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FIRST ACCESS to Nadeem Walayat’s Analysis and Trend Forecasts

Understanding the Proper Use of Gold and Silver

Commodities / Gold and Silver 2011 Jan 15, 2011 - 05:34 AM GMT

By: Mike_Stathis


Best Financial Markets Analysis ArticleFor a couple of years now, many investors have been bombarded with claims of hyperinflation and a Zimbabwe-like fate for the U.S. dollar. These gold bugs would have you believe that gold has value as a form of currency. They have made these claims hoping that everyone will line up to buy gold, so as to raise the price.

The swarm of gold bugs has reached out to cover every crevice of the media, from television and radio networks to print media and the Internet. And their efforts have been quite effective. Today, gold ATMs are being rolled out across the U.S. to take advantage of the hype generated by this misguided and deceptive movement of gold pumpers.

As I have discussed many times in the past, predictions of hyperinflation and a Zimbabwe-like fate for the dollar are complete nonsense. In my opinion, anyone who states otherwise is either a fool or else is lying in order to pump up the price of gold. [1] [2] [3]

Others have positioned gold as a hedge against deflation. While this is a valid investment strategy, the problem is that the U.S. is unlikely to face a deflationary period of long duration, but rather intermittent bouts of deflation over the next several years. The reason for this is simple. The Federal Reserve remains committed to printing its way through this economic depression. As you can imagine, this is only going to increase the duration and severity of this dark period.

Furthermore, because gold and silver experience bull-bear investment cycles of very long duration similar to other commodities (although I do not consider gold to be a pure commodity), a buy-and-hold strategy for gold and silver is very risky for those who do not have a relatively low cost basis because gold and silver are now in the later stages of their bull market cycle. The lower one’s cost basis, the larger one’s cushion to protect against price corrections, or even a trend reversal signaling the beginning of what promises to be a very long and painful bear market cycle.

So who’s right and who’s wrong about the big topics of debate? deflation or hyperinflation, gold and silver as a long-term investment versus their use as a cyclical investment. Those who have been following me for some time know my views on these issues. [4] [5]

When assessing the merit of the predictions/forecasts made by the army of gold bugs, you should pay particular attention to their bias and track record. The problem is that most people seem to be unable to accurately assess track records. Others simply don’t have the time or else have come to trust what the media has stated about their track records. This is a huge mistake.

Instead of focusing on specificity and accuracy, as well as the overall the hit-miss ratio and timing of forecasts, most people confuse open-ended statements with specific predictions. Others forget about the large number of bad calls made by their sources. Finally, most people do not bother to conduct a thorough examination in order to determine whether or not their sources have been making the same predictions for many years. These are very important considerations one must make. In fact, it would appear that most people seem to believe whatever is repeated the most by the largest number of individuals. This is human nature. However, such behavior often leads to a herd mentality. By now, you should understand the ultimate fate of the herd. [6]

The media has embraced the views of biased individuals and extremists whom they have positioned as “experts” for specific reasons. You must understand that the media is not concerned with broadcasting the views of credible and unbiased experts because this does nothing to boost its revenues. The financial media makes the vast majority of its revenues from selling ads, commercials and sponsorship for shows.

Because gold dealers, mutual fund companies, discount and full-service brokerage firms spend huge sums of money on advertisements, they must receive a healthy return on their investment in order to justify these marketing expenditures. As a result, the media engages in soft dollar arrangements as its primary criteria when determining what “experts” to interview.

Likewise, smaller firms (often one- and two-men shops that have been positioned as large firms) cannot afford to pay for commercials, so when their “experts” are interviewed by financial networks, they are careful not to say anything that would upset the large financial firms that furnish the bulk of ad revenue to these networks. After all, the last thing they would want to do is risk losing all of that free publicity.

