Gold in the big picture

Interview with Marc Gugerli by Oliver Disler.
Marc Gugerli is Fund Manager & Advisor of Gold 2000 Ltd and the Julius Baer Gold Equity Fund.

O. Disler: Mr. Gugerli you are a specialist for Gold and Gold mining stocks. Are you disappointed about the performance of the Gold price the recent months?

Marc Gugerli: No, I am not. Gold has outperformed all major asset classes like bonds and shares. The Gold price calculated in South African Rand, Australian and Canadian Dollar, British Pound, EURO, Swiss Franc and some other currencies Gold just recently reached new highs. Rather disappointing is the performance of gold mining shares.

O. Disler: We are facing one of the heaviest global financial crisis, why is Gold not trading much higher?

Marc Gugerli: Gold has primarily a function of conserving the value of purchasing power. Gold is money and goes hand in hand with the development of money supply long-term. In recent months a lot of money has been destroyed, although on opposite central banks are printing money.

The various problems and issues we have in financial markets, have been recognized much too late and most central banks (especially the ECB) are “behind the curve” reacting with adequate counter-measures. This is one of the reasons, why the gold price did not go up explosively.

O. Disler: What is the relation between the gold price and the supply of money precisely?

Marc Gugerli: Yes. Gold was, is and remains money. Gold supply and demand and the variation of paper money supply are two important parameters which have an impact on the price of gold. Before the financial crisis started in 2007, money supply was growing at a rate of roughly 10 % in most industrialized western countries. Nowadays it is a multiple of ten percent.

A lot of central banks try to get ahead of the curve by reducing interest rates and flooding the markets with new money. The gold price should reflect this already now and trade around its inflation adjusted top of approximately USD 2’000. Man wants to go against the curve.

This is my minimum target for the gold price! The inflation of gold (dilution) is about 1.6% (gold output) or 2’000 tons per year. The entire amount of gold ever mined in mankind history is estimated to be about 140’000 tons. Money supply growth is approximately 30% and exceeds even 100% in some specific cases. It is just a matter of time that Gold will rebalance this inequality.

O. Disler: Is Gold an alternative to treasury bonds, since the yields are so low?

Marc Gugerli: That is a great question. Treasury bills are the next big bubble (to burst). Investors and most asset managers have in average 20% cash and 30% invested in short-term treasuries. For a certain period this might be the right asset allocation.

Since the yields on cash and short-term treasuries are almost 0% in major currencies, Gold is getting more attractive as an investment. Now you have to ask yourself, if you rather want to be fully invested in classical assets only where the supply is exploding by the new money printed or at least add some Gold which can’t be copied, printed and is nobody’s liability?

O. Disler: How shall somebody invest into Gold? Do you suggest Gold coins as well?

Marc Gugerli: There are three possibilities, which are relatively safe:
1. You buy physical Gold and put it into a vault

2. You could buy the Gold ETF from Zurich Kantonalbank (ZKB) which is traded at the Swiss Stock Exchange, which is the only ETF available which is fully covered by physical Gold and if needed you can exercise and get the Gold delivered within 10 days. There are similar products available but as with bank metal depository accounts you run the risk that you have to wait a long time until you get your gold. Very important: Reduce to a maximum the failure of exercise, counterparty and depository risk.

3. It makes absolutely sense to purchase gold coins in respect of the designated use. Investors have to consider that gold coins trade at elevated premiums and are almost not available anymore in some regions, such as United States of America, Canada or Australian.

I suggest to have invested minimum 10% of total wealth in physical Gold. Consider this investment as an insurance which in worst case scenario protects the rest of your holdings and assets.

O. Disler: This is interesting, but again, why is the price of Gold not trading much higher?

Marc Gugerli: The majority of investors purchase Paper-(Gold)-Futures at the COMEX. The sellers or counterparties of those Gold-Futures are just a few very dominant players. Some of them have an in-official close link to the US government. So far most of the investors didn’t exercise the gold futures and have accepted cash instead of physical settlement.

