Chapter 9

Worshipping the Golden Calf

In Chapter 2 I discussed the folly of worshipping the false and deceptive god Mammon. Now I want to persuade you that it is an expensive mistake to worship any investment, but especially the Golden Calf. This is one of the rare times I learned something important by getting it right!

When I first came onto the investing landscape in 1975, I saw nothing but inflation ahead of us for several years at least, and became a vocal advocate for gold and silver as inflation hedges. My best-selling book, How to Prosper During the Coming Bad Years, was the first popular best-seller to alert the public at large to gold and silver as an inflation hedge. Gold subsequently soared to more than $850 an ounce in 1980, up from $120 an ounce in 1975 when I first recommended it. I have been told that because the book sold more than 3 million copies, it was a major factor in creating that spectacular gold and silver bull market and legitimatizing gold and silver as popular mainstream investments.

I thought of gold as an appropriate investment for the times, but I soon found out that for millions of Americans (not to mention Germans, Swiss, etc.) it was a near religion, with its own dogma. Massive investment conferences attended by thousands of true believers were built around gold, such as the annual National Committee for Monetary Reform (NCMR) conference in New Orleans, and dozens of my newsletter colleagues jumped on the golden bandwagon for reasons of their own—some well thought out and some out of mob psychology. I was nearly canonized as a high priest of the Gold Bug Church by the media, which made me a mite uncomfortable. (Actually, I didn't protest as loudly as I should have because I enjoyed the attention, and it was good for my newsletter business.)

But in 1980, gold soared to irrational heights of over $750 an ounce (it eventually shot up to $850, but only for a day or two) and silver shot up from its low of $1.80 to $35 (it soared to $50, but only for one day). I had temporarily lost faith in gold for a little while in 1978, but had gotten back in and ridden it to the top. But now I decided this was really time to sell; inflation had peaked at 18 percent, and I believed that the combination of Ronald Reagan's tax cuts and Paul Volcker, the tough-minded, inflation-fighting chairman of the Federal Reserve, meant that inflation would be under a serious assault. So I put out a sell recommendation to my more than 150,000 newsletter subscribers, suggesting that gold would come back down to $400 and silver below $10. And all hell broke loose. It was as if the Pope had committed apostasy and become a Southern Baptist. (I exaggerate, but not much; my apologies to John Paul II.) Of course, the rest is history. When gold finally broke $400, I was invited to appear on Nightline with Ted Koppel and explain why I was so smart—which, of course, I thought I was.

But this was when I learned that gold was a religion with millions of devotees, and I was castigated as an apostate by the believers. I was denounced in print in no uncertain terms by many of my colleagues, and suddenly was in much less demand on the investment conference circuit, which was not much fun. But I have had the last laugh—gold has done hardly anything for investors for more than two decades, and hasn't been in the headlines for years and years, with only occasional trading rallies.

So why was I so smart? Although I had been a passionate advocate of gold as an investment, I was never a passionate Gold Bug, and therein is the lesson I would like to teach you.

Philosophically, I looked at gold in three different ways:

1. I believed, and still do, that gold should be the centerpiece of the world's monetary system, because if the currency was backed by a finite amount of gold, national treasuries and monetary authorities would have to be very cautious about how much money they printed if it was redeemable in gold, for fear of losing it to redemptions. In a world where inflation was a serious threat to the stability of our personal wealth, we needed the discipline only gold would provide. On this subject I was passionate, and still am, but that had nothing to do with gold as an investment.
2. I recommended some gold and silver coins, no matter what the gold and silver markets are doing, and still do, as a part of my calamity-insurance core holdings, along with cash savings and an emergency supply of vital commodities, including a food storage program. This is not an investment program, but an insurance program explained in more depth in Chapter 12. That has not changed in 25 years.
3. Gold is a potentially valuable investment if bought and held when certain economic conditions create a gold-friendly environment, and gold stocks are even better.

Confusing these three reasons for owning gold can lead to ill-timed purchases and market losses, and that has been the case most of the time for two decades. A love affair with gold was a big loser, or at least a going-nowhere investment for most of that time.

So, when is the right time to invest in gold? There are three conditions that are favorable for gold. At least two of them must be present for gold to have a chance, and three is better:

