Hard Money E-Book

Shayne McGuire

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch

Seitenzahl: 316

Veröffentlichungsjahr: 2010

Beschreibung

An in-depth guide to making gold a serious part of your portfolio

Gold, the long forgotten store of value that was once the center of the global financial system, suddenly matters a great deal again. It has become a leading asset by virtue of its strong performance, and its booming demand has made it the only financial asset that remains in an uninterrupted bull market. And yet gold remains one of the least-owned financial assets in investment portfolios today.

Hard Money helps investors move beyond the simple, yet widely accepted notion that gold makes sense in today's financial environment, and explores ways to magnify potential investment returns driven by precious metals. This reliable resource examines the investment vehicles (bullion, stocks, derivatives, and even rare coins) and strategies (aggressive, conservative, passive, and variations) aimed at beating the price of gold as it rises, and ways to protect a portfolio should the metal decline.

• Identifies five key drivers that should continue to push gold higher in the years ahead
• Explores the ins and outs of investing in gold and making this precious metal a part of your portfolio
• Examines the pros and cons of multiple ways to buy gold via coins, ETFs, mining and royalty stocks, and other investment vehicles
• Author Shayne McGuire is a highly-regarded expert on gold

Written in a straightforward and accessible style, Hard Money offers key strategies to enhancing returns with new methods for investing in gold.

Leseprobe

Table of Contents

Title Page

Copyright Page

Dedication

Acknowledgments

Table of Figures

Introduction

The Logic of Gold in the New Investment World: Follow the Money

Taking Gold to a Higher Level: Setting Up Your Own Gold Portfolio

Notes

Part One - THE LOGIC OF HARD MONEY IN THE NEW INVESTMENT WORLD

Chapter 1 - Gold Driver 1: The Increasing Likelihood of Fiscal Crises in Major ...

Notes

Chapter 2 - Gold Driver 2: The Return of Inflation as a Major Investment Risk

The Risk of Hyperinflation

Notes

Chapter 3 - Gold Driver 3: The Return of Gold as a Significant Asset in the ...

Chapter 4 - Gold Driver 4: The Rise of China

Notes

Chapter 5 - Driver 5: Gold’s Potential Return to Being the Dominant Financial ...

Notes

Chapter 6 - Gold: How a $10K Gold Is Possible (Taking a Closer Look at Supply ...

Supply: Even When Gold Skyrockets, Supply Barely Moves

Demand: The Gold Market Is So Small That Little Is Needed to Make It Surge

$10K Gold

Is the Price of Gold Being Manipulated?

Note

Chapter 7 - Silver: Poor Man’s Gold May Offer the Richest Returns

Notes

Chapter 8 - Platinum and Palladium: Metals as Old as the World, but as New as ...

Part Two - TAKING GOLD TO A HIGHER INVESTMENT LEVEL

Chapter 9 - Taking Gold to a Higher Level: Creating Your Gold Portfolio

Constructing Your Gold Portfolio

Decision Outside the Gold Portfolio: What Percentage of Your Total Wealth Do ...

Gold Portfolio Decision One: Degree of Diversification Among Metals

Decision Two: What Part of Your Gold Portfolio Do You Want to Hold in ETFs and ...

Decision Three: What Part of Your Gold Portfolio Do You Want to Be in Physical ...

Decision Four: Do you Want to Roll Up Your Sleeves and Pick Stocks, or Do You ...

Managing Your Gold Portfolio

Portfolio Rebalancing

Protecting Your Portfolio If You Believe the Price of Gold Will Decline

A Few Final Thoughts Regarding the Gold Portfolio

Notes

Chapter 10 - Keeping It Simple with Precious Metals ETFs

A Different Animal: Return Magnification Vehicles

Note

Chapter 11 - Precious Metals Stocks: The Cornerstone of a Gold Portfolio

Valuation

Royalty Companies: A Different Play on Precious Metals

Notes

Chapter 12 - Physical Gold: The Importance of Wealth You Can Hold in Your Hands

Would the U.S. Government Ever Confiscate Gold Again (As It Did in 1933)?

