Paul Brodsky

Gold in Perspective

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As gold futures have declined 20% from their peak in September to their low this month, we thought we would reiterate some quick (albeit widely misunderstood) points that justify increasing our concentration of physical:

• Gold has always been a monetary commodity and, like dollars and all other paper currencies, has virtually no practical or industrial utility

• Gold is not currently a popular medium of exchange among private commercial counterparties, nor is it officially recognized by governments or central banks to be exchangeable in fixed terms with the competing paper currencies they produce

• Gold is manufactured in the private sector; its annual production adds about 1.5% to its global above-ground stock (estimated to be about 175k metric tons in total)

• The World Gold Council estimates that official gold holders (governments and/or central banks that manufacture competing paper money) retain about 30.7 thousand tonnes of gold, or about 18% of above-ground physical gold; are currently adding to their physical stocks

• Only about 0.05% of long positions in exchange-traded gold futures contracts actually take physical delivery of gold, and exchange inventories available for delivery are less than 5% of outstanding contracts

• Disaggregated private physical gold holders throughout the world tend to view their gold as strategic (rather than tactical) holdings, implying only long positions in gold futures contracts (non-manifest paper derivative claims) are susceptible to short-term funding and periodic calendar considerations

• As gold futures have weakened recently, the stock of physical gold bullion among bullion dealers has depleted at a significantly faster pace (at lower and lower prices), implying buyers of bullion (private holders and central banks) view declining futures prices as an opportunity to accumulate the metal

• Fundamentally, global central banks have produced much more paper currency and bank reserves (base money) than global gold production since 2008 (e.g. USDs +215% vs. gold 4.5%), and global debt denominated in paper currencies exceeds the actual stock of paper currencies with which to service and repay it by a wide margin (e.g. USD debt of $53 trillion vs. $2.7 trillion of base money)

• Real interest rates (nominal rates less CPI) are negative across the majority of the largest developed and emerging economies, implying that a stable or rising gold price has positive carry

• When properly accounted, global inflation is already substantially higher than common price baskets indicate, meaning real interest rates are even more negative than the CPI currently suggestsi

• As with all currencies, gold pays its owner nothing unless it is leant, (most bullion holders choose not to lend gold for fear of not being able to retrieve it when necessary); however, in real terms gold remains vastly cheaper to hold than paper currencies and so it is a store of purchasing power

• wrote in August (“Your Gold Teeth”), there are only two ways to safely own physical gold: take possession of above-ground bullion (and as we are seeing presently to do so outside the banking system where it can ultimately be hypothecated, pooled with financial assets and given away), or own in-ground bullion through shares in precious metals miners, which have been usurped in the marketplace by popular derivative claims on precious metals.

• When valued in terms of Enterprise Value per Gold Ounce (EV/Gold), in-ground bullion may be owned for as little as $30/oz through shares in operating companies already in production (we will distribute a more in-depth analysis of this to Fund investors later in the month).


It seems highly likely that from both capital stock (money stock vs. gold stock) and capital flow (real interest rate) perspectives, the future growth rate of global paper currencies will continue to exceed gold production by a wide margin, which implies the price in paper currency terms of physical gold should continue to rise substantially. Any sell-off in gold futures or other derivative claims serve the physical gold buyer’s interest and the interest of investors in shares of gold miners looking to accumulate in-ground physical gold.

Lee & Paul

QB Asset Management Company, LLC



[i] It is not necessarily true that price indexes like the Consumer Price Index accurately capture the loss of purchasing power, commonly referred to as inflation. The CPI calculates the price changes of components within a basket of goods and services. The components of the basket are subjectively weighted and periodically substituted, and are further subjected to hedonic adjustments (which seek to account for quality changes such as rising computing power). While the US CPI may accurately capture the loss of purchasing power for American wage earners living paycheck to paycheck, it does not capture the loss of purchasing power for savers or investors seeking to buy homes, travel abroad or send their children to college, nor for businesses seeking to delay capital spending, pay future wages or exchange goods or services for foreign currencies, nor for institutional investors managing employee retirement funds. The US CPI seeks to narrowly capture US dollar denominated price adjustments of basic goods and services for US dollar denominated wage earners spending their US dollars in the US, period.

Meanwhile, the United States imports the majority of the goods that American consumers buy with US dollars. This implies that the loss of purchasing power of dollar-denominated wage earners, savers and investors is largely determined by the exchange value of US dollars against other currencies. Exchange values fluctuate because producers and manufacturers demand constant value for their goods and services regardless of the nominal prices of their output. For example, if crude oil producers in the Middle East or toy manufacturers in Asia believe US dollars will hold more future purchasing power than Euros, then they would rather exchange their goods for US dollars. Another major shortcoming of “inflation indexes” like the CPI is that they do not capture the impact of necessary future money printing needed to service and pay down already existing debt. Such future money printing necessarily diminishes the purchasing power of savers and investors directly because it forces providers of goods, services, assets and labor to demand more currency in exchange (i.e. higher prices). The wider the gap separating the supply of existing debt from the supply of existing base money, the more future inflation (money creation) there must be. So, price baskets are simply very narrow measures of contemporaneous price changes. Finally, calculates its SGS-alternate 1990 based US CPI-U data series to be over 11% presently.

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Copyright © 2011 · Lee Quaintance and Paul Brodsky of QB Asset Management

Published by kind permission of the authors.

No part of this document may be reproduced in any way without the written consent of QB Asset Management Company, LLC.


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