You see a similar arrangement on websites focused on promoting gold and silver. Notice all of the gold and silver ads on these sites. Do you really think gold dealers would pay money to have their ads on sites that offered a neutral view of gold and silver (or permit a healthy debate)? Instead, these sites are littered with all kinds of doom and gloom, preaching hyperinflation, and featuring interviews and videos of the gold hacks from the media club. If you read enough of this stuff or watch some of the videos out there, you are likely to become scared out of your pants. That is precisely what they are there for. No matter how bad things get, these doctors of doom have a solution for you, and it’s gold; but not gold stocks or ETFs. According to these prophets of wealth, only by purchasing the physical metals will you be saved from hyperinflation, or so they say. They offer all kinds of reasons why you need to buy the physical metal, stating the disadvantages of gold stocks and ETFs. But they never seem to tell you about the dangers of owning the physical metal. And they never bother to tell you when they are gold dealers or they are being paid by dealers to instill enough panic into you that you’re ready to load up on gold as you await the apocalypse.

This deceptive scam carried out by the media and its financial sponsors is quite common. And it’s easy to execute due to the trust the general public has in the media. When the media introduces these individuals, television and radio journalists position them as experts. During their introduction, they run through a list of so-called predictions these individuals claimed to have made, without truly verifying and analyzing these forecasts for themselves. The unverified and embellished introduction of these “experts” allows the media to demonstrate that it’s providing you with value, so you will stay tuned for the commercials, which represents the engine of the media revenues.

The same applies to the print media. The only difference in this case is that print media makes its money from ads. Therefore, simply by reading or subscribing to an article, the media is paid by those who pay for ads.

Media interviews with gold hacks and perma-bears often provide a multiplier effect when it comes to ad revenues from gold dealers and others. When these hacks depict Armageddon-like scenarios, it creates drama and panic, which usually attracts a large audience. The larger the audience, the higher the price charged for ads and commercials. Similarly, the larger the audience, the more people are likely to purchase gold from the media’s financial sponsors.

Alternatively, some might elect to purchase gold from other sources. But this also serves to increase the price of gold. Either way, gold dealers who pay for commercials and ads benefit when the media carries out these soft dollar arrangements, which serve as the foundation for the misguided views delivered by the media.

But you shouldn’t make the mistake of thinking that Wall Street doesn’t benefit when the media airs the views of gold hacks. Remember that Wall Street also deals in gold and silver. Thus, when these hacks encourage and even scare Main Street into buying precious metals (often for all of the wrong reasons), the Street can more effectively make money through manipulation of the gold and silver market.

Moreover, when the ridiculous predictions made by these gold hacks and perma-bears fail to pan out down the road, Main Street will ultimately fall back into the arms of Wall Street. This shift has already commenced. After these hacks continued to warn Main Street of a further collapse in the stock market ever since the summer of 2009, much of Main Street missed out on the greatest stock market rally since the Great Depression; a rally of over 80% and running. As a result, Main Street is already eyeing Wall Street as a more credible source of investment guidance.

In this manner, the media is able to please both ends of the extremist spectrum, all while taking its cut in the form of ads and commercials. The problem with this is that Main Street doesn’t benefit one bit because they are led astray. As a result, those who pay attention to the media are always behind the curve. This scam has been going on since the inception of the capital markets. Yet, millions still don’t seem to understand how they are being fooled.

When narrating their doomsday portrayal of hyperinflation and a dollar that has lost all of its value, gold bugs offer predictions and scenarios whereby people will use gold and silver to trade for food and water. As a result, many naïve individuals have bought gold in preparation for chaos.

Prior to acting on these claims, you need to separate gold and silver as an investment from gold and silver as a form of currency. For instance, if you believe the dollar will become worthless and people will use these metals to buy food and water, you should stock up on food and water rather than take the risk of buying gold or silver and holding it as you await the “chaos.” Of course gold bugs will never offer you this piece of advice because their only motive is to scare you into buying these metals.

As in the case with securities, the only thing that really drives gold prices is the supply-demand disparity. However, unlike securities, gold has no inherent value (while silver has only a minimal inherent value relative to securities) so its price is absent of valuation criteria used for securities pricing.

You might recall that Warren Buffet made a large purchase of silver (130 million ounces) beginning in 1997 at a cost basis of around $6 per ounce. At the time, Buffett’s silver holdings accounted for about 37% of the total supply of silver in the world. By 2006, he sold his entire position at a reported price of $7.50 per ounce. Although it’s impossible to determine for certain without asking him, in my opinion Buffett sold his position because it had reached fair value. But you’ll notice that Buffett doesn’t own much if any silver now. And he didn’t buy gold back in the 1990s and doesn’t own it now most likely because it does not have an inherent value.

