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  • Precious Metals: Prices Down… Demand Way Up

    April 18, 2013

    Dear Reader,

    A lot has happened in the past few weeks. First, the Cyprus banking crisis roiled the markets and exposed, yet again, the risks posed by Western banks and their investments in sovereign debt.

    Two weeks later, we saw the precious-metals market drop significantly. The exact cause of the price drop is debatable, but one thing is certain: "paper gold" is playing a big part in the market's instability.

    Big buyers of paper gold and silver use leverage to make their purchases – a practice which causes price distortions during periods of volatility. When the price moves below their margin limit, they need to deposit more cash to protect their positions. That typically involves selling some or all of their holdings, adding more downward pressure on prices.

    I've never been a fan of the metal ETFs. They are best suited for short-term traders and speculators. For the long-term investor looking for asset diversification, protection against devalued currencies, and a store of wealth, physical precious metal remains a top choice.

    So what happened in the physical precious-metal market when spot prices dropped?

    Our dealer network reported strong demand for physical metal, and the Hard Assets Alliance had one of its single busiest days on record. We saw a near-record level of deposits and purchases. Very few customers sold their metals during the panic – thankfully – thus avoiding an unnecessary loss.

    In my view, this is further evidence of a shift under way in the metals market – a shift away from ETFs and into physical metals. It's also proof that many investors are nervous... with good reason.

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    Some of those reasons are detailed in this month's feature article by Jeff Clark.

    But first, a note on customer service – we've added to our customer service department, both in numbers and experience. If you have questions about purchasing, storage, our IRA program, or anything related to metals, our customer service team is ready with answers. Don't hesitate to call us at 1-877-727-7387.

    Best regards,

    Ed D'Agostino
    General Manager
    Hard Assets Alliance

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    Name That Black Swan

    Is there a potential event that could negatively impact your world so much that it's imperative you insure against it?

    Of course. That's why you carry fire insurance on your home, for example. The odds of your house burning to the ground are very low – but the outcome would be so financially devastating that you need to have insurance to protect against the loss. The same could be said of life insurance, auto insurance, etc.

    What about an economic or monetary event that, in spite of you being prudent with your money, could damage your financial status?

    Those exist too, and they're called "black swans." It's this type of event that is the basis of our third installment in the core reasons we must continue to own gold. In spite of gold's recent waterfall decline, we'll show that the need to own gold has actually grown.

    First, what exactly is a black swan?

    Like a black swan bird – something that occurs rarely in nature – a black swan event is a high-profile but rare occurrence that is beyond the realm of normal expectations. The term was introduced by Nassim Taleb in his 2004 book, Fooled by Randomness. It's a metaphor that, according to Taleb, has three characteristics:

    • The event is a surprise
    • It has a major effect
    • After the event, it is rationalized by hindsight, as if it could have been expected. In other words, the data were available to foresee it, but risk mitigation programs didn't account for it.

    What I found interesting in reviewing Taleb's thesis is that he stated in 2004, "Banks and trading firms are especially vulnerable to hazardous black swan events and are exposed to losses beyond those predicted by their defective models." In other words, his black swan theory essentially predicted the financial crisis that hit four years later.

    You might argue that a black swan event could occur at any time. That's true. But our current fiscal, monetary, and economic circumstances are so tenuous that the possibility of a black swan event hitting our economy is greater than usual. Indeed, the number of anomalous events that could take place is large enough that collectively they represent a high probability. And since we all live and work within an economic system and use money every day, the impact to us as individuals could be severe.

    So the question is this: what data are available now that show where we are most vulnerable to experiencing a black swan event?

    Social breakdown: Many European countries still have 50% unemployment in the under-24-year-old crowd, with little prospect of improvement. The triggers are in place for a breakdown of public order in the EU. Particularly concerning would be if the disorder spread to other countries and continents.

