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BMG ARTICLES Is Gold a Bad Investment? 1 Gold Coverage Ratio April 2014 By Nick Barisheff “Gold is an enemy of central banking—it infringes on the ability of central bankers to do as they please. It threatens them with loss of control of the currency when people flee to the safe haven of precious metals. Central bankers will do anything to prevent that—it is the entire basis of their power.” ~ Kelly Mitchell—Gold Wars. In my recent book, $10,000 Gold: Why Gold’s Inevitable Rise is the Investor’s Safe Haven, I make the argument that several long-term, in some cases irreversible, trends are working simultaneously to push the price of gold higher. At first glance these trends may seem unrelated, but all have one thing in common—they are each forcing the level of government debt higher by the day. Outsourcing, movement away from the dollar, tightening supplies of cheap land-based oil, the aging population—all in some way are creating a need for more currency, resulting in debasement that, in turn, contributes directly to the rising price of gold. In the book, emphasis is placed on the correlation between US debt, money supply and the rising gold price. Since 1973, the United States has enjoyed an “exorbitant privilege” because the world has been forced to use the US petrodollar to buy oil, which is why 61.2 percent of the currency presently in circulation globally is in US dollars. As well, it is the United States in particular and Western central bankers in general that have the most to lose from a rising gold price, so the dollar and gold are in direct competition. Short term, this means gold has some powerful enemies. Long term, the relationship between gold and US debt will come back into sync as it was until 2013, when desperate acts of intervention skewed the relationship. Therefore, we thought it would be valuable to look again at the gold coverage ratio and to see where gold should be trading were it not for the artificial and temporary price setbacks it experiences as a result of intervention. In 2011, Guggenheim’s Chief Investment Officer, Scott Minerd, presented an important chart showing three different scenarios for the future price of gold using the gold coverage ratio. This ratio measures the amount of gold on deposit in the US Federal Reserve against the total Monetary Base. Below is an updated version of the chart (Figure 1). Figure 1: Gold Conversion Ratio—April 2014 In October 2011, with gold trading 44 percent higher than today’s price, the gold coverage ratio was at an all-time low of 17 percent. Today it is at 9 percent. This is simply unsustainable. Gold Coverage Ratio Following Mr. Minard’s example, we have estimated what the price of gold would be under three different scenarios: If the ratio is estimated at 19 percent, at 40 percent and at 100 percent of gold to the money supply. The ratio was at 19 percent in 1971 when President Nixon closed the gold window and allowed the price of gold to float. It was at 40 percent at the time of the Bretton Woods agreement in 1944. It was at 100 percent in 1934 when President Roosevelt passed the Gold Reserve Act. It has reached 100 percent twice in the past century. Today, at 19 percent, gold would be valued at $2,800. At 40 percent, it would be at $5,900 and at 100 percent, gold would be priced at $14,800 an ounce. Many modern day economists argue the fiat model makes gold irrelevant. Keynes, the architect of fiat BMG ARTICLES 2 deficit spending, claimed gold was a “barbarous relic” that had no place in today’s economy. Paper currencies and gold have always been at war and for paper to retain power, gold must be discredited. Yet modern economists who see the writing on the wall know that it is only a matter of time before the US dollar goes the same route as every other fiat currency that eventually hyperinflated and then became worthless. Despite what Keynesian economists think, gold will almost certainly have to have a role in the world’s next reserve currency in order to provide confidence. Gold may not form a 100 percent relationship to the monetary base, but even a percentage would give stability to a new currency and would certainly give it credibility. When the gold coverage ratio reverts to fair value, as it always does eventually, today’s prices will seem unimaginable to most investors—especially to those who do not own any gold. Nick Barisheff is the founder, president and CEO of Bullion Management Group Inc., a company dedicated to providing investors with a secure, cost-effective, transparent way to purchase and hold physical bullion. BMG is an Associate Member of the London Bullion Market Association (LBMA). Widely recognized as international bullion expert, Nick has written numerous articles on bullion and current market trends that have been published on various news and business websites. Nick has appeared on BNN, CBC, CNBC and Sun Media, and has been interviewed for countless articles by leading business publications across North America, Europe and Asia. His first book, $10,000 Gold: Why Gold’s Inevitable Rise Is the Investor’s Safe Haven, was published in the spring of 2013. Every investor who seeks the safety of sound money will benefit from Nick’s insights into the portfolio-preserving power of gold. www.bmgbullion.com