepens, all currencies are coming under pressure. The US dollar is

rising because it is currently perceived to be the least ugly of an ugly

bunch. But is it? Americaʹs budget deficit (13 percent of GDP) is nearly

identical to that of Greece, and its debt as a percentage of GDP is not far

behind. And America’s problems are one hundred times the size. In

2009, the US incurred a budget deficit of $1.4 trillion, and its debt rose

by $1.9 trillion due to off‐budget expenditures. These off‐budget

expenditures alone were more than the 2008 budget deficit.

At the end of 2009, America’s total debt was approaching 100 percent of

GDP, but most investors are unaware of another, far bigger burden:

trillions of dollars in unfunded liabilities for Social Security, Medicare

and Medicaid. Money the government promised to taxpayers for Social

Security has instead been borrowed for its own use. Money the

government promised to fund future Medicare and Medicaid benefits

and military/government pensions has not been set aside at all. Richard

Fisher, a member of the Federal Open Market Committee, believes total

US debt – including Medicare and Social Security – is over $122 trillion

(Figure 6). This is more than $390,000 for every man, woman and child

in the US, and the number keeps rising.

83

“Fiscally, we are in uncharted territory.

Because of this gigantic deficit, our country’s ‘net debt’ is mushrooming...

no one can know the precise level of net debt to GDP at which the United

States will lose its reputation for financial integrity.” - Warren Buffett, Chairman, Berkshire Hathaway

When, not if, interest rates rise from their present near‐zero levels, US

debt payments will soar because every percentage point rise in interest

rates adds an additional $120 billion in interest payments. And if

inflation were to take hold, rates could easily rise to 10 or 15 percent, as

in the 1970s stagflation era. If that were to happen, interest payments

alone would gobble up over 90 percent of government tax revenues.

With this kind of economic future on the horizon, is it any wonder the

US dollar is in irreversible decline?

A MUCH BIGGER CRISIS AWAITS

Current economic conditions are ripe for the onset of another, even

bigger financial crisis. Zero interest rates, trillion‐dollar sovereign debt,

trillion‐dollar bailouts and stimulus spending are almost certain to

result in spiralling inflation, which could lead to a hyperinflationary

depression. Economist John Williams delves into this growing

possibility in his Special Report on Hyperinflation ‐ 2010 update.

(www.shadowstats.com/article/hyperinflation‐2010)

“It is absolutely inevitable that the US will have to ‘default’

on part of its existing liabilities, since the long‐run trajectory of government

borrowing is clearly unsustainable.” - Niall Ferguson, Author, The Ascent of Money

As confidence in fiat currencies continues to decline, gold prices will

rise causing mining stocks to rise as well.



IT’S TIME TO PRESERVE YOUR PORTFOLIO’S PURCHASING POWER

In a world of increasing volatility and uncertainty, precious metals

bullion provides tangible, predictable wealth protection for currency‐

denominated investment portfolios. For the past several years, as

currency creation has reached unprecedented levels, gold, silver and

platinum have resumed their traditional role as a store of wealth. Over

time, purchasing, or adding to, a core holding of physical bullion is a

prudent investment strategy. While a minimum 10 percent allocation is

considered adequate under normal conditions, a much larger allocation

of 20 percent or more is suggested for protection today. If you have not

already done so, now is the time to rethink your investment strategy

and preserve your hard‐earned wealth with physical bullion.

Th r e e Dom i n a n t F a c t o r s Wi l l

Imp a c t P r e c i o u s Me t a l s i n 2 0 1 1

A p r i l 2 0 1 1

As we near the end of the first quarter of 2011, the potential for a

widening of the uprisings in North Africa and the Middle East has

pushed oil prices past the $100 mark. Long before the riots began,

commodity prices had risen to uncomfortable levels, having soared

over 30 percent in a matter of months.

Currency creation by emerging market central banks was, and is, a

major factor behind the rise in oil prices. Egypt’s M2 money supply, for

example, rose 13.3 percent during 2010, while China’s M2 money

supply increased by 17 percent and India’s M3 money supply increased

by 15 percent. When currency creation outpaces GDP growth, too many

artificially created rupees and yuan and pounds and euros chase too

few goods, and price inflation results (Figure 1).

In an economy largely propped up by quantitative easing and money

supply expansion, three dominant factors are likely to impact gold and

precious metals prices in 2011. They are:

Movement away from currencies

Central bank buying

China


FACTOR 1: MOVEMENT AWAY FROM CURRENCIES

Major currencies, including the US dollar, have been declining in

purchasing power for years, but now the rate of depreciation is

accelerating. Investors are losing confidence in the ability of the world’s

largest economy to lift itself out of its $14 trillion debt. When (not if)

interest rates rise from their artificially low levels, interest paid on the

debt will soar. The Washington Post estimates it will quadruple by

2014. “When governments reach the point where they are borrowing to

pay the interest on their borrowing they are coming dangerously close

to running a sovereign Ponzi scheme,” says economist Nouriel Roubini.

The US is rapidly approaching that point, and investor anxiety is

increasing in concert with the realization that currency creation for

bailout purposes ‐ the knee‐jerk monetary response to the financial

crisis – is no longer a temporary matter. As quantitative easing becomes

institutionalized, the “safe haven” US dollar continues its decline,

sending precious metals prices higher.

The Pe t rodo l l a r Di lemma

As the world’s reserve currency, the US dollar has enjoyed special

status. Since 1973, the dollar has been the only currency in which oil

could be traded, a key reason the US has been able to amass over

$14 trillion in debt. However, the unquestioned status of the dollar is

coming to an end. On November 24, 2010, China and Russia officially

87

“quit the dollar” and agreed to use each otherʹs currencies for bilateral

trade—including oil. Official trading on Moscowʹs MICEX Index began

on December 15, 2010. Loss of the petrodollarʹs hegemony would have

a devastating effect on the US, as this is essentially the only reason most

foreign countries need to hold US dollars. Robert B. Zoellick, President

of the World Bank, says the US would be “mistaken” if it continues to

take for granted the dollar’s place as the world’s reserve currency, and

that, “looking forward, there will increasingly be other options to the dollar.”

