Why Gold Why Now

by Adam Crum

As we approach the fifth anniversary of the World Trade Center attack, I am struck by the enduring significance of that appalling incident.

While it was by no means the beginning of where the United States finds itself today, that tragic event has certainly moved us towards critical mass, with a far greater impact on our daily lives and the economy than many of us could have imagined five years, two years or even one year ago. We are now not only looking at a war on terror and wars in the Middle East; we are also now looking at the threat of a slowing U.S. economy.

Six forces that fan the flames of war

While it’s easy to view the conflicts in the Middle East simply as radical Muslim or anti–Western violence, in reality these conflicts are extremely complex, instigated by equally complex forces that have existed through the millennia.

• Force #1 – Economic
  With few exceptions, most of the wealth in the Muslim world is controlled by a despotic few. The poor have little or no access to adequate housing, modern sanitation, health care or education.
• Force #2 – Ethnic
  The Sunnis represent the majority throughout the Muslim world, and generally have the most wealth and power, while the poor and powerless tend to be among the minority sect, the Shiites.
• Force #3 – Cultural
  The privileged classes in the Muslim world are modern and westernized, while the masses are just the opposite. There is no place for the middle classes, who are generally forced to move out.
• Force #4 – Religious
  Islamic fundamentalists clash with more moderate Muslims, and both clash with all other religious groups. Muslim fundamentalism is the means by which militants recruit.
• Force #5 – Historical
  Many of the protagonists in the present conflicts support their case for revenge, martyrdom and annihilation by combining historical fact, religion, legend and myth.
• Force #6 – Military
  Virtually all of the players in the present conflicts and those on the horizon possess stockpiles of dangerous weapons hidden in a variety of locations outside the control of any governmental authority.

It now appears that these forces, forces that represent profound economic and cultural disparity and cultural, religious and ethnic hatred, are coming into frightening alignment. If ever there was a time that demanded serious investors ensure that their portfolios are properly diversified in order to hedge against what looks to be an extremely rocky economic future, this is it.

Wars and rumors of wars

Within three months after 9/11, the Taliban regime fell and many of us naively thought that was that. Five years later, the Afghan war is far from over and new wars have erupted with the prospect of many more to come.

• Afghanistan. Presently, while coalition and Afghan security forces fight both the Taliban and Al Qaida in Afghanistan’s bloodiest period of violence since the “fall” of the Taliban, NATO is assuming responsibility for the southern part of the country targeting not only the Taliban, but also the powerful warlords in the opium trade. For the record, the Soviets invaded and occupied Afghanistan in the 1980s with 500,000 troops, yet the Taliban won. What is absolutely disturbing is that the Soviet death toll of more than 15,000 far exceeds the total number of NATO troops deployed in Afghanistan today, a mere 9,000.
• Iraq. Iraqi Prime Minister Nouri Maliki told Congress during a recent trip to the United States that if the U.S. loses in Iraq it would be an immense victory for terrorism. Ironically, even if the U.S. triumphs in Iraq, it could also be a victory for Iran. The fact is that the relationship between the U.S. and Shiite leaders in Iraq is very new and one of expediency, while Iran’s long–standing alliance with the Shiite leaders is based on common religious beliefs, suffering under Saddam Hussein’s regime, years of joint training exercises and more.
• Lebanon. The U.S. recently undertook the voluntary evacuation of some 14,000 Americans from Lebanon as fighting erupted between Hezbollah in Lebanon and Israel. At this point in time, it is unknown what will transpire between this well–financed, well–equipped terrorist organization capable of doing a good deal of damage, the country in which it is located and the country it wants to wipe off the face of the earth.
• Iran. Indirectly, Iran and the United States are already at war. Hezbollah’s sortie into Israel is essentially Iran’s way of attacking the West. Why? Hezbollah is a creation of Iran, which also provides the financing and the arms. The terrorist organization is essentially Iran’s front line, while the U.S. is the chief arms supplier and financial backer of Israel.
• Syria. With forces already on their highest state of alert, Syria’s information minister has just warned that if Israeli ground troops or planes approach its border, Syria will enter the conflict. Syrian rockets have been discovered among those fired into Israel, and Israel has called up 15,000 reservists to be dispatched to the Golan Heights. Concerned with Syria’s emerging alliance with Iran, the U.S. has charged that Syria is also a major backer of Hezbollah and involved in the Iraqi insurgency.
• Turkey and Kurdistan. Turkey has vowed to invade Iraq if an independent Kurdistan is created on its eastern border. Should Turkey actually fulfill its vow, it would be the first time two NATO nations the United States and Turkey would be on opposite sides.
• India and Pakistan. Since their independence from Britain after World War II, India and Pakistan have gone to war four times, most recently in 1999. The recent terrorist blasts in Mumbai (previously Bombay) have severely affected relations between the two nuclear powers. India has indirectly blamed Pakistan, while Pakistan blames domestic Indian terrorists. Extremists on both sides want to disrupt the peace process, possibly setting the stage for yet another war.
• Central Asia, North Africa and the rest of the Middle East. It’s not much of a stretch to imagine the present conflicts spreading to other neighboring Muslim nations. These nations include Chechnya, Azerbaijan, Turkmenistan, Uzbekistan, Tajikistan and Kazakhstan to the North, Saudi Arabia (a staunch supporter of the Sunnis in Iraq) and Yemen to the south and Jordan, located between Iraq and Israel. Various North African nations are candidates as well.

