The Trader's Great Gold Rush

Must-Have Methods for Trading and Investing in the Gold Market

James DiGeorgia

• Publisher: Wiley
• Year: 2009
• ISBN:
  9780470552797
• Edition: 1
• Topic: Business
• Subtopic: Commodities
• Index: Business

THE TRADER'S GREAT GOLD RUSH

"James DiGeorgia is the best expert I know when it comes to investing in gold bullion. ¿This is not your father's gold market anymore, so getting the right information from the right people is key to helping you succeed as a gold investor."—Tom Mcclellan, Editor, The McClellan Market Report, ¿#1 Ranked Ten-Year Gold Timer (1999-2008)¿

"James DiGeorgia is a stalwart of precious metals. He draws on a lifetime of interest and commitment in The Trader's Great Gold Rush to inform you about 'tricks of the trade' that will come in handy as you seek to protect yourself from the looming solvency crisis of the U.S. government. This is a good book. But you have to read it now. Don't wait for the movie."—JAMES DAVIDSON, founder, Agora, Inc., and Editor, Strategic Investment

Throughout history, gold has been a safe haven in times of political and economic crisis. Right now, gold's fundamentals are remarkably strong, says veteran commodities market analyst James DiGeorgia. In fact, gold is poised to boom—reaching, DiGeorgia predicts, as high as $2, 500.

From the fundamentals of investing in the gold market to the 17 common pitfalls to avoid, The Trader's Great Gold Rush tells you everything you need to know to take advantage of the coming surge in gold.

This is the perfect time to invest in gold.
And this book will show you how.

PART I

An Introduction to Today’s Gold Market

CHAPTER 1

Why Gold Is Going to $2,500

Could gold really reach $2,500?

The metal has already been in a bull market since 2001. From its low of $255 in April 2001 to its shattering of the $1,000 barrier in March 2008, gold’s price almost quadrupled. Is it reasonable to think that an asset that has already gone up so far could (almost) triple again?

This is an important question. To answer it, we need to step back and look at gold’s recent history. Along the way, we’ll discover the four primary forces that control gold’s price—and how each force will affect gold during the near future.

We’ll start by asking ourselves why gold is valuable.

WHY IS GOLD VALUABLE, ANYWAY?

The value of gold is a mystery to many today. Modern financial commentators are scratching their heads over the current gold bull market. Why should anyone care about gold—the yellow metal that economist John Maynard Keynes famously referred to as the “barbarous relic”?

For the most part, today’s financial analysts are used to thinking of money as having no inherent value. They believe money is merely a convenient unit of exchange, worth nothing beyond the value a society assigns to it.

This is true for paper currency, but not for gold. Gold is inherently valuable. There are excellent reasons why ancient pharaohs hoarded it, Spanish conquistadores fought for it, and Klondike prospectors risked their lives to find it. Here are just a few.

• Gold is unique. Gold has a combination of properties found in no other element. It is uniquely malleable: A single ounce can be hammered into a translucent 100-square-foot sheet. It’s uniquely ductile: One ounce can be drawn into a wire over 50 miles long. It’s an excellent reflector of light, and one of the best conductors of electricity and heat. It’s also impervious to decay, rust, tarnish, or biological activity. Indeed, it’s oblivious to almost any known solvent, acid, or base.

• Gold is useful. The yellow metal has a long list of technological uses. From electronic circuitry to dental fillings to gold-plated visors on NASA’s astronaut spacesuits, gold is in demand for a variety of industrial applications.

• Gold is divisible and fungible. Every ounce of pure gold is chemically identical to any other ounce of pure gold. And the metal can be easily divided into tiny, identical quantities. This makes trade easy, even on an international scale.

• Gold is beautiful. Pure gold can be wrought into stunning pieces of art. If you don’t think beauty contributes to value, ask yourself this: Is the Mona Lisa valuable? If so, why? Without beauty, it’s merely an old scrap of wood with pigment smeared on it. What about Michelangelo’s statue of David? What makes it more than just a chunk of marble? And think of Tutankhamen’s sarcophagus—would it be as valuable if it were covered in sheets of tin, instead of finely wrought gold? Of course not. Gold’s inherent beauty and appeal provide a significant part of the metal’s value, and rightly so.

• Gold is scarce. The supply of gold is limited. The earth yields its golden treasure to us very reluctantly. Even with modern production techniques, gold is difficult and expensive to obtain. Thus, although the world’s gold supply grows every year, it does so slowly, predictably, and often by less than the growth in demand. This is in sharp contrast to other financial assets like dollars or bonds, the supply of which can be inflated overnight by the stroke of a central banker’s pen.

All these reasons explain why gold has historically been used as money. Despite the claims of certain ignorant economists today, gold’s 6,000-year history of being treasure is no accident. There are excellent reasons for it.

GOLD’S ROLE IN THE GLOBAL ECONOMY

Although gold is no longer used officially as money in Western economies today, it was until just a few decades ago. This change explains the huge gold bull market in the 1970s—and the fallout from this abandonment of gold is still being felt in the gold market today.

