Reality Check -
Buy Silver or Gold? Gary North's REALITY CHECK
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Issue 523 February 7, 2006
BUY SILVER OR GOLD? This problem faces every contrarian investor who has
decided that the U.S. dollar will not reverse from the
course it has been on since 1913: a 95% reduction in
purchasing power.
There are a few contrarians who think that deflation
is coming: both monetary deflation and price deflation. As
far as I know, there are only about a dozen of them who
write newsletters or run websites. For some reason, most
of the deflationists seem to think that gold's price will
rise in a mass deflation. They do not warn their
subscribers, "Don't buy gold or silver!" If they did, they
would have fewer subscribers.
Robert Prechter has never joined this camp. He
started predicting $125 gold at least 15 ago. He is
consistent. The other deflationists are either
inconsistent or silent on the gold question.
In contrast, I think gold's price will rise because
the money supply will rise. I recommend that your first
$10,000 in gold be purchased as one-ounce coins. American
eagles are more expensive than Krugerrands. Eagles by law
are designated as numismatic coins. In 1933, when the U.S.
government confiscated gold coins and bullion, it exempted
numismatic coins. If you are worried about gold
confiscation -- I am not -- then the eagles make some
sense. But you get more gold for your buck with
Krugerrands. On these and other precious money issues,
click here:
http://snipurl.com/kt61 Why gold's price should rise in the face of falling
prices, including all other commodity prices, remains a
mystery to the rest of us gold bugs.
The original deflationist, J. Irving Weiss, announced
a looming price deflation in 1967, at Harry Schultz's
original gold conference. I was there. He told us to buy
T-bills. I bought gold coins instead. Since then,
American prices have risen by about six to one. He remains
the model deflationist: he never retracted his prediction
over the next three decades. His son Martin continues to
announce it. But the father had an excuse for his
blindness. He had borrowed $500 from his mother in 1929
and turned it into $100,000 by 1931.
http://snipurl.com/sameoldstuffHe had made his fortune in the classic bear market of all
time, and he never figured out that this was a once-in-a-
career opportunity. The Great Depression dipped his
investment strategy in cement.
Here, I am talking about hard-core inflationists.
Most of them favor gold over silver. A few prefer silver
over gold for their core holdings. I am not one of them.
Let me tell you why.
THE DE-MONETIZATION OF SILVER In June, 1963, the government passed legislation
severing the legal connection between silver certificates
and silver. No longer could you take in a silver
certificate to the U.S. Treasury and get a fixed number of
ounces of silver.
I could see exactly what was coming: Gresham's Law was
about to be re-confirmed: "Bad money drives good money out
of circulation." That is, the government-overvalued money
drives out of circulation the government-undervalued money.
I began buying silver coins the next month with my first
full-time paycheck. I made $500 a month, and by September,
I had bought over $1,000 in silver coins. I believed in
thrift!
I bought them because the local bank had silver coins.
I kept buying more every paycheck. I remember a teller --
a young woman -- who told me: "You can always get coins.
Why do you want to buy so many of them?" I don't recall
what I told her. I doubt that I explained Federal Reserve
policy and Gresham's Law to her. Technically, the bank had
to provide coins for me on request. They had only silver
coins, other than pennies and nickels. I knew what would
come soon: clad coins. They did.
By October, silver coins were going out of
circulation. There was a shortage on the turnpikes for
making change. There were no clad coins yet. They came in
1964. So, dimes, quarters, and fifty-cent pieces were in
short supply.
That was the de-monetization of silver. Collectors
removed them from circulation. Occasionally, we would find
a silver coin among the legally authorized slugs, but not
often after 1966.
The public did not know the difference. There was no
outcry against the government for having legislated this
gigantic counterfeiting operation. Copper coins with shiny
laminate on them were just fine with the average Joe.
Beginning around 1968, gold began to be demanded in
ever-greater quantities by foreign governments, especially
France. This had been going steadily for a decade. The
Johnson Administration attempted several counter-measures,
such as a two-tier gold price: one for the European free
market in gold and the other for central banks to buy
American gold. Nothing worked. Finally, Nixon
unilaterally ended gold convertibility in 1971, which
destroyed the 1944 Bretton Woods agreement: central banks'
use of the dollar as their reserve currency, with the
dollar redeemable in gold at $35/oz, but only by national
governments and central banks.
