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Even gold can't hedge a nuclear implosion

Bob Moriarty
Oct 27, 2008

[Editor's note: The Original Gold Bear click]

We have had another week of carnage in the markets with gold hitting new lows and gold shares getting hammered yet again. It's enough to make a gold bug slit his throat. Wasn't gold supposed to be some magic commodity that acted as an insurance policy against financial chaos? We have the financial chaos but gold has tanked.

Actually gold has been a hedge but an imperfect hedge. If you were Canadian or Australian or English, you would wonder what all the hoopla was about from the Americans because in their currencies gold is hitting new record highs. Gold worked exactly as advertised and those investors are all standing in high cotton.

Even the hedge funds used gold to hedge. I use the term hedge funds lightly. I'm not sure who made up the name "hedge funds" because they functioned far more as out of control casinos with crooked dealers.

The hedge funds did hedge using gold. They may have had 5-10% in gold. Since gold was $660 an ounce only in August of last year, the hedge funds actually made money on gold before chaos appeared and they were forced to sell their gold. They had to sell their gold because the other 90-95% of their bets were leveraged 50 to 1 and when those went south, they sold their gold because they could.

Gold hasn't gone down in US dollar terms because it has lost its role as an insurance policy against chaos. It went down because it was being used as a hedge and it was the last thing of value the bankrupt hedge funds could sell. But if you think gold going down $40 in a day gets exciting, just wait a few days until it starts going up. Lots of hedge funds shorted gold and when they get forced out of their positions, gold is going to roar higher $100 a day. The $87 dollar move higher in a day that came 6 weeks ago was just the first of many barnburner days.

It's a confusing time for everyone. We are in a place the world has never been before; in uncharted waters. I've made the comment in the past that only 10 people in the world actually understood derivatives. That number is probably up to 100 by now, more people are catching on.

Derivatives are simple to understand. They are financial instruments that derive their value from something else. Gold calls are derivatives, stock options are derivatives, futures are derivatives, credit default swaps are derivatives. Securitized mortgages sold in large lots are derivatives.

But derivatives grew totally out of control and indeed were growing 50% a year and no one took any notice. I did. With derivatives growing 150% faster than the total underlying economy, there had to be a lot of fraud involved. There was and it's all coming to the surface. The hedge funds were similar to giant casinos where when they won a bet, they took the winnings home in real money and when they lost, they paid off in Monopoly money, secure in the knowledge that the government would bail them out.

Well, the governments of the world have been dumping piles of $100 bills on the bonfire and every day the situation becomes worse as markets realize the government action is counterproductive. So far the US administration of George Bush has nationalized Fannie Mae, Freddie Mac and the entire banking system. It nationalized insurance giant AIG about a month ago and the company has already gone through $123 billion dollars in two tries at the feeding trough and is back for another feeding. Ford, GM and Chrysler have had $25 billion thrown at them and want more. The government of California wants $7 billion. State and local governments across the country are whining to be bailed out.

Is there no price to be paid for stupidity and cupidity? Are we going to bail out every fool who made foolish bets? Under the Bush administration is failure the new "No Chump left behind?" Where are we going to get the printing presses required to make all the new money?

The solution is going back to a real Bretton Woods agreement where all currencies are tied to gold directly. Where all international currencies are denominated in units of gold. We have total financial chaos yet you can still, for the time, buy an insurance policy in the form of physical gold and silver. If you never have before, you need to quickly.

Someone sent me a copy of a list put out by Canaccord Capital on Friday showing about 100 resource companies selling for cents on the dollar. I want my readers to understand that these are good companies who have been dumped by hedge funds because of deleveraging and nothing more. When you can buy $1 bills for $.80 and get a free mine and mill with it, it's a situation that won't last long.

Evolving Gold has a market cap of $13.6 million and cash of $19.5 million. Olympus Pacific has an $11.6 million dollar market cap and $16.2 million in the bank. Full Metal Minerals has a market cap of $8.1 million and cash of $9.8 million. My favorite, ATW Gold, has a market cap of $14.6 million and $14.7 million in cash and owns two gold mines and two mills and will be in production in March of 2009 at a rate of 50,000 ounces of gold a year. It doesn't get any better than that.

To conclude, gold won't hedge totally against a nuclear implosion and we have had that. Nobody really called how bad it would get even if there were a lot of people who knew it would be bad. Bob Hoye did the best job of timing and recommendation that I have seen.

The system is breaking apart. We are not past the shoals; there are some really bad times ahead. TA and Fundamental analysis are both pretty useless because we don't have anything to compare where we are or where we are headed. It's a time to be prudent, very prudent.

And while gold and gold production stories are not a perfect hedge, they are better hedges than anything else.

Oct 26, 2008
President: 321gold

321gold Ltd