Bailout Could Spur a New Gold Rush

A James Bond villain who would be overjoyed today if he hadn't met the fate of all 007 adversaries is Goldfinger. The words vary, but that's essentially the message from several market watchers who say they see sizable market risk in Uncle Sam's bailout — a $700 billion rescue package they call heavily flawed, strongly indicating the prospects of further dollar weakness and higher inflation. That, in turn, could trigger a new gold rush.

One money manager critical of the rescue package, Leonard Mohr, a principal of Los Angeles-based MCR Associates, tells me he expects it to set the stage soon for the dollar to drop to below 1/1,000th an ounce of gold. The dollar, which wrapped up 2007 at 1/833rd an ounce of gold, plummeted to an all-time low last March of 1/1,033th an ounce of gold and is currently hovering at around 1/880th an ounce of gold.

The tracker of precious metals and natural resources at Florida-based Weiss Research, Larry Edelson, also casts his ballot for a sharply lower dollar resulting from the bailout translating into a higher gold price. "The government is printing money like crazy to clean up the financial mess and prop up the economy, but at the same time it's devaluing the dollar and creating hyperinflation, which is great for gold," he says.

Mr. Edelson says he's seeing a lot of the same symptoms that were visible in the 1920s, such as a collapsing dollar and rising unemployment.

Given his expectations, he insists "no ifs, ands, or buts, gold is definitely on the ascendancy. It's no longer just an inflation play, but a crisis hedge."

His outlook calls for a drop in the dollar to 1/1,200th to 1/1,250th an ounce of gold by the end of the first half of next year, followed by a further drop to 1/2,100th an ounce of gold over the next couple of years. He notes the dollar is already establishing a base at about 1/800th an ounce of gold, which was its previous record reached in 1980. His best-case scenario for the dollar is 1/600th an ounce of gold, but he says if that should occur, it won't stay there very long.

Echoing a number of economists who believe the American economy is experiencing its worst financial crisis since the Great Depression, Mr. Edelson sees darker financial days ahead. "The airline industry is broke, the big three automakers are bankrupt, and more woes are inevitable," he says."

Addressing the plight of the dollar — which has shed 33% of its value in the past few years and whose price movement invariably influences the price of gold — Mr. Edelson reckons a further decline is in the cards. How, he asks, can it not decline, given the rapid and ongoing deterioration of the balance sheets of both the Treasury and the Federal Reserve?

Just a little more than a year ago, he observes, nearly 100% of the Fed's balance sheet was invested in Treasury securities. Today, more than 40% is in assets and securities that would otherwise be labeled as junk in the private sector. That means, he says, the Fed's once pristine balance sheet — the assets behind the dollar — is now being largely diluted.

As for the Treasury, Mr. Edelson notes it's now on the hook for $5.2 trillion of Fannie Mae and Freddie Mac bonds, not to mention the nearly $9.7 trillion in national debt. If just 10% of the mortgages out there go bad, the Treasury will take a $500 billion loss, he points out. Further, if 20% go bad — a not unreasonable assumption in this environment — the loss would expand to $1 trillion.

To Mr. Edelson, it suggests that other than a short-term bounce, the value of the buck is destined to decline much further, which would inflate the price of gold.

What about the threat of deflation? Mr. Edelson notes in the country's actual three deflations — all of which occurred during the gold standard — gold consistently outperformed, increasing its purchasing power dramatically as investors lost faith in financial institutions and hoarded gold over virtually all other asset classes.

Mr. Edelson has long recommended investors hold 10% of their investment assets in gold. He now recommends an immediate boost to 25%. Aside from the fallouts of the bailout, notably higher inflation and a weaker dollar, other reasons he's gung ho on gold include declining supply (South African production has fallen to an 85-year low), virtually no new supply coming on stream, and only relatively modest central bank sales to keep a lid on the gold price.

His favorite gold plays include the SPDR Gold Trust (GLD), a liquid exchange-traded fund that owns the physical gold for you, and several gold stock mutual funds, such as Tocqueville Gold Fund (TGGLDX), U.S. Global Investors World Precious Minerals Fund (UNWPX), and U.S. Global Investors Gold and Precious Metals Shares (USERX).

As for individual gold stocks, he favors Agnico Eagle Mines Ltd., Yamana Gold, and Royal Gold.

dandordan@aol.com