Gold in the Depression

Gold has worked down from Alexander's time. Can that be prejudice or mistaken theory...?

GOLD JUST PUT in one heck of a month in May, writes Byron King of Whiskey & Gunpowder, rising about 9%.

Silver did even better, advancing more than 26%. It's that silver slingshot effect, in which silver occasionally makes up for the time spent in the shadows of gold.

But can gold and silver do it again in June? You surely know that price of gold and silver can go down as well as up. Don't be shocked at a pullback. But for the medium and long term, precious metals look good.

I've often referred to owning gold and silver as a form of "insurance". And now, guess what? According to a recent report from Bloomberg, Northwestern Mutual Life Insurance Co. – the third- largest US life insurer by 2008 sales – has been Buying Gold. This is the first time in its 152-year history that Northwestern has purchased gold.

According to Northwestern CEO Edward Zore, "Gold just seems to make sense; it's a store of value." Then Mr. Zore added, "In the Depression, gold did very, very well."

According to Bloomberg, Northwestern has accumulated about $400 million in gold. CEO Zore believes that the Gold Price could double "or even rise fivefold" if the economy continues to weaken.

"The downside risk is limited, but the upside is large," Zore said. "We have stocks in our portfolio that lost 95%." But gold "is not going down to $90."

So here's a large, sophisticated company like Northwestern Mutual putting gold where its money is. I guess it wants to be around for another 152 years.

Meanwhile, the central banks, money center banks and most politicians of the world continue to hate the idea of monetized gold and silver. Why? Because precious metals require governments to operate in an economy based on hard work and long-term investment, rather than on bailouts and deficit-spending. So there are serious forces out there attempting to manipulate the precious metals back down. Expect it.

But you can't cheat Hephaestus, god of the forge. So if the metals retreat and share prices pull back for mining companies, use the opportunity to acquire more metal and shares at a discount to the future price. And remember that my basic precious metals recommendation is that you should have 5-10% of your portfolio in physical metal – and TAKE DELIVERY!

I'll be plenty happy if gold and silver move upward in the short term – say, over the next few months. But if we have to wait for the medium term, say, six-12 months, that's okay too. And surely, over the long term, a year or more, these metals ought to shine (no pun).

US politicians are spending the country so deep in the hole that the nation will never be able to work and pay its way out. Thus, the monetary stars are aligning toward economic hard times and future inflation. And as we see with Northwestern Mutual above, one investment idea that has historically worked out during hard times and inflation is the precious metals angle.

Along those lines, let's look at the share price of the old Homestake Mining Co. back in the 1920s and 1930s. Homestake was among the world's largest gold miners in its day, digging gold from the Black Hills of South Dakota. Due to a dearth of records, many historians use Homestake as a proxy for the entire gold-mining industry in that era.

Between 1929-1935, the Homestake share price rose – along with a significant rise in both earnings AND the dividend. Homestake's earnings per share (EPS) increased from $4.16 in 1929 to $32.43 in 1935. In other words, the gold miner showed annual compound EPS growth of 41%!

And much of the rise took place in 1930, 1931 and 1932, before Franklin Roosevelt became US president and seized the nation's gold, in April-May 1933. But even FDR's gold seizure didn't stop the upswing for Homestake. The stock, and its earnings and dividend, kept appreciating and held strong through most of the early years of the New Deal.

That is, the rest of the US business economy suffered from declining earnings during essentially ALL phases of the Great Depression. The overall US economy was awful, with national unemployment rates well over 25% at times. But through it all, the gold mining industry was a hot spot of economic vibrancy.

While we're looking at the history of gold in the Great Depression, let's consider what was going on with the banks in the US According to economist John Walter, writing in 2005 in the Economic Quarterly of the Federal Reserve Bank of Richmond, the US went from over 31,000 banks in the mid-1920s to under 15,000 banks by 1934. That is, over HALF of all banks FAILED! In 1933 alone, over 4,000 banks failed – that's about 80 per week, or 16 per business day.

And back then, a bank failure was almost always a total wipeout for depositors. There was no federal deposit insurance until late 1934, and the initial coverage was just $2,500. Most depositors in those 16,000 failed banks of the 1920s and early 1930s just plain lost everything. There was no relief at all. If you were a depositor, you went down with the ship.

Banks that didn't fail paid depositors a paltry 1% (or less) in "earned interest" on their savings. Makes you wonder why people kept any money in banks at all. Risk losing it or get paid 1% interest. Not much choice, right? No wonder that a lot of Depression-era people spent the rest of their days saving money in coffee cans in their basement.

All the while, Homestake shareholders collected dividends in the range of 8-10%, plus capital appreciation. The Homestake dividend went from $7.00 in 1920 to an astonishing payout of $56 per share by 1935.

It's interesting that "hard times" are somehow good for gold miners and gold mining stocks. One explanation I've heard is that the after-effects of the 1929 stock market crash caused a sustained contraction of the money supply (thanks to the Federal Reserve), along with a reduction of bank credit.

The result of less credit was that lending just plain froze. (Sound familiar?) Many businesses, households and individuals simply could not obtain credit no matter what their story. And most of the early New Deal programs – "relief", the Civilian Conservation Corps, the Works Progress Administration and the like – were just transfer payments to otherwise idle individuals. The New Deal may have institutionalized humanitarian government policy toward the unemployed, but it was NOT capital investment.

So with most private capital investment halted during the New Deal, there was a dearth of fundamental capital formation in the economy. The economy couldn't get traction to move ahead.

Tight credit extended even to governments, and by extension to their fiat currencies. As world trade tightened due to protectionism, public credit evaporated as well. Eventually, investors fled from paper currencies (even US Treasuries). The big players in international finance converted paper currency into the only "money" that was not someone else's liability – and not subject to counter- party default: gold.

Let me sum up by quoting one of America's legendary financial geniuses, Bernard Baruch (1870-1965). He said, "Gold has worked down from Alexander's time… When something holds good for 2,000 years, I do not believe it can be so because of prejudice or mistaken theory."