By Stephen Leeb
The Complete Investor
Banks are sitting on a ton of money. Once they start lending it out - and eventually they will - the money supply will explode, resulting in surging inflation. As always, the single best investment under such circumstances will be gold.
If you're still hoping against hope that the economy has lost its way only temporarily - that a replay of the halcyon 1990s lies in the future - we're afraid you'll be sorely disappointed. The economy has been permanently altered, with 2008's wild zigzagging between inflation and deflation setting the template for years to come.
In particular we expect inflation to reach extraordinary levels. For investors, this means that the one investment you should own above all is gold - not just as a mere hedge but as a key asset category on a par with or even more important than cash, bonds, and stocks.
Exhibit No. 1 in our analysis is what's known as the monetary base. Roughly speaking, the monetary base is equal to bank reserves and cash: it's what banks have no hand to make loans. During the recent crisis, the monetary base - which is largely controlled by the Federal Reserve - has soared. In fact, as the chart on this page shows, the current growth in the monetary base far exceeds anything seen in more than a century. The fastest growth up to now, occurring in the build-up to World War II, was just one-third today's rate.
The monetary base, however, represents banks' potential lending power and is distinct from the money supply, which is money actually in the economy. The more that banks lend, the more the money supply grows, but if the monetary base simply sits around in banks' vaults, it does nothing for the money supply. And as you can see from the second line in the chart, M2, a standard measure of money supply, has barely grown at all. Seemingly, despite having the most lending power they've ever had, U.S. banks have been using a smaller portion of that potential than ever before.
What explains this? After all, banks presumably should want to use the largesse handed them by the Fed to lend, since lending is at the heart of bank profits. The problem is that bad past loans - the so-called toxic assets - continue to overwhelm the massive increase in bank reserves. Meanwhile, consumers, the would-be recipients of bank lending, continue to become ever less creditworthy as the economy weakens and unemployment keeps rising.
And the longer this situation continues, the less creditworthy consumers become, while risks build up in other sectors such as commercial real estate - adding further to toxic assets and making banks even less willing to lend. It's a vicious circle that, to be broken, will likely require even more massive injections of liquidity into the banks and perhaps even outright purchases of toxic assets.
Eventually banks - primed with additional huge boosts in the monetary base and, perhaps more money from Congress - at last will become willing to lend. That's when M2 and other monetary measures will explode, as lending leads to spending and investing and in turn to more lending. The economy will be flooded with money, and that means massive inflation. Even Warren Buffett, not prone to making dramatic forecasts, looks for inflation to exceed that of the 1970s.
And this, it's worth noting, is the outlook event without the inflationary impact of likely resource shortages and stronger labor unions. Suffice it to say that the case for raging inflation has probably never been stronger.
Recent history tells us that in such times, gold, along with other precious metals, is the single most important investment you can own. To give just one historical comparison, in the 1970s high-quality bonds lost some 40 percent in purchasing power, while gold climbed about ninefold. If you had started with $10,000 that would have meant the difference between ending up with $6,000 in purchasing power, had you bought bonds, or $90,000, if you put everything into gold. If inflation in the next decade is greater than in the 1970s, the difference could be even more striking.
Keep in mind that cash, bonds, and stocks, the assets many advisers view as comprising the sum total of an investment portfolio, are denominated in dollars. That's fine if the yields or earnings from these investments are higher than inflation. But when inflation takes off, that's no longer the case - which makes gold the only currency providing a real shelter. If you don't view gold as a currency, realize you can easily chart its price going back to the 1200s or even earlier. In fact, not only has gold been a currency throughout civilization, it has outlasted all forms of civilization humans have created.
And remember, too, that besides being the best inflation investment, gold more than holds its own during deflation. In the 2000s, as we've alternated between deflationary and inflationary worries, gold has been the only major investment to rise every year, including in 2008.
We advise dividing your gold holdings pretty equally between the metal and the miners. The best way to buy the metal is with SPDR Gold Shares (GLD) (Growth Portfolio), an ETF that tracks bullion closely.
The case for mining stocks is that the price of gold rises faster than miners' costs, allowing margins to increase. We think that many miners are exceptional bets today (see next article). That's not to deny the risks, such as possible shortfalls in production, sudden price increases, environmental costs, and so on. Still a miner that can increase production and maintain or boost margins will outperform the metal over time.
Our favorite gold investments include longtime and more recent Growth Portfolio picks, Agnico-Eagle Mines (AEM), ASA Ltd. (ASA), Newcrest Mining (NCMGY), Randgold Resources (GOLD) and these we review in the next article. One, however, NovaGold Resources (NG), is in our Small-Cap Value Portfolio. It illustrates particularly well the potential a superior miner can have even when gold prices are flat.
Barrick, now Nova's partner in developing one of the world's largest gold deposits proves that miners can rise independently of a bull market in gold. Between the mid-1980s and early 1990s, Barrick climbed more than fifty-fold on extraordinary increases in gold production. Production of gold, copper, and silver from Nova's major properties, Donlin Creek and Galore, may come close. The Donlin discovery, one of the largest ever in North America, is estimated to contain at least 54 million ounces of gold.
How much gold is this? In 2006 with gold trading below $700, Barrick offered to buy Nova for the equivalent of $16 a share. Then as now Barrick had a 50 percent interest in Donlin. Today, in the midst of a credit crunch, Nova has been beaten down to where it trades at some 80 percent below Barrick's 2006 bid. Barrick still has a 50 percent interest in Donlin, whose potential reserves are considerably higher than in 2006. Moreover, the other significant holding of Nova is Galore, which represents one of the largest undeveloped copper deposits in the world. What are the risks? The only meaningful one is that the company does not get the financing to develop the properties. But that's extremely unlikely given Barrick's 50 percent interest in a deposit that would more than double its North American gold resources. Clearly any company that has no production and is dependent on others for its continued existence has to be rated as highly speculative. That said, from a risk/reward perspective you won't find a better play than NovaGold.
Editor's Note: Stephen Leeb is editor of The Complete Investor, P.O. Box 248, Williamsport, PA 17703, 1 year, 12 issues, $72. In this fact-packed newsletter you'll learn about Leeb's top investment recommendations: growth stocks, mutual funds, oil and energy stocks, currency plays, dividend stocks, zero-coupon bonds, treasury securities, value funds, precious metals, speculative stocks and more. You'll also learn about options, annuities, mega-politics and retirement strategies.
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