    War: While Kim Jong-un of North Korea captures all the current headlines, US General James Mattis reports that sanctions and diplomatic efforts to stop Iran from gaining nuclear capabilities are not working. He said Iran is at the point of "enriching uranium beyond any plausible peaceful purpose" and called 2013 the "year of reckoning."

    Financial system collapse: The world economy is worth about $80 trillion. Banks hold derivative positions worth about $1.6 quadrillion (1,600 trillion). If a portion of those bets came crashing down, the financial system may not have the capability to cover the losses. Even if they did, the markets would be roiled.

    A major bank raid: The Ottawa federal budget last month revealed that politicians are contemplating the possibility of a Canadian bank failure. One potential solution is similar to the one just imposed in Cyprus: for the first time ever, officials did not include a guarantee in the budget language that expressly prohibits the possibility of a raid on the bank accounts of ordinary Canadians.

    China dumps Treasuries: As of January, China holds over $1.2 trillion in US Treasury securities, more than any other country. They've expressed concern for years about the diluting value of those securities due to money printing. If China were to sell Treasuries in any significant quantity, interest rates would jump and the dollar would crater.

    Sudden, runaway inflation: This would be particularly devastating for the simple reason that hardly anyone is expecting it. We outlined in our February issue that history shows inflation can occur suddenly and rise sharply. Since it hasn't occurred, many think it won't... a dangerous assumption, given the ongoing massive dilution of many G7 currencies.

    What about a black swan within the gold sector?

    Comex delivery failure: In the first three months of the year, stocks of gold held at Comex warehouses plunged by the largest figure ever on record during a single quarter. While the reason behind the move is unclear, nearly two million ounces of gold being withdrawn from the Comex and moved to undisclosed locations does not paint a picture of confidence in the exchange. And it wouldn't take an outright failure; an announcement of a delivery delay would send a very unsettling message.

    There are undoubtedly numerous possible black swans, and I'm sure you can think of others. The point is, given our current set of circumstances – runaway debt levels, ongoing global easing programs, and little political will to do what is necessary to steer away from the crisis instead of deeper into it – how do we protect ourselves against some of these possible outcomes?

    According to Wikipedia, "the main idea in Taleb's book is not to attempt to predict black swan events, but to build robustness against negative ones and be able to exploit positive ones."

    Gold won't solve all our problems, but when it comes to building robustness against possible monetary fallout, its 3,000-year track record says there is no substitute. Since many black swans swimming in our waters relate to our monetary or fiscal standing, the risk for gold is more to the upside than the downside. So in spite of gold's recent waterfall decline, the need to protect against a black-swan event has actually grown. Only those who have purchased gold before a black swan event will be protected and benefit from rising prices.

    Here are three concrete ways we think investors should consider "building robustness" with their gold holdings…

    Favor physical metal over paper forms. In today's environment, the pinnacle of risk is solely holding paper assets. Be sure that your gold holdings are denominated more in Eagles and Maple Leafs than in ETFs and certificates. This includes fractional programs where they don't offer delivery, even if the metal you own a portion of is fully allocated.

    Use non-bank storage. Private vaulting facilities are not subject to bankers' hours, the sudden declaration of a bank "holiday," or systemic risks within the financial sector.

    Store a meaningful portion internationally. By storing some physical holdings outside your political jurisdiction, you reduce four primary risks: confiscation, capital controls, asset seizure by a government agency, and increased lack of personal control. We can never eliminate risk; the goal is to diversify so that any one event doesn't impact our entire portfolio.

    While it's healthy to have an optimistic outlook, it's dangerous to not be prepared financially in light of the current fiscal and monetary predicament that has trapped many countries. The data available now should compel us to make those preparations.

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    Money of the Future or Fool's Gold?

    In the weeks since Cyprus President Nicos Anastasiades threatened to plunder the bank deposits of private citizens in order to quell the nation's banking crisis, both the stock and gold markets seem to have shrugged off the news. Interestingly, the unprecedented announcement appears to have provided the initial impetus behind the recent explosion in the price of bitcoins.

