first majestic silver

Gold Headed to $200 or $10,000 (Part III)

May 26, 2009
  • Gold & Historical average - Gold should be trading above $2500 these days in order to clock new 'real' highs
  • DOW/GOLD ratio points to $5.000+ gold before 2015
  • Gold & US public debt - Gold prices required to counter balance all US public debt held in foreign hands exceed the $10.000 mark

This piece is an update on Gold - Headed to $200 or $10.000?' part II in which we discussed 3 (out of 10) fundamental reasons to own gold. Last week we discussed point 1,2 and 3 making the case for gold to be money, this week we'll discuss point 6,7 and 8 which makes the case for $5000+ gold in the years ahead based on the thesis that gold is money.

10 Fundamental Reasons To Own Gold

  1. Gold remains ultimate form of payment - No counter party risk
  2. Currency debasement - US Dollar losing status as world reserve currency
  3. Gold crawling back into the monetary system
  4. Negative real rates
  5. Falling gold supply vs increased investment demand
  6. Gold & Historic averages - gold should be trading above $2500 these days
  7. DOW/GOLD ratio points to $5.000+ gold before 2015
  8. Gold & US public debt - gold prices required to counter balance all US public debt held in foreign hands exceed the $10.000 mark
  9. Large short positions - half of all central bank's gold has been leased into the market. (about 15.000 tons). Covering these short positions is not possible without catapulting gold prices to unimaginable highs.
  10. Gold acting as safe haven in times of rising geopolitical tensions

6. Gold & Historic averages

Gold should be trading above $2500 these days in order to clock new 'real' highs

When experts claim gold to be trading in record high territories these days they always refer to gold's 1980 peak of $850. Now comparing current gold prices of $950 with the old $850 high of 1980 doen't make much sense since even a chimpanzee can understand that one single dollar represented more purchasing power in 1980 than it does today.

So in order to calculate 'real' highs one has to adjust for inflation. When we take the 'official' inflation statistics then we'll see that the 1980 peak of $850 equals $2500+ today. When we take into account however the more realistic inflation statistics published by John Williams at then gold should clock $7000+ these days in order to reach new 'real' highs.

Sure enough one could argue that the official numbers are calculated by our government through honest and correct methodologies but by conveniently taking out those items causing the highest inflation numbers (food and energy) since the early nineties you can fool most of the people but not for an indefinite period of time.

The chart below is being calculated based upon 'official' inflation numbers and as you can see gold is nowhere trading near new 'real' highs these days. In order to do so gold should be trading at $2500+

Gold & Historical Average

7. DOW/Gold ratio - $10.000 Gold before 2015?

The DOW/GOLD chart is a powerful tool in order to determine major turnarounds. It's simple, when the DOW/GOLD chart tops you buy gold, when the DOW/GOLD chart bottoms you buy equities. Once you've established your position you can ride the wave up or down for at least a decade. The DOW/GOLD chart flashed a 'buy' for gold again in the year 2000 and indeed almost 9 years later gold is almost up 300% from its lows.

If it were all that simple why don't we hear that much about this powerful tool?

Well, the thing is the DOW/GOLD ratio chart isn't a useful indicator in order to predict yearly price movements. Next year could very well clock higher readings than this year instead of expected lower readings thereby losing confidence as being a reliable indicator. Unfortunately that's the same analogy as denying that higher temperatures will arrive in summer based on a single day temperature drop in spring. The problem is that the DOW/GOLD cycle has a wave length that's so big that we humans have a hard time to figure out where to position ourselves into this cycle

Q: What gold prices could we expect coming years based on historical Dow/gold ratio's?

A: Between $5000 and $10.000 before 2015

Now $10.000 gold seems a lot but from an historical perspective it seems a reasonable target. When the gold price peaked at $850 in January 1980 the DOW was trading in that range as well. The DOW/GOLD ratio bottomed out at one. When the markets peaked in March 2000 the DOW/GOLD ratio peaked at 44 and has been in decline ever since. In order to hit a DOW/GOLD ratio again of 'one' gold should appreciate near the $10.000 mark indeed with current DOW levels. I don't see the DOW plunging much further from here. Compare it with the 1968 -1982 period were the DOW hovered around the 1000 mark for 14 years. Same is happening now, the DOW peaked in March 2000 (inflation adjusted) and it could take very well another couple of years before the DOW manages to leave the 10.000 mark for good. I mean, there's no economic justification now for the DOW to rise much further while a surge in inflation will cushion the DOW to the down-side. A DOW struggling around the 10.000 mark from 2000 to 2012-2015 is not unthinkable and neither is $10.000 gold somewhere in 2012-2015

8. Gold & US public debt

Gold prices required to counter balance all US public debt held in foreign hands exceed the $10.000 mark

