Is Marc Faber’s Gold Valuation Rationally Optimistic Or Just Insane

The precious metals have been on a tremendous upleg as I predicted. But for the past few years I have maintained that gold and silver are about average value and sometimes a little expensive. In other words, they are no where near as cheap as they were at the beginning of this secular bull market in 1999.

Then my ears perked up when I heard Marc Faber on CNBC say, “I think maybe gold is cheaper today than it was in 1999 when it was $252.”

Is Mr. Faber’s subjective valuation of gold rationally optimistic, delusional or just plain insane?

Plus, one should be acutely aware of return-free risk.


When I am looking to buy or sell an asset, whether real estate, stock, bonds or precious metals, I generally use the 200 day moving average to determine its relative price and give a quick determination of whether it is cheap, average or expensive. On RunToGold I even have key ratios where one can easily view the DOW:gold or DOW:silver ratios based on the spot price or 200 day moving averages. I find these extremely helpful to get a quick assessment of current market ratios.

Despite being extremely bullish about silver and understanding the silver backwardation implications on the silver price I have nevertheless been extremely cautious because of the overstretched 200 day moving average; based purely on technicals silver looks very expensive and due for a correction to around $30. But these are just techniques and do not get to the fundamental issues. They are only as good as their underlying premises.

Many financial professionals struggle with valuing gold. This is because traditional valuation techniques and strategies focus on discounted future cash flows, discount rates, interest rates, risk-free rates, real returns, ROI, IRR, WACCs, etc. Distilled simply they base all of their premises and conclusions on a faulty premise: The 10 year US Treasury is the risk-free rate.

As a result, most people including almost all the gold bugs I know keep their balance sheets, income statements and cash flow statements using the FRN$ or Euro as the numeraire. Even among gold bugs I know it is only myself and Anthem Blanchard who seem to keep regular financial statements denominated in gold as the numeraire.

The truth of the matter is that the benchmark for ‘risk-free’ is subjective and a decision every investor should make for themselves. What one uses for a numeraire is a completely different issue from what one should buy, sell or hold, etc. Plus, one should be acutely aware of return-free risk. Here are a few of the factors that persuaded me to use gold as my prime numeraire:

1. Gold, an element in the periodic table, is a tangible physical asset with a constant definition.

2. There are large above ground stockpiles of gold which results in low relative changes in size and those changes are largely predictable.

3. Gold is a current asset with significant financial liquidity properties. It belongs in the cash portion of the balance sheet.

4. Gold has value in itself, is not subject to counter-party risk and can never become worthless.

5. Gold has a long-term relationship with other commodities. Professor Jastram in The Golden Constant explained on page 130,

As we have said, the purchasing power of gold depends on the relation of commodity prices to gold prices. A close scrutiny of this relationship over time discloses an affinity of a curiously responsive character. It could be called the ‘Retrieval Phenomenon’, meaning that the commodity price level may move away higher or lower, but it tends to return repeatedly to the level of gold.

6. When feeling insecure about the financial and economic conditions one can always pet their gold. Go ahead, pet your platypus.

Perhaps most shocking when one begins to perform this initial paradigm change is to see what I like to call the inversion of interest incomestore of capital expense.


Viewing the financial and economic world through the prism of the FRN$, Euro, Yen, Pound, etc. leads to gross distortions. Due to the gold price suppression scheme one’s vision is only slightly improved, and definitely not to 20/20, by viewing through the lens of gold as numeraire. But the one-eyed man is the dodgeball God when playing among the blind.

To be honest, I do not really care if people disagree with how I assess value; I just kick their bum in the market and am rewarded with the purchasing power. It reminds me of what one of my banker’s said about 10 months after we had closed on an acquisition, “You sure underpaid for that business.” My response was, “We were buying, right?” Duh. Plus, the seller named his price so he got exactly what he wanted!

In nature, atrophy is the natural order of things. The fiat currency and fractional reserve banking system has resulted in a concave financial prism that results in a financial inversion. The natural order of things would have a negative, not positive, interest rate. Perhaps most shocking when one begins to perform this initial paradigm change is to see what I like to call the inversion of interest incomestore of capital expense.

For example, if you have a batch of bananas or wheat you would not expect there to be more of higher quality tomorrow merely by the fact of putting them in a pile. In most cases, wealth does not just magically create and organize itself. In fact, most rational people would assume there would be less wealth because the bananas or wheat would spoil. So likewise with gold; there is a storage expense and insurance instead of earning interest. Most people forget that interest is supposed to compensate for risk which has largely been cartelized and resulted in tremendous moral hazard that will be meted out under economic law with systemic collapse.

