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    Wednesday, September 03, 2003

     
    Why Gold will keep going up.... for a while

    Historically currencies were tied to a precious metal and were exchangeable for that metal. Pounds sterling were actually exchangeable for sterling silver and at various times US dollars have been exchangeable for a set amount of gold. This provides some "reality" to the money that we exchange. Without currency being tied to hard assets, the only thing that makes it work is the assumption that the next person will accept your cash. Money that is not tied to hard assets is called "fiat", there are many problems with fiat currency not least of which is the country can print more money beyond any reserves of gold/ silver etc that they have. Back in the days when currency was tied, a country had to have most of the hard asset stored somewhere safe to exchange for currency if required. The amount of money in circulation could grow as the government received more taxes as the economy grew. Today any country can print more money leading to inflation.

    The problem world wide today is that many of the largest economies do not want their currency to appreciate relative to other currencies. As the US dollar appreciates it becomes more expensive for other countries to purchase our goods and therefore our economy is hurt, not a good thing during a recovery. China and the US are a prime example. China is deliberately holding their currency down relative to the US dollar. At the same time the US is attempting to hold it's currency down relative to other currencies. In the end there is only one way that all currency's can be deliberately undervalued. The mechanism they must use is to print more money and use it to buy hard assets such as gold. As the Chinese currency appreciates against the dollar, the Chinese print lots more money and buy gold or other hard assets with that money, including US currency (creating demand and driving the US dollar up). This additional supply of Chinese currency reduces the price. Now China just buying US dollars would make the US dollar appreciate. The US would retaliate by buying Chinese currency and nothing much is gained. Both countries, however, can buy some real assets with their newly printed (worth less) money. This has to lead to significant inflation in the medium term. Fortunately for the governments they should be able to sell their gold at the inflated prices maintaining the real value (after inflation), which was the point of pegging currencies to gold historically. The average person, though, does not have a big gold reserve to cash in when his dollars are worth 50c in today's currency.

    The Chinese refusal to devalue the Yuan is a pretty hot news item at the moment. The US treasury secretary is over there at the moment trying to convince them to devalue; he is very unlikely to succeed. With economies worldwide needing massive liquidity to get out of their recessions this is a reasonable short term move. It is almost guaranteed, though, that countries will overshoot the mark and significant inflation is likely one to two years out.

    How can you trade off this? Well I strongly recommend that you do not hold any fixed interest securities of duration longer than 2-3 years to maturity. Treasury Inflation Protected Securities (TIPS) are a great way to avoid the loss of value of your assets, as is being short treasuries. American businesses will continue creating real value and will grow beyond inflation, it is always relatively safe to be invested for the long term in an S&P 500 index fund. I don't recommend buying gold as in the end it has no intrinsic value aside from it's scarcity. Remember stocks have returned $462,502 dollars since 1801, Bonds 1,070, Gold 1.19 and Cash 0.07.

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    Disclaimer and Disclosure Analyses are prepared from sources and data believed to be reliable, but no representation is made as to their accuracy or completeness. I am not paid by covered companies. Strategies or ideas are presented for informational purposes and should not be used as a basis for any financial decisions.
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