Mone t i z ing Debt by Demone t i z ing the Dol l a r

The US Federal Reserve is quietly trying to ward off economic disaster

by purchasing hundreds of billions of dollars of US Treasury bonds via

the second stage of its quantitative easing program, QE2. Few investors

seem to care that the Fed is in effect funding the US government; that

QE has created $2 trillion new US dollars out of thin air that debase the

value of existing US dollars; or that QE1 and QE2 have been pumping

liquidity into the equity markets, and thus pushing stock prices to

unrealistic levels. Monetary inflation leads to price inflation, and

today’s rising energy and food costs reflect that fact. Food prices have

political consequences in emerging markets because the cost of food

consumes such a large percentage of income.

Quant i t a t i ve Eas ing i s Globa l

QE programs are also at work outside the US. In October 2010, the Bank

of Japan unveiled its latest program, a 5‐trillion yen ($60.1 billion) fund

to buy assets including government bonds, corporate debt, exchange‐

traded funds and real‐estate investment trusts. Deputy Governor

Kiyohiko Nishimura of the Bank of Japan went out of his way to defend

the Bank’s QE actions. “It is crucial to avoid creating an impression of

the monetization of government debt. Otherwise, purchases may lead

to a substantial and lasting ratcheting‐up of long‐term rates which

would pose a serious problem for economic recovery and the financial

position of the government.”

The 9.0 earthquake and tsunami that rocked Japan in March have dealt

the country’s already struggling economy a potential knockout blow.

At the time of writing, Japan’s central bank had already poured nearly

60 trillion yen ($688 billion) into the economy, but that is just the

beginning of the money creation. Hundreds of trillions more new yen

are expected to be pumped into the economy over the next few months

in an effort to keep it afloat. Japan’s devastation and its efforts to

Three Dominant Factors Will Impact Precious Metals in 2011


recover are going to add fuel to the currency fire, sending precious

metals prices higher.

QE supporters say that QE currency creation is used to stimulate the

economy, and not used to finance government spending. This is a very

fine line indeed. Richard Fisher, president of the Federal Reserve Bank

of Dallas, doesn’t even bother to draw the line. He puts the blame on

Congress: “The Fed could not monetize the debt if the debt were not

being created by Congress in the first place,” Fisher said recently.

“The Fed does not create government debt; Congress does.” Fisher is

technically correct, but the Fed is and always has been Congress’s

enabler. Without acquiescence from the Fed, America wouldn’t have

been able to sink into its current debt quagmire.

The consequence of this movement away from currencies will be a

decline in real purchasing power. If we examine a 10‐year chart of the

US and Canadian dollars, the British pound, the euro and the yen

(Figure 2), we can see that these currencies have lost between 70 to 80

percent of their purchasing power in terms of gold. In truth, however,

gold is not rising. Currencies are falling in value, or purchasing power.

89

FACTOR 2: CENTRAL BANK BUYING

In 2009, for the first time in 20 years, monetary gold, or central bank

and investment buying, outpaced gold buying for industrial or

jewellery purposes. In 2010 China, Iran, Russia and Indiaʹs central

banks were all significant buyers as they moved cash reserves to gold.

As the flood of cheapening US dollars continues to flow into

developing world economies, emerging market central banks are

converting substantial amounts of their dollars and other paper

currency reserves into gold, partly due to currency‐related fears. In the

third quarter of 2010, Russian central bank gold holdings rose 7 percent

to 756 tonnes. In 2010, the Russian Central Bank bought two‐thirds of

its own gold production. In December we learned that China had

imported 209.7 metric tonnes of gold in the first 10 months of the year, a

500 percent increase over the same period in 2009. This was in addition

to the purchase of its own world‐leading gold production (Figure 3).

By the third quarter of 2010, Indiaʹs gold imports for the year, both

commercial and private, were 624 tonnes, putting them well over the

previous yearʹs total of 595 tonnes. Fourth quarter purchases could put

Indiaʹs annual total over 750 tonnes.



China and Russia need to acquire gold to bring their gold reserves to

outstanding currency ratio closer to that of Western central banks.

Russia needs to acquire at least 1,000 tonnes and China at least 3,000

tonnes to remain on parity with the US. Chinese officials have stated

publicly that China would like to acquire at least 6,000 tonnes.

Unofficially they have stated targets as high as 10,000 tonnes

FACTOR 3: CHINA

Investment demand for gold and silver is soaring, due in part to inflation

fears in many of the emerging economies. A key demand driver is China,

whose massive population and surging economic growth has led to rising

prosperity and a burgeoning middle class with a keen desire to protect their

new‐found wealth. Although the West shares many common economic

principles with the East, because the banking systems are similar, in one area

there is a clear distinction: how Easterners view the role of gold as money.

Western governments fear the rising gold price because it restricts their

ability to create currency. They fear rising silver and platinum prices

because these are harbingers of economic uncertainty and instability. In

the West, governments borrow and encourage their constituents to

follow their example. Banks encourage us to borrow for everything

from vacations to widescreen televisions made in China. They tell us

we are “stimulating” the economy through consumption. Generally

speaking, the investing public in the West sees gold as a wealth‐gaining

asset to be traded like stocks and bonds. This is why Westerners are

constantly fretting about the price of gold in currency terms.

China : A Dif fe ren t At t i tude Towards Gold

The Chinese government, on the other hand, respects gold. This is

evident by the laws they have passed to facilitate mining and private

gold ownership. China currently leads the world in gold production.

