As Safe As Gold

By: Eric Sprott, Sasha Solunac

The US government is bankrupt, just like Citigroup, just like AIG, just like Fannie Mae. Citigroup, AIG, Fannie Mae, and countless others are being kept afloat only by the good auspices of the US government. Under whose good auspices will the US government be kept afloat? The US taxpayer? Don’t count on it. The government has no assets. All they have is borrowing and taxing power, the former being based on the latter. But the taxing powers of government are useless during a severe economic contraction. It’s like taking blood from a stone. When everybody’s income is down, what is the government supposed to tax? Furthermore, instead of reporting capital gains, people will be reporting capital losses, and asking for tax refunds. The government’s huge spending spree is coinciding with a precipitous fall in tax revenue. The projected $1.75 trillion deficit for fiscal 2009, a deficit that is over 12% of GDP, is double the size of any deficit as a percentage of the economy post-World War 2. Even this mind-boggling deficit is based on the assumption that we are in a mild recession, with strong growth to follow over the next several years. Not only is it a pipedream, it is ruinous. Rather than adopt austerity measures, as any government should during times of financial crisis resulting from over-indebtedness, the government is doing the exact opposite, spending beyond their means, and increasing the indebtedness of their citizenry even more. In and of itself, the massive bailouts and deficits incurred to ‘save’ the financial system will be a huge anchor on economic growth going forward. Even if the depression were to miraculously end tomorrow.
When we say gold is the only investment, we need to qualify this opinion. We mean physical gold: gold bars in the vault or gold coins. This is a very important distinction to make. Anything else is just another derivative, and thus subject to counterparty risks just like any other financial asset. Recently, the gold exchange-traded fund (ETF), as represented by the ticker GLD, has become a very popular investment vehicle for those looking to invest in gold. This ETF is now purported to hold over 1000 tons of gold, having reportedly bought 220 tons in January alone. At this rate, GLD is effectively buying all the gold that is being produced at any given time. That’s just one ETF. Being gold investors ourselves, we know the difficulties involved in taking physical delivery of gold. To buy physical gold in that quantity in that short a timeframe would be a significant market-moving event. Did they really buy that much physical gold? Furthermore, is all that gold tucked away in some vault? Maybe it is… or maybe it isn’t. GLD is a complex legal structure, with the Bank of New York as the trustee, and HSBC Holdings as the custodian, and a chain of subcustodians and sub-subcustodians, many of which are banks that are known to actively lease gold. In our opinion, owning physical gold is very different from owning a lease-receivable. If any of the numerous counterparties were to default, it could be very difficult for GLD to actually get the gold it is purported to own. We’re not saying that it’s a fraud. It’s a structure whose price is meant to legitimately track the price of gold. That said, in our opinion, an ETF is not a substitute for owning physical gold. It defeats one of the main reasons to own gold during these times; namely, the fact that gold is nobody else’s liability. This is not the case with GLD. It is essentially a creditor, whose assets are somebody else’s promise.

Why take the risk? Especially when it will cost just as much, perhaps a little bit more, to own the real thing. Don’t settle for a paper asset – a second-rate knock-off. In this environment, counterparty risk lurks around every corner. Buy the real thing: GOLD, not GLD.

*This is just an excerpt from the full article that can be found here. Physical Gold is still the best way to hold your metals.