Buy Gold To Keep Up With Inflation

During the recent stock market rally, it was easy for investors to get complacent about the future and engage in reckless speculation. The common refrain is that there is nothing much to fear except fear itself. After all, esteemed economics professors, including Paul Krugman, have ascertained that the worst is over.

Nevertheless, in the short term, the stock market rally is almost done. Window-dressing and opportunistic trading aside, we can expect a consolidation or downward correction. If you are sitting on cash, well, liquidity never hurts. If you are vested in blue-chips and getting attractive dividends, just maintain the status quo. 

I won’t be looking at stocks for a while. Inaction is a decision too when it comes to safe investing. Of course, you can always add to your portoflio if you are a long-term investor. For the time being, I am keen to accumulate gold. We may still be in a deflationary environment but the impending inflation from all the printed money is no laughing matter.

As it is, we are damned if we store our cash under the mattress and damned if we don’t. Think of inflation as a silent tax which eats away at our wealth which have been accumulated painstakingly from investments and savings. The same amount of money will purchase lesser goods in future.

The Federal Reserve has lighted the fuse of hyperinflation with its intervention in the Treasury bonds market. While its Quantitative Easing through buying debt with printed money achieved a shock and awe effect in March, this weapon to control interest rates has become blunt after repeated use. Long term interest rates will find its own level according to supply and demand, not artificial intervention.

In fairness, the Fed has little choice but to intervene because if nobody wants to buy US debts, then interest rates have to rise to attract investors. The cost of borrowing will increase and add to the ballooning deficits. Thus, inflation is deemed the lesser of two evils especially when there are still strong deflationary pressures to counter.

Whether monetization of debt is indeed the best option for the Fed may be debatable but one thing is clear, it doesn’t generate real wealth. All these money created out of thin air only serves to transfer wealth from solvent savers to insolvent debtors who are greedy and irresponsible. This redistribution of money from current taxpayers (and our future generations) is tantamount to looting but because it is done subtly, public outrage is manageable.

Thanks to decades of over-consumption (fed by easy credit) and an entitlement mentality, America is in a rut hole and currently experiencing a harsh deleveraging process. Being a keen student of the Great Depression, Ben Bernanke is determined to get credit flowing again, induce more consumption and stabilize asset prices. And America is not alone, all over the world, trillions of dollars are being spent to reflate the economy.

The problem is these governments are in debts, and can only finance their massive stimulus programs, bail-outs and loans guarantees by borrowing and money-printing. I am not against Keynesian policies but there is a fine line between starting a bonfire and a forest fire to stay warm. Saving all the too-big-to-fail institutions will eventually put nations at risk of defaults.

The latest figures show that the US has racked up fiscal deficits at 13% of GDP in 2009. Timothy Geithner’s promise to the Chinese that the US will keep its deficits to within 3% of GDP was met with derision. Clearly, nobody is taking his commitment seriously. US federal debt stands at nearly $13 trillion, almost equivalent to 2008 GDP, and that is not including obligations to Medicare and social security.

The US is so deeply entrenched in debt (it will be deemed insolvent long ago if it was a business), it will take a lot of time and political will to sort out the mess as well as to encouraging Americans to live within their means.

Because of the sheer size and the lack of fiscal discipline, there is little hope of US ever repaying its debts. Its current modus operandi is to roll over the principal and interest by issuing new bonds, at the expense of more debts. When US debts lose its allure, the house of cards will collapse, similar to the last stages of a Ponzi scheme.

Ponzi schemes survive by robbing Peter to pay Paul, thus, a constant influx of investors is needed to provide impressive returns to existing investors. If no more suckers come in, the game is over. Though the US government is big enough to guarantee US Treasuries, but with so much “risk-free” goodies being issued, investors must be wondering where is the breaking point, leaving them with worthless paper assets.

The crumbling of the mighty United States of America is akin to Britain after WWII when she gave up her empire and her currency collapsed. To peep at the future of America, one has only to study the “fiscal meltdown” of California due to a budget shortfall. Top state officials have pleaded Obama administration for emergency aid but to no avail. The worry is that a bailout of California would set off a dangerous precedent and other states may make similar demands.

California needs deep budgetary cuts to balance the books but this may worsen the state’s recession – unemployment figures will spike and housing market decline further. California is the 8th largest economy and its slump will be detrimental to America and global economic recovery. Of course, California may eventually be saved by the federal administration and all will be well.

But what happens if the United States is the one now facing the fiscal crisis? No institution is big enough to rescue them and unlike a business, you can’t force it into bankruptcy and auction off its assets. Not unless you want to risk a war with America. Thus, it is more likely that another Bretton Woods style conference to write down debts and devalue all nations’ currencies may follow.

I am increasingly skeptical about the viability of paper money as a store of value, especially the US dollar. You can feel the uneasy truce in the dollar’s status as the world’s reserve currency when the Russian Finance Ministry had to issue two conflicting reports in a matter of hours on their confidence in the greenback. Not reassuring at all.

In public, the three largest creditors of US debts, China, Japan and Russia will maintain that the US dollar is crucial and hope that the US economy is back in the pink of health. A weak US dollar does no good to export nations and reduces the worth of their investments in US debts. The currency in which trade is settled still remains dominantly U.S. dollars. And we don’t need any disruption in trade now. But away from the public scrutiny, US Treasuries are being dumped in exchange for commodities. At the very least, you won’t find any more buying frenzy in the US Treasuries.

If you are talking about safe investing, gold and silver should really be in our portfolio. With the amount of paper money in circulation (and more coming up off the printing machines), a tiny fraction of fiat currencies is enough to bid up prices of precious metals. Even though gold has fallen recently, it is an adjustment from overbought levels.

To date, about 160,000 tons of gold has been mined from the ground and at US$950 per ounce, it is worth US$4.9 trillion. But with at least US$60 trillion of paper money in circulation (currencies, savings, deposits, money-markets and CDs), gold is grossly undervalued.

It is prudent for investors to allocate 15%-25% of their portfolio to gold bullion, gold mining stocks, etc. Over the next weeks, gold may dip further and I see it as a good opportunity to accumulate gold. Buy gold to keep up with inflation and think about profit later. As far as I am concerned, that is the best safe investing advice.

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7 Comments

Filed under Currency, Deflation, Economy, Inflation, Stocks, bonds, gold

7 Responses to Buy Gold To Keep Up With Inflation

  1. Pingback: Festival of Stocks #147 | Value Investing Pro

  2. Firstly I have enjoyed browsing the posts on your site. However I’m not sure that I would agree that gold is an investment, maybe a store of value. 1. The price of gold is also very volatile, 2. gold does not produce any form of income and therefore any ‘investment’ in gold, would be speculation.

    Inflation-protected bonds or/and equities are better investments, as an inflation hedge.

  3. I believe that over the long term inflation will ne a problem but over the short term it appears that deflation is a bigger issue.

  4. Pingback: WIP vs. TIP: Two Ways To Hedge Inflation | ETF Database

  5. Gold may be a stable investment but will never provide any windfalls, For real profits one needs to take more risks. The rewards from investing in stock or property if done properly can any day be higher than Gold will ever provide. Of course the risks are greater too.

  6. I prefer to invest into gold at this point. This will maximize your profit with lowest risk.

  7. Edna

    Gold is money, but better. I T CAN MANTAIN ITS VALUE INTERNATIONALLY AND HENCE IT IS VERY LIQUID.I SUGGEST KEEP IT AND SPEND SOME FOR THE NEEDY.Peace.

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