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Gold a No-Default Asset

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Precious metals perfect insurance in this economy.

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It's been awhile since I've written anything on the markets, since I've had my hands full down here. I may be a little rusty, but I think you'll get the drift.

The AgAu Global Producer Fund's imminent launch, which was put on the back burner last year after my father's stroke, is occupying most of my time. That now seems somewhat prescient.

The recent sharp decline in precious metal prices has prompted me to throw my two cents into the mix of commentary and pontification. Longtime Minyans may recognize my reasoning: Paper metal is very different from physical metal.
Markets ebb and flow; this is just an ebb. Even "easy" bull markets confound almost anyone who thinks they've got things under control.

The last great precious metal bull run (from $35 to $850 over 8 years, beginning in 1972), had 3 retracements of more than 50%. This current nasty move, while painful, is just a bump in the road - an opportunity to take out some insurance, in case all the pundits and talking heads are wrong, and we haven't yet "seen the worst."

I contend the "worst" is still a fair way off.
Leverage cuts both ways, and the market cap of precious metals is minute compared to the general equity market. When funds want "out," the door's pretty small - so they have to force it.

Fast, scared money is usually irrational, as evidenced by some of the gold equity prices of today. Half-price equities on a 20% underlying physical gold price move is insane. Some equities are priced lower now than they were when gold was $500. So who's right?

Unlike any other financial instrument, precious metals are a physical, deliverable asset - a simple fact many overlook. They're a physical asset that will inevitably and resolutely dictate the price to the "paper" market. Eventually.
The recent snowballing sell-off in precious metals has been significant and intense "paper" selling, which in turn sent equity prices rushing south. For this reason alone, I contend that this price slide will be short and sharp. I see little chance of gold trading sub $770, or silver $13.45, for longer than a week. Sure, we may bumble around for a little while, but talk of "the end" for precious metals seems laughable to me. In my opinion, the bull market in precious metals is still in its infancy.
First, the market won't be able to supply enough physical gold to keep it down. Buyers of physical metal will assert control, just as happened in the late 1960s, with the destruction of the London Gold Pool. That eventually led to the international default of the US Dollar in 1971. Nixon's abandonment of Bretton Woods was a US Dollar default; anyone who says otherwise is kidding himself. The other dollar default came in 1933: The "domestic default" caused by Roosevelt's Gold Confiscation Act.
Consider: China alone has over $1.3 trillion in US government debt (and is looking to diversify). It doesn't matter where the Euro is, or the yen, or any other piece of paper. The Chinese have dollars they want to ditch for real assets, as evidenced by purchases of mining and agricultural companies around the globe. One can readily conclude they'll be lining up to buy physical gold at a discount of 25% to January.

The US economic story's no better -- in fact, it's clearly deteriorated -- and yet China can receive a quarter more gold for their "dollar assets." They have dollars coming out their asset managers, growing monthly at horrific rates. These "give-away" prices will be impossible for them to ignore. Russia will be buying right next to them.

The physical metal market is very small, and a quiet hundred billion here or there will soak up more gold than almost anyone could imagine. There's a floor to the gold price (and we're very close to it at $800), whereby the huge dollar asset holders will "diversify" to the financial asset that cannot ever default.
Second, the Fed's habitual yet historically ignorant response to every financial crisis guarantees higher precious metal prices, as all economic history tells us. MZM was up 17% or some such outrageous number for the last year.

Did Mr Bernanke bother to attend Central Banking 101 - as per the central bank of Zimbabwe? And even if he had, he faced the unenviable choice between printing and dying the death of a thousand cuts, or killing the economy in one fell swoop. No wonder that he chose to print willy-nilly, though that's never ended well.

Either way, undoing the financial excesses of the past 15 years is going to be very painful.
When priced in terms of gold, gold equities are cheaper today than they were in 2002, when gold was $275. I think this is a remarkable short-term window to accumulate insanely cheap gold reserves in the ground. I suspect cashed-up gold majors will steal some junior explorers, thereby cheaply replacing expended reserves with advanced projects with rich resources.

A rising tide floats all boats, so picking almost any unhedged gold producer will be a winner move over time - but astute judges will return multiples over the next 3 to 5 years. Gold producers are not created equal, no matter how similar they may appear. Stock selection is paramount.
The Gold-Silver ratio has blown out 10%, to 56. I contend that we'll see this ratio somewhere down in the 30s over the next couple of years, with silver reclaiming its rightful monetary status alongside the yellow metal. The ratio will head to 15 over the long term, in my opinion. Physical silver at $13.50 to $14 per ounce is the most attractive, undervalued financial asset on the planet.
The dollar rally is really just a case of replacing one piece of overvalued paper with another. The Euro economies are being rightfully recognized as being in less than perfect health. That investors would seek refuge elsewhere is common sense, but buying dollars is like swapping deckchairs on the Titanic. The US economy is no better off, and the dollar has earned no positive re-rating.

The precious metals have been hit hard following this "re-allocation," due to typical Pavlovian fund response and mob mentality. There's no justification for the dollar rally - nor is there for the Euro's strength!
Smart investors and asset managers will seek refuge in the only truly global and debt-free currency: Gold. Investors are gradually waking up to the fact that all currencies are backed only by the issuing government's ability to tax its own citizens - and by unsubstantiated confidence that they won't fail. History shows otherwise.
Markets provide opportunities at unlikely junctures all the time. I contend that this is an undeserved opportunity for investors to allocate capital to select precious metal equities and physical metal.

Insurance is usually expensive. This financial insurance isn't: $800 for gold will appear very cheap in a couple of years.
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Position in gold, silver

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