The government encourages the public to put 5 percent of their savings

— yes, they encourage saving — into gold. This is significant because

the Chinese can save up to 40 percent of their annual salary.

The campaign appears to be working: In the first two months of 2011,

domestic gold purchases in China jumped to 200 metric tonnes, far

outpacing the previous year. The Chinese see gold as a wealth‐

preserving asset that will weather all seasons. Pierre Lassonde, former

CEO of Newmont Mining, thinks that buying by the Chinese public

will eventually propel gold prices into the stratosphere.

91

Cur rency Wars

Federal Reserve Chairman Ben Bernanke’s $600 billion QE2 program

infuriated the Chinese. It not only debases the value of the $840 billion

in US Treasuries that the Chinese hold, but it also requires them to

debase the yuan, which is pegged to the dollar. This causes inflation,

which is showing up in rising food prices. The ensuing rift between the

US and China may develop into the major gold‐related news story of

2011. Currency wars lead to price wars. We saw the beginning of this in

November 2010, when China began putting price controls on Wal‐Mart.

Although all major countries are participants in this “race to debase”,

the battle between the US and China is the most significant. China has

been financing the US for years through the purchase of US

government securities. In 2010 we saw an alarming decrease in Chinese

US Treasury purchases. This has led to a vicious cycle in which the Fed

has to buy US debt with more currency creation, which leads to more

debt and interest payments for the US taxpayer.

Morgan Stanley Asia Chairman Stephen Roach says the US should

expect “a natural, organic reduction of Chinaʹs buying of dollar‐

denominated assets.” This is troubling news for an already

beleaguered US dollar, as America’s escalating debt will likely

encourage more policy measures that devalue the dollar, further

depreciating China’s US bond portfolios in the coming years.

THREE IRREVERSIBLE TRENDS

In addition to the three immediate factors helping to drive metals prices

higher in 2011 – movement away from currencies, central bank buying

and the China effect – three longer‐term, irreversible trends are at work

that will likely affect the price of gold and currencies for decades.

These three trends are:

Aging Population;

Outsourcing; and

Peak Oil

Trend 1 : The Aging Popu la t i on

The aging population is a result of two things: a populace that is living

longer, and the “pig in a python” effect of a tidal wave of baby boomers,

born between 1946 and 1963, who are beginning to retire (Figure 4).



As people age, they spend less and downsize. GDP and tax revenues

are reduced and a much smaller workforce follows the baby boomers,

creating a triple whammy. This problem is universal. In China, it is

further exacerbated by the one‐child‐per‐couple policy. Governments

will have no choice but to create more currency and further debase it.

The baby boomer generation has been the world’s prime socio‐

economic driver for the past 50 years. As they were getting married,

buying houses, having children and starting to invest, the boomers

drove a growth economy. Now, as they approach retirement, the

economy will slow as boomers’ spending habits decline, because they

already own everything they need. So consumer spending, which has

driven the economy for the last number of years, will begin to drop.

Moreover, as they start withdrawing money from the system in terms

of pensions, social security and Medicare, boomer retirees will become

a cost to society. In the US, social security is a giant black hole with

obligations in the order of over $100 trillion. The government is already

spending money that is not in the program. As the baby boomers age,

Medicare obligations are going to be massive.

This will result in a reduction in GDP, a reduction in government

revenues and an increase in government outlays, which will force the

government to borrow more money. At some point, monetization by

93

the Fed will go into overdrive because the US will no longer be able to

sell its debt to foreigners. This is not just an American problem,

however. Japan, Russia and many European countries are in the same

boat. As governments race to debase their currency by creating more

and more, the price of precious metals will continue to rise.

Trend 2 : Outsourc ing

Outsourcing has almost entirely destroyed the manufacturing sectors of

many first‐world countries like the US and Canada, and much of

Europe. The Chinese worker who built your iPhone made $287 a

month; this was after a well‐publicized raise. The West simply cannot

compete with these labour costs. The US was the worldʹs largest

manufacturer after WWII, and has driven the worldʹs economy ever

since. However, the dismal US unemployment rate (Figure 5) means

Americans are no long able to buy things with their former gusto. As

factories move offshore, the high unemployment becomes systemic.

Without jobs, the GDP and the tax revenues of the US fall. As the

mountain of federal, state and municipal debt becomes harder to

service, the government will be forced to go even deeper in debt and to

further debase its currency.



Trend 3 : Peak Oi l

Peak oil is the point at which the maximum rate of global petroleum

extraction is reached, after which the rate of production enters terminal

decline. Peak oil has already been reached in the US, Alaska and the North

Sea (Figure 6). In other words, the era of cheap oil is rapidly coming to a

close. In the next few years, Mexico will become an importer of oil and the

US will lose its third‐largest supplier. America’s fragile, highly indebted

economy relies on this land‐based cheap oil to grow, and it will not easily

withstand the shock of transitioning to more expensive alternatives.

September 2010, a German military think‐tank reported that the

German government was taking the threat of peak oil seriously and was

preparing accordingly. Numerous studies from around the world have

concluded that we are very close to peak oil production, which will be

accelerated due to Gulf drilling bans and unrest in the Middle East.

Even the National Petroleum Council recognizes the end of cheap oil.

In its July 2007 report, “Hard Truths: Facing the Hard Truths about

Energy,” the Council concluded that “hydrocarbon resources are

becoming more difficult to access and challenging to produce [and the]

costs of developing and delivering energy are escalating.”

Peak oil will inevitably lead to uncontrolled inflation on a global scale,

because oil is a vital component in the discovery, delivery,

manufacture, refinement, processing, packaging, distribution, sale and

consumption of virtually every product on Earth.