The financial consequences in just one word…INFLATION

The inevitable financial consequences of the escalating conflicts in the Middle East mean just one thing…INFLATION.

‘The disruption of critical commodities. Because the war–prone regions we’ve just discussed have the greatest reserves of the world’s oil and some of the planet’s largest deposits of natural gas, magnesium, tin, uranium, coal, iron, copper, zinc and gold, commodity prices will almost certainly be affected. In actual fact, the commodity price increases we’ve already experienced are enough to stimulate additional inflation. When you add the intense demand from the burgeoning economies of China and India, it’s a classic predictor of out–of–control inflation.

An exploding national debt. Increasing at an average rate of $7.4 billion per day, the overall debt in the United States is now a whopping $41.7 trillion (at the moment anyway), $11.2 trillion of which the U.S. government is directly or indirectly responsible. There is only one way that Washington can keep this mountain of debt from crushing the U.S. economy and that’s with the printing presses running at full bore. This can only send inflation soaring.

Inflation will continue to get worse. Federal Reserve Chairman Ben Bernanke and his colleagues apparently need a history lesson. A similar scenario unfolded with Fed Chairman Arthur F. Burns in the early 1970s and again with Fed Chairman G. William Miller in the late 1970s. Both presided over massive increases in the money supply and sizable declines in the dollar. Both ignored the obvious signs of inflation until it was too late.

• In the early 1970s, the Reuters CRB Index (which represents a broad range of commodities), rose from 100 to roughly 200. The cause was an extreme upsurge in energy prices and the result was soaring inflation.
• In the late 1970s, commodity prices surged from 200 to just about 330. Once again, the cause was an extreme upsurge in energy prices and the result was soaring inflation.
• Now it’s happening again, but today it’s even worse. The Reuters CRB Index has more than doubled, from 186 at the end of October of 2001 to a recent 386. The primary cause once again is an extreme upsurge in energy prices. The likely result is yes soaring inflation!

Regardless of what Washington tells us, inflation is NOT running at 3.5 to 4 percent, and that’s VERY apparent when you consider that:

• Since 2001, gasoline is up 49 percent; beef is up 28 percent; eggs, oranges and tomatoes are each up more than 30 percent.
• Property taxes all over the country are escalating.
• The cost of services has increased at an estimated 8 percent annually.
• The price of oil is up more than 500 percent since 2001!
• The cost of buying a home has more than doubled.
• Health care costs are out of sight.

Meanwhile, the actual cost of living is skyrocketing in the double digits every year. That’s an important fact, because during the previous “officially recognized” inflationary crisis from 1974 to 1980, the average annual inflation rate was 8 percent. During that period, gold prices rose from $58 to more than $800 an ounce, a better than 1,000 percent increase. Today, true inflation is probably higher than 8 percent. But even if gold shot up only a quarter as much as it did in the 1970s, you’d be seeing the price of gold at more than $2,000 per ounce!

The huge demand for gold

It appears that the Middle East and surrounding regions are poised for expanding war. It is an environment in which gold is the ultimate hedge, as it has been through the centuries, and where demand will push prices higher and higher.

China to take millions of ounces of gold off the market. With the largest in history at nearly $900 billion, China plans to put a minimum 2.5% of its trade surplus into gold. And, it will continue to invest ever–increasing amounts of its reserves in gold. China would have to buy 3,467 tons of gold in order to match just half of the gold reserves of the United States. That alone could send gold to $2,000 an ounce.

Worldwide gold supplies dwindling! There are now less than 45,000 metric tons of proven gold reserves left in the ground worldwide. That’s according to the U.S. Geological Survey. In addition, the mining of gold has fallen almost 3 percent in just the past year, while the above ground supplies of gold can’t begin to satisfy the increasing demand.

The bottom line? No matter how you look at it, a very compelling argument, using only fundamentals, can be made that we will see higher gold prices throughout the rest of 2006 and beyond. Whether it be semi–numismatic gold, like $20 Saint-Gaudens…or coins with historical significance, popularity and rarity, like earlier big gold coins…gold bullion and/or gold in one of its many other forms MUST be part of a truly diversified portfolio in these turbulent and uncertain times!