This is about to change. I believe that the comex will default and the entire paper gold market will crash and gold could rise very quickly to 2000 until 3000 US Dollars. When this happens it will be too late to exercise or to try purchasing physical gold. It’s the same with a house insurance, which you need before the beds are burning!

O. Disler: What is your view about the price of Silver?

Marc Gugerli: The situation in the paper silver market is even worse. At the actual levels, Silver is extremely cheap and investors are divided if Silver is rather an industrial or still a precious metal or both. But having a look at the price development it is rather treated like other industrial metals as well. Silver is the Gold of the poor Man.

I believe that the price of Gold becomes extremely expensive and will be considered rather as “store of wealth” than money. What concerns Silver I can imagine that for example China or Mexico could accept Silver to be money and mean of payment (Silver Standard). I expect that Silver could outperform the price of Gold. Silver takes much more space to store and in most countries you have to pay VAT on Silver purchases. I suggest the Silver ETF of ZKB, which can be traded at the Swiss Stock Exchange.
O. Disler: What is your opinion about the US Dollar?

Marc Gugerli: The question is always compared to what? I believe that basically most industrial countries are trying to weaken their currencies with the goal to boost exports. To remain competitive other countries needs to do the same and start the money printing press and the devaluation carousel is launched.

Central banks are devaluating their currencies against limited available and tangible hard assets like land, commodities and precious metals like Gold or Silver. The ECB is far behind the curve and the printing machine runs slower than the one of the Federal Reserve. But all this can change very fast.

O. Disler: What is your opinion about the slogan too big to fail?

Marc Gugerli: You know, that in the United States everything has been undertaken to prevent a recession. Just little signs of a weakening economy and Greenspan started to pumb money into the system and reduced interest rates immediately. Economic problems have been suppressed artificially for years.

This is the reason why many thing became „to big to fail, safe and solve“. Since decades the formula is the same: There is a problem, money will be printed and debts increased and interest rates go down afterwards. This is the main reason for the actual financial and economic crisis but one day the bill MUST be settled.

O. Disler: What do you think about how or if the debts will be paid back?

Marc Gugerli: There are three possible outcomes:
1. They will really pay back. But in the actual situation this is impossible.
2. They will default and declare bancrupty. But this is not what they want - "too big to fail", examples are the automobile or banking industry
3. Or through inflation, you can bet on this.

O. Disler: Is there a risk of inflation, since economies are cooling off or are already in a recession?

Marc Gugerli: I believe the correct description what we have to expect in the very near future is inflationary recession or some other may call this stagflation. As I mentioned already, everything will be done to stop the deflation. I expect that we are getting back inflation especially in the food and energy sector. I expect that yachts and Porsches become rather cheaper.

O. Disler: What shall investors buy right now?

Marc Gugerli: This year several 1000 billion US Dollars rescue packages will be rolled-out. The biggest part of this fresh money will pour into infrastructure projects. Of course there will be companies which will benefit from this. During German “Weimarer” hyperinflation period some stocks of industrial companies perceived 70% of the purchasing power.

Cash and government bonds became worthless. Remember, in which asset classes are investors mainly invested those days? My top choices are companies in the commodity, food and energy sector.

O. Disler:What about gold mining shares?

Marc Gugerli: Good point! Have a look at industrial metals like nickel, zinc or crude oil. Some of them dropped more than 70% from last years peaks. The industrial metals mining companies share prices tumbled 50 to 70%. The price of Gold is trading only 10% below its highest level and as mentioned already reaching new highs calculated in many other currencies. But gold mining shares are still trading XX% below its peaks.

I consider this to be a miss-pricing and a big buying opportunity. Due to lower price for energy, production costs are falling substantially and Gold price close to its highest level means that profitability of gold mining companies will increase substantially. The Philadelphia Gold Index (XAU) is trading at an attractive level and could double easily. From a historical valuation point of view and compared with the price of Gold the XAU is very cheap and my favorite investment 2009.

O. Disler: Dear Mr. Gugerli, thanks for your time and the interesting interview!