95

According to the International Energy Agency, over the past year the

oil import costs for the 34 countries that make up the Organisation for

Economic Co‐operation and Development soared by $200 billion to

$790 billion. “Oil prices are entering a dangerous zone for the global

economy,” reports Fatih Birol, the IEA’s chief economist. Interestingly,

he made these remarks before the uprisings in North Africa sent oil

prices skyward.

Oil prices are surging (Figure 7), but they could skyrocket over the

coming weeks and months if the uprisings in North Africa spread to

Algeria and Saudi Arabia. Some analysts are predicting $220 per barrel

should Libya and Algeria halt oil production.

As Ambrose Evans‐Pritchard of the Telegraph notes, “A shut‐down in

Libya and Algeria would cut global supply and reduce OPEC spare

capacity to levels comparable with those at the onset of the Gulf War

and worse than during the 2008 spike, when prices hit $147. Both price

shocks preceded a recession in Europe and the US.”

The US is the world’s largest consumer of oil, importing almost

10 million barrels per day. China is now the second‐largest consumer.

Among the top 15 consumers are Japan, Germany, France, Canada,

Italy and the UK. Yet outside of Canada and China (which,

like the US, produces roughly half of its daily consumption and is



also the world’s third‐largest producer), none of the others are in

the top 15 for production.

Rising prices as a result of peak oil will hurt the fragile US economy

most, because America currently pays less for oil and gas than any of

the first‐world countries. When added to the effects of the waning

strength of the petrodollar, the results will be devastating.

OUTLOOK FOR PRECIOUS METALS

Gold, silver and platinum prices will continue to rise, driven by a shift

away from depreciating paper currencies and massive economic

growth in China, the world’s second‐largest economy.

Out look fo r Gold

Despite rising prices, overall demand for gold is expected to remain

strong in 2011, building on 9 percent growth in 2010, its highest rate in

a decade (Figure 8).

Investment demand for gold is soaring, and investment in physical bars

surged 56 percent over the past year to reach 713 tonnes. In recent years

the Chinese government has actively encouraged its 1.3 billion citizens

to put a portion of their savings into silver and gold.

China and India are major demand drivers, accounting for over half of

world demand for jewellery, bars and coins. China is poised to overtake

97

India as the worldʹs largest consumer of gold, thanks in part to strong

economic growth, but also due to the government’s gold‐centric

policies. Since 2003, China has more than doubled its official gold

reserves, yet even today, gold accounts for only 1.6 percent of the total

reserves held by the People’s Bank of China, China’s equivalent of the

US Federal Reserve. Chinese officials are on record as saying that the

country needs to raise its gold reserves, which are considered

“inadequate” compared with the 8,133 tonnes held by the US and 3,408

tons by Germany. Given the size and scope of China’s central bank, this

bodes well for future gold demand.

India continues to be the largest market for gold, accounting for

approximately 20 percent of world demand. India’s gold imports

surged to 800 metric tonnes in 2010 (compared with 557 tons in 2009)

driven mainly by investment demand. Indian consumers see gold as a

store of value and protection against inflation, which has been surging

over the past several years. Indian investment is traditionally in the

form of jewellery as opposed to gold bars. Jewellery demand rose

67 percent year in 2010, despite rising prices. Gold demand in India has

increased 13 percent per year, on average, during the past decade,

outpacing the country’s real GDP, inflation and population growth by

6 percent, 8 percent and 12 percent respectively.



Currently, Indians own roughly 18,000 tonnes of aboveground gold, or

approximately half an ounce of gold per person. This is significantly

below consumption in Western markets. Since incomes and wealth

continue to rise in India, there is plenty of scope for additional future

growth. Gold has already surged to new highs in 2011.

Out look fo r Si lve r

Like gold, silver has been money for thousands of years, and was used as

ordinary coinage in both Canada and the US until 1965. Recognized for

its unique attributes as both a monetary and industrial asset, silver is both

a safe haven in the event the economy regresses and a scarce commodity

that will soar if the economy enters an inflationary boom. Despite its

recent price rise, silver remains undervalued compared to gold, and the

recent “backwardation” in the price of silver reinforces this view.

Backwardation occurs when the current or spot price is higher than the

price for future delivery, clearly indicating that there is a silver shortage,

since demand is greatly outpacing the ability of dealers to deliver.

Many factors are pushing silver prices higher today (Figure 9): falling

currencies are raising the likelihood of spiralling inflation; new high‐

tech applications are increasing industrial demand; rising energy costs

are pushing production costs higher; and China, India and other

developing economies are ramping up their silver purchases for

industrial and investment purposes.

The supply/demand characteristics for silver are even more attractive

than for gold.

For many years, the governments of India, China and Russia have been

selling off their stockpiles of silver, but now these countries have

curtailed sales. Silver shortages are the most likely reason. Globally,

demand from the developed world combined with accelerating

demand from the emerging world should continue to stretch the limits

of supply. While it is true that silver is ten times more abundant than

gold, silver has been in supply deficit for many years because much of

it is consumed. Although silver is a critical component in a vast number

of industrial and high‐tech applications, the amount of silver consumed

in each application is generally so small as to make recovery

economically unviable. In addition, investment demand is likely

understated. China, the world’s third‐largest producer of silver,

imported four times as much silver in 2010 than the previous year, and

99

demand shows no signs of abating in 2011. Meanwhile, escalating drug

wars in Mexico are threatening to choke off silver production from the

world’s second‐largest producer.

Silver may finally be ready to jettison its title as the “poor man’s gold”.

Regardless of how well or how poorly fundamentals are clearly in

silver’s favour. If the economy shows signs of recovery, industrial and

monetary demand will push prices higher, and if the economy

continues to stagnate or decline, silver will remain firmly in demand as

a store of value. The price of silver, like gold, is simply mirroring the

disarray in the global monetary system. How long can silver prices

keep going up? As long can monetary authorities keep printing

currencies at breakneck speed.

