THREE MYTHS CONFUSING GOLD MINING INVESTORS
By Kenneth J. Gerbino
July 26, 2004
Information and ideas that are not true can still
gain confidence among many professionals. In the investment field,
the more you grind down to truths the better off you are.
Below are some myths that are confusing and misleading
gold investors and the so-called hard money camp. I might add
the economists from Harvard to most of the big Wall Street firms
are confused on some of these points also. Before we start, some
definitions regarding the money supply. M1, this is the money
supply number that consists of cash plus checking accounts and
travelers checks. M2 equals M1 plus retail money market funds,
savings and small time deposits. M3 equals M2 plus large time
deposits, Eurodollars, and institutional money market funds.
A large portion of the M3 money supply is not money.
The M3 money supply is not an accurate money supply number. It
should never be included in any money supply discussions. Money
is cash and spendable checking account balances. That’s
Follow this very carefully. If the butcher takes
$100,000 (cash or check) and deposits it in a large time deposit,
his bank will report to the Fed $100,000 in a new large time deposit.
This will be counted as part of M3. OK so far. Now if this bank
lends the same $100,000 to the baker, and the baker decides
to buy a Mercedes, then the Mercedes dealer now has the $100,000
and he goes to his bank across town and deposits this $100,000
in a large time deposit, that bank will also report to
the Fed $100,000 of M3. The butcher owns a certificate saying
he has $100G’s in his bank. The Mercedes dealer also has
a certificate saying he has a $100Gs in his bank. The Fed will
now count $200,000 in M3. But only $100,000 is really in circulation.
The truth is that money circulates and is counted many times because
it is not labeled correctly.
The real money supply in this example is the original
$100,000 (cash or check). That’s it. The second $100,000
that was counted should really be counted as a financial asset
(since the Mercedes dealer bought a large time deposit certificate).
It should not be counted as money.
A portion of M2 is actually double counted also.
So the question is how much have the powers that
be increased the “real” money supply in the U.S. Real
money being defined as cash or checking account money (the stuff
that chases goods and services and creates inflation). The answer
is not precise but the amount is most likely very large. M1, which
is the real inflation creating money, I have always suspected
is much higher than we are told. In fact it actually is, and I
confirmed this recently (see below).
I have been using M2 as a gauge of money supply
growth, but it also has its flaws. I believe the best guideline
is using ratios from the mid 1950’s to mid 1970’s
before money market accounts with check privileges came into vogue
and distorted and confused the counting of “money supply”
numbers. Back then the average ratio between M1 and M2 was about
1 to 3. M3 was usually only 10% higher than M2. These ratios I
believe can be used today to get a handle on money growth. Also
the Monetary Control Act of 1980, which I lobbied against on many
trips to Washington with Congressman Ron Paul, I believe created
some backdoor mechanisms to the entire money creation process
and this has added to the confusion.
Using the above ratios, the portion of M2 that is
actually spendable cash or cash equivalent checking account money
might be as high as $3.6 billion and this should actually be counted
in M1. If this is true then the bottom line is that the real inflation
inducing money supply (M1) in the last 10 years has increased
by $2.2 trillion, not the $190 billion increase reported. I spent
some time on the phone with a Federal Reserve Board official a
few days ago to confirm my findings. What I discovered in the
maze of documents that we both reviewed was that I was not too
far off. It appears that there is $1.971 trillion of money market
mutual funds buried in M2 and these accounts have check writing
privileges, so it is really “real” money. In other
words M1 should actually be $3.3 trillion. It is being reported
as $1.3 trillion (June 2004). This portion of M2 should be in
M1, which is the basic money supply. These numbers imply that
a severe and sustained inflation is more likely to occur than
most people suspect and is very bullish for gold.
The confusion is that money (cash), credit money
(checking account money (demand deposits) lent to you by a bank,
under the fractional reserve system or created by the Fed by buying
government securities) and financial assets are totally different
This is why when the stock market (stocks are a
financial asset, not money) loses $2 trillion because the tech
stocks decline or we have a 1987 style crash, it really doesn’t
affect the price of carrots, pizza or movie tickets. You would
think a $2-3 trillion financial hit would create a huge “deflation”,
but it doesn’t work like that. Stocks and bonds and buildings
are assets that can be sold for cash, but are not cash. Remember
the cash you get from someone who buys your stocks or building
means that person now doesn’t have the money anymore to
spend, since he has given it to you. The easy maxim is that financial
assets and real assets are not inflationary, and that paper money
increases floating around are what makes the prices of goods and
services go up. To better understand all this I would suggest
grinding through Ludwig Von Mises’ Theory
of Money and Credit, one of the most insightful economic
books ever written. Unfortunately it takes many years to honestly
get through it. Some pages can take hours to really grasp what
he is talking about. But the truth is all there.
A debt collapse is close at hand…. and with
it a massive deflation. Someday this could actually happen, but
to worry about this now is premature. Consider the following hypothetical
scenario: There is a severe recession in the U.S. and there are
massive bankruptcies and thousands of banks are about to go under.
There is panic in the streets.
