Precious Metals Will Depose Cash from Its Temporary Throne

by: Peter Cooper November 17, 2008 | about stocks: GLD / SLV    

Peter Cooper

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‘We have just been in Bahrain and everybody is cashed up!’ one banker told me today. My reply was that if everybody is now in cash, then it just has to be the wrong place to be. There are some very good reasons to worry about a large cash position.

Quite apart from the contrarian argument that the crowd is always wrong, you have to consider what is happening to the supply of cash. We know that with the sell-offs in global capital markets there is plenty of demand for cash, but what about the supply?

Money supply out of control

Another banker today showed me a chart of US money supply growth over the past few months, and highlighted a 111% increase. This compared with something like 15% money supply growth in the early 1930s as the US authorities grappled with the Great Depression.

There is an absolute tsunami of money coming into the system. What happens when the supply of something exceeds the demand? The price drops. And that is exactly what is going to happen to the US dollar - the authorities are about to inflate away their debt problem.

It is so simple: The debt stays at the same nominal amount, you print more money and the real value of the debt falls. Of course, in the real world that also means a bond market collapse as inflation will make both the coupon and real value fall.

I wonder how long it will be until cash is deposed as king of the investment world? My guess is that it will not be long after the sell-off ends. How long will that take? It could be at the end of the year as the hedge funds attempt to square their positions, or it might be next spring after another lurch downwards in stock prices.

The bottom for stocks will be the top for cash and treasury bonds. Then inflation will start to emerge and depose cash from its temporary throne. Who will be the new king?

Gold and silver

Step forward precious metals to take a bow. Everybody knows that gold is inversely correlated to the US dollar and that silver is leveraged against the gold price. But why have precious metals taken so long to claim their crown in this financial meltdown?

The straight answer is that hedge funds have been selling assets across the board and turning gold into dollars, or at least the paper gold of futures contracts into greenbacks. The physical demand for gold and silver has been growing strongly all the time, hence the silver coin shortage and the $3.5 billion Saudi gold purchase.

Once the hedge funds stop selling (you always do eventually run out of assets to sell), then gold and silver prices will rally, and the rush out of cash and into precious metals will do something pretty spectacular to the price. Gold and silver stocks, languishing at a 40-year low, should jump and deliver phenomenal performance for new investors and repay the patience of long-term holders.

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This article has 22 comments:

  •  
    Nov 17 08:31 AM
    storms are brewing in the finacial markets. The gales have produced a few waves and troughs. I think the real storm is coming! Unfortunately I think the actions seen so far have mostly added steam to the storm! I see folks finding safe harbor or riding the waves. I see little effort in actually weakening the storm. to weaken the storm one must weaken the cause. What caused the current financial situation? Is it the same things which made life soo good for so long? was it the laziness of many? Was it ignorance of those who think they know? was it greed of those with wealth? was it greed of those who wanted the wealth? was it ignorance of truth? Was it ignorance in beliefs? Was it power abuse? Was it abuse of force? was it special intererest abuse? was it general interest abuse? I could go on A small part ofan ovious problem has been recieving enormous thought while most of the problem is ignored with little concideration of the reasons which can not be blamed on somebody else.
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  •  
    Nov 17 08:56 AM
    i think we've already seen the worst - from now on, we wont have more high-profile bank failures - already had bear, lehman with merrill, aig, fnme, fdmc saved...

    the govt will need to keep pumping these with cash - which at some point will lead to hyperinflation - gold is a great long-term investment... as for short-run, im still bullish dollars... when shit hits the fan, investors flock to dollar and yen!

    Reply | Link to Comment
  •  
    Nov 17 12:20 PM
    Gold and platinum are great longer term investments, but most people want more liquidity and shorter term results. However, we are harshly finding out that it is difficult to impossible to gain both at the same time in the same vehicle, but people still seek that nearly impossible(and lazy) dream and lose countless billions in the process.

