By Neland Nobel

Written by Neland Nobel

We have seen in Part One and Part Two that gold bugs have gotten some intellectual revenge, as deficits and inflation have become entrenched in our economic system —and frankly, just about everywhere else. Their contention that only a gold standard coupled with an originalist interpretation of the Constitution could produce prolonged periods of stable money has proven correct. Many of their arguments have been adopted by those promoting cryptocurrencies and have received a revival of sorts.

While they have taken intellectual revenge, they have also taken some revenge for being mocked in the financial world by making a handsome profit, albeit through a long period of terror and boredom. As mentioned earlier, one of the things that triggered this series of essays is the ability of gold to outperform the stock market over the past 20 turbulent years. In that process, gold has reached a historic milestone. It has reached a value 100 times what it was when the last shackles of the gold standard were thrown off by President Nixon in 1971.

But gold has done more than that, as the notations below indicate. We asked GROK, an artificial intelligence, to perform some calculations. You can do this yourself if you doubt the conclusions.

The first arguments we became familiar with for using gold as a private investment were the writings of Col. E.C. Harwood, founder of the American Institute for Economic Research, dating as early as 1958.  He was concerned early on about the potential for inflation, as well as America’s growing trade deficit.

The first gold stock mutual fund was founded by John Van Eck in 1968, International Investors. The firm is still in operation today and manages the most significant gold stock exchange-traded fund, GDX.

Both felt the post-war monetary system would break apart and the dollar would be devalued, and then enter a long period of depreciation. Harwood advocated for the private ownership of gold. But gold was illegal to own, making its use as an investment impossible. And while gold mines were available to invest in, they had little future as long as the gold price was controlled and fixed at a set price.

It was the legalization of gold in 1974 that allowed both physical gold buyers and investors in gold mines to profit from their monetary theories. 

There was, however, a loophole in the law that allowed the ownership of gold before it was legalized. These were coins that had once been currency. A fledgling market for previously circulating gold coins, such as British Sovereigns, older US coins, and even Mexican coins, began to develop before formal legalization. However, it too would not work in the long term unless the gold price was freed to reflect ongoing currency debasement.

It was an inefficient over-the-counter market among dealers, and investors had to pay 10%-20% premiums over the gold price. That said, it allowed private individuals to own physical gold legally. This legal loophole allowed investors to buy gold at a fixed price of $35 per ounce, and later, at a two-tier price of around $42 per ounce.

The most significant promotion for gold, however, was the publication in 1970 of You Can Profit From The Coming Devaluation by Harry Browne. Browne would go on to write several other widely circulated books and later run as a Presidential candidate for the Libertarian Party. His books were highly promoted at the time by the Conservative Book Club, so the advocacy for gold was one of the rare times Libertarians and Conservatives sang from the same hymnal.

This cooperation continued with the push to legalize gold in 1974 and for the US to mint a one-ounce gold coin.  Republican Congressman Ron Paul of Texas and Senator James McClure of Idaho deserve considerable credit for both advocating for and building support within the Republican Party to legalize the ownership of gold.

Browne, in his seminal book, advocated investing in physical gold, as well as in Swiss Francs, which at the time were 40% backed by gold. However, Switzerland broke all ties to gold in 2000 and joined England in selling a vast portion of its gold reserves. In the case of England, Gordon Brown sold at an absolute low of $250 per ounce. Looking back from today’s prices, that seems pretty dumb.

In the early 1970s, there were few advocates for gold among investment managers. For the most part, Wall Street has hated gold bugs. The reason should be apparent. If you believe that money will depreciate, then most paper investments will be harmed. Thus, a client who fully embraced gold bug arguments may not be willing to buy stocks, bonds, CDs, annuities, and insurance policies. In other words, gold bugs made it hard to sell what Wall Street was selling.

However, there has always been a market for independent opinion, and in the 1970s and 1980s, independent newsletters widely circulated. While there were others, three men stand out in their ability to walk and chew gum at the same time. They were Richard Russell of Dow Theory Letters, Harry Schultz of the International Harry Schultz Letter, and James Dines of the Dines Letter.  

Also, Robert Bleiberg, the editor of Barron’s, was friendly to gold and often published articles by Russell and others on various topics, including gold and technical analysis.

All four could embrace elements of the gold bug argument, but still participate in the stock market. This was not a purist position to be sure, but it worked. As mentioned above, well-run and growing companies also achieved a rate of return above the inflation rate, yielding good returns. And bonds, which were locked in at high interest rates, such as the double-digit rates of the early 1980s, also proved a good investment. So, while it wasn’t a pure gold bug position, remaining flexible and open to opportunities has also been vindicated.

Their writings circulated widely and spread the idea of hedging in gold to the broader investment public. Later, Howard Ruff came along with his newsletter and TV show.

The difference was that these investment writers included gold in their analysis and their portfolio recommendations, and incorporated elements of the gold bug arguments into their investment philosophy.

Most also used technical analysis, which involves using charts to help guide investors in timing their buying and selling. This was especially true of the Aden Forecast, which still publishes today. This proved helpful. If gold was going up in price, they took notice, even if they didn’t bother to absorb all of the gold bug’s arguments. If gold was working, they got on the train because they were attracted to the positive price movement. If gold prices started to decline, they also let their readers know.