The central banks still kept their interest-bearing T-
bills and other dollar-denominated assets as part of their
legal reserves. They kept gold, too, but from 1971 on,
they still bought mainly dollar-denominated assets, not
gold. This is true today. The dollar has never lost its
reserve currency status, despite the closing of the gold
window. The bankers ignored this semi-final de-
monetization of gold in 1971, in much the same way that
Americans ignored the final de-monetization of silver in
1963.
I say semi-final. Why not final? Because the U.S.
government did not immediately sell off its gold hoard in
1971. Most central banks have refused to sell all of their
gold. They have generally ceased buying newly mined gold
or gold from the free market, but they do buy gold bullion
from each other. Some of them have sold off part of their
gold supplies, but this has been done mainly since the mid-
1980s.
Silver, in contrast, has been completely de-monetized.
It is an industrial metal or a jewelry metal. Its price
peaked in January, 1980, at $50 an ounce. It then fell for
the next 23 years, bottoming at $4.67 in January, 2003.
That was a 90% loss of price, but really closer to 94%,
because of the fall in the dollar's value, 1980-2003. In
short, silver was an investment catastrophe for over 20
years.
Gold is perceived as a money metal that is used by
central banks. It is used by Asians as an inflation hedge.
Silver has lost that perceived value. So, silver is more
volatile. There was nothing to prevent its fall after
1980.
There is something else to consider. For almost the
entire 23 years of its price decline, there were bullish
silver brokers who kept talking about the huge gap between
low silver production and high silver consumption. Here is
my question: If that argument led to losses for 23 years,
why should anyone believe the same argument today? There
was a negative correlation for most of those 23 years
between that argument and the price of silver.
The official figures for demand and supply remain
steady, year after year: from 770 million ounces to 900
million ounces. See the figures for 1995-2004.
http://snipurl.com/silverstats I have seen no plausible explanation for the fact that
for 23 years, a metal that was being consumed out of
unknown storehouses could keep falling in price. If the
publicly available supply/demand statistics were that
impossible for that long a period -- silver supplies by the
hundreds of millions of ounces per year coming from above-
ground sources (where?) -- then why should anyone trust
price forecasts based on today's supply/demand statistics?
Until a silver bull can explain clearly from
verifiable evidence the origin of the silver held in above-
ground sources -- at least 200 million ounces per year
every year for 25 years -- I will pay no attention to the
argument. How was it that above-ground supplies did not
decline in availability, despite a 94% decline in silver's
real price? When you hear this argument, be polite, but
ignore it. Do not invest a clad dime based on this
argument.
THE GOLD-LEASING OPERATION For at least a decade, central banks have been lending
gold to specialized brokerage firms, called bullion banks.
The bullion banks borrow this gold at absurdly low interest
rates -- well under 1% per year. Then they sell this
borrowed gold into the world's private gold markets. This
keeps down the price of gold: added supply.
The bullion banks then take the money they earn from
the sale of this borrowed gold and purchase higher yielding
debt certificates. They may get 6%. So, they are borrowed
short -- the low lease rate -- and lent long: bonds.
They owe gold, not money. The central banks still
list this leased/sold gold on their books. But there is no
gold in central banks' vaults; it has been leased out, then
sold. The public believes that the gold is there, but it's
gone. It has gone into jewelry, maybe in India. Some
daughter has her share of the central banks' gold in her
dowry in the form of a necklace or rings.
The central banks do not report that it is gone. So,
there is always the threat that the public will figure out
that the leased gold is gone. But, for now, the
politicians either are as ignorant as the public or content
with the arrangement. So, the odds are that the public
will not learn about the missing gold. In any case, voters
are just about incapable of mounting a political attack on
central banks, which truly are untouchable politically.
But the fact remains that the banks have depleted
their hoards of gold. So, their ability to push down the
price of the gold is becoming more limited. Central banks
have not announced lately the usual warning: "We are going
to sell gold over the next few months." Of course, no
profit-seeking owner of a commodity ever announces his plan
to sell. That would depress the price. He wants to
maximize the sale price. In contrast, central bankers do
make these announcements. This indicates that their
profits come from other sources. One such profit source is
political: the public's perception that monetary policy is
sound, a fact testified to by the fact that gold's price
has not risen much. The central bankers are temporarily
buying the illusion of price stability: a lower gold price.
