Start Your Own Gold Standard

Source: Eric McWhinnie, Wall St. Cheat Sheet (8/30/12)

"While politics has the power to cloud even the most basic beauties in the financial system, it does not currently prevent individuals from applying the gold standard to their own portfolios."

The gold standard is a monetary system where the standard economic unit of account is a fixed weight of gold. The purpose of this system is to force responsibility onto the government and its fiscal policy. The United States abandoned ties to the gold standard in 1971, but has recently caught the attention of the political world due to the Republican party. However, as many market participants are showing, you do not need a political movement to start your own gold standard.

The Financial Times reported last week that the Republican party is set to create a gold commission to examine the benefits of reinstating a gold standard. Drafts of the party platform also call for an audit of the Federal Reserve. The commission is reminiscent of the one setup in the early 1980s by President Ronald Reagan. "Now, three decades later, as we face the task of cleaning up the wreckage of the current Administration's policies, we propose a similar commission to investigate possible ways to set a fixed value for the dollar," the proposal explains.

Although it is highly unlikely that the Republicans will be able to steer the nation back towards the gold standard, the mere mention of doing so has drawn heavy criticism from economists and journalists. However, gold does not care about politics or the usual campaign rhetoric. Its role of sound money in the financial system has been determined by market participants for thousands of years. Investors seeking a hedge against devaluing fiat currencies and poor fiscal policy often turn to gold, and today's market is no different.

In addition to individuals purchasing gold and silver bullion to diversify their portfolios, major entities are loading up on precious metals. The second quarter of this year was a record breaking period for central bank gold purchases. Demand from the banks surged to 157.5 tonnes, the highest demand seen since the sector first became net buyers of the safe-haven asset in 2009. Meanwhile, China continues to purchase gold in large amounts. In June, Beijing imported 68 tonnes of the precious metal from Hong Kong. This brings the nation's total to nearly 400 tonnes for the first six months of the year, according to Zero Hedge. China National Gold Group, a state-owned enterprise in China, is also in talks to purchase a majority stake of Barrick Gold's African mining business. Barrick Gold is the world's largest gold producer.

Bill Gross, founder and co-chief investment officer of Pimco, has been vocal about his views on the economy and actions of central banks. In a recently released investment outlook letter, Gross claims "the cult of equity is dying." He goes on to say, "The primary magic potion that policymakers have always applied in such a predicament is to inflate their way out of the corner. . .The problem with all of that of course is that inflation doesn't create real wealth and it doesn't fairly distribute its pain and benefits to labor/government/or corporate interests. Unfair though it may be, an investor should continue to expect an attempted inflationary solution in almost all developed economies over the next few years and even decades."

In response to the company's inflation outlook, The Pimco Commodity Real Return Strategy Fund, which has roughly $20 billion in assets, increased its gold exposure to 11.5 percent of total assets, compared to 10.5 percent just two months ago. The fund added gold when the price fell towards $1,500 earlier this year, according to Nic Johnson, the fund's co-portfolio manager. In August, it was also made evident that billionaire fund manager John Paulson added heavily to his SPDR Gold Trust position.

While politics has the power to cloud even the most basic beauties in the financial system, it does not currently prevent individuals from applying the gold standard to their own portfolios. Even a small allocation of precious metals can help investors weather the financial storm that is gathering speed around the world.

Eric McWhinnie
Wall St. Cheat Sheet

Disclosure: Long EXK, AG, HL, PHYS

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