Gold as Armageddon insurance

October 7, 2009

Deflation could be the biggest threat to the economy, but gold — usually an inflation hedge — is reaching new highs. That’s because smart investors aren’t playing the inflation trade, they’re buying currency crisis insurance.

With the amount being spent by the public sector, with the huge amounts of leverage still in the system, there’s a palpable fear that America won’t be able to meet its obligations. Relative to GDP, the amount we’re borrowing to finance deficits makes us look irresponsible.

When such economies hit a wall, investors make a run on the currency, typically moving their assets to a stronger currency, like the dollar.

But this time the problem is the dollar, along with other leading paper currencies, all of which are threatened by profligate fiscal and monetary policies. So some investors want out of the system entirely. Gold, as my colleague Neil Collins noted earlier, is a way to do that.

The gold market is small enough that a decision by a handful of money managers to increase their asset allocation from, say, zero to 5 percent can move the market. All the gold ever mined would fit aboard an oil tanker; its total weight of 125,000 tons amounts to a few hours’ output for the U.S. steel industry.

But economists tell us that inflation isn’t a risk now. Are they wrong? No and yes.

The conventional way economists view inflation is to look at things like “output gaps.” When the economy falls below a level of output it previously achieved, it is said to have unemployed resources. If you think of inflation as workers demanding and getting higher wages, which leads to higher prices for the goods and services they produce, then inflation isn’t a threat.

So economists tell us more borrowing and money printing won’t be inflationary as long as people are unemployed.

One problem: Their models ignore the fact that peak output was artificially inflated by a credit binge. Borrowing more to sustain an unsustainable level of spending borders on insanity, yet that’s precisely what such economic models tell us we need to do.

There’s an extra variable these models don’t account for — the Chinese and all major lenders to the United States. They don’t much care if our employment rate is below desirable levels. At a certain point, they may recognize that the United States is acting like a banana republic and choose to stop lending.

When that happens, we might see a “sudden stop” event: Capital inflows to the private and public sector cease as everyone races to get out of dollars.

Eric Sprott, CEO of Sprott Asset Management has $4.5 billion under management, $2 billion of which is invested in physical bullion — silver and gold — stored at banks in Canada. Another large chunk is invested in gold stocks.

He views gold as an insurance policy against both inflation and deflation. Central bank quantitative easing policies mean “we’re printing paper currency like crazy,” so he doubts the long-run value of fiat currencies.

On the flip side, if central banks pull back, you could enter a deflationary spiral, essentially a banking collapse, in which case “your deposits wouldn’t be returned to you. Better to have physical gold in your control.”

Most economists and investors still labor under the illusion that there’s a way out of debt that doesn’t involve a drastic reduction in the paper value of wealth. Smart investors aren’t so sure and want at least a portion of their assets out of the financial system.

A dollar crisis isn’t necessarily coming tomorrow, so there’s no guarantee gold’s price will keep going higher. Still, gold is a decent insurance policy against economic Armageddon.


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At 125k tons x 2k lbs/ton x 16 oz/lb x 1k $/oz, I get $4T in total gold mined. That seems like a lot more than a few money managers could move.

Posted by winstongator | Report as abusive

The issue is that the market is thin. Take all the gold, subtract gov’t reserves, gold in use for industrial/medical purposes, and locked up in safe deposit boxes, matresses, and backyards, and there’s not really that much gold flowing.It’s like the difference between proven oil reserves and daily output: global proven reserves might be a bajillion barrells of the lightest, sweetest crude a refiner could ever want to buy, but if daily global output is only a few million barrels barrels a day then the price can be easily impacted by the entrance of a few extra players. Of course oil would be stupidly expensive if global output fell from the current max cap of about 85/day to just a few/day.

Posted by Andrew | Report as abusive

Also, gold is quoted in troy ounces, which is not 16/lb.About 14.6/lb.

Posted by Andrew | Report as abusive

All the gold ever mined, if purified and melted together in to a cube, would measure approx 20 yards/meters per side.”Good Delivery” bars are pure. That is why it is obvious that there are scammers out there (GLD?). You can find pictures on web searches of warehouses of gold that look to be full of bars. Well, those pictures are obviously fake based on the abovementioned fact along with the fact that no one warehouse has more than 1/2 the worlds gold.India has the most in absolute terms, USA has the biggest store of big bars (supposedly).