In fact, Buffett knows what every competent investment professional knows about gold. Let’s have a look what Buffett had to say when asked about gold a few months ago.

"Look, (laughing), you could take all the gold that's ever been mined, and it would fill a cube 67 feet in each direction. For what that's worth at current gold prices, you could buy all -- not some -- all of the farmland in the United States. Plus, you could buy 10 Exxon Mobils, plus have $1 trillion of walking-around money. Or you could have a big cube of metal. Which would you take? Which is going to produce more value?" [7]

[You’ll notice the interviewer is none other than Ben Stein, one of the clowns in the financial media club. Similar to everyone else featured on CNBC, Stein has no idea what’s going on and never did. In my opinion, listening to anything he says represents a potential danger to your investments unless you do the opposite of what he says. People should be asking how it is that this guy still has a job after getting so many things so wrong. Think about it for a minute and you might be able to figure it out. If you you’re not sure, you might want to read my articles on the media.]

If you do elect to purchase gold and silver for investment purposes, I suggest you buy shares of the precious metal ETFs since they are more liquid and the transaction costs are lower. Certainly there are risks with this approach. But there are more risks and higher costs if you buy the physical metal in my opinion. Incidentally, this advice, as first discussed in America’s Financial Apocalypse accounts one of the reasons why I’ve been banned by the media and most websites. You see, gold bugs can’t make much money if investors opt for gold ETFs over the physical metal. That is specifically why you are unlikely to have ever heard a single gold bug recommend these ETFs. It’s all about money and agendas. They want to exploit you in order to put money in their pockets.

Furthermore, holding physical gold or silver does not allow one to capture gains through trading the characteristically high volatility observed with precious metals.

Finally, perhaps more important than anything else, if you elect to invest in precious metals, you must establish a definitive exit strategy, because as I have pointed out, these metals have no inherent value (especially gold). As a result, at some point, they will collapse back to historical levels and remain there for many, many years as they have in the past. And you don’t want to get stuck when the bag empties.  

You see, gold bugs have never discussed the need for devising an exit strategy because they want you to think that gold will remain high forever. And when it does finally come crashing down, they will be more than happy to take it off your hands as they reload their vaults and wait patiently for the next bull market. That means YOU are likely to be the one who sells to them at the bottom. This game is similar to the one Wall Street plays to get investors buy high and sell low.

Despite the fact that I am confident gold and silver will reach higher levels, I have personally chosen to remain out of this latest round of appreciation (although I might do some short-term trading). I have owned gold and silver in the past, but as I mentioned in the past, I sold out of my positions in 2009.

I do have some graded Silver Eagles which I purchased several years ago. But I bought these coins with the knowledge that I would be paying higher transaction costs and an added premium for their numismatic value. So for anyone who believes silver is headed to $100 or even $500 per ounce (as the gold bugs and their pigeons have claimed), please contact me and I will sell you my collection of Silver Eagles now while silver is still at the “low price” of $28 per ounce. [8]

Will I ever get back into gold or silver?

It depends on several factors. But I can tell you this. I have no plans to enter at current levels. In my opinion, the average investor should carefully consider whether or not to purchase gold or silver at current prices because the downside risk is quite high for those who intend to take a buy-and-hold approach.  

On the other hand, both metals are currently in a potential short- to intermediate-term correction mode. So if you are able to determine points of entry, you are likely to enter at levels that will provide a short or intermediate-term trading opportunity.

You might be wondering why I have no interest in gold or silver if I am confident each will rise higher. The answer is simple.

First, it’s a personal decision based on what I feel to be more lucrative investment opportunities adjusted for risk.

Second, I could be wrong in my forecast as I am only human and I do not have a crystal ball, unlike many of the gold hacks appear to have.

Third, I feel there is more downside than upside when viewed from a long-term perspective.

Fourth, I do not want to get stuck in precious metals if the stock market should correct or when the precious metals bull market ends. 

But why am I willing to hold stocks if I sense the risk of a market correction?

As I have been discussing for several months in my newsletter, the U.S. market remains very bullish. While this momentum could fade in coming weeks, the odds of retesting the March 2009 lows have diminished significantly in my view. However, that does not mean another large correction will not occur. It’s just that the downside has been greatly reduced.