    Two days after the Cyprus story broke, the price of a bitcoin jumped from $45 to $55. The digital currency continued to rise parabolically before reaching an all-time high of $266 on April 10. Like other euphoria-driven bubbles, this meteoric rise was followed by a violent correction that dragged the price down to $105 in a matter of hours. Subsequent price gyrations led to a suspension of trading on bitcoin's largest exchange, Tokyo-based Mt. Gox. The nausea-inducing ride was the latest chapter in the digital currency's brief yet fascinating history.

    The Rise of Bitcoin

    The Bitcoin story began in 2008 when a pseudonymous character known as Satoshi Nakamoto announced the creation of the revolutionary virtual money on an obscure hacking forum. Though cryptographic by nature, the genesis of Bitcoin was explicitly motivated by contempt for the tyrannical and intrusive nature of the fiat money regime.

    Today, the decentralized and nonpolitical bitcoin is the world's most widely used alternative currency. Although it was first embraced by cypherpunks, anarchists, and libertarians, the virtual money has attracted a mainstream following as faith in fiat currencies weakens with each passing round of monetary stimulus.

    The popularity of Bitcoin largely stems from its intelligent peer-to-peer framework that enables rapid and anonymous exchange across geographic boundaries and political lines. Unlike fiat money supplies which can be expanded with a quick keystroke, bitcoins are "mined" into existence when challenging proof-of-work problems are solved, usually by highly specialized and powerful computers. The difficulty of these puzzles is poised to increase over time, thereby ensuring that the supply of bitcoins grows at a diminishing rate until the final bitcoin is created in 2140.

    In short, this digital money supply is based upon faith in mathematics, rather than trust of central banks and the government, which governs paper money.

    Though it is not the first of its kind, Bitcoin is succeeding where prior digital currencies failed due to an ingenious feature of its network that registers a timestamp with each transaction, which prevents double spending since each transfer must be authenticated by more than half of the 20,000 independent users.

    With its unique advantages and distrust for paper money on the rise, a marketplace for Bitcoin is beginning to take shape. Respected businesses such as WordPress, Reddit, and Namecheap now accept bitcoins, while the number of daily transactions has multiplied from 1,000 in early 2011 to roughly 50,000 today.

    Avoid the "Greater Fool" Pitfall

    In spite of an evolving marketplace, bitcoins remains a dangerous vehicle. After last week's tumultuous ride, one must question whether Bitcoin is a legitimate alternative currency or simply a disruptive technological experiment.

    Elementary economics tells us that for an object or record to constitute money, it must be:

    • a store of value
    • a unit of account, and
    • a medium of exchange

    Based on its small size and the inherent instability of its economy, Bitcoin fails to meet the first two criteria, since wild price flucutations make estimating day-to-day values a crapshoot. Even Bitcoin's role as a medium of exchange is dubious, due to the fact that the majority of coins are still being hoarded for speculative purposes. Even if the maturation of its digital economy eventually brings about greater price stability, Bitcoin will forever remain a risky digital construct due to the fact that it is devoid of intrinsic value.

    For investors looking to safeguard their wealth from the corrosive effects of inflation as well as the talons of marauding governments, an investment in Bitcoin is a daring gamble. Though the talking heads would like you to think that gold is a bubble in its own right, this rhetoric ignores the fact that the yellow metal has retained its perception of value since the dawn of human civilization. At the end of the day, investors must ask themselves if they would rather possess a tried and true source of wealth – in the form of gold, silver, or other precious metals – or roll the dice on the latest fad in monetary rebellion. This decision could have profound implications for one's financial security.

