The Virtuous Cycle of Higher Gold Prices

Gold took a big hit today. As I write, gold is down $51 per ounce.

Wall Street’s momentum-chasing traders, whose new found affinity for the yellow metal helped push gold up 20 of the last 25 trading sessions, are scrambling for the exits today as the monthly jobs report turned out much better than expected.

For Main Street, the news was good. The headline unemployment rate fell to 10% from 10.2% last month. The underemployment rate fell from 17.5% to 17.2%. Despite the decline in the rates of unemployment, the U.S. economy lost 11,000 jobs last month. That’s relatively good news compared to recent past.

For Wall Street, the jobs numbers weren’t so good. In today’s markets good news means we may be getting one step closer to the Fed’s free money party. In other words, good news is bad news.

But it’s all short-term market noise. There are much bigger fundamental forces at work in the gold market. And for those investors who can put aside the short-term volatility and focus on the real catalysts for gold’s next big move, they will be set up to make a fortune in the years ahead because gold’s next move is likely to surprise a lot of folks. Here’s why.

The Truth about the Dollar Carry Trade

The Fed’s free money party has been the biggest driver of gold in the past few months. Traders, through the banks they work for, can borrow money at near 0% interest and go out and buy anything. Lately, they’ve been buying gold.

Also, the low interest rates make the cost of holding gold much lower. As you know, gold pays no dividends and there are storage costs. So when savings accounts yield 3% or more, they’re much more attractive. When they pay 0.25% per year, gold at 0% yield is pretty competitive.

But the big driver is the U.S. dollar carry trade – where banks, investors, and traders borrow U.S. dollars and buy up non-dollar related assets with them. We talked about this before and how it has the potential to be the dominant investment theme for years to come.

So far many analysts and pundits have said this will not last. And they’re right. It will not last forever. But, as we’ve seen time and time again, a trend in the market will last far longer than most expect. The last big carry trade, the Yen carry trade, provides all the proof we need.

Consider this. The Yen carry trade started in 2004 when the Bank of Japan announced it was going to ramp up its monetization of Japan’s government debt (a.k.a. money-printing).

This announcement launched the Yen carry trade. The IMF International Bank of Settlements reported the carry trade grew to $19 billion in 2004 and $87 billion in 2005.

Again, many analysts and pundits said it would be over. In 2007, two years after the trade was deemed “too crowded,” the Yen carry trade was estimated to be worth $1 trillion.

The yen carry trade lasted years longer and grew 10 times bigger than the herd ever expected. It should be reasonable to expect the potential of the dollar carry trade, as the world’s reserve currency, to have the potential to last longer and reach far greater heights.

That’s not all though.

Relative Value is Still Low

The big reason most investors will swear off gold until it’s nearing the end of its run (remember, most investors are waiting for the worst possible time to buy), is because there’s no classical way to value gold.

Gold pays no dividends. There are no cash flows to be discounted. It actually costs money to store it. And, it has no utility value.

As a metal, gold is not strong, it’s very heavy, and, contrary to popular belief, it is a relatively poor conductor of electricity (it’s only used in electronics sparingly because of its resistance to oxidation).

That’s why gold, for all intents and purposes, is still considered by the majority worthless. But that is exactly what makes it the best store of value in the world.

Again though, there’s no way to put a hard dollar value on it because the number of dollars in circulation is extremely volatile. We can, however, put a relative value on it. And if we do that, it doesn’t take long to see gold, even as high as $1200, is still undervalued.

Consider this. According the U.S. Census on Housing, the median price of a house in 1980 was $47,184. With gold at its previous peak of $850 an ounce, the middle-of-the-road house was worth 55 ounces of gold.

Today, the National Association of Realtors pegs the median price of a house is $173,000. In gold terms, that’s 146 ounces of gold.

For gold to get back to its peak of 55 ounces of gold per house, gold would have to climb to $3,132 per ounce.

It’s not just houses though. Other big ticket items help show how deeply undervalued gold is. For instance, a comparison of the “average” car yields similar results.

In 1980, the best-selling car in the U.S. was the Chevy Citation (Note: Yes, it’s true…the Citation. In 1980 almost half a million people went to the dealership and said, “I’ll take that.”). The base price on a brand new Citation was $4,800 in 1980. In gold terms, the car would cost 5.6 ounces of gold.

Last year, the top-selling “average” car in the U.S. was Toyota Camry. The Camry’s base price last year was $19,145. In gold terms, that’s 16.2 ounces of gold.

For gold to get back to its peak of 5.6 ounces of gold per “average” car, gold would have to climb to $3,413 per ounce.

As you can see gold is still significantly undervalued relative to its past bubble highs.

Then there’s one final aspect that truly separates gold from other financial assets.

The Virtuous Cycle of Higher Gold Prices

There’s something special about gold. Gold, to most people, evokes a strong emotional attachment. There’s just something about holding gold in your hand. If you’ve ever bought gold or silver, you know what I’m talking about. That’s why they say there’s no fever like gold fever.

There’s also something else about gold which makes it a bit different from most assets and it all came from our gold bullion dealer friends over at

Back in February when gold passed $1,000 an ounce, folks were lining up to buy gold. The bullion dealers told us the phones were lighting up with gold at $1,000 per ounce. But when gold was at $800, no one wanted it.

This is very true. As Prudent Investors know, your editor ramped up his silver purchases over the summer. When silver was in the dumps around $13 an ounce, it was looking like a very good buy.

We even had one of the world’s most knowledgeable silver investors, David Morgan, join us in the Prosperity Dispatch to give us all the details to zig into silver while the rest of the market zagged into other hot ideas.

Since then, silver has been on a tear – up nearly 45%.

But here’s the scoop. When I called my bullion dealer over the summer, we’d chat about all sorts of things. He had all the time in the world. And it only took about two weeks for my silver to arrive.

That’s all changed. A few days ago, I called him up to place another order and I was on hold for 20 minutes, and then quickly placed the order. Not much small talk.

On top of that, my silver is not expected to arrive for at least six to eight weeks because there’s so much demand.

Remember, gold (and silver) aren’t much different from other financial assets. When they’re cheap, nobody wants them. When they’re setting new all-time highs, the herd can’t get enough of them. And that’s why higher gold prices will lead to a self-fulfilling prophecy since the higher gold goes, the higher demand goes right along with it.

There’s No Turning Back

Now, there’s no certainty about where gold’s headed in the short-term. Today’s sharp correction in gold prices is something everyone has been predicting for quite a while.

We, however, continue to believe it will be looked back upon as merely a “test” for investors in the ongoing gold boom.

There are so many reasons to expect gold prices to go even higher over the long run. Most importantly, the Fed has publicly declared its willingness to monetize the U.S. government debt, devalue the dollar, and stave off natural deflationary forces at any cost.

The worst part of it all is today’s unemployment numbers. The positive surprise can only boost the confidence level of an already overconfident Fed in that its destructive policies are the right moves.

Until that perspective changes, the sky truly is the limit for gold and we continue to reiterate our perspective since the Fed started monetizing government debt:

Every few decades a chance to get rich off gold comes along. This is one of those times.

Use corrections like the one today, which could easily spook the hot money traders out of gold for months, to build up solid positions in the gold boom.

Although gold will not be the only investment that does well in the next few years, it has all the fundamentals in place to make it an opportunity you will regret taking advantage of during the periods when gold temporarily falls out of favor.

By Andrew Mickey

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