Mom's Buying Gold, Should I Worry?
By Tom Dyson
October 1, 2007

"Perhaps I should buy some gold?"

Uh oh. My mother wants to buy gold. Usually that would make me sell gold. But this time I'm not so sure...

"I hear there's a way to buy gold through the stock exchange," she told me yesterday on the phone from London. "I'll probably do it that way."

My mother is scared. Last month, Brits experienced their first run on the bank since 1866. The bank is named Northern Rock.

A run on the bank is a rare situation where people lose confidence in their bank. They worry it's going out of business and it won't have enough cash left in the vault to return everyone's savings.

Banks never hold 100% of depositors' money. It's inefficient to have money sitting in the vault. It's much more profitable to put it to work earning interest. So banks usually hold closer to 10% of depositors' money in the vault and loan out the rest to businesses and homeowners.

Everyone knows, to have any chance of getting their money back, they have to be at the front of the line when the bank opens its doors for business. So they rush over. As word spreads, it turns into a stampede pretty fast.

That's what happened at Northern Rock last month. It had to ask the central bank for emergency funds to meet withdrawals. According to the British newspapers, the panic got so bad that people started fighting each other to get to teller windows, police had to calm down angry customers and organized queues of people turned into rugby scrums.

"The bank's phone lines were jammed for most of the day, its website crashed and the company's 72 branches were besieged by worried customers after it admitted being forced to ask the Bank of England for emergency funding," reported the London Telegraph.

It turned out to be a false alarm. The Bank of England stepped in and let everyone know it would honor its deposits. The stampede died down, but Northern Rock lost 4 billion pounds in deposits and its share price has now dropped 90%. Otherwise, the system held together just fine.

Here's the thing: Even though nothing happened and everyone got their money out, it gave people a glimpse of what could happen. It stoked the public's fears.

An elderly lady standing in line outside Northern Rock expressed it best: "They say don't panic, but it will be too late if things go wrong. I know that you need to keep level-headed about these things, be we are not youngsters who can afford to lose this money."

Meantime, the gold price has risen $75 in the month of September, reaching a new 27-year high. I bet much of the recent demand for gold came from nervous Brits... people like my Mum and the elderly lady... looking for a safe place to stash their life savings. When people lose confidence in the banking sector, they only want one thing – gold.

Where there's smoke there's fire, runs the cliché. Northern Rock can't be the only bank in trouble. The world of finance is so integrated – everyone owes money to everyone else – this is probably the pinnacle of a much larger problem. Remember New Century Financial? It was the pinnacle of the subprime catastrophe in America. But the major shellacking didn't happen for at least four months after New Century went bankrupt. So even though the dust is settling at Northern Rock, the worst could still be to come...

And that means more fireworks in the gold market. My mother maybe a great contrarian indicator, but this time I don't recommend betting against her...

Good investing,

Tom

Editor's note: Tom Dyson is a regular contributor to DailyWealth, a free investment newsletter focused on the world's best contrarian opportunities. We write with a simple belief in mind: You don't have to take big risks to make big money with your investments.

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