The Investment Case For Gold
By John Hathaway www.tocquevillefunds.com

The price of gold will rise as the dollar based system of credit and commerce falters under an overload of bad debt, weakening financial institutions, and a stagnant economy. The end of the NASDAQ mania marked the beginning of this process. The Enron bankruptcy, de facto default on sovereign debt by Argentina, and a looming financial crisis in Japan are random but high profile reminders of a deteriorating global credit environment. Turning points in long-term market trends rarely achieve completion within the confines of a single business cycle. The NASDAQ blowout was the noisiest and most visible sign of a turning point. Much more quiet has been the failure of the dollar price of gold to make a new low since August of 1999, a good six months before the Nasdaq peak.

A revaluation of the dollar, like a credit downgrade, will choke off the flow of capital destined to be misspent. Its principal manifestation is likely to be a substantially higher gold price. The revaluation of gold will be permanent, based on three factors, each representing time spans of different but overlapping durations.

The three factors are:

(1) The structure of the gold market, including the short positions, the annual flows of physical metal, and the economics of mine production, favors a price rise to $400 - $500. Current gold prices of around $280/oz. do not justify sufficient investment to maintain world gold production. Production is set to decline slowly in the current year and more precipitously in the years after.

(2) The deflationary climate prompts economic policies that lead to the increased issuance of dollars including rapid money growth and fiscal deficits. It will inspire protectionist measures, which effectively devalue dollars held offshore. It will lead to rising interest rates, inflation and weakening balance sheets.

(3) The metaphysics of gold, or market mythology and popular perception, have the potential to exert more influence than the other two factors combined. Market metaphysics change glacially over decades. They explain the vast swings in valuation as demonstrated by the chart depicting the Dow Jones average by the dollar price of an ounce of gold. These very long cycles in the public mood range from mania to depression. Imagine the opposite of the recent mania and you will picture the 1970’s, even if you weren’t there. The 1970’s featured miniscule equity valuations, a cynical and apathetic public regard for investing, and distrust of financial institutions, political leadership, and currency.