Notes

Chapter 13 - How to Invest in Coins and Bars (Without Getting Ripped Off)

Chapter 14 - The Most Widely Respected Investment Coins

Gold American Eagle

Gold American Buffalo

Canadian Maple Leaf

South African Gold Krugerrand

British Gold Sovereign

Chinese Gold Panda

Australian Gold Kangaroo

Austrian Gold Philharmonic

Swiss PAMP Gold Bars

Silver American Eagle

Silver Kookaburra

Platinum American Eagle

Chapter 15 - Rare Coins: An Attractive Market Unreachable to Fund Managers

Some Basic Ideas behind Investing Profitably in Rare Coins

Some Final Thoughts on Investing in Rare Coins

Notes

Conclusion

About the Author

Index

Table of Figures

Figure I.1 The Dollar’s Decline Was Interrupted by the Credit Crisis

Figure I.2 U.S. Debt/GDP, GDP Growth, and Inflation, 1950-2010

Figure I.3 Global Fund Management Industry

Figure I.4 Percentage Holding in Gold at a Typical Pension Fund ($ Millions)

Figure I.5 Keynesian Predicament Faced by the United States, European Nations, and Japan

Figure I.6 Putting Today’s Gold Rally in Context

Figure 1.1 General Government Debt and Deficits as Percentage of GDP, 2010

Figure 1.2 Soaring Bond Supply: International Bond Market Issuance, 1998-2008

Figure 2.1 Annual Inflation Rates in Major Economies since 1980

Figure 2.2 U.S. Inflation, 1901 to the Present

Figure 2.3 U.S. Capacity Utilization and Unemployment Rate, 1970-2009

Figure 2.4 Total Debt to GDP for Major Industrialized Countries

Figure 2.5 U.S., UK, and Japan Budget Deficits as Percentage of GDP, 1980-2009

Figure 3.1 S&P Dividend Yield, 1900-2009

Figure 3.2 Gold Exchange-Traded Funds in Comparison with Other Assets

Figure 4.1 Total World Gold Jewelry Demand

Figure 4.2 Gold Jewelry Consumption per Capita

Figure 4.3 China Foreign Exchange Reserves ($ Millions), 2000-2010

Figure 4.4 Global Gold Demand, 1989-2009

Figure 4.5 China’s Market Share of Demand for Gold and Selected Commodities

Figure 5.1 Composition of Global Monetary Reserves, 1971-2009

Figure 5.2 American Debt as Percentage of GDP by Private Sector, 1915-2008

Figure 5.3 Total U.S. Public Debt Outstanding as Percentage of GDP, 1996-2009

Figure 5.4 Gold versus Major World Currencies, 2000-2010 (Indexed at 100)

Figure 6.1 Size of Several Major Financial Markets, 2009 ($ Billions)

Figure 6.2 Gold as a Percentage of Global Financial Assets

Figure 6.3 The World’s Gold (Amounts Are Millions of Ounces)

Figure 6.4 Scrap Supply as a Percentage of Aboveground Gold, 1977-2009

Figure 6.5 Exchange-Traded Gold Holdings, 2003-2009

Figure 6.6 Market Value Comparison (Value in $ Billions)

Figure 6.7 Gold Price since 1985

Figure 6.8 Stock Market Crash, 1987

Figure 7.1 Silver Price, 1972-2009

Figure 7.2 Price Chart of Silver and Gold, 1971-1982 (Indexed to Start at 100)

Figure 7.3 Silver and Gold Mining Supply, 1999-2009

Figure 7.4 Net Government Sales of Silver, 1998-2009 (in Million Ounces)

Figure 7.5 Gold ETF Holdings

Figure 7.6 Silver ETF Holdings

Figure 7.7 Gold to Silver Ratio, 1950-2010

Figure 8.1 Platinum Demand

Figure 8.2 Platinum Supply

Figure 8.3 Palladium Demand

Figure 8.4 Palladium Supply

Figure 8.5 Platinum and Palladium Price Performance, 2008

Figure 8.6 Ten-Year Platinum Price Chart

Figure 8.7 Ten-Year Palladium Price Chart

Figure 8.8 Jewelry Demand for Platinum and Palladium

Figure 8.9 Platinum ETF Holdings, 2007-2010

Figure 8.10 Palladium ETF Holdings, 2007-2010

Figure 9.1 Investment Decision Tree

Figure 9.2 Gold Price Performance, 1971 through January 2010

Figure 9.3 Portfolio Allocation

Figure 9.4 “Conservative” Portfolio

Figure 9.5 “Risk-Taking” Portfolio

Figure 9.6 Ten-Year Performance

Figure 9.7 2008 Performance (Down Market)