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    Data Wrap Up

    Metals Prices as of 2/19/2013
    Resource Last 1 Month Ago 3 Months Ago 1 Year Ago
    Gold $1361.10 $1592.60 $1683.20 $1649.70
    Silver $23.36 $28.85 $31.54 $31.39
    Platinum $1424.20 $1592.40 $1692.20 $1583.40
    Palladium $667.00 $773.70 $726.45 $650.70

    As I'm sure many of you already know, precious metals were hit hard this last month. Gold – which is down 14.5% in April alone – had its biggest single-day drop in 30 years, as the Chinese economy showed signs of weakness, the European debt crisis continued to lull, and partisan bickering in Washington stayed relatively calm, at least for the time being. This paradigm has pushed investors out of precious metals and into higher-yielding assets.

    Silver was also in the doldrums, plunging to a two-and-a-half-year low on weaker than expected Chinese economic data, along with the continued losses in the gold market. Platinum and palladium were no exception, as they fell 10.5% and 13.7% respectively over the last month.

    We'll continue to monitor developments in the precious-metals market and will bring more news in our next update.


    As depicted above, central banks have been aggressively purchasing gold since the start of the global economic downturn. In fact, the amount of gold added to central bank reserves in 2012 was the most since 1964. This trend is even more impressive considering that China has not reported official gold reserves since 2009. With the Federal Reserve firing the printing press on all cylinders, the future status of the dollar as the world's reserve currency is in serious jeopardy.

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    Questions & Answers

    Question: I am interested in internationalizing my assets, but see that a Hard Assets Alliance account is technically based in the US. Should this concern me?

    Hard Assets Alliance Team Answer: The seamless, highly secure platform used by the Hard Assets Alliance currently requires that accounts be technically domiciled in the United States, though your precious metals can be stored in insured vaults outside of the US – in Zurich, London, Melbourne, or Singapore with more to come in the near future.

    While we are currently working through the considerable technical and regulatory challenges of also offering non-US accounts, the current US account requirement should be of little or no concern to anyone.

    If you are a US citizen or resident, the fact that it is a US account will save you a huge amount of time and hassle complying with the latest US government regulations that require detailed reporting on foreign-held assets.

    However, if you ever become at all concerned about your US account registration – for example, in the unlikely event that the US government began signaling it might again want to nationalize gold holdings – a quick call or a couple of clicks from you will set in motion the delivery of your metals, or the proceeds from the sale of your metals, to the destination of your choice, including one outside of the US. All transfers, either in physical metals or the proceeds from a sale of those metals, will take place within two business days.

    If you were really concerned that gold was going to be targeted, you could also log on to sell your gold holdings and replace them with another metal (platinum or palladium).

    Realistically, if you are worried that transferring your funds or metals would ever have to take place more urgently than two business days, then the Hard Assets Alliance is probably not right for you. But for most people, two business days should be more than sufficient for any conceivable scenario.

                                                                   
    Question: Is the bullion I buy really mine?

    Hard Assets Alliance Team Answer: When you buy from the Hard Assets Alliance, whether it's coins or bars, gold, silver, platinum, or palladium, the exact amount you ordered is bought on your behalf, attributed to your account, and placed in the vault at the location you chose when you ordered. The metals you buy and store with us are no less yours than if we had shipped them to you.

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    News Highlights

    Like Germany, Texas Wants Its Gold Back (Bloomberg)

    With close to a billion dollars in state pension money and various state assets held in gold, Texas is pushing to pass a bill to move its holdings, currently stored in New York, back home. Jim Rickards says, "Texas is not crazy, they're being very prudent."

     

    Over a Dozen US States Show Their Trust in Gold... Not the Federal Reserve (Bloomberg)

    Signaling discontent with federal monetary policy, more than a dozen states are pushing to recognize gold and silver coins as legal tender.

     

    Gold Imports by China Up 89% in February(Bloomberg)

    Chinese gold imports rebounded 89% in February as lower gold prices prompted investors seeking wealth protection to buy. "The price decline in gold has attracted Chinese investors and jewelry buyers," said a spokesperson at Xiamen City Commercial Bank Co. "Gold consumption in China will continue to rise this year as China's recent moves to cool the property market and curbs on savings products have boosted investment demand for bullion."

     
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