Thoughts on the gold and silver markets

Thoughts on the gold & silver markets►

Sunday 3rd June 2007

Old German banknotes offer a sombre lesson from history on the perils of paper money!

At NZ Gold we believe it is essential to know exactly why you are undertaking investment in the precious metals sector. As we note in our site disclaimer, such investing "confers a significant element of risk". Therefore, it is very important to be clear as to why one might transfer 'wealth' from New Zealand dollars or Pounds Sterling etc into physical gold and silver - or related equity investments.

Indeed, anyone conversant with the behaviour of the gold and silver markets, since this time last year, will be aware that - in U.S. dollar terms at least - the price of these two metals has appeared somewhat lacklustre. So that our readers can conveniently track precious metal prices NZ Gold now includes relevant 24 hour charts on the home, the about gold and the about silver pages. These charts show how gold and silver are doing in U.S. dollar terms and we believe - that whilst the 'greenback' remains the world's leading monetary unit - such an approach to pricing information is entirely appropriate. As readers will note from an inspection of the financial pages of their newspapers, prices for the precious metals are essentially quoted in U.S. dollars and Pounds Sterling. Here then we face our first conundrum for the Kiwi gold and silver investor! It is not generally sufficient to simply take a cursory glance at current prices and then conclude that they are up - or down. The more incisive approach requires us to asses the precious metal price performance in New Zealand dollar terms. Now, as our readers will be aware - especially if they are exporters - the Kiwi has been relatively strong against the United States dollar and Pound Sterling for some years. We use the term "relatively" because we would suggest that any Kiwis on holiday, or travelling on business in America or Britain - especially Britain - might collapse into hysterical laughter at the suggestion they are holding a 'strong' currency! Few things more roundly humiliate a wallet full of Kiwi currency than the need to convert it into pounds, whilst doing the rounds of tourist activities in London. It is a reminder, that despite all the 'feel-good' propaganda to which New Zealanders are constantly subjected by the ruling elite we remain the poor relations.

In our shortly to be released guide 'Good As Gold' we examine the potential impact of local currency strength or weakness on gold and silver in some detail. For Kiwi precious metal investors it is important to understand the way in which the behaviour of our dollar can amplify or diminish available returns. In a sense a state of equilibrium always exists - for if the Kiwi is 'overvalued' then precious metals and related investments can be purchased at an effective discount. Conversely, if the Kiwi is 'undervalued' they might be sold at an effective premium. The secret, of course, is to know when to buy and when to sell and critically - as we mention at the beginning of this article - why you are buying in the first place.

At NZ Gold our principal reason for holding the precious metals is for financial insurance and not short-term speculation. Clearly, fortunes can be made - and just as easily lost - speculating on price movements of bullion or seeking the leverage that is available from related equity investments. Our approach is significantly promulgated on a respect for the lessons of history and the fact that politicians have often shown themselves to be very poor custodians of monies value.

Mindful of the above, we would draw our readers attention to the images of the banknotes at the commencement of this article. We believe they tell a salutary story and speak eloquently for the protective potential of precious metal investment. Look at the first banknote, one hundred marks (issued in February 1908). There is an artistry on both sides and a sense that this is a vehicle of 'monetary communication' worthy of respect. Fast forward to the second note, twenty marks (issued in February 1914). This note entered circulation six years later - just a few months before the outbreak of the first world war. It might not have quite the artistic aura of the first banknote but there is still a sense of something communicating value! Moreover, it is informative to consider that a monetary unit issued in 1914, with a face value one fifth of the hundred mark note from 1908, was still something 'worth holding'. Now move on to the miserable specimen that is third on the list. This note, two million marks, was issued in August1923. We might have thought that a monetary unit - with a face value 20,000 times that of the one hundred mark note issued just fifteen years previously - would offer a commanding visual symphony. Yet no! So thin is the paper that scanning the item gives the appearance of a subdued mirror image of the front - on the reverse side. Actually there is nothing printed on the reverse at all and the whole impression this note gives is of some miserable 'token' that might be blessed with plenty of zeros but that offers no store of value!

Perhaps the holder of that two million mark note was lucky - provided he spent it the minute it entered circulation. Robert Beckman, in his 1988 book 'Into The Upwave', [Milestone Publications] points out that a pair of shoes costing twelve marks in pre-war Germany (1913) had risen to over a million marks by the Summer of 1923. Our lucky 'holder' of that 100 mark note could have purchased many kilos of prime beef in 1908 - yet by June 1923 just one kilo would have costs nearly 19,000 marks and by November of the same year some 5.6 trillion marks.