Figure 9.8 2009 Performance (Up Market)

Figure 9.9 Hard Money Portfolio

Figure 9.10 Kinross versus Gold

Figure 9.11 Theoretical Gold Portfolio with Mining Stocks

Figure 9.12 Theoretical Gold Portfolio with Physical Gold and ETFs

Figure 9.13 Theoretical Gold Portfolio with Physical Silver and ETFs

Figure 10.1 Price Chart at ETF Inception Date

Figure 10.2 ETF Allocation 1: Equal Metals

Figure 10.3 ETF Allocation 2: Economic Bull

Figure 10.4 ETF Allocation 3: Monetary Metals Only

Figure 10.5 Performance of ETFS Leveraged Platinum (LPLA LN), 2009

Figure 10.6 Performance of PowerShares Double-Short Gold (DZZ), 2008

Figure 11.1 Price Performance of XAU Gold Stock Index versus Physical Gold

Figure 11.2 Price Performance of Key Gold and Silver Stocks (Indexed to 100)

Figure 11.3 Risk/Reward Trade-Off for Gold Stocks

Figure 11.4 Price Performance, Royal Gold versus Gold (Indexed at 100)

Figure 11.5 Price Performance, Silver Wheaton versus Silver (Indexed at 100)

Figure 14.1 Gold American Eagle

Figure 14.2 Gold American Buffalo

Figure 14.3 Canadian Maple Leaf

Figure 14.4 South African Gold Krugerrand

Figure 14.5 British Gold Sovereign

Figure 14.6 Chinese Gold Panda

Figure 14.7 Australian Gold Kangaroo

Figure 14.8 Austrian Gold Philharmonic

Figure 14.9 Swiss PAMP Gold Bar

Figure 14.10 Silver American Eagle

Figure 14.11 Australian Silver Kookaburra

Figure 14.12 Platinum American Eagle

Figure 15.1 1932 Indian Head Gold Coin

Figure 15.2 Example of a Certified Rare Coin

Figure C.1 The Price of Gold 1971-1980

Figure C.2 Real Interest Rates

Figure C.3 Inflation, 1971 to Present (U.S. and OECD)

Figure C.4 S&P 500 Price-to-Earnings Ratio, 1979 to Present

Copyright © 2010 by Shayne McGuire. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

McGuire, Shayne, 1966-

Hard money : taking gold to a higher investment level / Shayne McGuire.

p. cm.

Includes index.

ISBN 978-0-470-61253-8 (hardback)

1. Gold. 2. Investments. I. Title.

HG293.M395 2010

332.63-dc22

2010024724

For my mother

Acknowledgments

There are a number of people who helped me write this book whom I would like to thank. My deepest thanks must go to John DeMichele, who contributed to the writing of Hard Money and without whom it would have been impossible to complete. His deep curiosity and rapidly expanding knowledge of the precious metals world, attention to detail, and long hours of dedication to the project after work each day greatly helped this book become a reality.

The book was helped tremendously by numerous conversations and correspondence with brilliant people in the precious metals world. I have been very fortunate to exchange many thoughts about gold and finance with Thomas Kaplan, one of the world’s boldest gold investors, who also kindly gave me access to his global precious metals team. Two of the world’s finest gold fund managers, Caesar Bryan and John Hathaway, were extremely helpful, as were other precious metals experts, John Bridges, David Haughton, William Rhind, Jonathan Spall, and James Turk. Each of them contributed extremely useful information for the book, but most importantly they shared with me their insightful ideas about gold. I would also like to thank Jeffrey Christian, who kindly gave me complete access to his team and the rich precious metals research provided by the CPM Group, as well as Juan Carlos Artigas and Jason Toussaint of the World Gold Council, who shared the organization’s resources with me.

That the GBI Gold Fund, the first dedicated gold fund launched by a global pension fund, ever became a reality is primarily thanks to the support provided by Mohan Balachandran, Chi Chai, and Britt Harris at Teacher Retirement System (TRS) of Texas. I need to thank Mohan for spending a great many hours thinking about and working on the project with me, which gave rise to numerous ideas in this book. But I would like to thank Chai and Britt, in particular, for their encouragement and for supporting my effort to write Hard Money. At TRS I would also like to thank Patrick Cosgrove for helping revise parts of the text and for continuing our multiyear conversation about precious metals, and Tom Cammack, who has shared his thoughts about gold with me over the years.