While the gold bug has been proven correct and is enjoying his revenge on those who doubted him, the gold bug position does, unfortunately, lend itself to “investment extremism.” Once accepting the arguments and premises, some investors can almost turn into doomsday preppers.

There is nothing wrong with preparing for bad times. But since currency depreciation and the decline of nations are a long process, one can’t know the timing. History is full of twists and turns, starts and stops. In addition, always looking for the bad times, investors can lose sight of the good times and miss many worthwhile investment opportunities.  One of the benefits of charts is that they objectively tell you if something is working, even if they do not explain why.

Gold bugs can be faulted for their narrow, perhaps pessimistic view of things. However, Wall Street money managers can also be faulted for ignoring key elements of monetary history and overlooking the warning signs that our money has not been healthy for years and is unlikely to improve anytime soon. Many lost the opportunity to invest in gold, and just as some gold bugs lost the opportunity to invest in stocks.

Exactly where gold will go in the future is difficult to know. But until we, as humans, stop trying to acquire prosperity by printing money faster than we can produce things and paying for political promises by running up huge debts, money will continue to lose its value. As money loses value, gold will take notice.

Despite the claims of crypto advocates, we don’t see a real alternative to gold, and apparently, central banks don’t see one either.

Inflation is more than a loss in purchasing power. It is a social evil. As Keynes noted, it is a hidden tax to redistribute wealth. That redistribution may not go in the direction that socialists thought. Finance capital is often the beneficiary due to expertise, access to capital, and the ability to leverage debt. Single mothers on a budget, wage earners, and those on pensions are all lagging behind the inflation rate. Because the rich know how to navigate the financial system, money tends to gravitate from the poor to the rich, exacerbating the divide between the rich and the poor and fueling resentment and envy. Inflation confuses accounting, obfuscates investment returns, curbs commerce as the quality of products declines, creates ‘shrinkflation‘ in the size of goods, and fosters all manner of speculative schemes bred from desperation.

The reader might also be aware that we have omitted a discussion of cryptocurrencies. We don’t have the time or expertise to get into that now. But it is worth noting that many of the arguments for crypto sound very much like classic gold bug arguments. They are saying, if the government can’t produce a stable currency, we will. Unfortunately, in many cases, crypto advocates have been involved in fraud and deception. The volatility of crypto doesn’t resemble that of a currency. In addition, with their proliferation, the argument that they would be limited in quantity no longer holds. However, the reader should keep an open mind to the possibilities in this area. For us, we don’t fully understand them sufficiently and distrust storing our “gold” on a server in the cloud.

Will gold ever regain its status as a form of money? In some sense, we are seeing that as central banks are buying vast quantities of gold and diversifying out of their dollar reserves. That gold will become a Tier One asset this summer, under the terms of Basel III, is also significant.

As an aside, it is also worth observing that governments don’t telegraph their intentions when there is an anticipated change in the monetary order. Confiscation came suddenly and without notice in 1933, and the final break from gold came suddenly and without notice in 1971. The same is true of multiple currency devaluations by many different nations. The government does not want you to know about their actions ahead of time. Usually, only those working closely with the government will know when significant monetary changes are coming.

If we’re headed for a new monetary regime, don’t expect to be given advance notice. Like car insurance, it won’t help to buy after the wreck.

Why are banks buying gold at a pace beyond that when the post-war monetary arrangements collapsed in 1971? Besides fueling a gold price advance, what does this mean in the longer term for money? Increasingly, some analysts, such as Ray Dalio, believe that a change in our monetary system is on the way. Some might dismiss Dalio as a crank, but since he founded and ran the most successful hedge fund in history, it might not be easy to do so.

It is this dual demand from central banks and from the investment public that will be the source of future gold price appreciation.

We think it is implausible that the government will voluntarily put back on the straitjacket of a gold standard. Only a crisis could cause that. If gold has a future in the international monetary system, it will only come when conditions force governments to find something to restore the market’s confidence in money. Is that what central banks are preparing for?

Nor is it likely that political parties that want the government to grow and redistribute wealth will voluntarily put themselves back in a straitjacket of monetary restraint. The economics profession is enamored of discretionary control by experts and is unlikely to support any automatic regulatory system, like the gold standard.  Here, too, only a monetary crisis will cause the government and the economics profession to reexamine their promotion of fiat currency.

There is a flicker of activity to bring gold back into the domestic economy.  The state of Utah has invested in gold, and the legislature has passed legislation (apparently blocked by the governor), which would allow gold and silver to be used as payment for state vendors.

That leaves the gold bug in his customary place of pessimism. They were right: in the absence of a strong constitution that limited the power of government, coupled with a gold standard, the government would not be able to issue stable money. The temptation is too great, and the incentives so biased, the government will fail. So, money will continue to be used as a tool for exercising political power, rather than serving as a stable medium of exchange.

And they were right about gold as a private investment.  Despite the claims of the gold bugs, it was not at all clear in 1974 that gold would outperform the stock market or prove helpful in diversifying portfolios. But history has once again proven to support the gold bug’s basic argument.

Maybe gold bugs are disliked because of what they tell us about ourselves and our history.

The irony remains. While the gold bug may profit and enjoy some intellectual satisfaction, he does so while watching his civilization unravel.

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