A Gold crash coming?

If you’re loaded up on gold, silver and commodities, congratulations, you’re in good company.  Mega hedge fund managers John Paulson, David Einhorn, and George Soros (rumored to have sold his GLD for gold stocks) are with you.  Iconic investors and gurus, Marc Faber, Jim Rogers, Jim Sinclair, James Turk and Richard Russell are on board the gold train, as well, along with many more lesser-known brilliant investors.

So, should the above-mentioned investors be frightened by articles published by Reuters, entitled, “Gold crash: What could trigger the inevitable”?  That’s the title of a piece posted on the news agency’s Web site over the long weekend.

From the start, the premise of the article’s title, that a gold crash is inevitable, is flawed.  Long-time gold expert Jim Sinclair, Richard Russell of the Dow Theory Letters, James Grant of Grant’s Interest Rate Observer, and World Bank president Robert Zoellick would most likely disagree with a gold crash theory, as these three men suggest highly that some form of a gold-backed currency, including a gold-backed U.S. currency, or not, must eventually become part of the new international monetary regime.

Under that scenario, as outlined on many occasions by James Sinclair, gold would most likely trade within an elevated band (instead of fixing the price) as central banks become locked in a gold-backed regime that loosely resembles the articles set forth at Bretton Woods in 1944.

The inevitable gold crash?  It’s much more likely that a crash in the U.S. Treasury market should be assessed as inevitable.  PIMCO’s Bill Gross would be loaded to the gills with U.S. Treasury notes bonds if gold was destined to crash.  Gross is not. In fact, the Bond King has no bonds in his BOND fund.

Can you imagine McDonald’s not offering hamburgers?

The article goes on to suggest that betting on the dollar’s next direction is akin to gambling.  In the short run, the author is spot on.  But, as a long-term investors, which the author believes is the only way to play this financial debacle, betting on the dollar’s demise is for the foolhardy—better yet, for the “nervous Nellies.”

“The clearest threat to gold’s reign as the reserve currency of nervous Nellies is a possible rebound of the dollar,” according to Reuters. “Given the congressional wrangling over the debt limit, budget and growing inflation, betting on the buck is like trying to figure out whether a racehorse will finish. They often pull up lame.”

The author suggests that a miracle is in the offing and that politicians who know that shutting down the U.S. Government to save the dollar is political suicide (the 1992 Congress comes to mind) and will miraculously learn the meaning of noblesse oblige and do the right thing for the country.  But, until we see Ben Bernanke and Ron Paul scheduled to a duel on the White House front lawn, the author may be onto something.

Holders of gold will take the other side of this author’s bet in a New York second, and have, by betting on a racehorse that’s come in first, without except, for more than 5,000 years. And not only have the heavy weights of finance mentioned above taken that bet, but central banks around the world, who have collectively become net buyers of gold, are increasingly placing that bet, too.  According to another Reuter’s article published in April 2010, central banks have become net buyers of gold in 2009, a first since 1989.

And as far as the author’s points regarding a “strengthening U.S. economy and rising interest rates . . . derailing the epic yellow metal mania,” they are as flawed as the title of the piece.

Mania?  This Reuters writer originally suggested that gold investors are nothing but “nervous Nellies,” which is quite the opposite mindset to the greed thesis characterized by manias?  So, which is it? Is fear or greed driving the decade-long gold price rise?

Reuter’s point that a strengthening U.S. economy will save the day and stop the embarrassing ascent in the gold price may well be true in a relativistic context, but not in real terms, however, which is the whole point of the Fed’s zero interest rate policy (ZIRP) and the investor revolt into the gold market.  Real interest rates at, or below, zero propel the gold price, not nominal GDP.  So, the notion that gold doesn’t throw off income is a species one within today’s financial environment of near-zero Treasuries at the short end while food and energy prices soar well past the double-digit mark.

And as far as the case that higher stock prices presage an economic turnaround in the U.S. economy has less to do about a real strengthening economy, but has more to do with institutional investors locked into the bond/stocks allocation charters betting on a devaluation, a la Zimbabwe—wherein the Zimbabwe stock market, in one year, outpaced the returns of the S&P over its entire history as an index.

And lastly, higher interest rates, as Swiss money manager Marc Faber has stated, mean nothing if the rate of inflation is higher than the Fed’s federal funds rate—as during the 1970s. Maybe the author was too young to remember that golden decade of wealth destruction, which in real terms eclipsed the the wealth destruction of the Great Depression.

And since this present crisis is expected to dwarf the financial pain of the 1970s, it makes a lot of sense for investors to become “nervous Nellies”—and fast.

