Keynote Speech Presented by Nick Barisheff at the Empire Club’s
15th Annual Investment Outlook Luncheon Thursday January 8, 2009
"Yet throughout the financial turmoil of the past year, gold preserved investor wealth and outperformed all other asset classes except bonds. Over the past five years, gold has been the best-performing asset.
To understand why this is the case, it is crucial to realize that gold is primarily a monetary asset, and not simply a commodity like copper or zinc. That’s why central banks hold over 29,000 tonnes as part of their currency reserves. That’s why the turnover of physical bullion in London is over $20 billion a day. That’s why precious metals trade on the currency desks of most banks rather than the commodity desks. That’s why gold should be compared to other currencies – not commodities.
At an increase of 5 percent in US dollars for 2008, gold performed extremely well, considering the Dow lost 38 percent. Gold’s performance was somewhat muted in US dollars, largely because of the extraordinary demand for dollars caused by deleveraging.
Gold’s performance against other major currencies was even more pronounced, as global equity markets lost between 30-70 percent.
Gold rose:
9 percent in Euros
45 percent in British pounds
25 percent in Russian Rubles and
38 percent in Brazilian Reals
Gold increased by 31 percent in Canadian dollars, while the Toronto Stock Exchange lost 35 percent of its value.
Only the Japanese yen rose against gold, due to the exceptional demand for yen produced by the unwinding of the Yen Carry Trade.
Now let’s take a look at some of the other factors in 2008:
The US government and the Federal Reserve spent $3.2 trillion in 2008 bailing out institutions that were “too big to fail”, and committed another $5 trillion. Total amount: over $8 trillion.
$8 trillion is nearly twice the combined cost of the space program, the Vietnam War, the invasion of Iraq, the Korean War and the Savings & Loan crisis.
In contrast, the bailout of Long Term Capital Management in 1998 amounted to a ‘mere’ $3.6 billion, and Worldcom’s bankruptcy was $103 billion.
The end result will be inflation, not just in the US but in the UK, Europe, China, Russia and Canada, all of which have adopted similar bailout programs.
We can only hope that these bailouts will work and not morph into stagflation or hyperinflation.
Rising inflation is already on the cards. In 1971, when the US abandoned the gold standard, total M3 money supply stood at $800 billion. Since then, the Federal Reserve has increased the money supply well in excess of GDP growth.
In 1987, Alan Greenspan opened the floodgates and expanded the money supply from $3.5 trillion to $10 trillion – more than all of the previous Fed chairmen combined. Ben Bernanke surpassed Alan Greenspan’s record by adding another $4 trillion in the last three years.
While there’s been much talk about deflation, the increases in the money supply we are witnessing clearly contradict this view. As Milton Friedman said:
"Inflation is always and everywhere a monetary phenomenon. As the government increases the rate at which it prints money, the result is too much money chasing too few goods and services."
While the rate of M3 money supply increases has declined from 16 percent at the beginning of 2008 to 9 percent currently, money supply has still increased. For deflation to occur, money supply must actually decrease, not simply slow the rate of increase.
In addition to the fact that money supply data points toward inflation, we have Ben Bernanke as Fed chairman. Deflation is unlikely to occur under Bernanke’s watch. He made it clear in his PhD thesis, and in recent speeches, that he will avoid deflation by using every tool at the Fed’s disposal to create as much money as it takes.
The resulting growth in money supply will ultimately lead to a declining US dollar and higher inflation, resulting in higher gold prices.
Looking ahead to 2009, it seems many people believe the crash of 2008 was just a correction, and that real estate and equity markets will soon recover.
Current data does not support this argument.
While we all like to be optimistic, as investors it is critical to be realistic and adjust to changing circumstances.
We can hope that real estate prices and the stock market will recover.
We can hope that job losses will stop, and that consumers will start spending again and the economy will recover.
Unfortunately, this is just wishful thinking.
Until consumers feel confident about their jobs, the value of their houses and the safety of their savings, they will curtail spending and the economy cannot improve.
During the past 25 years we have experienced the longest equity bull market in history. However, markets move in long cycles, and the next 20 years are unlikely to be a continuation of the past.
Warren Buffett noted that the stock market “went exactly nowhere” for 17 years from the end of 1964 to the end of 1981.
He forgot to mention that on an inflation-adjusted basis, 1964 investors who held for the long term didn’t break even until 1995!
During this same time period, however, precious metals soared:
Gold rose 2,300 percent
Silver rose 2,400 percent
Platinum rose 900 percent
For investors, the takeaway from all this is that while a “buy and hold” strategy may work during a bull market, it doesn’t work during a bear market.
The crash of 2008 is not a simple correction, as the financial imbalances that broke open last year have been building for decades and are unlikely to correct in a single year.
In 2009, the 6-year upward trend for precious metals should continue, while real estate, equity markets and even bonds will likely decline. One factor is the massive imbalance between financial assets and above-ground bullion.
Today, annual gold production is about 2,500 tonnes, a decrease of 200 tonnes from its peak in 2006. This represents an annual increase in the global supply of above-ground gold of about $75 billion.
Contrast this with the estimated $10 trillion increase in global money supply expected to fund the bailout and stimulus programs. This disparity in growth cannot continue without a significant price adjustment in gold.
At the end of 2007, privately held gold bullion amounted to less than $650 billion, and the total amount of above-ground silver and platinum bullion was less than $5 billion. Put together, this is less than 0.5 percent of the estimated $187 trillion of global financial assets.
Yet even after six years of gains, most portfolios have no allocation to precious metals whatsoever.
As a result, most portfolios are neither balanced nor diversified. This means investors are not protected from inflation, or from currency or market declines.
Equally important, most portfolios are not aligned with the current investment trend, which has been moving away from paper assets towards hard assets like precious metals for the past six years.
As more investors come to realize this, and adjust their portfolios accordingly, even a small shift away from the $187 trillion of financial assets to precious metals will result in dramatic price increases, and may ultimately lead to shortages of even the largest bullion bars. Last year investors experienced shortages of the smaller bullion wafers and coins, with premiums running as high as 10-40 percent for gold and 30-100 percent for silver.
In addition, China, Russia and the OPEC countries are considering substantial increases to their gold allocations in order to diversify their currency risk. Any reallocation by these countries will drive prices much higher.
Citibank predicts gold soaring to $2,000 an ounce sometime in 2009.
Ultimately, the exact number is very hard to determine – and it doesn’t really matter.
Over the next few years precious metals will continue to outperform real estate and equities, and probably bonds. Precious metals will continue to hold their purchasing power whether we experience deflation, inflation, stagflation or hyperinflation.
During these uncertain times, the question investors should be asking is:
What percentage of my portfolio should be in precious metals bullion?
Ibbotson Associates recommends between 7-16 percent just for proper diversification, while Wainwright Economics recommends between 18-47 percent to protect portfolios against inflation.
To make money in 2009, you will likely need an even higher allocation than those recommended by Ibbotson and Wainwright. Furthermore, given our experience in 2008, it is critical that investors hold actual bullion and not a paper proxy or derivative. Physical bullion is the only asset that is not someone else’s liability.
The single point to remember from these comments is that, no matter what your allocation to bullion turns out to be, it should certainly not be zero.
In order to adapt to current global changes, investors need to rethink their investment strategy and their portfolio allocations, because the next 20 years are going to be completely unlike the past 20."
No comments:
Post a Comment