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Gold Headed to $200 or $10.000 part II

By Eric Hommelberg      Printer Friendly Version Bookmark and Share
May 18 2009 4:56PM

  • Gold remains ultimate form of payment
  • US debt levels unsustainable – dollar losing status world reserve currency
  • Gold prices required to counter balance all US public debt held in foreign hands exceed the $10.000 mark
  • China, Russia calling for new world reserve currency

Gold is sneaking its way towards the $1000 barrier again which is prompting as usual the gold bears to come out swinging declaring the end of the bull market for gold. For newcomers to the gold market it’s very confusing to hear ultra bearish reports from one side calling gold prices to crash, some even predicting gold to crash below the $300 mark while from the other side they’re hearing ultra bullish reports calling for gold prices heading to $5000, some even predicting gold prices to top $10.000. Well, that’s quite a difference and sure enough some analysts will be proven terribly wrong over the next few years.

In my previous piece ‘Gold Heading for $200 or $10.000’ part I wrote a fictive exchange between a staunch gold bull and a newcomer to the gold market being fed with all bearish arguments for gold you can think of. This piece was received very well since it was a real eye-opener especially for newcomers what gold is all about and why it is so much hated by governments today. Readers having missed that piece can read it HERE.

This update is again aimed at newcomers to the gold market and shines a light on all fundamental reasons to own gold.

When I started writing about gold 7 years ago (2002) it was my aim to paint a clear picture about gold’s strong fundamentals pointing to significant higher gold prices the years ahead. I started writing a Gold Drivers Report discussing all critical drivers (declining dollar, increase demand, decline supply, negative real rates, come back in monetary system and record high short positions) that were pointing all to much higher gold prices indeed.

Now after 7 years one could easily argue that the Gold Drivers Report has been a lucky shot indeed since gold did appreciate from $250 to almost $1000 but to set things straight, I’m not writing this piece to prove up my point for the last seven years but to make the case for a record run still ahead of us. Especially during times like these where many gold bears are screaming ‘SELL’ it’s good to know where gold came from, why it did rise from $250 to $1000 in the first place and how the critical drivers that lifted gold are affected these days.

So gold bull over or $5000 gold?

Readers who have followed my work over the years know that I belong in the latter camp which calls for gold prices heading to $5000 or more within a few years. I’ve written extensively for reasons why but I want to emphasize that the primary reason for gold investing should be wealth protection, not to get rich quick. Gold heading to $5000 of course reflects the underlying weakness in our current monetary system so the basic question here is what to trust more. Should you trust your hard earned money to gold which has proven itself as the ultimate protection of wealth for more than 6000 years or should you trust the honest bankers keeping your savings in paper instruments yielding astonishing interests of slightly more than one percent? Of course all guaranteed by our beloved government that favors and guarantees a strong dollar.

The gold bears are opting for the latter since they are basically saying that gold will be losing purchasing power. Saying gold will be losing purchasing power equals saying the dollar will be gaining purchasing power. Saying the dollar will be gaining purchasing power equals saying our monetary system is healthy and functioning well.

This week in part I (point 1,2 and 3) we shine a light on our monetary system well being and is part of an extensive summary "10 fundamental reasons to own gold". Even the staunchest dollar bull will have to admit after reading this piece that all is not well in the financial hemisphere.

10 fundamental reasons to own gold

1. Gold remains ultimate form of payment – No counter party risk
2. Currency debasement – US Dollar losing status as world reserve currency
3. Gold crawling back into the monetary system
4. Negative real rates
5. Falling gold supply vs increased investment demand
6. Gold & Historic averages – gold should be trading above $2300 these days
7. DOW/GOLD ratio points to $5.000+ gold before 2015
8. Gold & US public debt – gold prices required to counter balance all US public debt held in foreign hands exceed the $10.000 mark
9. Large short positions – half of all central bank’s gold has been leased into the market. (about 15.000 tons). Covering these short positions is not possible without catapulting gold prices to unimaginable highs.
10. Gold acting as safe haven in times of rising geopolitical tensions

1. Ultimate form of payment – No counter party risk

Gold still represents the ultimate form of payment in the world." - Alan Greenspan, Testimony before US House Banking Committee, May 1999

Gold has been used as money for thousands of years, it may have even been the first metal used by humans. A funny detail concerns the oldest known map called the Turin Papyrus, an ancient Egyptian mining map 1320 -1300 BC, which is showing the plan of a gold mine together with indications of the local geology.