Ultimately, money is merely a form of communication. That is why all sorts of things such as shells, beads blankets and of course - gold and silver - have been used in the past. Now paper enjoys monetary hegemony - but the critical question is not "can you put your money where your mouth is?" but "can your money put its value where its zeros are?". Clearly, in the case of Weimar Germany the answer was an unequivocal no! Likewise Zimbabwe - where infinitely more 'dollar millionaires' will have been created in the last few years than New Zealand has managed. Indeed, it is interesting that former Rhodesian Prime Minister Ian Smith, in writing a postscript to his memoirs in June 1988, offers a lamentation for the fate of the Rhodesian dollar [The Great Betrayal - Blake Publishing Limited]. He points out that this used to be worth one pound sterling and then goes on to write of the replacement Zimbabwe dollar's performance since 1980. He notes "the last six months has witnessed a disastrous collapse, and today ZD30 are required to purchase £1 sterling". Well, today we note the 'New Zimbabwe Dollar' being quoted at an exchange rate of almost five hundred to each pound sterling - assuming anyone would want such a debasing unit. It is a reminder that you may hold in your hand a piece of paper that declares itself to have value - but is anyone listening?

Of course, living in New Zealand, Britain, or the United States we can console ourselves that such nonsense cannot happen here. The fact that all of our currencies have undergone a dramatic fall in purchasing power over many years seems to escape us because, as we have pointed out previously at this website, the process is relatively insidious. In 'Into The Upwave' Robert Beckman makes an enquiry "have politicians learned anything from the macabre events that surrounded the German inflation?". At NZ Gold we would suggest not - because we appear to be in the midst of the greatest monetary expansion in history! In all this gold and silver stand aloof because their supply cannot simply be expanded at the stroke of a politician's or bureaucrat's pen, or a twitch of his mouse and keyboard. Historically these metals have been money and they cannot be debased or 'competitively devalued' (that impoverishing fate that so many New Zealand exporters seem desperate to see befall the Kiwi dollar). This, we would suggest, is the key reason why the 'exchange rate' for the precious metals has risen so favourably in recent years. Of course there are other factors, such as tightening supply demand dynamics for silver in industrial applications. Yet this must not obscure our fundamental understanding that gold and silver are historic forms of dependable 'monetary communication' whose voices, although still being heard by relatively few, are becoming more discernable.

Of course, there will be those with an interest in the precious metals who are disappointed that last year's breaching of US$700 per ounce for gold has not been repeated - thus far - in 2007. There will be those lamenting the fact that silver has not yet exploded to the stratosphere! At NZ Gold we are more circumspect. It can be argued that the current period of 'sideways movement' - especially given the relative strength of the New Zealand dollar against the $US - is providing Kiwis with a great opportunity to get some precious metal exposure before prices become prohibitive. Equally, some will argue - that with interest rates rising round the world - the precious metals bull is over. At NZ Gold we cannot know the future with certainty - if we did we would probably be stretched out by a pool in the South of France with cocktail in hand! We can only be guided by history and the insights we have sought to develop into the psychology of man. What we do suspect is that the magnitude of new money creation has been so extraordinary - and on such a global scale - that a monster has been created that may prove uncontainable. New Zealand is but one example of the contagion, with the supply of money expanding at an astonishing speed. Do we really believe, with so much of the population now exposed to flabbergasting levels of debt, that interest rates could be raised dramatically to rein in the inflationary effects of all that new money? Much more likely we suspect, both here and overseas, will be the need for a carefully 'stage-managed' surrender to the consequences of monetary debasement.

Ultimately, unless the genius of contemporary leaders has rendered history mere 'bunk' we suspect there will be little that can be done to prevent a dramatic fall in the real value of assets - most notably housing! Already, in their ebullience over house prices - and how much they have made - Kiwis might be shocked by our analysis that suggests average New Zealand house values have gone nowhere in recent years - when considered against gold and silver. Of course, government can make your house price higher or shares worth more money - they can simply add a few noughts to every banknote in circulation and, if they need advice on such financial conjuring, perhaps they should consult Zimbabwe. Yet can they make these things more valuable - we fear not!

If politics ultimately triumph and it becomes necessary to slash interest rates, in order to try and save the ruinously indebted consumer both here and overseas, then a loss of confidence in fiat currencies might follow. This could cause a stampede into precious metals and the price to skyrocket. Obviously, investors would want to have made their purchases ahead of any such event. Herein lies the dilemma - for without a crystal ball it is impossible to know what will happen. So at NZ Gold we simply take the view that precedents from the past mitigate towards allocating a proportion of wealth to gold and silver.

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