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Government Debt Rescue a Boon for Gold!

Thu, Sep 25 2008, 09:40 GMT
by Sean Brodrick

Money and Markets

Treasury Secretary Paulson and Congress are hammering out details of the government's rescue plan for financial institutions, and we don't know what final impact it will have on the debt crisis. But I can tell you one thing — it's going to drive gold prices higher.

In this plan, the government is squirting out hundreds of billions of dollars through a fire hose. That is inherently inflationary and should pump up the price of gold.

And then there's the whole question as to whether this mega-bailout is going to work or not. Martin told you his doubts on Monday. I have my doubts, too. After all, here's just a partial laundry list of all the schemes the government has hatched in recent months to "save" the market ...

• * The Bear Stearns takeover by JP Morgan, which was midwifed by the federal government (cost to taxpayers: $29 billion)
• * Special Fed liquidity programs including the Term Lending Facility and Term Auction Facility ($200 billion)
• * The Economic Stimulus package ($168 billion)
• * The Federal Housing Administration's scheme to refinance failing mortgages into new, reduced-principal loans with a federal guarantee ($300 billion)
• * The bailout for Fannie & Freddie (up to $200 billion)
• * The bailout for AIG ($85 billion)
• * Last week's decision to block short-selling of financial stocks
• * The insurance program for money market funds (potentially $50 billion from the Great Depression era Exchange Stabilization Fund)
• * Direct Treasury purchases of mortgage-backed securities ($10 billion)
• * Another $300 billion injected into global credit markets on Friday

Add in the $700 billion proposed for the current bank bailout plan, $87 billion in repayments to JP Morgan Chase for providing financing to underpin trades with bankrupt investment bank Lehman Brothers, etc., etc., and I tally up over $1.8 TRILLION ... so far.

A flood of dollars into the system lowers the value of dollars. It's simple supply and demand. Since commodities are priced in dollars, as the greenback goes lower, they usually go higher. And gold is an obvious play for a falling dollar.

Some of these programs and ad-hoc spending sprees were more successful than others, but any short-term rallies they caused in the stock market didn't last for long.

Oh, and there's more to come. We still haven't gotten to the billions of dollars in special loans proposed for GM and Ford, as well as the next new economic stimulus package which may be tied in with the bank bailout — a second economic stimulus that Treasury Secretary Paulson ruled out as recently as May.

If you think I'm being hard on Secretary Paulson, remember that he was in charge at Goldman Sachs when that company (among others) went crazy for bad debt that is now impossible to value properly. He's been in office a year and a half, and now — SUDDENLY! URGENTLY! — he needs us to approve his new bailout plan without time for deep discussion or changes ... to give his friends on Wall Street a check for $700 billion without a second thought.

I mean, just to focus on the cost of the current bailout plan: $700 billion in new U.S. debt is an additional $5,072 added to the debt burden of every U.S taxpayer. Plus it's ...

• * Roughly what the U.S. has spent so far in direct costs on the entire Iraq war.
• * As much as the combined annual budgets of the Departments of Defense, Education and Health and Human Services.
• * Three and a half times what the S&L crisis cost taxpayers ($126 billion back then, $200 billion in today's dollars).

All this and it still might not fix the problem?! That means the U.S. government might have to spend even more money ... a lot more! Can you see why I think gold is looking so good?

And what if Paulson's plan doesn't work? He and other Wall Street types have been dropping hints that we averted disaster at the last minute. Maybe they're bluffing, but maybe they're not. What could happen to the U.S. dollar in a full-blown bank solvency crisis? Could it do a lot worse than it is now? Probably!

Just take a look at a recent chart of the U.S. Dollar Index and you'll see that it has broken its short-term uptrend. If this crisis gets worse ... if the Treasury opens up the floodgates on the money supply ... if the bailout plan fails ... all bets are off.

And that's when you want to own gold.

A Steep Correction Lays a BaseFor The Next Leg Higher

We saw gold prices crushed in recent months. And this came despite bullish fundamentals. I'm talking about facts like ...

• * Global gold mine production continues to go down ... and should decrease by 2% in 2007-2008.
• * So far, in 2008, we have seen the least gold sales by the central banks since 1985. That means less gold supply coming on the market.
• * The price of mining gold is going up ... from approximately $395 per ounce in 2007 to $458 in the second quarter of 2008, according to the World Gold Council. This puts a base under the price of gold, because if gold gets too cheap, mines close down and new projects aren't pursued.

One of the biggest drivers of gold now is gold ETFs. In fact, the world's biggest gold ETF, the SPDR Gold Trust (GLD), holds more gold than many countries. Its gold hoard rose by 24.5 metric tonnes on September 19th, and it now holds 679.60 metric tonnes.

It's not alone. For the week ending Friday, all of the gold ETFs sponsored by the World Gold Council showed a collective increase of 65.41 tonnes to their gold holdings, totaling 834.54 tonnes worth $23.3 billion.

And sure enough, as you can see from this chart, the more that ETFs stock up on gold, the higher the price of gold goes.

I'm thinking that the smart money is betting on a big rise in gold. This pullback in gold has created a base for its next leg higher. Don't get left behind.

What You Can Do

This is one of those times when you might want to have some physical gold and silver on hand. I'm not saying a lot ... but I keep some just in case, and it lets me sleep at night.

And the GLD is a great way to buy gold without having to store it. If you don't have some in your portfolio, consider adding some now. Gold should be part of a well-balanced portfolio anyway. And the troubles for banks, brokers and the market in general probably aren't over ... not by a long shot. After all, as Shakespeare said: "When troubles come, they come not single spies, but in battalions."

When troubles come, make sure you have some precious metals handy and in your portfolio.

Published on  Thu, Sep 25 2008, 09:40 GMT

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