The bottom line is that gold has retained its purchasing power over thousands of years and therefore has proven itself as the ultimate protection of wealth. Gold has no counter party risk, gold is not some one else’s liability, gold can not be printed out of thin air, no nation has the capability to destroy the value of gold, gold does speak for itself.

Some one who understood gold’s real value against paper money very well is former French President Charles de Gaulle:

There can be no other criterion, no other standard than gold.
Yes, gold which never changes, which can be turned into ingots
bars, coins, which has no nationality and which is eternally and
universally accepted as the unalterable fiduciary value par exellence?

Charles de Gaulle

In February 1965, President De Gaulle said in a landmark press conference “What the United States owes to foreign countries, it pays, at least in part, with dollars that it can simply issue if it chooses to?.

De Gaulle not too happy with the implication of having the dollar as the reserve currency responded this way:

Since dollars could still be exchanged for gold at the time, De Gaulle instructed the Banque de France to increase the rate at which new dollars were converted to gold bullion and sent the French navy across the Atlantic to hand over dollars and pick up gold bullion in exchange. In 1965 alone, the French navy ferried back over $150 million of gold bullion thereby increasing the proportion of French national reserves held in gold from 71.4% to 91.9%.

The bottom line is that De Gaulle didn’t trust the paper dollar which were circulating in ever increasing quantities and opted for real money which is of course gold.

History leaves no doubt it. The only money that stood the test of time is gold, all other currencies have failed. Gold is the only true protection of wealth.

2. US debt levels unsustainable - Currency debasement inevitable - US Dollar losing status as world reserve currency

You may wonder why De Gaulle didn’t trust the dollar since the US had pledged the dollar to be as good as gold in accordance with the Bretton Woods agreement. The answer is simple. In the mid sixties the US couldn’t finance the Vietnam war without the help of the printing press. Needless to say the US money supply took off thereby debasing its own currency. For the US it didn’t matter since the world was forced anyhow to accept the US dollar as a reserve currency. Yes, the US promised the dollar to be as good as gold and yes, foreign central banks were allowed to exchange their dollars for gold but the US made it very clear that foreign nations exercising their right of exchanging dollars for gold would be considered as ‘American unfriendly’.

Sure enough De Gaulle wasn’t too much impressed and sent the French navy across the Atlantic to hand over dollars and pick up gold bullion in exchange. The US gold reserves were shrinking at such an alarming rate that President Nixon was eventually forced (1971) to close the gold window.

The bottom line is that countries printing their way out of debt will see its currency depreciating. A good example concerns the German Reichsmark. After world war I Germany tried to print its way out of its debt which eventually led to a worthless currency being used to heat up stoves.

Germany : Inflation 1923-24:

Germany : Inflation 1923-24: A Woman feeds her tiled stove with money.
She chose to feed the stove with Money because it cost less than buying the wood with Money

A more recent example concerns the Zimbabwean dollar. Robert Mugabe called for the printing press coming to the rescue as well but we all know the outcome by now. Inflation numbers running at levels exceeding 200 million % aren’t exactly reflecting a strong currency showing off much confidence.

What we are witnessing these days is a massive currency debasement on a world wide scale. A trillion dollars bailout here, a trillion dollars bailout there, all done with money that does not exist but extracted from the printing press. All this freshly printed money is adding of course to governments ballooning debt which can only be paid back by issuing even more funny paper notes..

Since most countries world wide are fighting the derivative fall-out with fresh printed money (most countries are running their printing press at double digit numbers these days) their currencies will not devalue much against each other..

So in which currency to park your hard earned money then if all major currencies are debasing at the same time? The answer is quite simple, the one and only true alternative remains of course gold which can not be debased at will.