Yamana Gold Inc. (NYSE: AUY)

Gold Corp. Inc. (NYSE: GG)

Barrick Gold Corp. (NYSE: ABX)

If this doesn’t get you to buy Gold . . .

Not much will.

While the bullish case for buying gold bullion as a store of wealth primarily centers on financial protection from central bankers’ dirty deeds of the West, as well as the gold accumulation by central bankers of the East, little is mentioned of the Indian retail market and how this market will play a major factor in keeping gold supplies tight for many years to come.

Instead, China’s burgeoning “middle class” has been the talking point for make the case for everything going up—as with the “peak everything” theory—from oil consumption, base metals, food, John Deere tractors, pharmaceuticals to hair gel.

Gold demand for China is, you guessed it, going to go up, too, and not just from China’s central bank accumulating as much as it can before the world’s major reserve currencies no longer serve as reserves, but from the buying power of China’s emerging middle class too.

India, however, is another market—the market of many individuals, which comprise the big buyer, which is poised to grow by mind-bending numbers of tens of millions during this decade.  India’s 1.1 billion population is going middle class, just as everyone knows China’s 1.3 billion population is.

But Indian culture (Asian culture, in general) stands apart from other cultures in that gold is synonymous with wealth.  Indians have never heard of Maynard Keynes and his “barbarous relic” propaganda and economic theories which center on the premise that politicians are uniquely qualified to manage a people’s currency.  Indians know better.

“The rise of India as an economic power will continue to have gold at its heart. India already occupies a unique position in the world gold market, and as private wealth in India surges over the next ten years, so will Indian demand for gold,” World Gold Council (WGC) managing director for India and the Middle East, Ajay Mitra said in Mumbai in late March.

While stockholders of the West saw their holding swoon in 2008, India was buying gold on the big dip, importing between 700 metric tons and 800 metric tons of the precious metal in 2008, or approximately 30% of total global demand.  Two years later, in 2010, India imported 963 tons.  And according to Albanian Minerals president and CEO Sahit Muja, India is expected to break the 1,000 ton mark.

At that rate, approximately 10% increases per year, the World Gold Council’s recent estimate of India’s gold imports reaching 1,200 tons by 2020 appears to be an easy slam dunk. If India remains in its present trajectory, gold imports into India will reach 2,240 tons by 2020.

If India leveled off to the expected 1,000 tons this year, that amount is more than three times the UK’s 310.3 tons of total gold reserves held by the Bank of England, and is on par with China’s officially stated gold reserves of 1,054 tons, according to the World Gold Council’s 2010 statistics.  In fact, in any one year, India’s gold imports would rank it somewhere between sixth and eighth, globally, in total banking reserves.

Since 1997, India’s GDP growth has averaged more than 7% per year, according to the World Bank, and correlated strongly with India’s gold imports during that 13-year period.  And according to the World Gold Council, the strong upward trend is expected to continue.

“We predict that the new demand for gold will be driven by rapid GDP growth, urbanisation, the emergence of a strong middle class and a sustained and potentially rising savings rate of 30%-40% of income,” WGC’s Mitra said.

And according to Marcus Grubb, managing director at the WGC, the emerging middle class buyers of gold will number in the tens of millions by the close of this decade.

He told MineWeb in mid-May, “With the building of infrastructure, with the increased urbanisation of populations – in India you are probably going to see another 100 million Indians move into urban conurbations in the next ten years, you are going to see the middle class go from 15 million to possibly as many as 90 million by income bracket in 10 years. Indian households will probably be 4 to 5 times wealthier than they are today in ten years time.”

So as gold bugs ponder whether the International Monetary Fund (which reports holding 2,827 tons of gold as of the close of 2010) will make another surprise announcement of its intentions to dis-hoard a measly 100 tons of gold in its  alleged attempt to shake some longs out of their gold holdings, remember that India presently needs that nearly each month just to satisfy its population’s demand for the precious metal.

And considering gold supplies have been declining, falling 4.4% in the first quarter of 2011, year-over-year, to 872.2 metric tons, according to the WGC, with future supplies expected to struggle from declining all through this decade, how will demand from India, alone, be met with available mining and recycled gold supplies in the coming years?

As gold prices rise amid growing demand and tight supplies, wouldn’t high prices, at some point, kill demand?  One would think so.

But in Indian culture, “gold will remain auspicious given its connection with tradition, whether religious or attitudinal, will remain powerful,” said Mitra.

He added that Indians lean toward being risk averse, and religiously view gold as a traditional means of wealth preservation, which inspires security and stability to the people of India.  It has been so for thousands of years.

“Therefore, the view that Indian demand for gold will be driven by the concept of enduring value, not price,” he said.