To understand why, we’ll need to start in the early twentieth century. Before World War I, the major Western nations had been on the gold standard. Each nation had its own monetary unit—dollars, pounds, marks, francs—but each was defined as a certain amount of gold. (For example, a dollar was about one-twentieth of an ounce.)

In effect, the various currencies were merely accounting units for yellow metal. Since gold is immutable, this fixed the currency exchange rates between nations. It also stabilized the economies involved, by imposing fiscal discipline.

The health of each economy could be gauged by the flow of gold across its borders. If a nation’s citizens bought more from their neighbors than they sold to them—in other words, if they spent more than they earned—they would soon run into trouble. Gold would drain out of their country, into their neighbors’ coffers. If they didn’t correct themselves, they would eventually run out of money. This would force them to be more productive, which would increase their sales of goods and services to their neighbors. Soon, they would be earning more and the problem would resolve itself.

The opposite would occur if a nation bought too little from its neighbors. Gold would increase and accumulate inside its borders. The resulting price inflation would make their neighbors’ goods and services cheaper by comparison, so trade would increase. Again, the problem would correct itself.

Therefore, the gold standard tended to enforce fiscal discipline and encourage trade among Western economies. Not only that, it kept price levels stable overall. Prices could only increase as fast as the money supply increased. Since the gold supply increased slowly each year, economic growth and expansion were possible, but only at a reasonable rate.

The gold standard was tremendously beneficial to the West. Unfortunately, this stability couldn’t withstand the madness of European leaders, who plunged their nations into World War I. This conflict then led directly to the horrors of World War II. In an effort to survive these conflagrations, European leaders first drained their national treasuries, then eventually left the gold standard completely.

By the time World War II was over, most Western nations had been devastated. The leaders of these nations needed to rebuild, and fiscal restraint of any kind seemed unappealing.

The United States, however, had not only survived the war with little damage, its economy actually flourished during this time. (According to the U.S. Dept. of Commerce, gross domestic product went from $126.7 billion in 1941 to $222.3 billion in 1946.) Plus it had grown into the strongest military power in the world. Not only that, the United States now had most (about 75 percent) of the world’s monetary gold, from wartime sales of goods and supplies to other countries. Lastly, the world watched in amazement as America demonstrated a remarkable benevolence, rebuilding the countries it had just fought as bitter enemies.

Because of all this, Western leaders erected a new monetary structure after the war. This became known as the Bretton Woods system (named after the New Hampshire town where delegates from 45 countries met to hammer out the agreement). The United States dollar would replace gold as the foundation of the world’s financial system. No longer would nations maintain large gold reserves. Now they would have hoards of U.S. dollars instead.

In a financial sense, this was almost the same thing. The dollar was convertible into gold upon demand, after all. So dollars were just as good as gold. Actually, they seemed better in a few ways. They were certainly more convenient to store. More importantly, financial officials understood that the United States would quietly inflate its monetary supply just a bit, to juice the global economy and jolt it out of its post-war slump. So a dollar-based financial system was readily accepted.

BANK RUNS ON THE NATIONAL LEVEL

The flaws in this system were apparent before the Bretton Woods agreement was even signed, and it’s too bad the Western leaders ignored them.

By signing the agreement, Western leaders had decided to rebuild their financial structures upon the dollar as the foundation. In doing this, they were in effect entrusting their finances to an unregulated bank.

To see why this was so foolish, we need look no further than the nineteenth-century United States. Back in the late 1800s, bank failures were not uncommon in this country. Private banks would accept gold and silver from depositors and, in return, issue banknotes—receipts for these metallic deposits. The notes would trade freely as cash among local citizens, and why not? They were the equivalent of gold and silver, but were more convenient to handle than the metals themselves.

This system had an inherent weakness. Bankers faced enormous temptations to print up more receipts than they had deposits. Although people frequently exchanged banknotes back into metal, this accounted for only a fraction of the bank’s deposits. As long as the bank had enough deposits to cover redemptions and loans, nobody would know if the banker printed up a few extra notes for himself.

Of course, the local population was vigilant for signs of trouble at the banks. If a bank seemed to have lent out more money than was prudent—or, even more alarmingly, if a lot of banknotes started to circulate for no apparent reason—depositors would queue up and ask for their metal back. A bank run would occur, often resulting in the failure and collapse of the bank. The depositors who hadn’t retrieved their metal would be ruined.

This problem was so common that the Federal Reserve was created to solve it. The Fed became the lender of last resort to bail out banks that got into trouble. All this did was move the problem from the local to the national level—but that’s a story for a future chapter.

Back to the post-World War II period. Once the Bretton Woods agreement went into effect, the United States was essentially printing banknotes (dollars) for the entire world. The notes were supposedly convertible into gold upon demand. But the world was relying on the fiscal restraint of the United States—the ability of American leaders to resist the temptation to print up more notes than they had gold.

This was a foolhardy decision. In fact, the United States had already defaulted on its financial responsibilities 11 years earlier in 1933. In that year, President Roosevelt took America off the gold standard, because the government had printed a blizzard of dollars to pay for his social programs—far more currency than the gold reserves could support. As a result, more and more Americans were redeeming their depreciating dollars for gold.

The proper response for Roosevelt would ha...