The New Gold Rush

Gold closed above $800 per ounce on Friday for the first time in more than 27 years. It's now just a short distance to gold's all time nominal high of $850 per ounce that was reached in January 1980. In inflation-adjusted terms, though, gold is still well below its all time high of more than $2,200, so it still has plenty of room to run - and run it will.

The conditions that led to gold's last monster run were stagflation and a plunging dollar, coupled with all-time high oil prices due to a tense standoff between America and Iran. Sound familiar? I was in high school then, and I remember very clearly that at the peak of gold's run there were stores in every shopping mall selling gold coins, television commercials extolling the merits of investing in precious metals, and investing in gold was a popular conversation topic at parties, much as Internet stocks were in 1999. My father told me recently that he bought some one ounce South African Krugerrand coins in 1979 that are just now becoming worth more than what he paid for them again. Until we see this type of activity again, it will still be safe to buy more gold.

Gold is traditionally bought as a hedge against inflation. When governments print excessive amounts of paper money, each existing dollar becomes worth less than it was the day before the new paper money was printed and added to the money supply. Governments worldwide are currently printing new batches of paper money like it's going out of style in a desperate but futile attempt to bail out the big banks which are sitting on large piles of now worthless securities that were backed by pools of subprime mortgage loans that are being foreclosed on right and left as Adjustable Rate Mortgages reset beyond the ability of cash-strapped homeowners to pay. Last Thursday alone, the Federal Reserve pumped an additional $41 billion new dollars into the world monetary system.

It's simple supply and demand - as the value of each dollar becomes less, the amount of stuff you can buy with it goes down. The result - rising prices of everything from bread to automobiles to gasoline to heating oil. Throughout human history, at such times people have turned to gold as a store of value to protect them against the drop in value of their rapidly becoming worthless paper money.

This is a worldwide phenomenon, but is particularly acute for the United States, since unlike in the late-1970s, we now have the largest accumulated debt of any kind in the history of the universe, more than $9 trillion and growing ever larger as you read this. There is no possible way the United States can ever pay this debt back in full. Just servicing the interest on this mountain of debt will cost American taxpayers more than $400 billion dollars in the next fiscal year.

There is only one way out of this mess - to deflate the value of the dollar so we can pay back the nations (primarily Japan and China) that lent us this money with dollars that are worth much less than the ones they originally lent us. This is the exact strategy that was used by the Weimar Republic in Germany in the 1930's. They could not afford to repay the excessive war reparations that were thrust upon them by England and France at the end of World War I, so they devalued their currency and paid the reparations back with worthless money. At the height of the ensuing hyperinflation, people were actually burning stacks of German money in their furnaces to keep warm because firewood was more valuable than the paper money - and everyone has heard the stories about needing a wheelbarrow full of money to buy a loaf of bread then.

So why hasn't this happened in America yet, when our national debt has been off the historical scale for quite some time now? The answer is simple. For the last 75 years or so, the other nations of the world have allowed the dollar to function as the world's reserve currency, and therefore helped to prop it up. Oil, gold, wheat, etc. are all priced in dollars. That is now changing. Many nations, including China and Kuwait, have dropped their currency pegs to the dollar. Iran will no longer accept dollars as payment for their oil. There are reports that at OPEC's next meeting they will vote to no longer price oil in dollars, but rather against a basket of other currencies. Most tellingly, there is this story.

History tells us what happens when a nation's currency ceases to act as a reserve currency. When the British pound was replaced by the dollar as the world's reserve currency, it lost more than 70% of its value. In this inflationary environment, gold will do what it has always done throughout human history in similar situations - soar in value. Fair warning, though - the governments of the world will do their best to hold gold down in a vain attempt to preserve the values of their paper currencies. They will lose, but they will put up a heck of a fight. Before this is all over, we will see gold moving up and down as much as a $100 per ounce in a single day. And don't be too surprised if President Clinton takes away the right of Americans to own gold around 2010 or so to protect the dollar, just like President Franklin Roosevelt did. So fasten your seat belts and climb onboard the gold train now!

The next few posts will detail the best ways to play the rise in gold, starting with the most conservative methods, and working up to the high risk-high reward strategies.