Posted by Goldfinger | Report as abusive

Using Andrew’s 14.6 oz/lbs and Rolfe’s 125k tons, I get 3.650 billion ounces. That’s less than 1 ounce per capita for the global population. Can that be right given dental gold, wedding bands, etc.?I haven’t bought any physical gold though I did buy some gold mining stocks ( Canadian) earlier this year. Having physical gold around seems risky to me, more so in the event of a ‘sudden stop’ type crisis. Try and spend it then and you might find out 9 grams of lead is all it takes to commandeer all your gold.

Posted by sangellone | Report as abusive

To sangellone: It has worked for me just fine over the years. I bought a bit at 300, five years later when an emergency hit and I needed cash, I sold 10 ounces that cost me 3K to pay 6K. I put all my 401k into coins in 2003. Even with the tax hit, guess who is ahead today?Silver is the place to be…..long.

Posted by M Novak Jr | Report as abusive

It’s hard not to see a major stock market correction coming within a year, and, because of that, a drop in all commodities due to margin calls. Good stocks get clobbered along with the bad. But they do recover faster.I still don’t see a decoupling – yet. Though I do believe it’s in our future, I think that a market lunge downward is in our more immediate future.I’m waiting until the next correction, then I’ll put my toe in the water.

Posted by Lisa | Report as abusive

Gold is money.We have 6000 years of human history and books proving that paper does not work and only gold has been used as money for all 6000 of those year.Even today central banks hold only one “commodity” in there vaults and it ain’t Oil.Only in man’s mind can a contradiction of reality exit. The belief that money that someone creates virtually on a computer is more valuable than something real can only exist in the mind not in reality. lol n1M08

Posted by Davinci | Report as abusive

“But this time the problem is the dollar, along with other leading paper currencies, all of which are threatened by profligate fiscal and monetary policies.”So are you saying that the government should have done NOTHING, and allowed all the banks to fail, and maybe 25%-30% of the workforce be unemployed? Would that action have been appropriate?Or is this once again a scare scenario from an elitist who really has no answers, just complaints ? ?

Posted by Edgy | Report as abusive

Rolfe, something is not gelling. icial_go ld_reserves -I created an Excel table and sorted the table by % of forex reserves, just for interest sake. It adds up to about ’42 251 tonnes’ holdings, so a lot must have been used up or hidden away, unless your ‘tons’ is not the same as ‘tonnes’.Nonetheless, that oil tanker will sink fast and Goldfinger’s cube will be as heavy as a small neutron star. Gold does have a ‘pull’, you are right.Lisa has a good point. Base/precious metals have a physical value and a paper value, i.e. free cash flow streams/dividends from the underlying shares and capital growth. As always, supply and demand the key.

Posted by Gaspard | Report as abusive

…sorry that link came out wrong because of the hyphen: cial_gold_reserves

Posted by Gaspard | Report as abusive

Gold doesn’t really have any more intrinsic value than paper money: it’s still fiat currency.Sure, there’s a few thousand years worth of history demonstrating a strong unspoken understanding that gold is a nearly universally acceptable transferable medium of storing wealth. You can take gold anywhere in the world and find SOMEONE that will give you local currency or goods for it.The only real advantage gold has is that the supply of gold is, mostly, limited and outside the control of governments… and should a gov’t debase metal coinage, it’s fairly easy to tell.

Posted by Andrew | Report as abusive

Andrew said, “The only real advantage gold has is that the supply of god is, mostly, limited & outside the control of governments….”Boy, am I glad you said “mostly.” You may recall that FDR signed an executive order in 1933 requiring that all Americans turn over to the USG any gold that they had…hardly outside the government’s control then.And that is one thing (among many) that keeps me from getting too enthusiastic about gold now. While the USG is not tied to a fixed dollar value for gold as it was in 1933, that doesn’t mean that an administration wouldn’t once again seize gold if it thought that gold hoarding was disrupting the American economy.

