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Peter Schiff's Case for Gold

Get Ready for a Spike

Written by Joseph Cafariello
Posted August 8, 2013 at 12:23PM

How in the world could gold be so cheap amidst all that is going on in the world? Almost every developed nation is lowering interest rates to weaken its currency and then printing more money, which weakens it even further. Shouldn’t gold be well over $2,000 by now? What is holding it down?

gold barsAccording to Peter Schiff of Euro Pacific Capital, a better question to ask would be: Who is holding it down? Schiff believes the big banks, along with some U.S. Federal Reserve banks, are involved.

Just what is it that has raised Schiff’s long-running suspicions? If he is right that gold has been artificially kept down, might it some day also be manipulated back up? The banks pulling the strings would certainly benefit from a rapid spike back up. And so can you.

Schiff’s Three Signals

Three signals have raised Schiff’s expectations for a sharp gold price spike, as he outlined in a recent CNBC interview:

  1. Weaker economic recovery: According to the latest U.S. GDP data, the American economy in Q2 grew at an annualized rate of 1.7%. However, Schiff contends that this figure is based on 0.7% inflation, when the government’s own inflation reading came in at 1.1%. If inflation is truly greater than the GDP calculations have been allowing, then GDP cannot be as high as has been reported. Schiff asserts GDP is barely in the positive, perhaps even stagnant at 0% growth.

  2. More stimulus required: If the economic recovery truly is that weak, Schiff believes there is no way the Federal Reserve will curtail stimulus. In fact, he argues the Fed has no choice but to increase stimulus, which the Fed has been indicating in its press releases that it reserves the right to do if incoming data warrant it.

  3. Inflation will take its toll: Combining a weak economy (which Schiff expects to recede into another recession) with continued easy-money stimulus can have no other effect than to unleash inflation to run amok. The Federal Reserve has also stated in its releases that it wants to coax a higher inflation rate of at least 2%. Inflation is part of its agenda, and it will not stop stimulus until it arrives.

Once these three symptoms of a diseased economy become full blown, the flight to the safety of gold will resume. Even as Marcus Grubb, managing director of investment at the World Gold Council, indicated in a CNBC interview, “This is a correction in a trend, rather than the end of that trend.”

Inventory Misrepresentation

Schiff is also astounded by the stark disparity between physical gold purchases and paper gold sales. More physical has been purchased than paper sales have made available.

When paper gold – shares of gold ETFs, for example – is sold, the trust fund is supposed to release a corresponding amount of physical gold into the marketplace. Why would they want to hold more than their clients have purchased?

But the two volumes do not add up. Grubb indicated to CNBC that so far this year, paper gold sales from ETFs have reached some 650 tons, while demand for physical gold in China and India is estimated to reach 1,000 tons and 850 tons respectively by the end of the year. Meanwhile, central bank purchases by Russia, Turkey, Greece, and numerous others are estimated to reach 550 tons for 2013.

Assuming two-thirds of those purchases have been completed so far would pit 1,600 tons of physical purchases against just 650 tons of paper sales. That’s a ratio of nearly 2.5:1. So why has the gold price fallen so dramatically when purchases have outpaced sales by so wide a margin?

Even more importantly, from what source have these physical purchases been supplied? Stockpiles have not changed that dramatically, and new supply has been curtailed due to scaled-back mining operations as metals prices have fallen below operating costs.

Schiff believes not all of these purchases have been fully supplied and never will be – because there simply is not enough gold available to go around. Schiff believes the large banks have been lending and selling more gold than they have in their inventories.

Not all physical gold that is purchased is actually delivered but will often be stored in bank vaults for safe-keeping. So while ownership of physical gold is transferred from the banks to the buyers, in many cases the actual gold is never moved. There is nothing to stop a bank from selling the same bar of gold to more than one buyer with the arrangement of storing it for them for an added fee.

Schiff wants to see an actual inventory count to make sure banks haven’t been selling the same gold twice. Does anyone really know how much gold is still in America’s Fort Knox? Not since the last complete audit in 1953. Since then, there have been partial inspections of its gold, but no full-scale inventory audit.

As of January, Germany has begun a process of repatriating 300 tons of gold held at the Federal Reserve Bank of New York. Although this is only 5% of the bank’s gold holdings, the process of delivering Germany its gold is expected to take until 2020 – a full 7 years.

Why so long? Could it be that the bank is now scrambling to accumulate 300 tons of gold currently worth nearly $12.5 billion? Could this be the reason why the gold price has fallen so sharply lately – to make it cheaper for banks to get their hands on it? First they over-sold gold above $1800, now they’re buying it back for $1300 and then delivering it to other central banks. Possible? Schiff doesn’t put it past them.

Proper Allocation

Cheap prices have forced mine closures, restricting supply. At some point, when the selling finally stops and people start buying again, Schiff expects the gold price to shoot up dramatically, since there isn’t as much physical gold out there as people think, and new production has been curtailed by mines operating at greatly reduced capacity. It takes a long time – several months or quarters even – for producers to replenish stockpiles, especially if they have to reopen closed mines.

No one knows when the price spike will come exactly. So sticking to that universally accepted allocation of between 5% and 15% in precious metals is wise. By rebalancing your portfolio every couple of weeks or so to restore your desired percentage allocation, you would be buying a little on the dips and selling a little at the peaks.

In so doing, not only would you profit through the choppy volatility, but you would also be able to participate in gold’s correction to the upside whenever it happens. You can’t go wrong with that.

Joseph Cafariello

 

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