Out look fo r Pla t inum

While gold and silver are often in the news as they jump to new highs,

there is little or no mention of platinum, even though it has been in an

uptrend for ten years.

By year‐end 2010, platinum had reached $1,755 per ounce (Figure 10),

well beyond the $1,070 level reached in 1980, and not far from its

pre‐crisis 2008 high. By any metric, but especially compared to its

precious metals cousins, platinum is considerably undervalued. Beyond

its jewellery and industrial demand, there is increasing investment



demand for platinum because platinum, like gold and silver, is a store

of value. But platinum’s supply story is even more dramatic than that

of gold and silver.

Total annual world production of platinum is about 7 million ounces −

a mere 10 percent of the world’s annual gold production of 76 million

ounces, and less than 1 percent of the world’s annual silver production

of 416 million ounces (Figure 11). South Africa supplies about

75 percent of the worldʹs platinum. Platinum is both a monetary and an

industrial metal, so platinum prices are influenced by the price of gold

and silver, as well as by key applications such as catalytic converters for

automobiles. Auto‐catalyst and industrial demand rebounded by

18 percent in 2010.

Demand for industrial uses other than autos rose 30 percent in 2010.

Current platinum prices are limiting production as the industry’s

margin is “barely positive” at these prices, according to BNP Paribas.

In addition, a stronger South African rand and rising energy and wage

costs are pressuring margins and constricting supply.

For these reasons, platinum should be considered a key portfolio

holding, a store of value and an exceptional wealth preservation

vehicle. Supply constraints combined with increasing demand as a

result of rising global inflation should help propel platinum prices

higher in 2011 and beyond, while investors seeking a safe haven will

discover that platinum, along with gold and silver, preserves

purchasing power over the long term, more so now than ever as paper

currencies decline.

GROWING COMPETITION FOR THE WORLD’S GOLD

The three long‐term trends we noted above will have consequences for

years to come, especially in the developed world. The cost of

supporting aging populations whose income is destined to flatten or

decrease can only create a drag on economic growth. Meanwhile, the

ongoing outsourcing of jobs, including skilled labour, will further

hollow out already fragile Western economies. Finally, the end of cheap

oil will create tremendous unpredictability and price uncertainty,

creating exogenous price shocks that will drive food prices to

unprecedented levels.

As we enter 2011, there is little indication that global governments

are any closer to getting their fiscal and monetary houses in order. The

US in particular remains on a spending path of a size and intensity

never before witnessed in human history. As investors lose confidence

in currencies, the worldʹs appetite for the relatively small amount

of available gold will increase.

As a direct result of worldwide debt and currency debasement, more

people will be competing for the world’s available gold, yet fewer

and fewer new deposits are being found. Smaller, lower grade deposits

with none of the “economy of scale” benefits of larger deposits are

being put into production out of desperation. Mine supply has been in

a deficit since 2005.

THE FUTURE OF PRECIOUS METALS

Based on current economic factors, we expect gold prices will end the year

somewhere between $1,700 and $2,000 per ounce. Silver and platinum

prices will experience similar growth based on investor demand.

As safe haven demand accelerates, there will be a transition from the

$200 trillion financial asset market to the $3 trillion aboveground gold

bullion market. Of the $3 trillion aboveground gold bullion, about half

is owned by central banks and half is privately held. (Figure 12)



The privately held bullion is largely owned by the world’s richest

families and is not for sale at any price. If the world’s pension funds

and hedge funds decided to move only 5 percent of their assets into

gold and precious metals, which these days seems quite conservative,

gold would trade above $5,000.

The multiple powerful trends identified in this review confirm that we

are in a long‐term precious metals bull market with strong

fundamentals and many positive indicators. In addition, attitudes

about owning bullion have irreversibly changed. Investors are

beginning to understand that precious metals are money. They do not

lose value like currencies, their past is far longer and their future is far

brighter than any currency on Earth.

P o r t f o l i o D i v e r s i f i c a t i o n My t h s

M a y 2 0 1 1

Pension funds across North America are facing record shortfalls.

Research shows that 33% of Canadian pension funds are struggling to

meet liabilities (Figure 1); the Ontario Teachersʹ Pension Plan funding

shortfall, for example, ballooned to $17.1 billion in 2009, despite strong

investment returns.

In the US, public pensions expect a shortfall of $2.5 billion that will force

state and local governments to sell assets and make deep cuts to services.


When anticipated future payments are taken into account, the amount

reaches a staggering $1.9 trillion. The solution for pension funds is

simple: restructure asset allocation and include precious metals bullion.

FIDUCIARY RESPONSIBILITY AND RETHINKING ASSET ALLOCATION

Pension fund managers have a fiduciary responsibility to meet

liabilities; they use asset allocation to achieve diversification in order to

reduce risk, maximize performance and thus responsibly manage their

funds. To ignore the best‐performing asset class year after year could

conceivably expose managers and trustees to legal liabilities (Figure 2).

The traditional view is that three asset classes (stocks, bonds and cash)

are sufficient to achieve diversification. But Figure 3 shows that only

precious metals offer negative correlation to stocks, bonds and cash; a

portfolio that consists of only positively correlated asset classes is not

balanced or diversified.

Portfolio Diversification Myths


Holding cash for portfolio protection does not work either. Figure 4

shows the dismal performance of five major currencies versus gold

since 2001.

HOW TO INVEST IN BULLION

For wealth preservation and portfolio protection, gold bullion should

form the foundation of an investment portfolio.

Figure 5 shows various investment vehicles based on inherent risk.

During periods of economic uncertainty, wealth preservation is critical

and unnecessary risk should be avoided. The best investment strategy

for long‐term investors seeking low risk with secular growth potential

is unencumbered physical bullion, as illustrated in the Precious Metals

Investment Pyramid.