1. Rising inflation: Inflation to classically trained economists, especially those of the Austrian School, is not rising prices; it is an increase in the money supply that dilutes the value of each dollar and creates an instinctive flight by investors, especially abroad, to the stability of gold as an inflation hedge. Rising prices are an indicator of inflation, but calling rising prices inflation would be like calling a hurricane falling trees. All during these two lackluster decades for gold, inflation has been stable but slightly positive, or falling slightly, a condition called disinflation, which means there is still some price inflation, but at a lesser rate. So what could cause a new outburst of inflation?
   • Exploding government spending because of a war, or more social spending to buy votes for the politicians to stimulate the economy out of an incipient deflation/depression, creating a need to fund rising deficits without paying the political price of raising taxes, causing the Fed to increase the money supply in excess of increases in productivity.
   • Failure of the government to face the inevitable consequences of a shrinking Social Security Trust Fund (even though it is phony), and the burden of fewer and fewer workers to support more and more retirees. The choices are stark: Increase payroll taxes to as high as 40 percent, causing a war between the generations, or print the money (which is the option the government will choose), which will be immensely inflationary.
2. Repeated big-time terrorism and/or war: A series of cataclysmic events that throw a serious cloud over the potential survivability of the U.S. economy will revive gold's classic role as a calamity hedge.
3. A falling dollar in relation to foreign currencies, especially the euro and the yen: This is the indispensable condition that must be met along with at least one of the preceding events to trigger a true gold bull market. The dollar can fall as soon as foreign investors lose confidence in dollar-denominated investments (stocks, U.S. Treasury securities) as a safe haven against troubles with their own monetary system, or lose confidence in the stability of the American political and economic system. It can also be the consequence of low U.S. interest rates, making dollar investments less attractive to foreign investors.

BUYING GOLD

There are several easy ways to buy gold:

Gold Bullion Coins

The most acceptable and widely owned and most liquid coins are the South African krugerrand, the Canadian maple leaf, the Australian nugget, and the American gold eagle. They are all available in one-ounce coins, and there is little to choose between them, although the gold eagle has one advantage. When Congress authorized IRAs, they made it illegal to buy gold bullion or coins in an IRA, probably as a sop to the antigold forces in the banking system. But when they later authorized the production of the eagle, they specifically authorized it for IRAs and other retirement accounts, because eagles were minted from the U.S. gold reserves, and they wanted the sale to be successful.

These coins can be bought from coin dealers in any quantity, and there will be a modest premium above the price of the ounce of gold, so shop around and compare prices and premiums. You will get it back when you sell the coins.

You should have $2,000 to $3,000 worth of gold and silver coins of a variety of sizes and denominations for each family member as part of your core financial calamity hedge right now, regardless of the current gold market, but don't think of this insurance stash as part of your investment program.

Gold Bullion Bars

These are useful for bigger investors, and you will usually leave them in the depository from which you bought them so that when they are eventually sold, they do not have to be authenticated or assayed. It's a very convenient way to buy gold, if the depository is honest and has a history of dependability. There were several big frauds in the early 1980s, including one I exposed where the gold that was allegedly stored for the customers did not exist, and they lost a lot of millions.

Gold in the Ground

Perhaps the most convenient way to buy gold is while it's still in the ground, by buying the shares of gold-mining companies. This is a good idea when we are in a true gold bull market, and it introduces several variables that you don't have when you buy bullion or gold coins, such as cost of production, management skills, and so on. One of the biggest advantages is that the law allows any securities in an IRA, so the way to make an IRA bet on gold is to buy gold-mining shares. Also, you don't have to store them like coins or insure them.

There is much more risk and more potential profit or loss in a gold-mining stock than in coins or bullion. You are investing in a business enterprise that should be weighed like any other industrial company. As the price of gold rises and falls, the value of their reserves in the ground rises and falls accordingly, and so do their profits per ounce of gold mined, as their costs remain fairly constant as the price rises.

For example, let's say you bought gold at $400, and it went to $500. You would have a 25 percent profit. But if at the same time you bought stock in a company that had a cost of production of $350, and gold was selling at $400, the mine would have a $50 an ounce profit. If gold then went to $500, the profit per ounce would triple to $150, and it is likely the stock would triple also. So gold stocks are leveraged to the price of gold, are much more volatile up and down, and in a gold bull market are much more profitable than bullion or coins.

In a gold bull market, the lowest-cost producers rise first, followed by the higher-cost producers, followed by the exploration companies with proven reserves but no production yet, followed finally by the holes in the ground surrounded by liars, often called penny golds.

A rising gold tide truly raises all boats. I have listed my preferred mining stocks by category in Appendix B.

WILL GOLD RISE AGAIN?

Yes, it will. My best guess is that if deflation or economic downturn gets serious—which is a possibility as this is written—to stave off deflation and recession/depression, the Fed will expand the money supply to stimulate the economy and Congress will also step up spending to alleviate financial distress. Consequently, inflation will soar, the dollar will fall further, and gold will rise again. There is a great future for gold, but not until the forces that will drive it are all in place.

How far will it go, and when? It's like what you get when you combine an elephant and a rhino, “Elephino!” These events could happen at any time, maybe before you read this book. I track gold closely in my newsletter, The Ruff Times. You can get subscription information from Appendix A or on my Web site at www.rufftimes.com. I will put out a buy or hold signal when my indicators say so, which may have happened even before you read this. Don't buy gold or gold stocks until you check out my recommendations in The Ruff Times, as the world is always in a state of flux.

So don't fall in love with gold or worship it when you invest in it. Buy some coins now as a calamity hedge against sudden surprises, and root for a return to the gold standard, but only invest in gold when the preceding investment conditions are right, and include silver in the same calculations. Any other gold strategy can be an expensive mistake.