Posted by Lilguy | Report as abusive

That’s a risk of a physical asset like gold. However, because it is usually sold/purchased witha minimum of paperwork, there’s really nothing to keep people from not turning in their gold (other than the fact that it wasn’t legal tender any more… you’d have to take it out of country to use it).I’m not so sure the gov’t could make the same case for confiscating gold now that it made back then as the currency is totally independent from the gold standard. I doubt the supreme court would rule the same way now.Perhaps the bigger risk is that the US Gov’t decides that it looks bad that gold is so expensive (let’s pretend it gets to $1,800-2,000/ounce). If the gov’t announced it was even thinking about selling a portion of the gold reserves, the relatively thin gold market would probably get crushed with selling activity. It wouldn’t even really HAVE to sell any reserves.

Posted by Andrew | Report as abusive

It’s worth remembering that Armageddon was several fairly localized battles, a long long time ago that in reality didn’t affect that many people. There were winners and losers in the battles of Armageddon. Civilization continued.Some people through-out history keep declaring there’s going to be another Armageddon, and that next time everyone will perish, but this is the product of deluded minds intended to frighten sheep and little children.

Posted by Peter H | Report as abusive

Read “The Creature from Jekyl Island” The bailout of the major banks with our tax dollars was all a plan of the bankers to get a hold of our money. They have done it over and over since the federal reserve was created, which is NOT part of the government. They have bankrupted our country with their greed and the paper dollar will be worth nothing because of the massive debt this has put our government in. The ONLY save play is gold, silver, guns and ammo.

Posted by Jason Campbell | Report as abusive

I’m pretty sure you forgot beans and band-aids.You know, once we run through the trillions in SS, medicare, other future healthcare costs, and current… $13? 11? trillion in gov’t debt…It’ll be that few hundred billion bank bailout that really broke the camel’s back. All those greedy bankers and the people they forced to borrow from them.

Posted by Andrew | Report as abusive

[…] Gold as Armageddon insurance – ler/2009/10/07/gold-as-armageddon-insura nce/ […]

Posted by Daily Wrap – 10/8/2009 « | Report as abusive

Andrew, the market is not thin at all, in fact it is very thick, as the playing field is not the private sector as much as the public sector. Jason, say hi to Charlton Heston. Correct, Armageddon was included in the most printed Book ever, the author reacting to what was actually happening in the regional society at that time. As for the symbolism and supposed prophecies, frightening stuff, but show me the money/gold.

Posted by Gaspard | Report as abusive

The gold market is actually thin as it can react very violently to sudden shifts in either demand or supply. Just because there are a lot of ounces being traded doesn’t mean it is “thick”. An unexpected increase in annual supply of 10% (about 200-250 tons) would have a significant impact on gold prices.

Posted by Andrew | Report as abusive

That’s fine Andrew, we have different training, maybe ‘medium rare’ is more appropriate.

Posted by Gaspard | Report as abusive

The spike in the increase of the value of gold and the increase of pirate attacks around the world must be connected.The ones off Somalia and the China seas are the most honest.

Posted by Dan | Report as abusive

If gold is such a hedge against financial disaster and loss in the paper financial market, what is the value of having paper certificates of gold ownership? If the financial market takes a dump, gold certificates will be as worthless as stock certificates. DUH !!!!

Posted by BOBBYG | Report as abusive

All part of operation destroy the US.We are to big to be occupied, however, we are just right to sink ourselves.Look in history, it happened again and again, and again.Russia most recently.Napolean, Hitler, and others have tried to take russsia, they could not do it, but the russians did.We are next.

Posted by Ron S. | Report as abusive

Ron S. is right. National financial disaster happens from a economic cancer within, not from external forces. Gold is an archaic form of exchange going back thousands of years. Today, financial strength is derived from the strength of a national economy, not a horde of metal. Productivity, efficiency and innovation is the gold which built our nation, not the amount of a particular metal we dug out of the ground and locked away in a vault.

Posted by Rite Onn | Report as abusive

This is a limit to gold price, and there is a limit to the decline of Greenback.The moment Greenback halts in decline and shoots up in value, those gold-diggers will suffer loss.

Posted by scheng1 | Report as abusive

[…] Metals Precious metals, notably gold, is what some economists call Armageddon Insurance. Mathematically, for gold to function as a global currency, it would need to trade in the range of […]

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