Thursday, October 04, 2007

Gold – What’s in a Currency?

Whether a currency is weak or strong seriously affects buying power. Being Canadian, I have traveled the US when it took $1.50-1.60 to buy one US dollar. It keeps the cost of imports expensive. It helps export businesses and it helps tourism as people from countries with strong currencies see tremendous value in their vacations.

Gold is not a currency, but it does act like a form of money, and it preserves wealth in countries experiencing currency devaluation. It can work the opposite for countries whose currency is gaining strength.

We think we have cost of living issue, have you checked out Zimbabwe? According to this May article, Zimbabwe inflation in May, the cost of living double last April/May. It is predicted to be as much as 100,000% over this year, Zimbabwe inflation up more. The official exchange rate is very different than the black market rate where when converted to US dollars teachers make $100/month at the official rate and $6/month at the black market rate, Zimbabwe teachers on strike. Clearly demanding pay in grams of gold would protect buying power. Check out the video on life in Zimbabwe, Zimbabwe living in hyper-inflation. Currently, foreign currency is king.

Zimbabwe is experiencing hyperinflation. Check out their stock market and the graph goes straight up. Check out the early warnings, as this 2001 article shows, Zimbabwe 2001 decsions and one starts to see that the burden of debt and the inability to attract foreign dollars as investors did not see that the interest rate offered would protect their investment from currency devaluation. Life has gotten very bad, indeed, Zimbawe lifestyle lost to hyper-inflation.

Canada’s weakened dollar through the 80s and 90s was due to debt. Few Canadians appreciate the debt of gratitude Canadians owe former Prime Minister Brian Mulroney and finance minister Michael Wilson. They took over a Trudeau government that had program spending exceed tax revenues by $39 billion per year, never mind the cost of debt servicing. By the time Mulroney left office program spending match revenue. Canada still had a deficit in that tax revenue still did not cover debt servicing, but the changes they made during their tenure was outstanding.

Anyone who says other has a poor understanding of calculus, which tells us that if a graph is concave down, the rate of increase is coming under control. The graph for Canada debt was concave down for the entire time this team worked together. The graph of increasing debt under Trudeau is concave up, straight up. Many older Canadians look back at the Trudeau years as the glory years, but he left a burden of unsustainable program spending and debt that many Canadians blame the Prime Minster’s that were left to deal with the problem. No kidding the times feel very good indeed when fair share of taxes are not paid and the burden of paying for yesterday's lifestyle is passed on to future generations.

To that end, Mulroney and Wilson harped on and on about our debt problem and they set the stage for Canada to control debt and eventually move to surplus budgets, $13.8 billion for 2006-2007, Canada surplus budget, Canada budget highlights.

The US has increased debt, and they have increased it to levels that I believe are worse than Canada ever faced. And US currency is devaluing because of it and US congress is asking to increase the level of debt a few times per year. You can see that US debt was under control with Clinton, but out of control with Regan, Bush and Bush, graph of US debt. Last month the US Senate Finance Committee approved increasing the limit on debt to $9.8 trillion. Canada’s debt is $587 billion. With roughly 1/10th the population it means that the US level of debt per person at the federal level is about 1.7 times as high, and unlike Canada which currently has surplus budgets, there is no evidence that US government spending is coming under control, yet another increase to US debt.

Gold has protected wealth for Americans as government has continued out of control. With lowering the Federal Reserve rate last month from 5.25% to 4.75% the US government has chosen to devalue the US currency. The US dollar lost about 6% buying power in September alone in contrast with Canadian currency.

Gold has strongly outperformed many investments for US investors because of currency devaluation, but has not been nearly the performer for Canadian investors.

Photo Sharing and Video Hosting at Photobucket

Over five years gold is up 41% for Canadian investors, or about 7.1% per year annualized. For US investors gold is up 126% over 5 years, or 17.7% per year annualized. Over a shorter term, say 6 months, gold has not been a good investment for Canadians.

Photo Sharing and Video Hosting at Photobucket

Gold is down 6.1% for Canadians and up 8.3% for Americans. Gold is offering some protection of wealth from currency devaluation for Americans. If I were American I would consider owning some gold bullion as part of a diversified investment strategy. The Canadian dollar has had the fundamentals to strengthen the currency through debt management for a long time and it is showing up in a stronger Canadian dollar, from about $1.60 to by a US dollar five years ago to par today.

Photo Sharing and Video Hosting at Photobucket

Surely, if the US government reduces the Federal Reserve rate, the US currency will devalue more and gold will increase in price in US dollars. It may or may not increase in price in Canadian dollars. If the Canadian dollar gets stronger relative to the US dollar, it is likely gold will decline in Canadian dollars.

If Americans panic about preserving wealth from a declining currency and do it through buying gold, gold will likely skyrocket and even currencies gaining strength relative to the US dollar would see gold increase. Should this happen gold will also be a very good investment for Canadians.

Gold behaves like a master currency against all currencies, gaining when a currency declines, and losing when a currency gains. It is subject to the same market forces that lead to selling-off and under valuation and speculation leading to over valuation, which makes the contrast to currencies relative to how gold is valued in the market as a whole. But it is ultimately a master currency. Gold stocks are not bullion and have very different fundamentals that need to be looked at one at a time. A gold stock with costs in foreign currencies will see costs going up due to currency devaluation and will not necessarily see a leverage of earnings that investors expect. Some gold stocks have very strong leverage of earnings expectation built into their price, completely ignoring the explosive cost increases due to currency devaluation.

Currently gold stocks tend to sell off all of their gold, trading it for the very fiat currency their philosophy claims to abhor.

No comments :