This perception is now changing as gold's price keeps
rising. Yet the kitty is depleted. The gold has been
leased, then sold. There may be some future announcements
of some central bank's looming gold sales, but the silence
so far has been deafening.
So, the gold overhang of the central banks is no
longer the sword of Damocles. It is more like the
switchblade knife of Damocles.
The central banks now face a major problem. If gold's
price gets too high, the private bullion banks will be
trapped. They owe gold to central banks, but they cannot
afford to buy gold in the private markets in order to repay
it to the central banks. If they are ever asked to repay,
they will go bankrupt.
The central banks therefore will face exposure as
being in collusion with a bunch of profit-seeking Enrons:
busted and owing the government's gold to the central
banks. My guess is that central bankers knew from the
beginning that they would never see this gold again. They
just wanted a cover: "leasing" rather than "sales" of the
government's gold.
The downward pressure on gold is today no longer so
great as it was a decade ago. The threat is reduced
because the vaults are less full.
No central bank holds silver as a monetary reserve.
No central bank is committed to buying or selling silver
for public perception reasons. Silver has been de-
monetized. It is no longer on the political radar. So,
silver is closer to a true free market commodity. It is
therefore more subject to the ups and downs of the business
cycle.
You can make more money in silver when the market
rises: no overhang of leased silver in central ban vaults.
You can also lose more money when silver falls, along with
the economy: no central bank buying of silver.
Finally, if the bullion banks are ever asked to repay
the gold, the gold bullion market faces a day of reckoning:
massive buying by shorts (bullion banks) or else the
widespread awareness that central banks do not have as much
gold to sell off to keep down its price. Both events would
drive up the price of gold. There is no comparable upward
pressure for silver.
THE GOLD/SILVER RATIO There was a close correlation for many decades: 15 to
one. That was because this ratio was set by Federal law.
It was a price control. Gresham's law always took over.
The overvalued metal would drive out of circulation the
undervalued metal. For as long as the government would
supply the undervalued metal, the coins would circulate
side by side. But when the gold/silver ratio diverged too
much from 15-to-one, speculators would buy up the coins of
the undervalued metal and ship them abroad or melt them
down for their value as metal (higher) rather than money
(lower).
To find today's ratio, divide the price of gold by the
price of silver. It is nowhere close to 15 to one. In
1963, when silver went out of circulation, silver was about
$1.30, while gold was $35. That was 27 to one. Before
1963, silver's price was lower, so the ratio was higher.
But the ratio did not matter. Gold's price was a fake
price. Americans were not legally allowed to own gold
bullion. So, silver circulated. Gold didn't. Then, in
1963, it became profitable to buy silver coins and hoard
them or melt them down. Silver coins disappeared.
Again, the gold/silver ratio as a forecasting tool
produced only losses, 1980 to 2003. Silver's market price
fell by 90%. Gold's price fell by 70%. The gold/silver
ratio increased.
When you discover an alleged semi-fixed price ratio
that produces forecasting errors for 23 years, it is best
to avoid adopting it as your precious metals allocation
strategy.
In any given 12-month period -- and you can't be sure
which 12 months -- the price of gold or silver may rise or
fall by a greater percentage than the other. It does no
good to trade back and forth, given the income tax
consequences. You may do it once, but let it go at that.
STORAGE PROBLEMS The best way to buy silver is to buy 90% silver coins:
pre-1964. Take delivery. The sack of coins weighs over 56
pounds. Get them divided into two bags. I recommend
dimes: more transactions per bag. But it doesn't matter
that much unless there is a complete monetary breakdown.
Gold coins are far more versatile. That is because
they are worth more per unit of weight and volume. They
are easier to hide. They are easier to move across a
border.
You can buy bullion and store it at GoldMoney (London)
or (cheaper) at Kitco. Your bullion is pooled at Kitco.
It is allocated in your name at GoldMoney.
http://goldmoney.com http://snipurl.com/kitcopoolsCONCLUSION I return to these issues from time to time because
there are new subscribers coming on board all the time.
Also, the questions that I get on precious metals indicate
continuing confusion. I hope this has reduced some of the
confusion -- or at least added new, improved confusion.
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