Now let's go back to the US government’s spending attitude. As mentioned above the government has no other choice as to bail out failing banks that are too big too fail. A failing bank here, a failing bank there, the list goes on and on. You don't have to be a rocket scientist in order to understand what impact these bail outs have on the administration's budget deficit. Sure enough it'll explode. How the government responds to exploding deficits is predictable. They just raise the federal debt limit whenever necessary. They will raise the federal debt limit to $12.1 trillion allowing them to take on another trillion dollars of debt from current levels. Current reading of federal government debt stands at $11.2 trillion which is an increase of more than $5 trillion over the last 6 years, see chart below:

federal government debt chart

This chart leaves no doubt, the federal government debt is going up in a straight line which is very dollar negative. In order to prevent a free fall of the dollar the rest of the world has simply no other option as to buy this debt.

Unfortunately foreign willingness to take on that debt is in sharp decline which leaves the FED with no other option than buy up some debt itself. This is what we call turning on the printing press..

Now if the $11.2T federal debt wasn't already bad enough, the picture only worsens when looking at total US debt which clocked an alarming $57 trillion last year. The chart below speaks for itself:

total US debt

As you can see here total US debt is growing faster than its national income. Ever tried to run a business which its debt grows faster than its income? Needless to say you would be heading straight into bankruptcy. And that's exactly what's happening with the US, they're heading straight into bankruptcy which isn’t exactly a big plus for the dollar.

But wait, the US still maintains a triple AAA rating right? So what’s the problem?

Yes, the US maintains a triple A rating indeed but please note that its debt is rising faster than a Saturn V rocket. At least this should raise some eyebrows and therefore it’s no wonder that former US Comptroller General David Walker raises his concerns as well. In the Financial Times this week he said:

America’s triple AAA rating at risk
Financial Times – May 12, 2009

David Walker, former US Comptroller General:

How can one justify bestowing a triple A rating on an entity with an accumulated negative net worth of more than $11,000bn (€8,000bn, £7,000bn) and additional off-balance sheet obligations of $45,000bn? An entity that is set to run a $1,800bn-plus deficit for the current year and trillion dollar-plus deficits for years to come.


So we’re facing debt levels appreciating at an ever increasing pace thereby underming the US triple AAA rating. Needless to say this underminines the credibility necessary for a nation that issues world’s reserve currency. Now how is the US going to work its way out of its exploding debt?

The answer is shockingly simple, they can’t do it without destroying the value of the US$. Destroying the value of the dollar is destroying world’s reserve currency. Sure enough this raises serious concern among other big players and it seems déjà vu all over again with the sixties. As Charles De Gaulle didn’t like the US currency debasement in the sixties, China is challenging the US for a new world reserve currency now.

China Takes Aim at Dollar
Wall Street Journal – March 24, 2009

BEIJING -- China called for the creation of a new currency to eventually replace the dollar as the world's standard, proposing a sweeping overhaul of global finance that reflects developing nations' growing unhappiness with the U.S. role in the world economy.

Moving to a reserve currency that belongs to no individual nation would make it easier for all nations to manage their economies better, he argued, because it would give the reserve-currency nations more freedom to shift monetary policy and exchange rates


Well, let’s see:

“Moving to a reserve currency that belongs to no individual nation would make it easier for all nations to manage their economies better, he argued…

? Sure enough the only currency which does not belong to an individual nation is gold. Is that why China ramped up its gold reserves by 76% in the last 6 years?

China confirms talk by unveiling big pot of gold
Reuters – April 24, 2009

SHANGHAI/BEIJING (Reuters) - China revealed on Friday that it had secretly raised its gold reserves by three-quarters since 2003, increasing its holdings to 1,054 tons and confirming years of speculation it had been buying.

Speculation has gathered speed over the last year, since the tumbling dollar has threatened to weaken China's buying power -- and give it yet more reason to diversify into gold, oil and metals


China has taken the golden path and now they want the world to know about it. They clearly delivered a message to the financial markets that they see gold as an important part of the overall international monetary scheme.