GOLD IS LOW RISK

A prevailing myth says gold is risky and volatile. In fact, the opposite

is true. Standard deviation, a commonly used measure of risk,

calculates the total risk or variance associated with the expected return.

Using this method to compare gold to every Dow Jones component over

the last decade shows that gold is less volatile and has better

performance. Other methods, the Sharpe Ratio and the Sortino Ratio,

deliver similar results.

THE DOW:GOLD RATIO

The Dow:Gold Ratio measures trend changes in the gold price versus a

basket of stocks as represented by the Dow (Figure 6).

When the Ratio is rising, as in the 1920s, the 1960s and the 1990s, you

should be overweight stocks. When the Ratio is falling, as it did in the

1970s and is doing today, it is time to be overweight gold and precious

metals in portfolios. Currently the ratio is less than 9:1 and falling,

meaning investors should rebalance into gold and precious metals,

which will allow for reduced risk and maximized returns.

AN APPROPRIATE ALLOCATION

Although global pension assets are estimated to be $31.1 trillion, at

present, pension funds allocate virtually no funds to gold (Figure 7).

According to an Ibbotson Associates study, conservative portfolios

require a 7% allocation to gold, and aggressive portfolios require a 16%

– 17% allocation, simply to achieve a balanced, diversified portfolio.

This is known as strategic allocation.

From a tactical allocation standpoint, Wainwright Economics sees gold

as a leading indicator of future inflation. In a high‐inflation

environment, which the ongoing global money printing practically

guarantees, they recommend gold allocations of 17% in a bond portfolio

and 40% in an equity portfolio, just to break even against inflation.

Portfolio Diversification Myths


While pension funds are far below these recommended levels, the

mindset is beginning to change. Last year, the University of Texas

invested $500 million in gold due to fears of “unstable international

financial markets and the possibility of high inflation.ʺ This trend will

accelerate as the global economic reality we live in becomes more

widely understood.

Globally, financial assets are estimated at over $200 trillion, while total

aboveground gold bullion is a modest $3 trillion (Figure 8). About half

of that is owned by central banks, and half is privately held and not for

sale at any price. When pension funds begin to move into gold, the

price could skyrocket.

Savvy investors and pension fund managers alike can protect their

portfolios and ensure that future liabilities are met by allocating to

precious metals bullion now, while there is still enough supply

available to meet pension fund needs, and the price is reasonable.

Go l d a n d F i a t Cu r r e n c y :

F o r t y Ye a r s L a t e r

A u g u s t 2 0 1 1

ʺIn effect, there is nothing inherently wrong with fiat money,

provided we get perfect authority and god‐like intelligence for kings.ʺ -- Aristotle

Today, Monday, August 15, 2011, marks the 40th anniversary of the US

default on the dollar’s convertibility into gold. It was the world’s de

facto reserve currency and thus began an experiment with a reserve fiat

currency that was doomed to failure before it began, because there has

never been a successful fiat currency in all of history.. August 15, 1971

was just like any other day for most people, and President Nixon’s

unprecedented decision to cut the US dollar’s gold international

convertibility was largely ignored by the public. The majority of

citizens didn’t understand the implications for their financial future.

Contrast that to today, where a historic downgrade of US debt and a

very public $2‐trillion increase of the debt ceiling dominated headlines

and the television news.

Forty years later, it is a tale of contrasts between US dollars and gold.

The US dollar is the world’s reserve currency despite the fact that it is

being issued by the world’s largest debtor nation. Investors around the

world flee to it during times of crisis, despite it continually loses value

through debasement. Gold meanwhile is dismissed as a viable asset,

ignored by most pensions, institutions and asset managers despite

increasing from $35 in 1971 to over $1800 last week.


It is important to note that on this historic day 40 years ago, the dollar

quietly ceased to be money and instantly became a currency. Money

and currency are often considered as one and the same; however, there

are meaningful and significant differences between the two. While fiat

currencies function well as a medium of exchange and a unit of

account, they fail miserably as a store of value.

The US dollar has lost over 80 percent of its purchasing power

compared to gold in the last decade alone. Gold, however, has endured

as money for over 3,000 years, and maintained its purchasing power

throughout that time, because it meets all of the criteria for money.

To satisfy the functions of money, an item must be a unit of account, a

medium of exchange and a store of value. Gold is all of these things;

it is durable, portable, divisible, consistent, intrinsically valuable and,

of crucial relevance today, it cannot be created by central banks.

Gold is a tangible asset, something that is real and in limited supply, as

opposed to fiat currency, which is merely worthless paper that

governments can produce at will. It is only the promise written on the

paper enforced by a government decree that gives it any value. The

more governments produce, the less value it has.

In light of this, it makes sense to earn currency and then protect its

value through precious metals ownership of gold, silver and platinum.

The current monetary system, which, in its current form, began in 1971,

has two critical features that have profound implications for our

financial future:

1. Fiat currency is created out of debt via the banking system and the

Federal Reserve.

2. The amount of currency created must continually expand.

In May 2006, we wrote August 15, 1971 Inflation Unleashed, and I

direct you to key statistics of just five years ago.

There are limits to debt expansion, and it is my guess that we are now

entering the phase where the compounding of the debt and the loss of

our purchasing power is not only more noticeable, but also about to

become exponential. In three years time, it is quite possible that these

numbers could be double what they are today.

Chris Martenson quotes Dr. Bartlett, an emeritus Professor of Physics at

the University of Colorado, who said, “The greatest shortcoming of the

human race is the inability to understand the exponential function.”

I encourage you to spend eight minutes viewing the presentations

“Exponential Growth” and “Compounding is the Problem” from Chris

Martenson’s “Crash Course”(www.chrismartenson.com/crashcourse).