I would also like to thank the experts on the physical gold world at Austin Rare Coins. The constant support of Jay Bowerman, Ross Busler, Roxanne Byrd, Gabe Elton, Robert Kiser, Linnaea Swenson, and Mike Swingler was extremely helpful. Linnaea, in particular, went out of her way in helping provide information about modern investment coins. I continue to owe special thanks to Michael Byrd and Ryan Denby for permanently opening the firm’s doors and friendship to me. But I would like to thank Ryan, in particular, for sharing his sharp insights on physical metal market dynamics, which were very useful in writing this book.

Most importantly, writing Hard Money would have been impossible without the help of my loving wife, Alejandra (known to most as Winnie), whose constant encouragement in this and everything I do helped me through to the end. I also need to thank my wonderful children, Anna and Alan, for understanding my need to write another boring book with no pictures. My mother’s unwavering support and loving help with her grandchildren were indispensable. I would also like to thank my father, Stryker McGuire, for carefully reading through the manuscript and offering editorial advice. He has been there for me in more ways than he knows.

Introduction

The World Doesn’t Have to End for Gold to Go Hyperbolic

“When gold goes hyperbolic...”

“What did you say?” I interrupted, in stunned disbelief that a commodities specialist at perhaps the most influential and powerful investment firm in the world, would start a sentence with those words. Sitting at a table, talking over lunch, at Louie’s 106 in Austin, Texas, on November 11, 2009, the other two persons at the table did not find the words to be particularly momentous. The thought that a metal that pays no interest, produces no earnings, and does not grow could jump in value, like some mega-stock, causing a sudden chain reaction of surging investment demand, did not seem remotely possible. “Hyperbolic” is something more akin to what happened to Apple when it launched the iPod....

“Can we order?”

A colleague and I first approached the chief investment officer at Teacher Retirement System (TRS) of Texas in early 2007 to propose that our pension fund consider making a significant investment in gold.1 Being one of the fund’s equity portfolio managers at the time, I had already considered the possibility of a sudden price spike, the chance that gold could go hyperbolic. This was not particularly insightful of me: Just about everyone else in the global community of financial professionals was considering it, too. They just saw it from a slightly different angle.

In books like The Dollar Crisis, in the Wall Street Journal and the Financial Times of London, in the Economist and Exame of Brazil, and in countless Wall Street research reports, the message was the same: The dollar is sinking.2 The financial world was pointing at the United States’ inexorable surge in debt—funded largely by foreigners—to an unprecedented three and a half times the size of American GDP. It was almost making a giant sucking sound, as our current account deficit absorbed more than half the world’s net savings to fund it. At $60 trillion, just the government’s total liabilities, funded and unfunded, had grown to be larger than the capital stock of the entire country. And every time a Chinese central banker hinted that a new global reserve currency to replace the dollar would be “desirable,” the dollar would fall. Whenever the United States’ trade deficit worsened, the greenback would weaken a little more. Brazilian corn consumption rising? Time to sell more dollars.

Of course, the long-awaited collapse of the dollar—which has required some patience, as several economists were expecting it back in the 1960s—would necessitate the rise in another currency to replace the weakening greenback as the world’s monetary foundation. Being the premier currency in virtually all of the world’s central bank vaults, the U.S. dollar is the de facto foundation of the global monetary system, the metric used to weigh all other currencies, and hence the final measure of the value of everything that has a price. The dollar is the world’s money.3 And a new dollar, whatever the chosen currency would be, would probably soar, the thinking went, as the dollar began to crumble in the beginning of a new financial era. This dual movement would have to take place because, in the foreign exchange world, the plunge of a currency means the surge of another one. And this was what many in the world have long been expecting, which is peculiar if you think about it.