Now if the market corrects I might get stuck in stocks, right?

Certainly, but I am willing to go with my ability to forecast major market moves, as I have done a pretty job of this in the past. Even if I miss a market correction, I have an understanding of the inherent value of the stocks I invest in. Each has a specific purpose and each has unique characteristics. Some of them pay dividends, others offer excellent growth potential.

Let me give you an example.

Let’s say I bought Microsoft, and six months later the stock market tanked. You on the other hand bought gold. Microsoft is a blue chip, so it’s a safe investment long-term. Plus it pays an annual dividend yielding 2.3%. And it has shown some nice dividend growth. Finally, it has at has reasonable growth potential for its size and safety.

In contrast, neither gold nor silver pay cash dividends, nor do they have inherent value (silver’s inherent value is minimal). Therefore, the price of each of these metals is only a reflection of the auction-related supply and demand (as well as periodic market manipulation which cannot be predicted consistently). Thus, unlike the case with Microsoft or other securities, the supply-demand force that determines precious metals pricing is not based on traditional valuation metrics.

So even though I might get stuck in Microsoft if the stock market collapses, over time shares are likely to rebound. And while I am waiting for the rebound I will receive cash dividends. In addition, the bull-bear market cycle exhibited by securities is much different than that of precious metals.

In short, securities pricing is based largely on earnings growth, dividend payout ratios, dividend growth, cash flows, and other metrics used in standard valuation methodology. In contrast, precious metals pricing is based on supply and demand, which is primarily driven by the perception of panic, as well as the myths that it protects against inflation. 

Moreover, gold (like silver) is being manipulated. While such manipulation has been good for gold investors and recently for silver investors, we are likely to see manipulation to the downside at some point. In fact, this might become the tipping point that pushes these metals back into their long-term bearish cycle. Even if you are an expert in technical analysis, it may not offer much help when trying to spot this trend reversal because asset wash-outs frequently break many rules of technical analysis. [9] [10] [11]

Furthermore, there is a good deal of counterfeit gold across the globe, as well as several cases of inadequate physical gold and silver to back paper sales. Rather than a catalyst to boost the price, once these issues become known to the masses, it too could lead to the tipping point whereby investors sell in mass, driving the price down in panic. Sure, this scenario is not particularly likely at this point. However, the possibility does exist so it is something we must keep in mind.

The counterpoint favoring gold as an investment is based on the fact that it typically serves as a hedge not against inflation, but against large market corrections. However, this is not always the case. Furthermore, we know the stock market is likely to rebound over time (unless it’s the Nikkei) while gold’s next big move is likely to be down as it enters the long bearish part of its bull-bear cycle. [12]

I use market forecasting to hedge against market downturns so I don’t need gold. For me, it represents a wasteful use of investment capital when utilized for this purpose. Thus, for individual investors who are actively managing their investments and who are able to forecast major market corrections, I see no real value in the use of gold as a hedge against market declines. [13] [14] [15] [16]

If you are a fund manager your situation is obviously different. Using gold as a hedge against market declines can represent a nice component of risk management for large funds since it can be difficult to liquidate all positions prior to or during the early stages of a market collapse.

Now, before you form your own conclusions about this analysis, I’d like you to consider a few things.

First, I do not receive a single penny of compensation in any form by discussing the positive or negative attributes of gold and silver as an investment.

Second, I do not hold any short positions in gold or silver, so I do not stand to benefit in any way from the price movement of either of these metals. In fact, as I have stated, because I hold Silver Eagles, one might assume I would offer a bullish forecast without any consideration of risk.

Third, I predicted gold to head to $1400 (with the possibility of reaching higher levels), and silver to $30 or higher in the 2006 publication of America’s Financial Apocalypse. Thus, I have established a track record of accurate forecasts while not holding a financial bias towards these metals. I’m not sure both of these conditions can be met by others who discuss these metals. I feel this is a very important consideration one should make to assess credibility.

It would be easy for me to jump aboard the precious metals band wagon. In fact, if I were to propagate the same delusions of imminent hyperinflation and make the false claim that gold protects against inflation as gold hacks have done, these websites would publish my articles and this would lead to more business for my firm. But I’m not interested in lying, and I’m not interested in working with suckers.

