Many experts have called gold a bubble for the last five years, even as it outperformed the equities’ market by almost 200 percent during the same time frame. Others, on the other hand, believe it is being manipulated for a quick profit at the expense of retail investors.
The truth is the United States Treasury must refinance 36 percent of the debt this yearand 60 percent by 2013, and unlike Greece who can’t print money to refinance their obligations, the United States Federal Reserve has no such restraints.
The Fed’s balance sheet grew from $850 billion in 2007 to $2.3 trillion in 2010because they created money out of thin air and bought mortgage related securities off the balance sheets of the banks. Many of these bonds are now coming due, and sure enough, the Fed will use the proceeds to buy more government bondsto keep interest rates artificially low and facilitate business activity. If the average citizen did such a thing, he/she would go to jail.
The public was told that the extra liquidity would be lent to small businesses and consumers to stimulate the economy, but why would the banks lend money to the public at six percent when they can buy a risk-free government bond at three percent?
The reason we haven’t experienced high inflation is because the printed money hasn’t been released to the economy. Instead, it’s being returned to the government so Congress can pay for entitlement spending and the military costs, which collectively account for two-thirds of the budget.
How long can that last? The notion that our creditors will allow us to repay runaway national debts with an increasingly diluted currency is intellectually lazy, and quite frankly, a breach of logic.
The large banks used to buy one percent of the 10 and 30 year treasury bonds; now they represent 24 percent of the demand. Hedge funds now account for one-fifth of all trading in the U.S. Treasury bond market, up from three percent in 2009.
There’s no doubt that if the demand for government bonds dramatically declined it would put tremendous downside pressure on the value of the dollar and correspondingly increase the price of precious metals. So what would prevent institutional investors from building a position in gold with the intention of forgoing government debt purchases in the future?
Better yet, why wouldn’t they do it?
John Paulson, who made a cool $1 billion in the deal that begot the SEC fraud case against Goldman Sachs, would be the wealthiest man in the world if gold reached $5,000 an ounce, having invested 10 percent of his $30 billion hedge fund in gold related securities.
Gold is also the largest holding for George Mindich’s $13 billion hedge fund, himself a former partner at Goldman Sachs.
George Soros, the 15th wealthiest man in the world after he made $1 billion betting against the British pound in 1992, was quoted as saying “gold is the ultimate asset bubble” in December of 2009.
Unbeknownst to many investors, he’s also the 6th largest owner of gold.
(On CNBC.com: Oil, Gold, Natural Gas Prices Now )
The banks and other professional investors have neither the responsibility nor an incentive to fix the government deficits. In fact, it’s their fiduciary responsibility to make money for their shareholders by any legal means available, an obligation enforceable by civil law. Who would fault them for taking advantage of witless public officials who spent the last 30 years soliciting votes with unfunded promises of prosperity, commonly disguised as tax cuts, no-bid contracts and social safety nets indifferent to the basic principles of math?
Some have speculated that the hedge funds will pull the rug from underneath gold when the price is right, but maybe it’s the other way around?
Perhaps the large investors will instead exploit market inefficiencies by sitting on the sidelines of fiscal incompetence and refuse to buy Treasury bonds. The public’s appetite for economic gimmicks will have consequences, and whether we like it or not, nobody knows what happens when patriotism gets in the way of profits.
Disclosure: Mr. Johnson owns roughly $7 million of gold for his clients and about $200,000 personally.
Ivory Johnson is the director of financial planning at Scarborough Capital Management, Inc. He is a Certified Financial Planner, a Chartered Financial Consultant and a frequent guest on CNBC. Mr. Johnson attended Penn State University, where he received a Bachelor of Science degree in finance.