Why Invest in Precious Metals?

economic, financial and marketing analysis

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WHY INVEST IN PRECIOUS METALS

The rapid and ongoing growth in the global money supply and the massive scale of unfunded government deficits and long-term obligations – in the US, Canada, UK, EU and elsewhere - make us believe that we are heading into a period of high inflation, perhaps even stagflation in the developed world.

The monetary consequences of money printing and government deficits drive the inflation component. The lack of savings, the focus on consumption rather than production, poor demographics, rapid growth in the size of government, chronic current account deficits and accelerating social welfare obligations are driving the stagnation component.

Precious metals have a high positive correlation to inflation. Stocks and bonds have a negative correlation to inflation. Mathematically, this means that precious metals are an excellent inflation hedge and will tend to outperform bonds and stocks during inflationary times.

In addition to the inflation driver we believe that gold is in the process of being re-monetized. By that we mean that it is regaining is status as a safe currency in addition to being an inflation hedging commodity. In light of the clear intention of the governments in the developed world to devalue their way back to prosperity – as if such a thing is even possible – this process should only continue to pick up speed over time.

INFLATION/DEFLATION

Are we entering a deflationary or inflationary environment? Falling house and equity prices have many mainstream commentators convinced that deflation is the issue. However, by watching certain key indicators we can be much more confident that inflation is the looming risk for investors, not deflation.

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EXCESS BANKS RESERVES

Excess bank reserves continue to explode in the US and around the globe – US excess bank reserves stand at approximately US$ 1 trillion and counting. Assuming 10 to 1 lending ratios, the US banking system now has the ability to create around US$ 10 trillion in additional money supply on top of only US$ 15 trillion in existence – almost a doubling of the money supply once they begin to lend again.

GOVERNMENT DEBT LEVELS

The US bailout is running at approximately US$ 10 trillion and counting. The per capita numbers are equally alarming in Canada, UK, EU, China and India. The US monetary base is around US$ 15 trillion so this could add 40% to the US money supply. Research shows that even with the current dramatic deterioration in US government finances we can expect worse to come. Over the course of the typical banking crisis government debt levels rise an average of 86% in the three years following. If investment demand is not present for the huge debt issuances that this will entail, will the worlds central banks revert to monetizing their governments’ debts – or in simple terms printing the money.

MONETARY BASE GROWTH

The Monetary Base, narrow money supply or M0 is currency (notes and coins) in circulation and in bank vaults, plus reserves which commercial banks hold in their accounts with the central bank (minimum reserves and excess reserves). M0 is usually called the monetary base - the base from which other forms of money are created - and is traditionally the most liquid measure of the money supply. US M0 has exploded! The US Federal Reserve has increased the monetary base over 150% since the start of the crisis. Between January 1960 and August 2008, the 48-year average M0 growth rate was 6.0% with very little volatility around that number. Growth rates exceeding 10% were rare and often preceded sharp gains in commodities prices including precious metals.

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GOVERNMENT DEFICITS

Governments around the world are stepping in as borrowers and spenders of last resort via large Keynesian stimulus programs and/or quantitative easing – i.e. money printing. Large government deficits have historically been inflationary. Government deficit expectations for 2009:

US > 10% of US GDP– Deficit in 2007 was 2% and peaked at around 4% during the inflationary

1970s– US federal government needs to borrow US$2 trillion dollars in 2009 and

US$1.5 trillion in 2010– US money supply is currently US$15 trillion – where will this US$ 3.5

trillion come from?

Global > 10% of global GDP– Global government debt financing requirements are estimated to be

greater than US$5 trillion in 2009

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