How To Build Wealth During Turbulent Markets, Part II

I’m not really sure why but the private client wealth divisions of large investment firms by and large seem to ignore year after year investments in precious metals such as gold, silver, palladium, zinc and others. However, in turbulent times, this asset class is one of the most valuable. It’s not that the news doesn’t report on it. In fact, every night, in financial news reports, the closing price of commodities including gold is reported. However, at the end of the day, very few people ever seem to benefit from investing in the stocks that benefit the most during precious metal bull markets.

The average person does not understand the upside of investing in metals because it has never properly been explained to them. Many myths cloud the truth about metals as an investment vehicle.

Gold, silver and metals are NOT risky speculative investments if you invest in them properly.

The definition of speculation according to Webster is the following: “the assumption of unusual business risk in hopes of obtaining commensurate gain”. Speculation is one of the most incorrectly used terms in investing. Investors in general stay away from trying to profit from bull markets in precious metals because of its speculative stigma. However, what is never explained to most investors is that the great majority of risk can be mitigated by employing intelligent analysis and intelligent buying and selling strategies.

Therefore, these investment opportunities should not be rated speculative but more accurately explained as moderate risk, high return opportunities. If you don’t perform intelligent analysis and intelligent buying and selling strategies, then investing in large company stocks, typically described as the “safest” of all investments, can become highly speculative as well.

Large companies such as energy conglomerate Enron went belly up and investors lost every penny they had invested in this company. And in case you’ve forgotten the other “high quality” accompanies accused and investigated for fraudulent activity, in 2001 and 2002 alone, these companies included Adelphia, AOL Time Warner, Arthur Anderson, Bristol-Myers Squibb, Citigroup, ImClone, General Electric, JP Morgan, Lucent, Parmalat, Freddie Mac, Duke Energy, Dynergy, Enron, Global Crossing, Halliburton, K-Mart, Merck, Qwest Communications, Reliant Energy, Tyco, Worldcom, and Xerox to name a few. All were accused of falsifying their financials to make revenues or cash flows look better than they actually were.

Recently Hyundai, General Motors and Apple were all forced to restate their financial because they were inaccurate. In fact the flow of highly inaccurate financial statements from companies for the past several years seems to be non-stop. In fact, the financials of so many major companies have been such fantasy, presenting pictures of what they would like their company’s financial picture to look like versus what it really is, that I’m not even sure how much credence I want to give them when evaluating stocks.

How China and India are Likely to Affect Gold Markets

People are unaware of how deregulation in major markets like India and China, will advance the gold market in the next five to ten years. Like every other asset, precious metals go through cycles. However, the cycles precious metals experience tend to be much longer and much more drawn out than the cycles that stock markets undergo. For example I can only recall two great bull markets for gold and silver in my lifetime, including the one we are in the middle of right now. The last one was when gold rose in price from about $100 an ounce in 1976 to $850 an ounce in 1980 and silver peaked at about $50 an ounce that same year.

Over the next 21 years, the metal markets declined. Gold declined from its peak of $850 to a low price of about $250 and silver slid from its high of around $50 to $4. If we take the rate of gold and silver in 1980 and adjust those prices to today’s dollars for inflation, gold’s peak price was over $2,000 and silver was over $100. Looking at these figures, it is easy to see that it is not far-fetched for gold and silver to increase much higher than their current highs in mid-2006, although we will undoubtedly see one or two big pullbacks in price before it climbs higher.

Now let’s consider the huge new markets gold has been exposed to recently. Recent studies show that very few Americans still invest in gold as a long term holding. However, this is not the case in Asia. As a driver of gold prices, several things stand out about Asia. First of all, Asia is a saving culture, unlike the debtor culture of America. Aggregate saving deposits in India banks in 2002 was estimated to be about USD $200 billion, and in China, USD $1.2 trillion. Indians regard gold as the second most important asset of wealth storage after savings deposits. Up until 1990, gold bar holdings had been forbidden in India.

In 1993, the Indian government started allowing foreigners to bring 10kg of gold into the country on an annual basis, and in 1997, they increased this annual allowance to 20 kg. To complete the deregulation of gold in India, in the 2000’s banks introduced futures contracts, commodity contracts, and gold accumulation plans. As a result, from 1992 to 2002, India and Japan (spurred by investor’s fears of the Japanese banking crisis) hoarded half of all gold bar purchases in the world. With gold such an important part of India’s culture and with such vast amounts still held in savings deposits (USD $200 billion), the potential for significant growth of gold purchases in India still remains.

Now let’s look at China. In China, the Shanghai Gold Exchange, which established the gold spot market in China, only opened for live trading in October, 2002. Furthermore, up until August, 2001, the Chinese State Price Bureau fixed the prices for all gold retail purchases. Now gold retailers are allowed to set their own price dependent upon the quality of the gold and the associated craftsmanship. Finally, other barriers to the international gold trade in China were removed in March, 2003, effectively allowing the price of gold in China to mirror prices in the international market for the first time in their history. If Chinese appetite for gold approaches India’s, much of the private world’s gold supply could be removed from the public market.

But China’s similarities to India don’t stop there. Similar to India, China also has a deeply-entrenched savings culture. Private savings estimates several years ago were about USD $1.2 trillion, with USD $81 billion of these cash deposits believed to be held in U.S. dollar deposits. In India, after the government deregulated the gold trade market, jewelry and gold bar demand respectively exploded from 281 tonnes and 10 tonnes in 1991 to 658 and 116 tonnes in 1998. This reflects an average annual growth rate of 16% for gold jewelry and 30% for gold bars. If we look to the deregulation of India’s gold market as a model for behavior in China, then indeed, the potential for China to drive global gold market prices much higher remains very realistic.

As we stated there are at least six different asset categories that you can invest in to benefit from a precious metals bull market. Some categories will actually most likely lose you money, some will earn you decent returns, some will earn you phenomenal returns, and some will yield legendary returns that may allow you to retire early. Just knowing that gold stocks is a great place to invest your money in is not nearly enough. Sometimes there literally can be differences of several hundred percent in returns between the major gold stocks. You won’t likely see such huge differences in any other asset class. For this reason, ensure that you learn everything you can about gold stocks before you take the plunge. Many companies just add the word “gold” to their name to try to capitalize on the naivete of investors and are terrible investments. So though there are phenomenal opportunities, buyer beware!

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