Instead, every gold bug website has banned my articles, including Kitco. That should tell you something. I’m not in the business of selling out. I don’t get paid by advertisers and I don’t sell securities or precious metals. I’m in the business of providing critical analysis and investment guidance to serious investors ranging from financial institutions and financial advisers, to individual investors.  

Regardless of my personal views about gold and silver, others will have different viewpoints and that’s fine. What’s good for me is not necessarily good for you because everyone is different and everyone has a difficult level of risk tolerance, a different skill set and a different number of alternative investment strategies. I’m not here to determine your suitability for investing in anything.

Many are likely to already have a position in gold or silver. Accordingly, I have released a special report discussing the short- and intermediate-term technical picture for gold and silver. In this report I have indentified what I feel to be the highest-probability entry points for short- and intermediate-term traders, and longer-term investors. Unlike many of the special reports sent to subscribers of the AVA Investment Analytics newsletter, this report is being offered to the general public for purchase. For more information on this report, please visit


By Mike Stathis

Copyright © 2010. All Rights Reserved. Mike Stathis.

Mike Stathis is the Managing Principal of Apex Venture Advisors , a business and investment intelligence firm serving the needs of venture firms, corporations and hedge funds on a variety of projects. Mike's work in the private markets includes valuation analysis, deal structuring, and business strategy. In the public markets he has assisted hedge funds with investment strategy, valuation analysis, market forecasting, risk management, and distressed securities analysis. Prior to Apex Advisors, Mike worked at UBS and Bear Stearns, focusing on asset management and merchant banking.

The accuracy of his predictions and insights detailed in the 2006 release of America's Financial Apocalypse and Cashing in on the Real Estate Bubble have positioned him as one of America's most insightful and creative financial minds. These books serve as proof that he remains well ahead of the curve, as he continues to position his clients with a unique competitive advantage. His first book, The Startup Company Bible for Entrepreneurs has become required reading for high-tech entrepreneurs, and is used in several business schools as a required text for completion of the MBA program.


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Mr. Ready for it
15 Jan 11, 12:28
Prepared for hyperinflation

Remember, hyperinflation is a local event, it does not affect foreign currencies. Switzerland has been a safe haven from economic and other disasters for hundreds of years. Their economy and banking system has been super stable for centuries.

I am not worried about hyperinflation. I opened an online Swiss brokerage and bank account without leaving home. I can buy foreign bonds, stocks denominated and earning their revenue and paying dividends in a much more stable currency, or just stash cash in a CD in a variety of currencies in super safe Switzerland without leaving home.

15 Jan 11, 15:20
Gold's price is not important for sane sovereign states

Gold bugs are the world's central bankers. Gold is a superior financial asset as noone's liability. Gold is a form of financial power. The more a sovereign state owns gold, more power it has. Thus gold's price is not important for a sovereign state guided by sane and wise rulers. That is why FDR seized people's gold in 1933: to create the world's #1 managed reserve currency without any possible international dispute. In 1948 US treasury had 35% of world's above-ground gold stock! Today this ratio is below 5% (if there is any gold at Westpoint or Fort Knox) If China is offered, for instance 5,000 metric tonnes of gold at a price of $2,000 per ounce, she will probably be very very very pleased, as long as the deal remains secret. She will only pay $320 billion, just 11% of her forex reserves.

The problem with the fiat currencies is that they lie at the bottom of an inverted paper financial asset pyramide. $40 trillions of paper money stock and $200 trillions of total paper financial assets. When (not if) this pyramide collapse, namely stocks, bonds, mortgage backed assets lose value tremendously, the banksters and the bureaucracy will surely supply newly created paper money to meet cash demand. After the dust settles and deflationary death spiral swallows everything only gold and silver will survive. When it comes to hyperinflation, it is more a political matter. If US loses its military dissuasion in Middle East (the case when Arab sheiks don't anymore sell oil with dollars) or Shangai cooperation establishes a new gold backed currency or a radical systemic political change in Western countries occurs, yes, hyperinflation may occur. Rampant inflation is a certainty, but hyperinflation is a local matter and dependent on political factors.

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