The Fed would PR everyone into a one-time increase
in the money supply to add liquidity to the system and ease the
crunch, turmoil and panic. Let’s say they propose a 16%
increase in money and credit. Certainly a very large number that
would raise a lot of eyebrows but that is what would be necessary
according to them to handle all the problems. If they base this
16% increase on the M2 money supply that means the Fed could create
one trillion dollars! I am sure you will agree that $1
trillion would handle an awful lot of debt defaults and banking
Of course this would be inflationary and they would most likely
come up with some clever yet reasonably sounding explanation like
“this may raise consumer prices but the extra $1 trillion
will help productivity, create new jobs and help in capital investments
which we feel may actually counteract many price increases etc.
The thing to realize from the above is that this
is exactly what they will do. The Fed will create liquidity
(cash, credit…. whatever it takes) until the cows come home….
In order to bail out the establishment institutions, debtors,
banks and their savers and everyone who votes. This is inflationary
and of course debases the currency and is bad news. It will make
gold and silver and the mining stocks go up. Someday, when they
print too much money and no one wants it, a total collapse could
occur but this may be a long time from now. They will not let
the system collapse. At some point in the future they may not
be able to do anything, but I think we are many trillions of paper
dollars away from that point. Von Mises talks about the end of
paper money as the point when everyone knows everything they buy
will be selling at a higher price very soon (within days or weeks),
therefore everyone spends the cash as soon as possible to beat
the price increases.
This is when a hyperinflation becomes a runaway inflation and
paper money is exposed on the grandest of scales as a fraudulent
A deflationary collapse could occur sooner, but
it would have to be on the order of many trillions of dollars
of defaults and bankruptcies all at once - an economic accident
of huge proportions. Therefore I wouldn’t bet on a deflationary
nightmare just yet…. but I still would not take any chances
and recommend owning some gold as well as precious metal mining
stocks just in case. As long as they can print money and get
away with it, a massive or even small deflation will not take
To a gold investor the argument is non-consequential
because in an inflation gold is your best bet as it retains its
purchasing power. In a massive deflation gold is also your best
bet as it is the only money still standing. Either way you are
The gold price is somehow related to the price of
oil. Not true. Oil and mushrooms, shoelaces, wheat and beef all
have their own demand/ supply dynamics. Gold does too. But gold
is also money and until that idea changes, pegging gold to the
production of anything (except paper money) can lead to a false
Yes, if oil is going up because of “inflation”
and corn flakes and everything else are going up….. most
likely gold will go up for the same reasons…. the depreciation
of the money supply. But you could very easily see $25 oil and
$50 corn flakes someday because of price mechanisms that are based
on supply and demand and that are manifesting themselves independently
of currency depreciation and have nothing to do with gold.
There are over 1000 commodities. I am sure we could
all produce a few graphs that trend to gold and then we also could
go off into the world of false correlations. As a commodity, oil
does deserve to be included in any inflation discussion, but if
oil goes down to $25 a barrel but 200 other commodities go up
in price I wouldn’t bet on gold going down because it was
linked to oil - and the opposite is true as well.
I hope the above explanations help you.
In the final analysis I think gold mining shares
should be on the top of anyone’s investment list. I expect
the summer to be more or less quite for the mining shares. Canadians
who dominate the global mining professional circles usually freeze
so much during the winter they take plenty of time off in the
summer when the sun is out. The brokerage and investment industry
does the same. Europeans, traditional gold investors are also
gone for the summer. The summer is usually a good time to accumulate
shares on sell-offs.
A recent extensive survey of Global Fund Managers
by Merrill Lynch had 10% reporting that they thought inflation
would be “a lot higher” in one year. There are tens
of thousands of fund managers globally. If 10% of this group decides
to start buying gold mining stocks, as a hedge against this expected
“lot higher” inflation rate then a very strong demand
will develop in this sector. This is what I expect. Since the
inflation cycle is just starting, I am sure the number of managers
that start seeing the trend will swell in the months and years
to come. This will be a lot of buying power coming into the gold
Our portfolios are currently overweighed towards
mining companies with large billion dollar developmental projects.
These are companies that have very large and very well defined
deposits of mostly gold and silver, some with copper, zinc and
lead as well. This group looks better valued at this time than
the large producers. Both categories are a good idea, but right
now I would add weight towards the developmental sector on sell-offs.
The game that has now presented itself to the powers
that be is a tough one. How can they continue to print money when
inflation has clearly reappeared yet how can they not print money
when it is necessary to keep interest rates low to bail out the
huge debt burdens that are everywhere. It appears their only solution
is gradual rate hikes and plenty of new money at the same time.
It means more inflation and more money creation. Long term bullish
for gold mining shares.
Good Luck and visit our website, www.kengerbino.com
for other articles on gold and economics. I am giving a talk at
UBS PaineWebber in Beverly Hills on August 3rd. at 1:30 p.m. on
Gold Mining Stocks. RSVP to Jason at 310-281-3860 if you are interested.
Kenneth J. Gerbino
Kenneth J. Gerbino & Company
9595 Wilshire Boulevard, Suite 303
Beverly Hills, California 90212
Telephone (310) 550-6304
Fax (310) 550-0814