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Should the Silver-to-Gold Ratio Make You Tremble?

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Precious metals remain positive, but the price is being driven by emotions not fundamentals.

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In my previous essay, Was That the Top?, apart from commenting on the current situation and suggesting that the top is in for the precious metals sector, I also wrote about the positive fundamental outlook for this particular market as far as the long-term is concerned. I wrote the following:

The US is the world's largest holder of gold with 8,133.5 metric tones. At today's prices that's a little more than $300 billion. That's not enough.

If you throw in America's petroleum reserves and its foreign currency holdings, that still won't cover $2 trillion worth of debt that will mature in the next 12 months. Who will want to buy US Treasury paper? India has already voted in favor of gold when it bought 200 tons of IMF gold last month.


Does the above mean the US will go bankrupt?

That's hard to believe. Don't forget that the US government has its own printing press and it can always print new dollars. Besides, there was no audit as far as the abovementioned gold reserves are concerned, which may suggest that the amount of gold in vaults is lower than reported.

All these economic travails can mean only one thing for gold: It's heading up. We saw Tuesday that gold broke above $1,200. In fact, gold ended the month of November with one of the biggest gains in 10 years.

And anyway, human nature is to say, this time it will be different.

In fact, This Time Is Different: Eight Centuries of Financial Folly is the name of a book by economists Carmen M. Reinhart (University of Maryland) and Kenneth S. Rogoff (Harvard University) who examine the financial crises of the past 800 years. They identify the singular cause of great economic contractions:

The essence of the this-time-is-different syndrome is simple. It is rooted in the firmly held belief that financial crises are things that happen to other people in other countries at other times. The old rules of evaluation no longer apply. We are doing things better. We are smarter. We have learned from past mistakes. Unfortunately, a highly leveraged economy can unwittingly be sitting with its back at the edge of a financial cliff for many years before chance or circumstance provokes a crisis of confidence that pushes it off.


These plunges happen all the time, in erratic rotation, around the world, say the authors. It's no wonder, then, that investors' confidence in debt is fickle.

Can governments prevent economic meltdowns? Professors Reinhart and Rogoff say it's really not all that difficult, provided that governments are "sufficiently frugal," run budget surpluses, and avoid issuing bonds with shorter than 10-year maturities. (Do we know of any countries like that?)

Professor Rogoff was interviewed for The New York Times article I mentioned earlier. He said he expects a wave of defaults by weaker economies about two years from now. The stronger countries will be too busy with their own economic problems and probably won't be willing to bail them out.

Meanwhile, governments everywhere are plunging even further into debt. Maybe everyone thinks that this time it will be different.

In any case, the trend is clearly up for the precious metals in the long run.

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No positions in stocks mentioned.
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