“O accurst craving for Gold!”
– Virgil (Publius Vergilius Maro)

We have received many inquiries about our thoughts on gold. One could write an entire book on the subject, but we will condense our thoughts for purposes of this newsletter. In order to best understand gold, we believe a look at the history of the gold standard and why it doesn’t work during tough times is important to understanding our thoughts on gold as an investment today.

History of the “Gold Standard”

The Gold Standard Act of 1900 was established to control the printing of money by tying the money supply to the price of gold. At that time, gold’s price was set at $20.67 per troy ounce. That meant that one could turn in $20.67 of currency and receive an ounce of gold from the government or a bank. The only way the Government could print more money was if it increased the amount of gold it held on reserve (i.e., at Fort Knox). The Act was put in place because of the instability that pervaded the economy in the 1800’s. It was designed to ensure the value of the dollar, to build confidence in the dollar as a means of exchange, to help stabilize the country in those hard economic times and to restrict the government from making our currency worthless by opening up the printing presses any time it wanted to. After World War II, the International Monetary Fund (IMF) used the gold standard so other currencies could maintain their parity to the US Dollar and facilitate foreign trade. The Gold Standard Act was ultimately eliminated by President Nixon in the early 70s.

Pitfalls of the “Gold Standard”

We love Steve Forbes (Editor of Forbes Magazine), but we do not agree with his mantra to return to the gold standard. Why? Simply, during tough economic times, the gold standard does not work well. During normal economic times, the gold standard is fine and keeps the politicians in check. However, it can be a disaster during tough times because it can create economic recessions and depressions or make them worse. Here are two examples:

Panic of 1907 – In 1907, the US economy almost collapsed. This panic precipitated the creation of the Federal Reserve. In April of 1906, San Francisco was destroyed by an earthquake. At that time, San Francisco was the financial center of the West and its destruction threatened the entire western region’s economy. The region needed cash and needed it fast. However, because cash needed to be backed by gold, relief had to come in the form of gold. Britain shipped more than 14% of its gold supply to the United States in 1906. This outflow consequently created a fear among investors in Britain that its financial companies were not sound. This caused many investors in Britain to demand gold for their pounds. To halt the depletion of their gold supply, the Bank of England raised interest rates from 3.5% to 6.0%. Spain and France followed suit. All of this led to one of the worst stock market crashes of this century as liquidity around the world dried up.

The Great Depression – When FDR was inaugurated on March 4, 1933, people were in a state of panic and were rushing to turn in money for gold at banks. They soon discovered that the government did NOT have the gold to pay them for their currency. This created a fear that banks were not sound. As a result, on only his second day in office, FDR closed the banks due to “heavy and unwarranted withdrawals of gold and currency” for the purpose of “hoarding”. On March 9th (just 5 days since FDR’s inauguration) the Senate gave the Secretary of the Treasury the ability to compel every person and business to turn in their gold for money. One day later, FDR issued an executive order forbidding people from sending gold overseas and banks from paying out gold. In January of 1934, just ten months later, FDR issued another executive order that increased the price of gold from $20.67 a troy ounce to $35 a troy ounce. This reduced the value of the dollar by 40% in one day! This was done only after the government compelled the entire country to turn in their gold for dollars. The government needed more money and this instantaneously increased the money supply by 40%. Those that broke the law and held onto their gold made a fantastic return on their investment in one day. Even with this unprecedented increase in the money supply, inflation was tame in 1934 (+2.0%), 1935 (+3.0%) and 1936 (+1.2%) because of overriding concern about a credit collapse.

Our Thoughts on Gold

Gold is a hard asset that protects one from inflation. Part of the reason why gold is near all time highs (when most commodities are down 50%) is the prevailing fear of overspending by the government. Overspending leads to the printing of more money. On the other side of the equation, wages, housing and expanding credit ? all inflationary forces – are non-existent. In fact, credit is declining. All of this is deflationary, not inflationary.

The overriding question is whether our government will continue to inflate the economy. There are two things we see that indicate this trend may be reversing. First, the number one concern, according to the polls, among Americans is overspending by the government. This concern is starting to ring true in Congress as many in Congress are changing their tune on health care and cap & trade. Second, it appears that the Federal Reserve is starting to pull in the reigns. The Federal Reserve has decreased the money supply by an annualized rate of 12% during the past four weeks. If the Federal Reserve is effective in trimming some excess cash in the economy and, in turn, stems inflation, the price of gold will fall like other commodities. We believe the reappointment of Ben Bernanke was a positive step in the fight against inflation.

So where does THOR stand on gold as part of a portfolio? At this time, we do not see any compelling reason to buy gold. If one wants to buy gold coins and use them as a safety net so they can sleep at night, we have no problem with that. However, they should look at this as a safety net, not as an investment.

We also believe that part of the current interest in purchasing gold comes from the proliferation of radio and television commercials hawking gold. Such tactics look to take advantage of investor fear and the investment results for gold over the last 8 years (however, since 1980 gold is up just 35% cumulatively, which works out to less than 1% annually). As you listen to these commercials, the question you should ask is this: If these companies believe gold is such a great investment, why are they paying hundreds of thousands of dollars in advertising in order to trade it to me for my “worthless” cash? We, at THOR, sell investments because we think they are fully valued or over valued. We believe these companies are doing the same.

These are our views today. Nonetheless, we will continue to monitor the inflationary forces at work in the economy. If inflation becomes an issue down the road, we will consider investments that will protect you against inflation. Gold is one of the options we will consider. We will look for investments that will not only provide the best hedge, but appreciate the most in an inflationary environment. This will include investments in gold and other hard assets (oil, gas, copper, etc.). We will also look at TIP’s (Treasury Inflation Protected Bonds), shorting Treasury Notes and a higher percentage invested in international stocks or bonds.