If you had 3,800 gold ounces, about $1,000,000 of value, in 2001 and wanted to store the capital until 2007 you could choose among many different tools. Let’s assume you chose an interest bearing checking account and GoldMoney. The monthly store of capital expense for the bank account is about $1,500 while about $500 using GoldMoney. I should probably run the numbers to see if the fiat currency and fractional reserve banking system has gotten more expensive since 2007 but this is what Mr. Faber is asserting.



Over the past 40 years, the world economy has attempted to leave gold’s orbit through the world reserve currency rocket of the FRN$ but it has ran out of fuel before reaching escape velocity and therefore been unsuccessful which has resulted in The Great Credit Contraction that has only just begun a few years ago with capital burrowing down the liquidity pyramid. The regression theorem reversed.

A tremendous portion of the liquidity pyramid, particularly with derivatives, has been created since 1999. Looking just at high-powered currency, the adjusted monetary base, relative to gold gives an interesting valuation metric. Supposedly the United States government has 261.5 million ounces of gold in Fort Knox. Despite the gold having not been audited in over 50 years and rampant corruption, inefficiency, misstatements, lies and omissions by the United States and other governments on countless topics we will assume for the sake of argument that they really do have the approximately 8,000 tons of gold.

This chart from the Federal Reserve Bank of Saint Louis shows there was approximately $500B of adjusted monetary base in 1999 and about $2.5T in March 2011 with a corresponding 5.8x increase in the price of gold relative to FRN$. This places a ratio of adjusted monetary base to gold in 1999 of $1,912 and in 2011 of $9,478.

Reasoned analysis for Mr. Faber’s valuation comes into focus. As Mr. Robert Landis asserted at GATA’s 2005 event, “Any rational person who continues to dispute the existence of the rig after exposure to the evidence is either in denial or is complicit.” GATA asserts that central banks have only 1/2 to 1/3 of the gold they claim which would yield a ratio of $28,434.

After all of the worldwide quantitative easing and competitive devaluation of the last few years what are the adjusted monetary base ratios of the ECB, Bank of England, Korea, China, Japan, etc. relative to their minuscule gold holdings? As Alan Greenspan said to the Council of Foreign Relations, “Fiat money has no place to go but gold.”

When the crystal ball is clouded just hunker down at the liquidity pyramid’s tip.


For the last several years I have thought that gold and silver were about average valued based on the current market conditions and their liquidity. But after hearing Mr. Faber’s assertions that gold may be cheaper now than in 1999 and analyzing the changed market conditions such as the rise of the digital gold currency GoldMoney, increased gold hypothecation via JP Morgan, tremendous increase in the adjusted monetary bases of central banks around the world, failed quantitative easing policies, the exacerbation of the Greater Depression , lack of access to knowledge and facts concerning the true state of affairs which is exemplified by Bloomberg taking the Federal Reserve to the Supreme Court and negative business and entrepreneurial environment due to increased government regulation and taxation therefore I may be changing my view on the underlying valuation of the precious metals. Despite the massive secular bull market they may actually be getting cheaper!

The current metals prices may seem high in nominal terms but what is unseen is the change in fundamental value of the FRN$. I hate owning the precious metals because of the store of capital expense. I would much prefer to own a wealth generating business or real estate. But for now I will continue to buy gold, silver, platinum and palladium only because I do not see any other better alternatives and the difficulty in discerning the financial and economic landscape because of the twilight zone induced effects from quantitative easing. In other words, when the crystal ball is clouded just hunker down at the liquidity pyramid’s tip.

DISCLOSURES: Long physical gold, silver, platinum and palladium.

This Means a Lot

Via Yahoo:

The House on Friday passed a Republican budget blueprint proposing to fundamentally overhaul Medicare and combat out-of-control budget deficits with sharp spending cuts on social safety net programs like food stamps and Medicaid.

The nonbinding plan lays out a fiscal vision cutting $6.2 trillion over the coming decade from the budget submitted by President Barack Obama. It passed 235-193 with every Democrat voting “no.” [Emphasis added.]