For the dollar crisis to arrive, the greenback would have to crash against the euro (a currency barely a decade old which, thanks to the likes of Portugal, Ireland, Greece, and Spain—regarded economically and by acronym as “PIGS” in comparison with more frugal France and Germany—may crash before the dollar); against the yen (whose economy crashed two decades ago and has yet to recover, in part due to the demographic crisis that is unfolding there, and whose government debt is soaring, prompting worries of an eventual yen crisis); or against the British pound (the currency of a country with a massive and alarming fiscal deficit the size of Greece’s, a banking sector that is multiple times larger than the UK economy itself, and which has a terribly overindebted consumer). Perhaps the dollar will collapse against the Chinese yuan, as many are anticipating today. But that is unlikely, considering that China’s economy is heavily reliant on exports, and its leaders have accumulated over $2 trillion in reserves to prevent the yuan from rising. And besides, the currency doesn’t trade freely. Given these issues, what major currency, one widely trusted—for decades, if not centuries—and in broad global circulation, could replace the troubled dollar?

The search for the answer to this vital question was rudely postponed by the sudden arrival of the global credit crisis in 2007. When French bank BNP Paribas announced in August of that year that it was unable to value some of its assets linked to U.S. subprime real estate assets, the crisis began. Within weeks there was a run on a British bank, Northern Rock, and financial dominoes began to fall around the world. In time, concerns about the dollar were forgotten and the safety of deep, liquid U.S. financial markets was remembered, despite the sharpest decline in the U.S. housing market since the Great Depression, the failure of multiple American financial institutions, as well as the end of the U.S. automobile industry, as we knew it. The dollar began to recover. (See Figure I.1.)

Notwithstanding the renewed vigor of the greenback, within a year of the BNP Paribas spark, it had become clear that the soothing sense that American economic cycles had been tamed since the troubled early 1980s, and that recessions had become milder thanks to men like Alan Greenspan, was a complete illusion colored by debt. And yet the evidence that we had been deluding ourselves about our economic health all along is apparent in the chart in Figure I.2.

It shows that roughly over the past two generations, despite the cycles of rising and falling inflation (which influenced interest rates), of brief economic decelerations followed by seemingly healthy accelerations, the cycle of American debt was in no cycle whatsoever. It was rising steadily, outpacing our incomes at a brisk pace, and the peak of our leverage in 2007 was truly astonishing: At that point, five dollars in debt were needed to produce each dollar of American gross domestic product.

Figure I.1 The Dollar’s Decline Was Interrupted by the Credit Crisis

SOURCE: Bloomberg.

Figure I.2 U.S. Debt/GDP, GDP Growth, and Inflation, 1950-2010

SOURCES:Datastream, Federal Reserve Flow of Funds data, U.S. Census, Morgan Stanley Research.

When we hit the wall, the point at which our economy could no longer advance driven by debt and widespread deleveraging began, a new phase in the credit crisis had started. In 2008, with the economy frozen and beginning to contract, the trillions in annual credit that the public and companies were no longer willing or able to assume was taken on by our government—which means, essentially, that we borrowed from the future and made the government’s financial health even more questionable. The national debt surged past $13 trillion and, including unfunded liabilities, total government obligations soared to over $200 trillion.4 Consequently, we now know that our taxes will have to increase and/or that our benefits, like Social Security, will have to decrease substantially in the years ahead.

This is not a book about a financial crash, about the end of civilization, about storing up food and a mysterious form of wealth for a long, dark financial winter. Considering the substantial investment that has moved into gold in recent years, clearly there is a growing number of people that have moved beyond what I call the drama of gold, the often boisterously presented notion that gold is appropriate for persons expecting the end of the world, or at least some variant of a financial catastrophe—in short, that gold is for losers. I have a wise friend who will not own gold out of “financial principle,” the principle being that the metal does not pay a dividend or a coupon and that it is just a rock, a “barbarous relic”—as John Maynard Keynes famously called it—of some primitive financial era. “We have grown up, financially,” my friend says, and we don’t have to secure our wealth in the galleon anymore.

I agree—considering the lessons learned from two unprecedented debt-driven bubbles, one in the stock market and another in real estate—that we have grown up financially. Now that these bubbles have popped, the stock market has gone nowhere in a decade, and high debt has remained, there is a growing realism and understanding about the financial world we are living in, particularly regarding the need for financial insurance. And this maturation for a great many people has come from the sudden discovery of what ultimate financial insurance—that is, insurance providing insulation from government and financial firms themselves—really is. Gold is the only viable investment asset that allows a person to remove wealth from the financial system per se. A growing number of people concerned about wealth preservation no longer look to financial intermediaries for ultimate protection, this following the unexpected collapse in recent years of the world’s largest bank, the Royal Bank of Scotland, and the largest insurer, the American Insurance Group (AIG), among many other notable institutions now being directed by Western governments.