    My advice is to never, ever try to get the same investment advantages in one investment vehicle. Does not work. Have one for one purpose, one for another, etc. For example, gold and cash; stocks, gold and cash; bonds, cash and real estate, real estate, stocks and cash, etc., etc. in many combinations that work right for you(Cash means CD's or MMF).
    Reply | Link to Comment
  •  
    Nov 17 01:36 PM
    Peter, it seems our thoughts appear to align very well. Is it no surprise that the money supply is up over 100% over the past few months? According to Obama, TARP has already spent some $300B of the $750B. Hence money is being pumped at a RAPID pace into our withering economy.

    I fully agree that this action coupled with the US debt increasing each day, will only result in furthe devaluation of the US. Dollar.

    We must recall that the massive sell offs in hedge funds aren't usually voluntary and fund managers are being FORCED to sell because many investors believe that they are forced to sell. For example in Canada, investors with RRIFs, must pay taxes on at least $10,000 of their investment. However this value was determined at the start of the year, and with some portfolio's down by over 50%. They are now actually paying taxes on 20% of their current portfolio. Due to the lack of transparent investment advice, we will continue to sell these massive sell offs take its toll on already undervalued equities. It is only a matter of months IMO before we see a commodity correction.

    And as we know "Concurrently, the U.S. Government runs large operating deficits in circumstances where its National Debt approximated $9.6 trillion at July 31, 2008, up from $9 trillion at December 31, 2007 and $6.2 trillion at December 31, 2006."
    Quote Source: www.stockresearchporta.../

    The question is with the money supply increasing, debt increasing, unemployment increasing, foreclosures increasing, consumer confidence on the decline. How worse can things really get?
    Reply | Link to Comment
  •  
    Nov 17 02:00 PM
    Sonofabitch! An article that TELLS IT LIKE IT IS! Oohhh, are you gonna catch hell from the nay sayers (anti-goldbugs). Thanks for saying it!
    Reply | Link to Comment
  •  
    Nov 17 02:13 PM
    A couple of problems with this article.

    "The bottom for stocks will be the top for cash and treasury bonds."

    At that eventual point, it might indeed be good for gold, but by definition it would also be attractive for stocks.


    Also, by any measure of money supply that I follow, it has been stagnant in recent months, not growing at all. This is what the Fed is trying to fight - shrinkage in the supply and velocity of money.

    research.stlouisfed.or...

    www.nowandfutures.com/...


    So until these trends end (money supply stagnation with deflation in all asset classes plus USD and Treasury strength), cash will remain king.


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  •  
    Nov 17 03:49 PM
    "In my opinion, commodity prices can possibly hit new lows in the upcoming months as the recession is still going on. There are a lot of uncertainties that are still at bay and till they have been cleared up, the economy will still be going downhill. Questions pertaining to increasing unemployment? Will the Govt bailout the US Automakers? How much are Corp taxes going to increase next year when Obama is in power? These uncertainties need to be solved before the market actually is stable for investors.

    Hopefully you had found my insight helpful, I usually use the following website as a tool to gather all my data. Best of luck to all investors:
    www.stockresearchporta...;
    Reply | Link to Comment
  •  
    Nov 17 09:16 PM
    We enjoy your articles and more importantly they help us keep things in their proper perspective. Keep them coming Peter, and thank you!!
    Reply | Link to Comment
  •  
    Nov 18 02:18 AM
    pangaea: the coming bottom in the stock market doesn't necessarily mean a bull market for equities.  The market could bounce along the bottom for the next decade or two (as it did before the last great bull market) while we deal with the consequences of this mess.
    And the Fed and it's European counterpart are openly trying to weaken their respective currencies. It's a struggle right now, but they will succeed mightily at some point!
    Gold is the enemy of inflation, and the gold market recognizes this. That is why central banks and their allies continue to fight the gold price, as all central banks must.
    Do yourself a favor and buy some artificially cheap gold. Get out of dollars while the gettin's good!
    Reply | Link to Comment
  •  
    Nov 18 12:00 PM
    i support mr. courtenay's comment.
    Reply | Link to Comment
  •  
    Nov 18 12:49 PM
    Once again a fatal flaw. If the velocity of money collapses...a fancy word for recession, for those of you without an introductory economics textbook in your hand...all the supply of money in the WORLD wouldn't lead to inflation.