It puts into context why the only logical conclusion that can be drawn

from the ever‐expanding debt and money supply problems that the

US and other countries are facing is hyperinflation. See John Williams

Hyperinflation Report (www.shadowstats.com/article/hyperinflation‐

special‐report‐2011)

Until governments around the world stop spending beyond their

means, running huge deficits, incurring massive debts and creating

endless amounts of fiat currency, precious metals will continue to rise

and fiat currency values will continue to erode. The best way to protect

portfolios and preserve wealth from this impending crisis is to own

precious metals.

When we consider that total global financial assets are estimated at

over $200 trillion, but total global aboveground gold bullion is a modest

$3 trillion, and only growing by approximately $100 billion a year, we

can see that once a shift towards gold occurs, there will be too much

paper currency chasing too little gold. Of the $3 trillion of aboveground

gold bullion, about half is owned by central banks and half is privately

held. The central banks have been net buyers since 2009, and most of

the privately held gold is not for sale at any price. If only five percent of

the $200 trillion in financial assets were to allocate to gold, there would

be about $10 trillion trying to buy the $1.5 trillion of privately held gold

bullion. Under that scenario the price of gold will trade substantially

higher than the levels today.

There have been suggestions in the media that holding gold is too risky.

It has been called a useless, overvalued relic that pays no interest and is

in a bubble. We heard this same rhetoric when gold was $300, then

$500, $800, $1,000 and last week at $1,800This advice has been costly to

those who listened. In truth, gold is not rising; fiat currencies are falling

and will continue to do so until governments around the world begin to

act responsibly. There is nothing on the horizon to indicate this will

happen any time soon.

Gold and Fiat Currency: Forty Years Later


It is difficult to predict how the financial mess the major economies of the

world are in will unravel. Some economists believe the increase in money

supply will have an inflationary effect, while others believe the lack of

demand and lack of growth will result in deflation. Federal Reserve

Chairman Ben Bernanke made it quite clear in his famous “helicopter”

speech that there will be no monetary deflation on his watch. Other

historical examples indicate we will end up in a hyperinflation followed

by a deflationary collapse. Recent examples of this have occurred all

over the world. See http://en.wikipedia.org/wiki/Hyperinflation.

The best defense in either eventuality, however, is to hold precious metals.

The lack of understanding in the difference between money and

currencies is so pervasive that even Warren Buffett, who has received

many accolades for his investment track record, has criticized gold in

the past. In a speech to the 1998 Harvard graduating class he said:

“Gold, It gets dug out of the ground in Africa, or someplace.

Then we melt it down, dig another hole, bury it again and pay people

to stand around guarding it. It has no utility.

Anyone watching from Mars would be scratching their head.”

In contrast to this view of gold, fiat currency is nothing more than a

medium of exchange that is susceptible to abuse by the governments

that produce it. Trees are cut down, turned into paper, a number is

written on it and by force it is declared legal tender. It is created out of

thin air, backed by debt, printed without limit and its value decreases as

the amount of printing increases. There has never been a successful

paper currency in history; the longest‐standing currencies, the British

pound and the US dollar, have both lost 99.5 percent of their purchasing

power. Currency completely fails as a store of value. Anyone watching

from Mars would be scratching their head at this, as well.

Perhaps the former chairman of the Federal Reserve, Alan Greenspan,

explained the importance of the gold best when, in 1966, he said, “

In the absence of the gold standard there is no way to protect savings

from confiscation through inflation. There is no safe store of value.”

Forty years after President Nixon ended the dollar’s convertibility to

gold; it seems that Mr. Greenspan was correct.

Why R i s i n g Deb t Wi l l L e a d

t o $ 1 0 , 0 0 0 Go l d

J a n u a r y 2 0 1 2

As Presented at the 2012 Empire Club’s

Annual Investment Outlook—January 5th, 2012

Good afternoon, it’s a pleasure to speak about gold at this Outlook for 2012.

Today, I’d like to focus on one important idea: the direct relationship

between the rising price of gold and the rising levels of government

debt that result in currency debasement. Since we measure investment

performance in currencies a clear understanding of the outlook for

currencies is critical.

In order to understand gold’s relationship, it’s important to understand

that gold is money. It is not simply an industrial commodity like

copper, or zinc. It trades on the currency desks of most major banks—

not on their commodities desks. The turnover at the London Bullion

Market Association is over $37 billion per day, and volume is estimated

at 5‐7 times that amount – clearly, this is not jewellery demand.

The world’s central banks know gold is money: after decades of

modest sales they have become net buyers since 2009. This trend

strengthened in 2010 and gained momentum in 2011. They are buying

gold as a counterbalance to their devaluing currencies.

As money, gold has provided the most stable form of wealth

preservation for over three thousand years – it still does today. Gold

has outperformed all other asset classes since 2002.


Figure 1 clearly shows that US federal debt (purple) and the price of

gold (gold) are now moving in lockstep. This correlation will likely

continue for the foreseeable future. The red line represents the

repeatedly violated government debt ceilings.

Based on official estimates, America’s debt is projected to reach

$23 trillion in 2015 and, if the correlation remains the same, the

indicated gold price would be $2,600 per ounce. However, if history is

any example, it’s a safe bet that government expenditure estimates will

be greatly exceeded, and the gold price will therefore be much higher.

And it’s not just the US. Most Western economies have reached

unsustainable levels of debt that will be impossible to pay off. It’s worth

noting that the US Federal Reserve, unlike the European Central Bank,

can create currency without restriction. The US dollar has been the

de facto world reserve currency for over half a century; the rest of the

world’s currencies are essentially its derivatives. Whether global debt is

in euros or Special Drawing Rights issued by the IMF, the Fed, and thus

indirectly the US taxpayer, may become the lender of last resort.

There are four possible ways to reduce government debt:

One: Grow out of it through increased productivity and increased

exports. This is highly unlikely, as Western economies, and even China,

are poised for recession.

