Why Prices Go Up - Part One

January 1, 2004

Gold and silver have gone up a lot already, and in my opinion, will go ever so much higher. As a matter of fact, this may be but the beginning of a run up in both metals, with the top unknown, as of this period. Why is it unknown? Because there is no limit as to how far "down" paper currencies, and especially the dollar, can go. Were their some type of limit of degradation which dollars can suffer, I would give you a "top" in gold and silver. They are on opposing teams, you see. Mighty gold and silver in one corner, and in the opposite corner, wilting, unbacked, laughable dollars. Dollars go down, because of immense proliferation. Irresponsible proliferation, if you please. Dastardly proliferation, if you don't please, and there is nothing a citizen can do to stop the continual debasement of dollars, as well as other currencies. The Swiss Franc at 81 cents is really "high" in comparison to the buck, but still will buy but little of what it bought 50 years ago. It seems to be a race of the world's paper monies, to see which can become worthless first. Think about the dollars in your wallet, under your mattress, or in the bank. Like magic, they lose value a teensy bit every day, no matter how safely they are stored. Like a slow leak in a tire, or a pin point hole in a bucket, the value gradually leaks away.

Gold and silver have been ultra sound places to place surplus dollars, and will continue to be so. There are several reasons for this. Take silver first. There really isn't much silver around. The COMEX has millions of ounces of physical silver stored in various bank vaults, mostly in the New York area. However, it has twice that many ounces committed in futures contracts. A futures contract, means that the holder of that contract, upon paying the full value of the contract, may take delivery of the physical silver…half of which doesn't exist. The US government had millions and millions of ounces of physical silver in its vaults a long time ago. It now has none, and buys silver in the open market each week and month, to make Silver Eagles. Silver which is consumed, does not 100% recycle, and much of it is lost for all time. Consumption of silver, currently, is close to twice what is being produced. This type of equation cannot long exist, and prices of silver will escalate greatly. As price goes up, will consumption decrease? While this is usually true, in the case of silver and gold, increased consumption, and increased prices, will only increase demand. This means that increases in price will feed on itself, and make prices go up even faster.

In most markets, such as foods, oil, and the like, increases in prices, reflecting a short supply, will decrease consumption. Margarine instead of butter, no new car this year, and make the old clothes do, is the typical consumer response to increased prices. This levels the market, and makes consumption jive with production. The current beef scare with "mad cow" illustrates the principle perfectly. Not so with silver and gold. The reason is that as paper monies buy less, interest is low, and great uncertainty abounds, people turn to true money for security and safety. Since gold and silver have been true stores of wealth for thousands of years, and depend on no backing, paperwork, or empty promises for value, it is to be expected that masses of troubled, suspicious individuals, will turn to these for investment. As more and more convert their paper monies into tangible wealth, word will get around. Since there is virtually no silver around, and consumption of both metals is in excess of current production, the increased demand will cause both to rally beyond most persons' wildest dreams…in my opinion.

There are new uses for silver. Photography use is not increasing, and the year 2003 may show even a slight decrease. However, silver is being sprayed on hospital heat and air conditioning ducts, as bacteria cannot live on silver. Silver is now being used as a wood preservative, and if the low resistance wire ever gets going, it will require millions of tons of silver. Silver's ratio to gold has recently gone down 7 points. From 76 to 1 to 69 to 1. I think it will go below 35 to 1, meaning silver will go up faster than gold. The only way the ratios may not go down, is if terrorism strikes the world, and does it with severity. People always think of gold as safety, not silver. In a case of world wide terrorism, both will rise dramatically.

Gold is going to continue its rise in price for several reasons. First, is that the dollar in which it is denominated, is going down, as has been previously mentioned. Secondly, as is the case of silver, far more is being consumed, than is being turned out of smelters and manufacturers. About 2500 tonnes of gold is being produced, and roughly twice that amount is being consumed. This equation cannot long exist. To solve this unequal supply-demand situation, one of several things must happen. (1) demand must slow, (2) production must go up, and (3), prices must go up to slow demand. Demand will not slow, but increase. Production may well go up, but there is a lot of necessary steps between ore in the ground, and a Krugerrand or American Gold Eagle in hand. These steps are expensive, and not exactly environmentally pleasing to the bureaucrats in DC, who have for all practical purposes shut down mining in America. The ore must be removed from the ground, and then milled into face powder consistency. Then the powdered ore must have the usually 99.9% of rock removed, leaving the base gold and silver, in what is known as a "sponge." It then must be sent to a smelter, where the rest of the impurities are removed. Since smelters give off unapproved gasses and stack pollutants, none are left here, and the only smelters are in the orient, a long ship's ride away. The smelter turns out the pure metals (.999 silver and .9999 gold) which can be made into coins, or bars.

The time between ore reserves in the ground, and silver and gold eagles, can be a long time. Lots of investing in equipment needs to be made, before ore reserves are turned into useable gold and silver. The time lag between increased demand and increased supply, can be nerve wracking, and responsible for price increases. As happens with any trend, prices begin at the bottom and go to the stratosphere, value or not, as witness the current stock market as well as in 1929, and 2001. The higher prices go, the greater demand, to a certain point, is the usual course of events. In other words, the more that is bought, the more is demanded from new buyers. If Charlie Schmidlack buys a Krugerrand for $275, and it goes to $420, he'll tell a lot of people of his good fortune. Word will get around. Demand as well as prices will increase.

Central banks around the world, have sold thousands of tonnes to pay their bills, and keep prices as low as is possible. Gold and silver are the arch enemy of paper money, and naturally the banks which deal in paper money. High gold and silver prices, means a bank's hoard of pieces of paper with ink on them, lose prestige as well as purchasing power. Smart depositors, will remove their currencies, and convert them into gold and silver, which have been true money for thousands of years. Nothing can cause a bank customer to withdraw faster, than a better opportunity elsewhere. Banks paying 1% interest, are not attractive to savers, and millions have withdrawn and done other things with their currencies. Thousands have gone into gold and silver, and continue to do so.

Gold was not only sold on the open market from national vaults, but it was loaned at 1% interest to responsible parties. These parties sold the gold for the then current going price (usually $100 less than it now is) and re-invested the dollars into government bonds, stocks, or other paper investments at as much as 5% interest. Not bad, when one can turn 1% into 5%. It now happens that the loaners of the national wealth, might one day want their gold back. The borrowers will have to repay the gold they borrowed, and the 4% interest might not be a profit at all, if the price of the gold they are obligated to repay, has increased by 55%, as it now has. If you were head of a treasury of a nation which loaned gold at 1%, and you see the price of it has gone up 55%, mightn't you say to yourself, "Hey, I want the gold back. I'd better call in the loans." See what could happen when loans are called for leased gold? It won't be pleasant for the borrowers. Will the loaners accept paper money for the loaned gold? If they do, they're nuts. Just repaying the leased gold could cause the spot price to go into the thousands of dollars per ounce.

 

Don Stott has been a precious metals broker since 1977, has written five books, hundreds of columns, and his web site is www.coloradogold.com

China is poised to become world's biggest gold consumer.