By extension, these events may have also led to the realization that gold is the best vehicle for actually shorting government; that is, betting on our leaders’ failure to maintain our confidence in their ability to meet the ever-climbing liabilities they continue to incur (on our behalf) with money the world believes in. Expressed differently, gold is a good bet on a sudden rise in inflation. In the midst of surging government deficits across the world, readers of financial history know that betting against government—that is, on a sudden sharp rise in inflation—has strong odds.

Though fortunately a rare and extreme event, it is important to consider that all 30 documented cases of hyperinflation—that is, an economic situation in which prices rise by at least 50 percent per month—have been caused by deficits that got out of control. Ironically, hyperinflation invariably emerges in a deflationary environment of weak economic activity, such as the one that threatens numerous major countries today, most notably the United States, European nations and Japan. Hyperinflation can erupt when the public grows increasingly wary of holding the money being printed in growing quantities by monetary authorities, which are forced to buy—to “monetize,” in the financial vernacular—a surging supply of government bonds the market can no longer absorb. That hyperinflation does not rear its head today, when conditions for its emergence are present, will require that central banks continue to maintain their independence from federal governments that need to control their overstretched budgets.

Every single currency in history has eventually fallen against gold—most dramatically in times such as these, times of surging liabilities and an increasing inability to meet them. Gold is the only currency, the only credible store of value whose quantity cannot be expanded to meet the spending needs of governments in distress. By its very nature, it remains scarce and rises in value as the quantity of paper money grows.

The Logic of Gold in the New Investment World: Follow the Money

Today, we should all be paying attention to a new theme: the simultaneous and significant deterioration in the public finances of many advanced economies. At present this is being viewed primarily—and excessively—through the narrow prism of Greece. Down the road, it will be recognized for what it is: a significant regime shift in advanced economies with consequential and long-lasting effects.

—Mohamed El-Erian, Chief Executive Officer, PIMCO, March 11, 20105

Few financial professionals would question the assertion that asset allocation is one of the most important decisions in investing. The choices made regarding what percentage of your investment assets go into each bucket—how much to stocks, bonds, commodities (including gold)a, real estate, cash, and other investments—generally have a greater effect on your portfolio than the individual securities being selected. For example, picking great bonds in a declining bond market has a less positive impact on your wealth than the decision to move money out of the bond market, per se. Entering 2008, investors who were heavily invested in real estate and stocks fared far worse than those who were renting and had more exposure to government bonds in their portfolios. Those who had a balanced portfolio are better off than concentrated real estate speculators. The logic is simple and intuitive. Balance risk and reward based on your personal situation and don’t keep all your eggs in one basket.

Another approach to asset allocation—one mastered by investment legend Warren Buffett—is to consider and try to anticipate how the rest of the world is going to shift their baskets of eggs—particularly at important turning points in financial history. That is, to follow the money—particularly big money, the trillions managed at the world’s largest funds. Toward the late 1970s, money was flowing out of stocks, prompting headlines like “The End of Equities.” Then, thanks to declining inflation and interest rates during the 1980s and 1990s, money flowed back into stocks (and out of assets like gold, whose 1970s boom was over) like never before. Investors anticipating and then participating in these massive investment movements, radical changes in investor perception and behavior, were rewarded for being in the right place at the right time—and these were waves of money flows lasting several years. There was no need to read sophisticated Wall Street asset allocation recommendations to understand that a growing portion of household income and wealth was being transferred into stocks during the 1990s and then into real estate during the 2000s. That is where the money was going. And professional money managers who bet against this flow while it was under way, even believing that the Internet or real estate bubbles would eventually pop, did so at the peril of their investment performance.

