Why Gold Bullion Premiums are High and Going Higher

By Porter Stansberry Printer Friendly Version
Dec 19 2008 2:34PM

http://www.dailywealth.com

In my job as a financial publisher and professional investment analyst, a question I've heard at least a hundred times in the past few months is, "Why do I have to pay such a high premium to own gold right now?"

Before I can answer the "why" of this question, it's vitally important that you understand the "how" of it…

It seems redundant at this point to tell you massive changes are taking place worldwide in the structure of capitalism. It is difficult to know what impact these changes will have on stocks, but I believe in general they will drive up stock prices. In addition to buying the world's best businesses (the Cokes, Intels, and Microsofts of the world), I believe you should have hedges in place for the coming devaluation of the dollar.

The world's leading economy, the United States, has become fantastically indebted at every level ofsociety.

Entire industries exist today purely because of the widespread availability of easy credit – a trend that has ended. U.S. consumers have refused to save any significant portion of their earnings for more than a decade. This trend was unsustainable and has also come to an abrupt end.

As I've covered previously, fueling the debt and consumption binge in America were phony insurance schemes (AIG's bogus default swaps), record high levels of mortgage debt, and global investors (primarily Asian) buying American mortgage paper. In the most basic analysis, China and Japan lent us endless sums of money so we could keep buying their exports. America's real estate bonds became the world's collateral, supporting ever-greater amounts of borrowing. This global game of credit expansion has come to a crashing halt because the creditworthiness of American consumers and financial firms collapsed. In the dark days of September, October, and November, we witnessed a synchronized margin call, where credit of all types was called in. Any asset liquid enough to generate cash was sold.

Consider the folly of the AIG "bailout." The government has been shoveling money through AIG's front door, only to see it immediately leave out the back door en route to Goldman Sachs to cover an unknown amount of credit default losses. Or witness the charade of General Motors' "bailout." GM hasn't earned a profit in almost a decade. It owes, by my reckoning, close to $80 billion. The amount of overcapacity in the car industry is extreme. GM has more than 6,000 dealers in the U.S., compared to less than 2,000 for Toyota and Honda. Congress might as well light its $20 billion on fire.

With a currency and a budget process totally untethered to any reality, nothing limits the amount of foolish spending Congress can (and will) authorize. Something about the scene reminds me of watching King Kong flail at his tormentors on the top of the Empire State Building. Our government is the most powerful in the world. It controls the world's only reserve currency – meaning it is the only country in the world that can print money to cover all its debts, bar none. And yet, for all of this power, King Kong is still

We are witnessing the end of the paper-dollar standard.

Like every experiment with paper money in history, our dollar will be destroyed in an all-out attempt to paper over deficit spending, bad investments, and war debts. Says legendary investor and monetary expert Dennis Gartman:
The U.S. deficit for the two months of the fiscal year to date now stands at a record $401.6 billion, compared with the most recent official budget estimated for the full fiscal year of a deficit of $481.8 billion. This is a shockingly large number, and even we, who usually pay little if any heed to the deficit, find it both awe inspiring and terribly, terribly depressing as a tax payer.

Federal spending is now up 48% over last year. I hope for your sake you understand this is completely unsustainable. At some point, America's creditors will balk.

In addition to the Treasury's vast increase in spending, the Federal Reserve has opened the monetary floodgates. Says another legendary investor and gold bug, my friend John Doody: "The Fed's actions kicked into high gear in Sept-08 as its Total Assets have soared +143% to $2,109 billion, reflecting money pumped into the banking system."

The massive expansion of the Fed's balance sheet has come via the purchase of an alphabet soup of toxic assets from the money-center banks (read "Citigroup").

By the end of November, the Fed had purchased almost $900 billion worth of questionable assets. It also increased its lending to banks (and, for the first time ever, brokers) to more than $700 billion, up from a mere $481 million in November 2007. The result has been a truly fantastic expansion of the Fed's total assets, from less than $900 billion to more than $2.1 trillion. What you must understand is these assets form the basis of our currency. As the Fed's balance sheet expands, so does the lending capacity of the money-center banks. At the moment, they're not lending, but sooner or later, these resources will find their way into the economy. (The money will most likely be recycled back into Treasury bonds.) This huge increase to our money supply and the inevitable huge stimulus spending plan by the Obama administration position our economy for cataclysmic inflation beginning at some point in 2009.

The huge inflation underway right now will be what I call "The End of America." I don't mean an end to our political union – I mean an end to the special role America has played in the global economy since World War II. The coming great inflation will destroy America's economic leadership. It will lead – eventually – to the return of settling international obligations in gold instead of paper dollars. And this will happen much faster than anyone expects. By the time Obama leaves office, you will not be able to exchange dollars for any sound currency in the world without permission from the U.S government. The price of gold will be well over $2,500 per ounce. Most importantly, commodities will no longer be priced in dollars either, but instead in the currencies of the leading producer. Americans haven't experienced anything like this since the Great Depression.

I'm sure 99% of you don't believe anything like this is possible. All I can do is warn you. Looking at these numbers and watching the bullion premium growing, I'm reminded of a classic quote from science-fiction author Robert Heinlein: "There is no such thing as luck. There is only adequate or inadequate preparation to cope with a statistical universe."

If you protect yourself from what's coming, your neighbors will think you were lucky. But luck's got nothing to do with it. And you can still protect yourself from The End of America

The best way to protect yourself is to own gold bullion – plain, regular gold coins. The premium on these coins is moving higher over the spot price of gold. What does that mean? It means to actually take possession of gold in the United States, you have to pay a significant premium over the spot price of gold in the futures markets. According to Parker Vogt, the head of Camino Coin (phone: 650-348-3000), one of the leading bullion dealers in the United States, the premium on a $100,000 order of gold coins would be 9.25%-9.50%. I've made a $100 bet with my colleague Tom Dyson that this spread increases over the next year.

Why? The reason is simple and well understood by all economists. It's called Gresham's Law.

Thomas Gresham was an advisor to Queen Elizabeth of England in the 1500s. The queen was perplexed by the shortage of bullion in England following the great debasement of the currency under Henry VIII and Edward VI. The kings, like all governments, had clipped coins to increase the money supply rather than increasing taxes to pay for their governments.

Then, by edict, they enforced legal tender laws, requiring the clipped coins be accepted for all obligations at face value. As a result, all the "good" money – coins that hadn't been in circulation – fled the country where the king couldn't destroy it. Meanwhile, clipped coins from all over the world found their way to England where they earned more than their real value. As Gresham famously summarized, the bad money had forced out the good.

The same thing has been going on in America for years. As late as 1964, the U.S. half-dollar coin was still being minted with 90% silver. But in 1965, the silver content was lowered to only 40%. Even before this change became official, the market perceived the U.S. was slipping off the gold standard and the government couldn't afford to mint real silver coins much longer. The 90% silver coins had largely disappeared from circulation by the time the change was actually made in 1965.

In 1971, the government stopped including any silver in the coins. In 2007, the same problem arose with pennies and nickels, which are made with copper and zinc. The government banned the melting of the coins and forbade their export.

So... what does this have to do with the bullion premium?

The spot price of gold is set in London. Buying bullion in America now costs more because the market realizes the value of the dollar is inflated. Bullion has fled America. The market clearly believes legal tender laws will soon be imposed, forcing merchants to accept a fixed value of the dollar. The bad money, America's paper dollars, is chasing away the good money, gold bullion.

My advice is to buy as much gold bullion as you can reasonably afford. I'm currently holding about 10% of my net worth in gold coins. I encourage you to do the same.

Good investing,

Porter Stansberry