    Mv=pY, dude. Look it up.

    Reply | Link to Comment
  •  
    Nov 18 03:03 PM
    Pangaea:

    keep looking on the St.Louis FED's website:

    research.stlouisfed.or...
    Reply | Link to Comment
  •  
    Nov 18 03:14 PM
    "Mv=pY, dude. Look it up. " Cyclingscholar.

    Where M is the quantity of money, P is the price level, and Y is aggregate output (and aggregate income). V is velocity, which serves as the link between money and output. Velocity is the number of times in a year that a dollar is used to purchased goods and services.

    Mv=pY

    p = Mv/Y

    CyclingScholar, you are correct. However, notice that if aggregate output drops the price level will rise. Government is world famous for destroying output like it does most other things. Since Obama apparently does not understand economics, I reckon we will eventually have inflation.
    Reply | Link to Comment
  •  
    Nov 18 03:47 PM
    PV = nRT

    Ideally this would apply to politicians.

    (I'm not gonna explain that either. It's something of a pun.)
    Reply | Link to Comment
  •  
    Nov 18 04:05 PM
    Smarty, you are a gas and your ideas are ideal too.
    Reply | Link to Comment
  •  
    Nov 18 04:10 PM
    I did have red beans and rice for lunch. :-)
    Reply | Link to Comment
  •  
    Nov 18 06:35 PM
    Ok, I'm gathering smarty's pun has something to do with politician's moving at high velocities, in proportion to the amount of hot air (gas) they blow! Nicely done.
    Reply | Link to Comment
  •  
    Nov 18 11:26 PM
    Don’t forget one thing. In 1930s FDR outlawed private holding of gold (except for the jewelry) and forced Americans to sell it to the government at $35. Obama is much more to the left than FDR was, so are the both parties in the Congress. I can’t see why they would not do it again. They can pay government debt with your gold. This time other governments may join the fun.
    Reply | Link to Comment
  •  
    Nov 19 08:42 AM
    "I can’t see why they would not do it again" Mark Best

    Well, besides the practical difficulties such as overcoming the Mighty Mogambo Fortress of Doom (MFOD) the attempted seizure of gold would reveal the nature of the beast. It would validate the gold bugs, which is exactly what they don't want to do. It would be admission that government and the Fed cannot properly control the money supply.
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  •  
    Nov 19 10:41 AM
    "In 1930s FDR outlawed private holding of gold (except for the jewelry) and forced Americans to sell it to the government at $35." - Mark Best

    Actual wording:

    "pursuant to said section do hereby prohibit the hoarding gold coin, gold bullion, and gold certificates within the continental United States ... except the following ... Gold coin and gold certificates in an amount not exceeding in the aggregate $100.00 belonging to any one person; and gold coins having recognized special value to collectors of rare and unusual coins"

    Each person could actually keep up to $100 (5 ounces) of gold coin for themselves plus any 'collectibles' and jewelry.

    www.knology.net/~bilrum/goldconfiscat...
    Reply | Link to Comment
  •  
    Nov 20 08:50 PM
    Everyone losing their jobs and selling their possessions off (and also not buying many new items) is causing deflation. When that hits bottom around the time the literal TONS of new dollars catch up to the market-we will see amazing inflation. Hyper inflation. At this point the dollar will evaporate. Roosevelt was able to 'confiscate' gold (at $20 per oz, which he re-valued at $35 after he got most of it) because the dollar itself was still sound. This is no longer true. Look up Weimar Germany from the '20s for a scare. Good luck to all, and buy physical silver.
    Reply | Link to Comment
  •  
    Dec 28 06:10 PM
    I'm long gold for all the reasons stated, but if the Fed can drop interest rates to nil, and if the Treasury can print dollars ad nauseum, why can't both entities reverse their policies down the road, ideally when markets and economies stabilize--and when inflation rears its ugly head?

    I mean Bernanke could raise interest rates, and the Treasury can start tightening the money supply, can't they?
    Reply | Link to Comment
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