Each of these recent major financial periods had fundamental drivers that were linked to major economic changes and financial waves that benefitted particular asset classes, like stocks, bonds, and real estate. Presently, the financial waves continue to be dominated by the ocean of debt that has put a stranglehold on developed economies, in particular, and the leverage dimension is such that it will likely take quite some time to wash away. And I believe it’s safe to say that, following the most dramatic credit crisis since the Great Depression—one that is continuing to produce ripple effects, like events in Greece that are broadening into Europe itself—we are likely to begin to see deep investment shifts that will provide significant opportunities.

This book suggests that one of the major beneficiaries of these changes will be gold, and it points to five major drivers in the chapters that follow this one. But I believe the fund management industry, which manages much of the world’s wealth, will be gold’s prime mover. And this would not be the result of simple modest buying in the markets, which has been happening over the past few years as global fund managers have nibbled at precious metals exchange-traded funds (ETFs) and mining stocks in mostly tactical, short term trades. No, I strongly believe that present financial conditions are about to cause a major transformation in asset allocation at the world’s largest funds that will cause gold to surge substantially higher.

Figure I.3 Global Fund Management Industry

SOURCE: International Financial Services London.

To understand why this could occur, let’s consider today’s financial environment and take a look at asset allocation at some of the world’s largest investment funds. Pension funds, like the one I work for, have a significant effect on asset flows in the world’s markets since they collectively manage $24 trillion.6 (See Figure I.3.) To put this amount into context, Table I.1 shows the assets under management at all the world’s largest institutions—totaling $62 trillion at the end of 2008. If we include what is categorized as private wealth under management, this amount rises to over $90 trillion (Figure I.3). Table I.1 provides some detail on how assets at pension funds, insurance companies, and mutual funds are distributed across regions. Global pension fund assets are distributed into equities, bonds, and alternative investments (such as real estate, private equity, and commodities that include gold). Though the percentages can vary by region and country to some degree, pension funds around the world hold approximately 56 percent of assets in equities, 34 percent in bonds, and 10 percent in alternative investments.7

These percentages have been set because the funds’ asset allocators have determined that, over the long run, the combined portfolios provide an acceptable balance of risk and return potential. Considering that equities are the best-performing financial assets over the long run, it is not surprising that stocks dominate all large diversified portfolios. And bonds are also a significant part of the pie, as would be expected, considering the relative certainty of income and return of principal that the vast majority of bonds provide. Unless there is a financial crisis or severe recession, most corporate and government bonds deliver interest payments and return of principal, as promised. Hence bonds provide balance to the higher risk and volatility that stocks present to investment portfolios, and their diversification benefits are complemented by the 10 percent of assets that a typical pension fund holds in alternative investments such as real estate, private equity, and commodities—which include gold.

Table I.1 Sources of Conventional Investment Management Assets

SOURCE: International Financial Services London.

What is most striking about gold in relation to the fund management industry, the financial mammoth that invests tens of trillions of the world’s wealth, is the negligible role the metal plays in global asset allocation decision making today. There is a widespread perception that the whole world is buying gold,b but big money—the collection of massive funds that truly moves markets—has barely tipped a toe in the water. Once the very foundation of the global monetary system, as well as an asset almost any person of means held as a matter of prudence and principle, gold simply doesn’t matter in the big picture of modern global fund management today.

Figure I.4 Percentage Holding in Gold at a Typical Pension Fund ($ Millions)

SOURCE: Teacher Retirement System (TRS) of Texas.

While funds invest in commodities (baskets giving them exposure to price movements in things like crude oil, natural gas, and copper), gold represents less than 5 percent of a typical commodities portfolio, which forces the metal to be almost completely lost in the overall asset allocation math dominated by stocks and bonds at pension funds. Here’s why: If commodities represent 3 percent of a given pension fund’s assets (a typical level these days), this would mean gold probably represents 0.15 percent of a total fund’s assets (5 percent of 3 percent is 0.15 percent, as shown by example of a hypothetical $10 billion fund in Figure I.4). So, including whatever it may hold in gold mining stocks and ETFs (maybe another 0.15 percent of total assets, but unlikely more than that), a typical pension fund holds less than a third of one percent in gold—that is to say, virtually nothing (Figure I.4). This is remarkable considering the tremendous diversification benefits the metal can provide for a portfolio when the stock market is not delivering as expected: During the 2000s, stocks were down 24 percent and gold rose 280 percent, a fact that would have benefitted any fund that invested significantly in the metal. And gold was beating stocks even during the 2002-2007 stock market rally.

