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GOLD AT $10,000?

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Aug 13, 2011
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Quick now - what world-changing financial event happened exactly 40 years ago, on Aug. 15, 1971? Anyone?

The answer: President Richard Nixon took the U.S. off the gold standard, effectively freeing the precious metal to trade at whatever price the market would bear.

The President's decision, made as the U.S. Treasury was seeing its gold reserves rapidly vanish as foreign governments cashed in their greenbacks, ended the international monetary framework known as the Bretton Woods Agreement that had been in place since 1944. The price of the metal had been set at $35 an ounce (quotes in U.S. dollars) by that deal and every nation was allowed to convert dollars to gold at that price (individuals were not, however). The arrangement worked for more than 25 years but with the stroke of a pen Nixon blew it all away.

"The Nixon Shock was a central cause of the Great Inflation," Roger Lowenstein wrote recently on Businessweek.com. "It was also the end of the fixed relationships that had governed the financial universe. Previously, people took out mortgages for set periods and at fixed rates. They had virtually no options for saving money other than in banks, and the interest rates that banks could pay were capped. Floating currencies unleashed a new world of risk and instability…The world gravitated from the certainties of Bretton Woods to the dizzying market cycles we've lived with since."

Of course, at the time no one thought of all these complex ramifications. The headline story was that the price of gold had been freed. Perhaps even more important, Nixon repealed an Executive Order made by President Franklin D. Roosevelt in 1933 that prohibited Americans from "hoarding" gold coins, bullion, and certificates within the continental United States. The penalty for violating the law was a $10,000 fine or up to 10 years in prison!

By cutting the gold/dollar tie and allowing individual Americans to buy the metal, Nixon unleashed a trading frenzy. Over most of the next decade, gold rose steadily in price until it finally topped out in early 1980 at about $850 an ounce - a gain of more than 2,300% since the President's historic 1971 announcement. At that point, people were lining up around the block at the downtown Toronto branch of the Bank of Nova Scotia to buy the metal, obviously assuming the price would keep climbing.

It didn't. Bullion sold off and by the mid-1990s it was back in the $400 range, less than half of the 1980 peak. By January 2000 it was down to $300 an ounce and it bounced along in the $200 to $300 range until early 2002. At that point, it began a slow upward climb but it didn't really take off until 2007 when it moved from $600 to $900 in a year, a 50% spike. After a rather puzzling pull-back to the $800 range during the financial crisis of 2008-09, gold took off again and, except for some minor corrections along the way, has never looked back. It ended last week at $1,742.60 after flirting with $1,800 earlier.

So where does gold go from here? Are we at another peak, similar to what we saw in early 1980? Or will bullion continue to soar? A lot depends on how the global fiscal and economic situation unfolds in the coming months.

The latest spurt in the gold price was fuelled by a combination of the sovereign debt crisis in Europe along with America's debt ceiling stand-off and the subsequent downgrade of the U.S. credit rating by Standard & Poor's. Once the initial panicky reaction to those events subsided, the gold price retreated.

But the hard truth is that the underlying problems remain. There is simply too much debt out there and crises are going to continue to re-emerge until governments take the tough actions necessary to put their financial houses in order. It's interesting to see that Canada is being cited as a role model for countries looking for ways to restore fiscal stability because of the way the Liberal government of Jean Chretien and Paul Martin dealt with our debt crisis in the 1990s. During the 2008-09 financial meltdown, it was our banks that were touted as examples for everyone else, now it's our astute fiscal management. Who knew we were so smart?

I have never been an ardent gold bug and for many years I was skeptical of fanciful claims about how high gold would climb. For most of those years, I was right but this is a changed environment. It's not just that investors are more conscious of gold; even more important is the fact they have lost confidence in governments and central banks to manage not only the global economy but their own finances.

Demand is further fuelled by the fact there are more buyers in the marketplace. Many central banks are building their gold reserves - they own about half the world's supply at present. Bullion funds and ETFs such as the SPDR Gold Shares (NYSE: GLD) are hoarding billions of dollars worth of the metal - GLD alone has gold assets worth almost US$74 billion! Then we have China and India, where wealthy individuals are reportedly losing confidence in paper currency and accumulating large amounts of gold as protection.

So how high could the gold price go? I put the question to Nick Barisheff, who runs Bullion Management Services and has been studying precious metals for many years. His startling reply: $10,000 an ounce within five years. Barisheff believes that the inevitable outcome to current trends will be hyperinflation. In that scenario, gold will be one of the only true stores of value. "There is no good solution to this," he says. "It's not going to end comfortably; it's going to end badly."

Although he says the timeline is hard to predict accurately, if the situation continues to deteriorate he sees bullion at $5,000 an ounce within three years, and doubling in the two years after that.

Unfortunately, if he is right the global economy will be a basket case at that time. We will be in the grip of a crippling stagflation or, worse, a depression. The jobless rate will soar, hundreds of thousands of people will be destitute, governments, with rapidly falling tax revenue, will slash services, and social unrest will be rampant. It's not the kind of world anyone wants to see.

Having always been what I call an optimistic realist, I want to believe that world leaders will find ways to avert this grim scenario. I've lived through many apocalyptic predictions and not one has yet come to pass. Hopefully, this one won't either.

That said, I've taken a little insurance by buying some units in Barisheff's BMG BullionFund. It is unique in that in invests only in gold, silver, and platinum bars, in equal amounts. The fund has been in existence since 2002 and has about $320 million in assets under management. The metal it owns is stored in repositories of the Bank of Nova Scotia in Toronto, New York, and Hong Kong. The one-year gain to July 31 was 44% compared to an average of 36% for the Precious Metals Equity category. Perhaps more significantly, as of Aug. 10 it had gained almost 17% in 2011 while every precious metals equity fund was in the red.

I like the fund because of its diversified commodity holdings (Barisheff's pure gold fund has not done as well this year) however the MER is high at slightly more than 3%. If you find that too pricey, take a look at GLD or at the Claymore Gold Bullion ETF (TSX: CGL) which is hedged back into Canadian dollars. It has an MER of only 0.54% and was showing a year-to-date gain of 15.1% based on NAV as of July 31.

We are adding both CGL and BullionFund to the IWB Recommended List for members who prefer funds that invest in the commodities rather than in mining stocks. Of course, if you want to buy gold you can actually touch, head over to the Bank of Nova Scotia and they'll be happy to accommodate you. Their ScotiaMocatta division is one of the world leaders in bullion marketing. For more information go to www.scotiamocatta.com.

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