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Wednesday, January 06, 2010

Why I've been reading Bill Bonner

Back in 2000, Bill Bonner, author of financial newsletter The Daily Reckoning, announced his trade of the decade. It was a simple one: sell dollars, buy gold.

It turned out to be a good plan. In 2000, you could buy an ounce of gold for $280 (the average price over the year). Now, it will cost you $1,125. At the time, Bonner saw what most others did not. He saw the US not as an economy carefully and cleverly managed by then Federal Reserve chairman Alan Greenspan and his passion for low interest rates, but as a massive credit bubble waiting to burst.

He also saw the massive and growing national debt, the trade and budget deficits, and fast growth in the money supply as factors that would naturally debase the dollar over the long term. He also saw the credit bubble as global rather than peculiar to America.

So it made sense to him to hold the only non-paper currency there is – gold. Bonner had a good decade, making returns of 400 per cent plus. The question now is: Will he have another one?

I suspect he might. Why? Because he’s going for the same trade of the decade for the next 10 years as he has for the past 10.

This makes complete sense: nothing has changed since he made his first gold call except for the scale of the currency debasing going on around the world. Think ultra low interest rates almost everywhere, the money printing exercise that is quantitative easing, and the whopping rises in national debt levels – the arguments are all pretty well-rehearsed these days.

Another reason to suspect this next decade could go Bonner’s way is that he and the other gold bugs are no longer alone in their hoarding of gold – central banks have become net buyers for the first time in many years and fund managers are beginning to wake up to the idea that gold can hedge them against a great many nasty things.

Still, however compelling the case, one thing to bear in mind for this gold bull market is that it is likely to be very volatile. Why? Exchange traded funds (ETFs). These funds – which are much easier to buy and sell than physical gold – didn’t exist last time round, but this time they are huge: ETF Securities says it has $9.5bn worth of physical gold holdings backing up its products. That means that as investors fall in and out of love with gold, and trade ETFs that have to be physically backed, the gold price could gyrate violently.

Note that gold has already fallen back from its high of just over $1,200 back to $1,130.

Note too that, in the short term, it may well continue to fall. I mentioned in late October that I expected to see a short-term snap back in the dollar – that has happened, and as the dollar has strengthened, so the gold price has fallen. However, whatever happens in the short term, in a period of financial uncertainty on today’s scale, I just don’t think you can be without a proper precious metal.

I favour gold simply because it has no purpose other than to be an alternative currency, but there is also a case to be made for silver should you want to diversify (although don’t forget that physical silver, unlike gold, is subject to VAT). As they both fall back, it is probably worth stocking up on them at what I think will be temporarily lower prices. That’s particularly the case given the announcements in last week’s pre-Budget report. Gold pays no dividends so you can’t be forced to pay income tax at 40 per cent or 50 per cent on it. Instead, any profits will be pure capital gains – taxed at what now seems the very low rate of 18 per cent.
--from "The case for gold continues..." (December 11, 2009) by Merryn Somerset Webb

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