This story brings up another reason I dislike democracy. The system encourages political leaders to posture instead of actually solve problems. I do not blame politicians for working within the confines of the system. Rather, I blame the voters who have absolutely no grasp of reality. There will be plenty of people who will make a big fuss over this legislation. Conservatives will use this point out how liberals aren’t serious about addressing government spending; liberals will point out how this measure doesn’t actually address government spending either (because it’s non-binding), and the problem will remain unsolved. Then this cycle will be repeated endlessly for every issue henceforth: politicians will propose meaningless half-measures to solve serious problems, and such measures will fail.
This bill specifically, though, has nothing to love. It’s non-binding, extremely partisan, and doesn’t do enough to actually solve the problem. This is a farce of a solution.
First, what value is a non-binding solution in the face of such a significant problem? To test the waters? Americans know that the current situation is no longer tenable. Businessmen and economists know the situation is untenable. Even Bernanke, in the back of his brain, knows that we are no longer able to continue the excessive borrowing even though he will never say this publicly. Besides which, everyone already knows that Democrats are only good for the most feckless of proposals anyway. The Republicans should have simply offered a binding proposal and let it play. Go big or go home.
Second, there is no hope for permanent reform if the Democrats aren’t on board, at least at this time (which is of the essence, by the way). The fault for partisanship, in this case, lies not with the Republicans but rather with the Democrats. If the Republicans are unserious about reigning in spending, then the Democrats must think this a new opportunity to practice their stand-up routine. At least the Republicans are making an effort, albeit a futile one. All the Democrats have to offer is refusal and non-solutions. Actually, they don’t even offer the latter. All they can really do is hope that they can wish hard enough to change reality. Good luck with that.
(Note: I do have one minor criticism of the Republican’s political maneuvering in this matter. They should have suggested a considerably more drastic reduction in government spending in order to make $6 trillion look like a reasonable compromise. But that’s just a minor complaint, for it does not seem likely that Democrats would have accepted it or even negotiated in good faith. Still, the Republicans could have at least made the effort.)
Finally, $600 billion dollar budget reduction per year isn’t even forty percent of the projected deficit for 2011. The reality is simply that we can no longer continue to run any deficits. Period.
The projected deficit for 2011 is $1,645 billion, and the projected savings are $600 billion. That means we’re still running a TRILLION DOLLAR DEFICIT. This sort of thing is not sustainable. And, frankly, it’s completely unacceptable. Reality will eventually kick us in the face if we do not stop this immediately. And when it does, we will deserve it.
The time has come to get serious. The time has come to end the half-measures. I sincerely hope both parties are up to it.

Did the Indian capital controls work as a tool of macroeconomic policy?

Ila Patnaik and I wrote a paper titled Did the Indian capital controls work as a tool of macroeconomic policy?

The abstract of this paper reads: In 2010 and 2011, there has been a fresh wave of interest in capital controls. India offers an interesting setting for assessing the usefulness of capital controls. It has a complex administrative system of capital controls, and it also had an unusually good economic performance during the Great Recession. This paper examines the claim that the capital controls induced this outcome; it analyses the extent to which the system of capital controls helped achieve India’s macroeconomic and financial stability policy objectives. It finds that India’s experience is inconsistent with the revisionist view of capital controls. Macroeconomic policy in India has moved away from the erstwhile strategies, towards greater exchange rate flexibility combined with capital account liberalisation.

This is interesting, in part, in the discussion on Indian economic policy. But this has also become surprisingly interesting on an international scale.

Many years ago, policy makers and academics had figured out capital controls. Capital account liberalisation was an integral part of the package of policies that made up a modern nation. Plugging into globalisation meant shedding autarkic policy, and being open to ideas, trade, services, capital, etc. All good countries had an open capital account. One by one, emerging markets started figuring out how to remove capital controls. This led to many blow ups along the way, where countries tried to violate the `impossible trinity’. So the path has been a turbulent one, but the destination is clear. Once capital account openness came in, it was no longer possible to control the exchange rate except for extremely hard pegs such as Hong Kong and the Eurozone.

Policy makers and academics did not come to this conclusion from deductive reasoning. They came to this conclusion by getting bloodied over and over. The capital controls that were attempted did not deliver the required results, and the capital controls that could deliver the required results imposed too high a cost on GDP growth. The lack of usefulness of capital controls became the working consensus of practical people.

In recent years, these questions have been reopened, most notably by the IMF. These questions are, hence, back in the global economic discussion.

Among the G-20 countries, only India and China have a large system of capital controls. In most other places, practical experience with capital controls is actually hard to find. The generation which fought those issues has faded away. It is, hence, particularly interesting to study the experience of India and China with capital controls. This makes our paper a useful component of this global debate.

And, on these issues, also see The IMF needs to find its voice again, by Sebastian Mallaby in the Financial Times. The Frank Warnock paper that he talks about is also worth reading.

Economic Events on April 19, 2011

At 7:45 AM EDT, the weekly ICSC-Goldman Store Sales report will be released, giving an update on the health of the consumer through this analysis of retail sales.

At 8:30 AM EDT, the Housing Starts report for March will be released.  The consensus is that construction on 525,000 new homes were started last month, which would be an increase of 46,000 from the previous month.

At 8:55 AM EDT, the weekly Redbook report will be released, giving us more information about consumer spending.