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Why Gold and Silver are Risky Investments
publication date: Oct 7, 2010
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author/source: Brad Hamill
Many probably read the above headline and think that I have lost my mind. It’s
not hard to imagine with the value of precious metals rising fast.
Many others might think that I have something against precious metals, and don’t give their “inherent” worth enough credit. Let me see if I can lend support to my position. First off, I have absolutely nothing against gold and silver. I just treat them as the commodities that they are, instead of treating them like money. In fact, I hold both physical gold and physical silver as a small part of my investment portfolio (10%). They act as a “hedge” against having a wrong hypothesis about them. There are many that get very upset when I dare to take on the issue of gold and silver. Sadly, I have even had a dear friend sever our relationship since I wouldn’t adhere to gold and silver being the only “true forms” of money. That deeply grieves me, but I also am grieved by what I see as a commodities bubble that will most likely burst at some point – financially damaging many people. Permit me to go back to the basics. What is debt? “Debt” is a promise of future labor. What is money? “Money” is a claim on debt (the promise of future labor). Is all debt money? No, if debt has not yet been claimed then there is no money. For example, if I venture into the marketplace and wave around a sheet of paper promising 100 hours of my future labor in exchange for $100 then I have not created any money. However, if somebody “claims” my sheet of paper and gives me $100 for it then $100 of new money will have just been created in our economy ($100 original cash + $100 debt paper). There are many that get confused regarding the above example. After all, one can’t take that $100 of debt paper and immediately go buy groceries with it – so how can I call it “money”? Not all “money” is “currency”.  Our entire money supply is made up of various forms of “bonds”, or claimed debt. Some of those bonds are “special”, in that they’re circulated by the Federal Reserve in the form of physical currency that we carry in our wallets and purses. Other “money” is credited to our accounts electronically. We might have an electronic payroll deposit at our workplace. The “money” in our various bank accounts is in electronic form. Physical currency is typically only ever used for “carrying around” money. The last type of “money” is claimed debt that has a longer term before maturity – but it is still “money”. This money is not generally used as currency. These three components make up our nation’s overall “money supply”. Are gold and silver money? The answer is no. Neither one is a claim on future labor. Instead, they are both purchased with claims on future labor (“money”) and sold in order to receive claims on future labor. They are commodities. What do we know about “commodities”? We know that they go up in price with inflation and/or increased demand, and they go down in price with deflation and/or decreased demand. Gold and silver are seeing a jump in price due to “perceived inflation” on the part of buyers, as well as increased demand since people incorrectly believe that gold and silver are the best investments whenever there is uncertainty in an economy. Here’s the question that all precious metals investors should contemplate very carefully: What happens if there really is deflation instead of inflation? What happens if the current “demand” is really an effort by the various international banks to reduce a supply of gold that they no longer really need? What happens if the fervor surrounding precious metals purchases is more emotional rather than factual.? How many remember $140/barrel oil not too long ago? Oil is also a commodity. It is being artificially held at around $75/barrel, and should be trading at around $35/barrel. How much money did those believing in the falsehood of “peak oil” lose? How long did it take the price of oil to plummet? Not long at all. Many people would counter my position by pointing at the US Dollar Index, which has been dropping significantly in recent weeks. Here’s my question to those people: Is the US Dollar Index dropping as a result of a weakening US dollar, or is it dropping because of a major strengthening of some of the foreign currencies that make up the index? Let’s look at the formula used to compute the US Dollar Index: US Dollar Index = 50.14348112 * ((EURUSD ^ 0.576) * (JPYUSD ^ 0.136) * (GBPUSD ^0.119) * (CANUSD ^ 0.091) * (SEKUSD ^ 0.042) * (CHFUSD^.036) ) There are two important areas to look at. Notice how EURUSD makes up 57.6% of the weighting. Also look at how JPYUSD adds another 13.6%, for a total of 71.2% between the two! What has happened over the last few weeks to the Euro and the Japanese yen? They have both strengthened significantly! Isn’t that good? No, it’s bad. They are strengthening because their respective money supplies are shrinking precipitously due to the credit destruction brought on by the international banks. What effect does this have on the US Dollar Index? It causes it to drop, since the index is a reciprocal relationship between the US dollar and a set of foreign currencies. Folks, I don’t know how to say this more plainly. The US dollar is not weakening, it is strengthening. It only appears to be weakening because people are looking at the US Dollar Index, which is showing us that the European Union and Japan are mired in deflation even more than we are! Our economy is not the worst right now. Japan has been in a deflationary spiral for twenty years. Western Europe is beginning to come to grips with the new austerity measures it will have to force upon the people. Our currency is strengthening due to the fact that our money supply is shrinking due to collapsing credit. It’s just not strengthening anywhere near the rate of Japan or the European Union – yet. The only thing keeping our money supply at a false higher level is the $1.5 trillion dollar deficit our nation has run for each of the last two years. What would we be seeing if the US dollar truly was weakening? We would see the stock market rise extremely fast. It would not be beyond reason to expect the Dow to hit 30,000 to 40,000. We would see investors running, not walking, away from US Treasury securities. Why would one hold those when the stock market was about to erupt? This would drive treasury yields much higher, causing interest rates on loans to increase rapidly. What are we seeing? We’re seeing investors running, not walking, to BUY US Treasury securities. We’re seeing interest rates on those securities plummet, since high yields aren’t necessary to entice the buyers. We’re seeing loan interest rates drop quickly, even though the international banks are destroying credit at a much faster rate than new credit is being created. This credit destruction is what is driving the worldwide deflationary spiral. The only reason to hold large amounts of gold and/or silver right now is if one truly believes that we are in for major inflation, and that some large country will eventually revert back to a gold or silver standard. There is absolutely no evidence of either. In fact, there is a large body of evidence pointing in the exact opposite direction. Remember what happened to oil. Your comments and questions are welcome… If you are not currently on the Economic Update email list you can email me at: brad@newfamilyeconomics.com to be added. There is no charge and your email address will never be shared.  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