Two: Introduce strict austerity measures to reduce spending. This has

the unwanted short‐term effect of increasing unemployment and

reducing GDP, resulting in even higher deficits.

Three: Default on the debt. This will make it difficult to raise future

bond issues.

Four: Issue even more debt, and have the central bank in question

simply create whatever amount of currency is needed.

Most politicians will select option four, since few have the political will

to choose austerity, cutbacks and full economic accountability over

simply creating more and more currency. Almost inevitably, they will

choose to postpone the problem and leave it for someone else to deal

with in the future.

Last August, the world watched as the US government struggled to

come to an agreement on raising the debt ceiling, and was forced to

compromise and delegate the final solution to a “super committee”.

Its lack of political will earned the country an immediate downgrade

from the S&P. Then, the hastily convened “super‐committee” failed to

reach a solution.

In Europe, matters were even worse. Greece did try to write off half its

debt, but Germany and France reminded the Greeks that, if they did, no

one would buy their bonds. The British and Irish implemented

austerity measures that raised unemployment and reduced GDP,

resulting in even higher deficits. The Italians watched their bond yields

rise to 7 percent. While the tsunami and related nuclear incident

deflected attention from Japan’s financial problems, it is a temporary

lull, because Japan has the highest debt to GDP ratio of any of the

developed countries.

In order to compensate for slowing growth, governments attempt to

devalue their currencies and thus improve export competitiveness.

This can lead to a global currency war that author and Wall

Street/Washington insider James Rickards discusses in his bestselling

new book, Currency Wars. This process is now well underway.

A recent Congressional Budget Office report predicted the US federal

government’s publicly held debt would top an unsustainable

101 percent of GDP by 2021. Currently, the official US debt is an

Why Rising Debt Will Lead to $10,000 Gold


astronomical $15 trillion. Yet this is only the current debt. If the US

government used the same accrual accounting principles that public

companies must use, unfunded liabilities like Social Security and

Medicare make the real debt more than $120 trillion. This represents over

$1 million per taxpayer. Obviously, this amount is impossible to repay.

It’s interesting to note that in almost every recorded case of

hyperinflation, the point where inflation exceeds 50 percent a month

was caused by governments trying to compensate for slowing growth

through full‐throttle currency creation. This is exactly what we are

seeing today.

These events gave me the confidence to title my new book $10,000

Gold. The book connects the many trends that will be directly and

indirectly responsible for both the rising debt and the rising gold price

over the next five years. It will be published this year.

To make matters worse, the irreversible macro trends I discussed in last

year’s Empire Club speech are still very much in place today.

These include the added costs of retiring baby boomers, systemic

unemployment due to outsourcing of Western jobs through globalization

and rising oil prices due to peak oil. These irreversible trends will

increase unemployment, lower GDP, reduce tax revenues, increase

deficits further and force governments to borrow even greater amounts.

Governments find themselves between the proverbial rock and a hard

place, as even austerity measures tend to negatively impact GDP.

As GDP falls and debt increases, credit downgrades are likely to follow,

resulting in higher bond yields followed by even greater deficits. This

becomes an unstoppable descending spiral.

Loss of purchasing power against gold continued unabated last year

(Figure 2). The US dollar and the British pound have lost over 80

percent of their purchasing power against gold over the past decade,

and the yen, the euro and the Canadian dollar have lost over 70 percent.

As we remind our clients this is not a typical bull market. Gold is not

rising in value, currencies are losing purchasing power against gold,

and therefore gold can rise as high as currencies can fall. Since

currencies are falling because of increasing debt, gold can rise as high

as government debt can grow.

The sovereign wealth funds as well as the more conservative central

banks will have little choice but to re‐allocate to gold in order to

outpace currency depreciation. This is why some central banks,

particularly those of China and India, accelerated their gold buying in

2011, for a third year in a row, to nearly 500 tonnes—about one‐fifth of

annual mine production.

While central banks have been net purchasers of gold since 2009, the

real game changers will be the pension funds and insurance funds,

which at this point hold only 0.3 percent of their vast assets in gold and

mining shares. Continuing losses and growing pension deficits will

make it mandatory for them to eventually include gold—the one asset

class that is negatively correlated to financial assets such as stocks and

bonds. When this happens, there will be a massive shift from over

$200‐trillion of global financial assets to the less than $2 trillion of

privately held bullion.

In considering where gold will be at the end of 2012, I looked back to

my first Empire Club talk of 2005. I said then that it didn’t really

matter whether gold closed the year at $400 or $500 an ounce—the

trends were in place to ensure it had much further to rise. Seven years

later, we can say the same thing. It doesn’t matter whether gold ends

2012 at $2,000 or $2,500, because gold’s final destination will make

today’s price seem insignificant.

Why Rising Debt Will Lead to $10,000 Gold


These can be frightening times, but gold always offers hope. We may not

be able to heal the global economic problems of government debt, but

individuals can protect and even increase their wealth through gold

ownership. Gold bullion ownership, not mining shares, ETFs or other

paper proxy forms of ownership, is an insurance policy against

accelerating currency debasement. We use the analogy that ‐ In the case

of fire, would you rather have a real fire extinguisher or a picture of one?

A number of people have approached me recently and said they

wished they had listened five years ago. They feel they have missed

the boat, that it’s too late to buy gold. For those who feel that way, let

me close with a Chinese proverb I discovered last year:

The best time to plant a tree is 20 years ago.

The second best time is today.

Why Rising Debt Will Lead to $10,000 Gold Gold and Fiat Currency: Forty Yea Strategies Three Dominant Factors Will Impact Precious Metals in 2011 W Precious Metals Investments 2004-2009 Pompous Prognosticators Revis Critical Diversifier General Motors, the Stock Market and Gold Gold Myths an

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