Last week China raised its concens again and send out its clearest warning to date that western stimulus could be setting off worldwide inflation and undermining global bond markets.

China fears bond crisis as it slams quantitative easing
Telegrapgh – May 7, 2009

China has given its clearest warning to date that emergency monetary stimulus by Western governments risks setting off worldwide inflation and undermining global bond markets

A policy mistake made by some major central bank may bring inflation risks to the whole world," said the People's Central Bank in its quarterly report.

"As more and more economies are adopting unconventional monetary policies, such as quantitative easing (QE), major currencies' devaluation risks may rise," it said. The bank fears a "big consolidation" in the bond markets, clearly anxious that interest yields will surge as western states try to exit their QE experiment.


You don’t have to be a genuis in order to understand that something needs to be done in order to restore confidence in our current monetary system. In the end our monetary system is nothing but a confidence game. When confidence is gone, currencies end up being valued to the equivalent of toilet paper.

As long as confidence remain on the wane more countries will turn to gold like China and maybe calling for a greater role for gold in a new monetary system. After all not being on some sort of gold standard has been an expiriment which lasted for 38 years and has miserably failed (unless you call the creation of a quadrillion dollars derivate mountain a major achievement in human history).

So how to restore confidence then? Gold? Will gold ever makes it comeback into a new monetary system?


3. Gold & Monetary role

The gold standard has always been the anchor of world finance in the 19th Century but began breaking down in the early 20th century during world war I as governments engaged in unprecedented spending. Then it collapsed in the 1930s when the British Empire, the US, and France all abandoned their parities.

After world war II it was revived as part of fixed dollar system (Bretton Woods) until US President Richard Nixon was forced to close the gold window in 1971 in order to halt the dramatic outflow of gold caused by foreign central banks (France) changing their dollars for gold.

Ever since 1971 the US dollar has lacked any external anchor. It is widely argued that the financial excesses and extreme debt leverage of the last quarter century would have been impossible - or less likely - under the discipline of gold.

It seems now that after 38 years gold becomes an attractive alternative again for some foreign nations since the dollar as a wolrd reserve currency is losing confidence fast. We’ve seen China upping up its gold reserves and calling for a new world reserve currency that belongs to no individual nation. It seems that Russia is thinking alike:

Russia backs return to Gold Standard to solve financial crisis – March 31, 2009

Russia has become the first major country to call for a partial restoration of the Gold Standard to uphold discipline in the world financial system.

Arkady Dvorkevich, the Kremlin's chief economic adviser, said Russia would favour the inclusion of gold bullion in the basket-weighting of a new world currency based on Special Drawing Rights issued by the International Monetary Fund.


And what about the US itself? Do they back the idea of a new world reserve currency?

The answer is rather predictable:

Obama dismisses need for new international reserve currency
Washington - March 25, 2009

U.S. President Barrack Obama sees no need for a new global reserve currency as proposed by Russia and China, declaring the dollar "extraordinarily strong."

"I don't believe that there is a need for a global currency," Obama said during a prime-time news conference on Tuesday.

Russia has submitted a proposal to the G20 summit due in London next week for the IMF to examine creating a supra-national reserve currency, a move that was supported by the chairman of the People's Bank of China in an essay released on Monday.


You don’t have to be a genius in order to understand why the US does not want to give up the exclusive rights to print the world reserve currency.

De Gaulle called the Dollar "America's exorbitant privilege", repeating a phrase of his favorite economist, Jacques Rueff. This privilege gave the United States exclusive rights to print the Dollar, the world's "reserve currency", and force it on everyone else in payment of debt. Under the post-war Bretton Woods Agreement of 1946, the Dollar could not be refused.

Or as Amsel Rothchild once said:

Give me the right to print money and I care not who makes the laws.
He who controls the money streams rules.
Amsel Rothchild.

The battle for a new world reserve currency will unfold itself over the next few years whereby gold will shine as the only currency which no nation has the capability to destroy its value.


Next week point 6,7,8 which will back up the gold predictions of $5000 to $10.000 before 2015.

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Eric Hommelberg
The Gold Drivers Report
May 15, 2009



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