Gold migrates from a commodity form, to a barometer, to a currency,
to an international assets balance sheet form.
Jim Sinclair

When gold peaked at $850 in 1980 there weren't that many experts who had called for gold to reach such highs. One exception however was Jim Sinclair who called for $900 gold years in advance. Sinclair was considered to be one of the biggest influence of the gold market these days and often being quoted by the NY-Times and Wall St Journal as Mr. Gold. Sinclair argued that gold would eventually try to counter balance the US public debt held in foreign hands. Sinclair turned out to be right and explains:

When the gold price bottoms, that's the commodity value of gold, related to the industry's cost curve. Gold will move out of hat into a form of a barometer. A barometer mewasures the level of anxiety...Gold becomes a currency, when the appreciation in gold in percentage terms is greater than the appreciation in the strongestet currency at that time. Clearly then, gold has been elected as the currency of choice..The maximum value category in gold, in which gold gets fully priced, is when it attempts to balance the balance sheet of the United States. (source: Redburn Research - Gold War, Gold is money and nothing else page 15)

It should be obvious that gold is appreciating faster now in percentage terms than all other paper alternatives (currencies). Now if this cycle (commodity, barometer, currency, international assets balance sheet form) would unfold itself like it did in the 70's then what gold prices could we expect? In other words, what gold prices would be required in order to counter balance the US public debt in foreign hands?

Let's first take a peek first at the total Federal Government Debt itself.

Total Federal Government Debt:

As we can see total federal debt is exploding and stands at $11.3T today. Now what we are interested in is the total debt being held in foreign hands. The chart below shows us the answer. Total public debt held in foreign hands is $3.2652T

Foreign Holdings of Federal Debt

So what gold prices would be required in order to counter balance the US public debt held in foreign hands?

The answer is a rather simple one. Let's assume the US tells the truth about its total gold holdings. The US claims to have 8133.5 tonnes of gold which represents 261.5 million ounces of gold.

In order to offset $3.2T of US public debt held in foreign hands gold prices should rise to:

$3.2T : 261M = $12.500

Now please keep in mind that the total US gold reserves don't change, in other words, the US is not likely to add to its gold holdings. What IS changing however is the total public debt held in foreign hands which has been increasing at a stunning pace of $100 billion a month lately. In order to keep up with such increases of debt gold prices should increase at a rate of about $400+ per month.

You might wonder what the dollar's fate would be without these massive foreign purchases. Well, the answer is predictable. As described in point 1,2 and 3 the dollar is owned and issued by a bankrupt nation and held up by foreigners buying up US debt (with some help of the FED). This debt nightmare however cannot last for much longer, someone who seems to notice:

Obama Says U.S. Long-Term Debt Load 'Unsustainable'

May 14 (Bloomberg) -- President Barack Obama, calling current deficit spending "unsustainable," warned of skyrocketing interest rates for consumers if the U.S. continues to finance government by borrowing from other countries.

"We can't keep on just borrowing from China," Obama said at a town-hall meeting in Rio Rancho, New Mexico, outside Albuquerque. "We have to pay interest on that debt, and that means we are mortgaging our children's future with more and more debt."

Holders of U.S. debt will eventually "get tired" of buying it, causing interest rates on everything from auto loans to home mortgages to increase, Obama said. "It will have a dampening effect on our economy."


So the debt load will have a dampening effect on the US economy, well, according to Pimco's Gross things could be even worse, Gross fears the US could lose its triple AAA rating which of course would be devastating for the economy:

Pimco's Gross: Sell-off driven by fears US could lose AAA

Thu May 21, 2009 1:39pm EDT

NEW YORK, May 21 (Reuters) - Bill Gross, the co-chief investment officer of Pacific Investment Management Co., said market fears that the U.S. is at risk of losing its AAA credit rating is sending the U.S. dollar, stocks and bonds under severe selling pressure on Thursday.

Asked what is driving the market declines, Gross told Reuters via email that investors fear the U.S is "going the way of the U.K. -- losing AAA rating which affects all financial assets and the dollar."


The US losing its triple AAA rating would be devastating for the economy, pushing up the cost of borrowing for the Government, which would then feed through to higher taxes and higher interest rates nationwide. Many investors are limited to trading in AAA bonds, and therefore a huge number could be dumped on the market in the event of a downgrade. The end result would be a crashing dollar which in turn would catapult gold prices straight into new highs!

The dollar is being sold off again lately and is threatening to breach its 80 level support to the downside. Once this important support level fails then the dollar's slide could accelerate to the down-side.

When we take a peek at the dollar's monthly chart we'll see that the technicals leave plenty of room for a serious decline that could last for many months to come. Sure enough some support can be expected at the 80 level but since the dollar breached its 50 mma to the down-side odds are the 80 level won't be holding for that much longer.

TGDR Dollar Chart - Monthly



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