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This is an update to our prior report,
“Gold’s Role in Protecting Your Wealth”. Several factors
have recently taken center stage in the financial markets and further
strengthen the case for investing in gold:
• Huge and growing current account[1]
deficit
• U.S. Corporate fraud and bankruptcies
• Declining U.S. dollar
• Inappropriate monetary and economic policies
Huge and growing current account deficit
Direct foreign investments by the U.S. represented outflows of $440 billion
in 2001. Coupled with a current account deficit of $450 billion, this implies
foreign capital inflows must equal roughly $900 billion, almost $3 billion a
day, just to keep the dollar from falling.
U.S. Corporate fraud and
bankruptcies
With huge, high profile bankruptcies in formerly investment grade securities,
such as WorldCom and Enron, foreigners are unlikely to increase their U.S. exposure.
Declining U.S. dollar
The dollar index has broken long-term technical support in the 108-110 area.
Inappropriate monetary and economic policies
Flooding the economy with money at any sign of trouble has the effect of
killing the profit motive by keeping weak competitors alive. Money expansion
has been ineffective and is the cause of our current problems, not a cure.
This last point is really the cause of the
prior three, in that the perpetual flood of money creation leads to: growing
current account deficits, a declining currency, and a stock market bubble
with valuations so high that corporate chieftains use every accounting trick
available to try to live up to those valuations. The investing public is only
now beginning to grasp what has transpired. It is blatant, yet not
unprecedented, fiat money[2] creation with no offsetting increase in
production of goods and services.
Last week Mr. Greenspan proclaimed that he
was powerless to deflate any suspected stock market bubble because any rise
in rates would have brought about a recession in his estimation. When
governments and central banks intervene in business cycles to prevent
recessions at all costs, they are superseding the profit motive which
capitalism is based upon. The liquidation of non-viable firms is prolonged,
damaging the overall profit outlook. This can result in a deflationary
environment, such as we experienced in the 1930’s, and Japan has been experiencing throughout the 1990’s.
While many claim we are “no Japan”, the bulk of our population is in much worse shape to weather deflationary
forces. Japan has had very high savings and lower personal debt levels, while
Americans and the economy depend on borrowing and consumer spending. With
high cash levels, Japan has weathered the deflation quite well as their huge
savings can buy more products and services as prices fall. This highlights
the importance of holding high levels of cash during deflationary periods.
So, why gold?
In a deflationary environment, you would normally be protected by: owning
bonds, holding high levels of cash, and being largely out of stocks. This
would likely be correct if the Fed and government stood by and did not fight
the deflation. However, if they do fight deflation, through over-aggressive
money growth, bonds could plunge and cash could be devalued. Gold
experiences its strongest price rise when central banks are fighting
deflation and currencies are plunging. This can be seen most recently, in
Japan, which has been the largest consumer of physical gold while their
economy experiences deflation.
Additionally, gold makes sense as a
commodity investment since production has not exceeded jewelry demand alone
for over ten years. With production now in decline, much higher prices will
be needed to encourage new mines, even if the demand for gold as money does
not materialize, as we strongly believe it will.
Summary
When dollars are printed in an attempt to revive economic growth, and it is
unsuccessful; the purchasing power of an investor’s savings is at risk.
We believe this is currently the biggest threat to personal wealth. Thunder
Capital offers a dynamic mix of gold exploration and production companies in
its funds. Coupled with gold, we obtain exposure on the short side through
“paper money” financial institutions. We believe an investment
in gold is a powerful tool in protecting your assets from the effects of
inappropriate monetary policies.
Richard J. Greene
Managing Partner, Portfolio
Manager
Thunder Capital Management
More articles by the author can be accessed by the
"Research Articles" choice at: www.thundercapital.com
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