Go for gold to beat the coming currency crisis!

Thus it should come as no surprise that the heaviest buying of mutual funds specializing in one sector of the market always occurs after this sector already had a huge rally. Take for instance the recently much discussed high tech sector. Most of the buying of high tech funds and Internet stocks took place between October 1999 and October 2000, right around the top of the NASDAQ and the peak of most high tech companies.

Today, I should like to advocate the purchase of a group of stocks, which has over the last twenty years been the worst under-performer. This group consists of gold mining companies around the world, all of which have a combined stock market capitalization of only $30 billion.

In other words, you could buy the world's entire gold mining industry for just $ 30 billion. A bargain when you consider that Cisco and Microsoft alone had earlier last year a combined stock market capitalization of more than $1 trillion, and that Amazon.com was valued at its peak at $35 billion!

In addition, the market value all the world's gold mines is tiny when compared to the world's total stock market capitalization of around $35 trillion. Before going into my main argument for investing in gold and gold shares, let me discuss some of the gold market's fundamentals.

Every year in the 1990s, physical gold demand has exceeded the annual supply of approximately 2,500 tons - valued at present at about $35 billion - by about 300 to 500 tons. Compare this to the annual supply of bonds in the world, which amounts to about $3.5 trillion and it becomes evident, how small the supply of gold is.

Then consider this. In the year 2000, Indians bought about 850 tons of gold. In other words, in India, where the GDP per capita is only $300 per annum, every man, woman and child bought almost 1 gram of gold each. If gold became one day as popular as platinum or the NASDAQ is at present, and every person in the world bought just one gram of gold, it would generate an annual demand of 6,000 tons, which is about 2.5 times its annual supply from mines.

Also, noteworthy is the fact that the outstanding gold short positions amount to between five and eight years of production. So if a gold market rally took place - for whatever reason - massive short covering could drive the gold price far higher than anyone currently thinks possible.

Then, if we compare the price of gold to the Dow Jones Industrial Average in the US, it is clear that gold has never been as cheap as right now. In 1980, when the gold price reached more than $800 per ounce, you could have bought with one ounce of gold an entire Dow Jones, which at the time was hovering around the 800 level.

Today, it would take you more than 40 ounces of gold to buy a Dow Jones. Ergo, stocks are now by historical standards high, while gold is extremely low.

So, why is it that gold has performed so poorly when the fundamentals for buying gold seem to be rather compelling? Gold has performed poorly, especially given the above mentioned imbalance of demand over supply, because central banks in Europe have been massive sellers of their gold holdings over the last few years.

Moreover, there may have been some concerted effort by the US Treasury, the Fed and a number of banks to depress the gold price through active market manipulation. It has been alleged that such manipulation of the gold market was designed to artificially depress the gold price in order to give Americans the impression that there is little inflation in the system, and also to protect some financial institutions' huge short positions. Should the gold market rally in earnest, the gigantic short positions could never be covered, given the fact that they amount to a multiple of the annual supplies.

In my opinion, however, the year 2001 could mark a decisive turn in the fate of gold, not so much because of the favorable fundamentals, which I mentioned above, but because of the following sequence of events. The US economy is rapidly decelerating and, I think, there is a good chance we could experience an unpleasant deflationary recession this year, in the course of which corporate profits will collapse and corporate bankruptcies soar.

Now, it is obvious that the Fed, which through its irresponsible monetary policies created history's biggest financial bubble, will do everything it can to avoid such a painful recession. This means that Mr. Greenspan will to stimulate the economy, aggressively cut interest rates and ease monetary conditions - this at any cost!

This monetary intervention could, however, have some unpleasant side effects, the way interventions into a free market always do. Cutting interest rates may namely not help the still overvalued Nasdaq very much, nor will it lead to a lasting improvement in consumption. But it could lead to a pick up in the price of commodities, a rise in the rate of inflation and a massive fall in the value of the US dollar against the Euro.

Moreover, aggressive easing by the Fed will likely lead not to lower, but rising long-term interest rates, which would necessitate even more monetary injection into the financial system. I should like to remind our esteemed readers that if there is at present one dominant consensus in the world, it is the belief among investors that interest rates will decline.

However, I think that aggressive easing by the US Fed may very well lead to rising long term rates as long term bondholders' inflationary expectations rise. Thus, while short term rates decline, long term rates may rise and, therefore, I am no longer very positive about the US bond market.

In fact, a monetary crisis at some point, if not in 2001 then later, is almost a certainty. And when such a crisis strikes, or more likely already before, investors will begin to have second thoughts about the health of the monetary system, and lose faith in the omnipotence of central banks to steer and fine tune economic activity.

At that point, I would expect the gold price to rise very sharply, as more and more economists and policy makers will demand that the world needs a monetary system, which is totally independent from the Fed's monetary policies. Policy makers will then advocate, at least, a partial return to a gold standard, which actually served the world very well throughout its existence in the 19th and 20th century.

Hence, if you believe, as I do, that the continuous debt buildup in the world and the excessive monetary expansion we experienced in recent years is in the long run simply not sustainable, a small investment in selected gold and gold shares should offer a true diversification. An investment in gold is also the best hedge against the Fed's continuous irresponsible monetary policies and against the impending bear market in Mr. Greenspan's popularity.

Investors should gradually build up positions in a basket of gold equities such as Newmont Mining (market capitalization $2.6 billion), Homestake Mining, Placer Dome, ASA, Harmony, AngloGold, Franco Nevada and Agnico-Eagle.

Since 1985, there have been 13 minor gold market rallies with an average rise in the price of bullion of just 8%. However, the average rise in gold shares was 22%. Just consider if gold rallied 30% or more, how gold shares would perform!

Given their low combined market capitalisation, a doubling or trebling in price would not surprise me. From a risk/reward point of view, I, therefore, regard gold stocks to be very attractive. In the meantime, I also recommend to sell long term US Treasury bonds as US monetary policies may lead to more inflation and rising long term interest rates.