Due to longstanding perceptions of its volatility and risk, as well as the small size of the precious metals market, gold is simply not regarded as a major investable asset class on Wall Street today. But this explanation omits the irrational side of our human nature: In the drama about gold, the widespread notion that one should only buy the metal when the world is going to end, most modern financial professionals have never considered it seriously as a major investment. Since it was an asset that performed very poorly during the equities and bonds boom of the 1980s and 1990s—when most financial leaders today were moving up the ladder—there is this lingering sense for many that gold will never make sense as an investment.

But suddenly the financial industry is being forced to think long and hard about gold since it must answer a troublesome question: If the global government bond market is about to enter a period of significant turmoil, and a considerable part of the colossal $30 trillion in global sovereign debt is going to be dumped by the world’s pension funds, insurance companies, banks, and individual investors, where will that money flow to? If not only Greek, Portuguese, Spanish, and Irish bonds are at risk, but perhaps also government bonds in other, far larger economies with massive debts and deficits—indeed, those of many of the largest economies in the world—where will the money go in the new asset allocation math? Stocks? Real estate?

Few would dispute that there are serious concerns regarding the financial health of a great number of governments in the world, from Greece to Japan and from the United States to the United Kingdom, as well as many states and municipalities within the United States, which have hundreds of billions in debt outstanding. Many are in severe fiscal crises today. Warren Buffett told the U.S. Financial Crisis Inquiry Commision in June 2010 that municipal bonds in the United States faced a “terrible problem.”8 The federal government may soon need to confront it directly: A third of U.S. states have budget deficits exceeding 20 percent; California (with an economy as big as that of France, the world’s 8th largest) and Illinois (as large as Mexico, the 11th largest) have budget gaps exceeding 50 percent. The Bank for International Settlements (BIS), widely regarded as an authority among central bankers, released a study in April 2010 that made a startling assessment of the financial health of the world’s largest governments:

Our projections of public debt ratios lead us to conclude that the path pursued by fiscal authorities in a number of industrial countries is unsustainable. Drastic measures are necessary to check the rapid growth of current and future liabilities of governments and reduce their adverse consequences for long-term growth and monetary stability.9

That the value of a country’s bonds should fall when its credit quality declines is not rocket science. The logic that U.S. Treasury bonds are attractive investments because inflation is falling becomes questionable when the government’s very solvency is increasingly in question. And the same question is being raised about several of the other largest economies in the world. The United States and Japan, another country under severe fiscal stress, have issued more than half the value of all the government bonds on the planet. It would not be irrational to expect that a significant amount of investment could begin to flow out of the sovereign bond market, a move that would lead to higher interest rates and eventually have an impact on the value of all other kinds of bonds on international markets—and this would negatively affect the stock and real estate markets, as well. But if funds are indeed going to move out of sovereign bonds—and consider that we are talking about a $30 trillion market—where would this money flow to?

The certain answer is that part of it would move away from the sovereign bond market. And considering that pension funds already have high exposure to equities, and alternative assets like real estate and private equity, it is reasonable to expect that a fraction of the funds—perhaps as much as $500 billion or more—will eventually flow into gold, a time-proven real asset. Many of the world’s largest funds barely have any investment in the metal relative to other assets, as discussed above: They would practically be starting from zero. Teacher Retirement System (TRS) of Texas, which I work for and whose GBI Gold Fund I manage, probably holds a larger percentage of assets in gold than any other large ($10 billion and higher) pension fund in the world, but our holdings in the precious metal are modest, certainly in comparison with any major asset class like stocks and bonds.

If anything, a significant move into the metal could happen by default as even the most die-hard gold opponents might soon be forced to consider it. What would be the alternative investment asset if we are entering a financial environment permeated by a global government bond market problem, which would affect virtually all other major asset classes? Improbable as it may seem now that we have pulled back from the financial brink we faced in 2008, an eventual crisis of trust in the 10-year U.S. Treasury bond could imply the impending end of its reign as the global risk-free interest rate, the decades-old foundation for all formal financial valuation. Consequently, until a more trustworthy replacement for the king of bonds was found, perhaps the value of financial assets in general would come into question and many investors would likely flock temporarily to gold and other commodities, as well as multiple tangible stores of value of a physical nature until financial balance was restored.