Gold prices continue to move up as U.S. debt soars. That’s why gold stocks and investing in gold miners could be a good move in the near future for investors.
In 2003, when the economy finally turned up again after the dot-com bust, U.S. debt-to-GDP stood at 306.2%. We embarked on another debt-driven growth cycle and just at the beginning of the Great Recession in the third quarter of 2008 this same debt-to-GDP ratio stood at 358.2%. While in this recession, the government thought that it would be a great idea to try to resuscitate this debt-driven growth model and produced previously-unimaginable trillion-dollar-plus deficits — the total indebtedness number as I write this is getting dangerously close to 400%.
This situation terrifies me, and what I keep coming back to is that I need to find an investable solution to this debt predicament. America is a beautiful country — I love it, and this is why I live here — but it has seen remarkable economic mismanagement in the face of Alan Greenspan and the banking community that he served (the heads of many Wall Street institutions sit on the boards of regional Federal Reserve banks).
It is in the big banks’ interest to see ever-rising levels of debt in the economy as they simply make more money shuffling it around, using artificially suppressed short-term rates from the Federal Reserve to finance their bubbalicious operations. The banks love it; they feel rich.
You Cannot Borrow (or Print) Your Way Into Prosperity
This self-destructive behavior is destined to produce a crisis — economic growth driven by ever higher debt levels is simply not suitable.
Bernanke and President Obama, who inherited this mess, are witnessing the verifiable fact that massive new debts incurred in the past two years have produced very little in the way of economic growth, as an over-indebted economic system is simply refusing to circulate the new debt in order to produce more so-called “growth.”
If the debt mountain chart were a cliff, the administration and the Fed are currently having a slow-motion Wile E. Coyote moment.
The reason why everyone enjoyed the creation of this debt mountain is that taking on more and more debts really does increase economic growth far beyond what otherwise would be achievable. It is the same thing as abusing a credit card. You spend and live large — and the stores you shop at love it. But after the credit card company pulls the plug on that easy credit, it’s not good for you, the stores, or the credit card company. Everybody loses.
And the situation we are in right now is the crowning achievement of Mr. Greenspan’s illustrious career. I find it quite amusing that Mr. Greenspan is now an advisor to John Paulson — the man who made billions shorting the very housing bubble he created — on how to position his new precious metals fund, which benefits from the (further) unraveling of his pet debt bubble!
There is nothing you or I can do about this mess other than position ourselves to be winners in this economic shakeout. I have been going on at length about the merits of investing in emerging markets that don’t have this sort of debt-driven-growth-cycle problem, and I have also discussed the importance of focusing on U.S. companies that benefit from emerging markets’ sustainable economic growth.
The clogging of the over-indebted financial system is currently producing deflation — which is why zero-coupon bonds as represented in the Vanguard Extended Duration ETF (NYSE: EDV) are working — while the eventual unclogging driven by the lunacy of money printing will eventually produce higher (hopefully-not-hyper) inflation. This is why gold bullion is refusing to sell off, even despite the current deflationary shock.
If gold bullion sells off with intensifying deflationary pressure — buy more — for Bernanke would not stop the printing presses until we run out of trees.
The biggest beneficiaries after the rally in gold from $251 to $1250 in the last nine years will be gold mines with very high costs, as they see the biggest improvement in operational performance. I put the following in my book in 2006 and I still think the rationale is valid:
South Africa is synonymous to gold, and yet its stocks underperformed during the metal’s initial rally in the 2002 to 2004 period. Major South African mining stocks like Gold Fields (NYSE: GFI), Harmony (NYSE: HMY), Anglogold Ashanti (NYSE: AU) and Durban Roodepoort Deep (NASDAQ: DROOY), have had the incredible experience of seeing their share prices decline (precipitously in some cases) at a time when the price of gold bullion rallied. The reason is the historic rally in the South African Rand, which, from early lows of 13.86 against the dollar in December 2001 advanced to an incredible 5.60 in December 2004.
South African mining companies saw the highest price for gold in rand terms in December 2001. Since South African mines pay their costs in rand and sell their gold in U.S. dollars on the international market, they were faced with the double whammy of declining revenues and rising costs. Many of the South African mines have international operations, so the natural response of management was to aggressively expand their foreign operations and slow down their South African production. It was a reflexive, though understandable, response done in the interest of self-preservation.
For investors with a long-term view, the selloff in South African stocks may be a welcomed event — it will allow them to establish positions at prices last seen in 2001 and 2002. If gold is in a genuine bull market, the selling in South African mining stocks will prove to be the buying opportunity of a lifetime.
The real bull market in gold will begin when the commodity starts rising in terms of all major currencies, not just against the dollar. So far, gold has behaved as the anti-dollar and an alternative currency, but it has also shown signs that it can perform well as an alternative to all paper money, not just U.S. dollars.
While we have now seen gold begin to rally in all currencies — due to the unholy practice of quantitative easing — we have not yet seen a massive rally in the above-suggested South African stocks. In 2008, John Paulson begun to aggressively buy the very South African stocks that I profiled in 2006. I suggest you do the same.
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