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Why Gold Could Reach $20,000 an Ounce

By Tom Dyson, publisher, The Palm Beach Letter
Wednesday, June 11, 2008

The amount of liquid savings I keep in gold would make the average investor choke.

In fact, on the occasions when I have told people how much of my money is in gold, they think I'm nuts. Gold represents more than 50% of my savings. 

When folks hear that, they think I'm making a crazy speculation on the price of gold. Or they think I'm an eccentric. 

I tell them gold is the safest place to keep your money. It's the modern equivalent of putting cash under the mattress. Gold is such a conservative investment, it doesn't even pay an interest rate. 

Here is why I like gold:

To stave off the housing and credit crisis, politicians have increased the amount of paper (and electronic) money in our financial system. If you double the number of dollars in the system, then the market should make you pay double the number of dollars for an ounce of gold. If you increase the quantity of paper money by a factor of 20, the gold price should also rise by a factor of 20.

This is simple mathematics. It's the same calculation for tailored suits... loaves of bread... or rare seashells. Double the quantity of money, double the prices.

Chris Weber, the editor of the excellent Weber Global Opportunities Report, makes the calculation in the most recent issue of his newsletter. He adds up the value of all the paper money in the world... and comes up with $100 trillion. Then he divides this by the total amount of "above ground" gold in existence – 5 billion ounces – and finds a fair value of gold at $20,000 an ounce.

Total value of paper money

$100 trillion

Gold in existence

5 billion ounces

Theoretical fair value of gold

$20,000/ounce

If Chris Weber's calculations are correct, the gold price would need to rise about 22 times to match the rise in the quantity of paper money in the system.

For gold to get that high, people would have to lose confidence in paper money. I think this will happen eventually... just not anytime soon. And of course, this calculation is theoretical. I'm not predicting $20,000 gold. The point here is lots of paper dollars are floating around, but only so much gold.

Normally, gold is an expensive investment to own. That's because it doesn't pay interest. And you have to pay a small cost to maintain a safety deposit box. So you lose a few percent a year in opportunity cost when you put money in gold instead of in a savings account.

But right now, that penalty doesn't exist. My bank pays 1% interest in its savings accounts. Ten-year U.S. Treasury bonds pay 4% interest. The government says inflation is running at 4% a year. I think it's higher... around 5%-7% per year. Real interest rates are negative... You're losing money in your savings account. 

You can see this "penalty on savers" in the chart below, which shows real interest rates over the past 12 years:

Real Interest Rates Are Negative


Tom DysonThat's why I keep my savings in gold. It's a safe investment with huge upside. And right now, I pay no interest penalty for making this bet. Other people are starting to figure this out. That's why gold has risen from $250 an ounce to $900 an ounce over the last six years. 

I don't see our growing inflation disappearing anytime soon... and I see commodity prices in a long-term uptrend. That's why I'm comfortable with such a large gold position... and why gold's bull market still has a long way to go.

Good investing,

Tom




Market Notes


THE GREATEST BOOM/BUST MARKET ON THE PLANET

We're starting to feel bad for China Southern Airlines.

Back in November 2007, we singled out China's largest air carrier as a stock that could plummet as air seeped out of the China investment bubble. True to its airline roots, the stock is down 50% since then. Each time China Southern looks like it's forming a bottom, it slides a little more. The stock should be a great buy someday though...

China is without a doubt the world's greatest economic growth story. Never before have so many people started on the path from collectivist poverty to capitalist prosperity. It's a story that will attract trillions in investment capital.

All of that money and promise will produce booms worth hundreds of percent returns... and equally big busts. Travel and tourism is one of the ultimate spots for investment in this boom/bust theme. But as our chart today shows, the theme is still "bust" for our old whipping boy.


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