Bullion as an Investment, Part 2

With gold being ridiculously undervalued, all the bubble propaganda generally has only a mild impact on the gold market.
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Editor's note: This is part 2 of a three-part series on gold bullion as an investment. Here are part 1 and part 3.

Central Banks Repent

In the

first part of this commentary, I introduced readers to my model for bullion valuation, and discussed the most important component of supply to this market: mine production. There is, however, a second component to the rate of change in gold stockpiles. Because gold is the world's best "money," it has been almost completely conserved by our species. In other words, nearly every ounce of gold ever mined could (theoretically) be gathered together, into a single stockpile. On a much more practical level, what this means is that significant amounts of gold are continually being recycled through "scrap sales" -- primarily selling old, gold jewelry, melting it down, and re-converting it to ingots.

Once again, we have an expectation, based upon the fundamentals of economics: as the price of gold rises, we would expect more and more of this scrap supply to come onto the market. In fact, as with mine supply, the actual data does not reflect the expected trend.

More specifically, scrap supply is also relatively flat, although there is much more volatility in this part of the gold market -- meaning that this number regularly bounces up and down. In reviewing the fundamentals of the gold market, the World Gold Council has concluded that scrap supply has not been a simple function of price, but instead is a more complicated function of the rate of change in price.

What the

World Gold Council has observed (to date) is that while there has been no steady trend higher in scrap supply to match the advance of prices, whenever there is a sudden spike in the price of gold, there is a corresponding spike in scrap supply -- but these spikes are of very brief duration.

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In this respect, I can go beyond the analysis of the World Gold Council to provide a more detailed explanation for this fact pattern. As I mention on a regular basis, we are being subjected to an endless deluge of anti-gold propaganda. Indeed, it is now impossible to go even a single week without some pseudo-expert boldly proclaiming a bubble in the gold market.

As I pointed out in

a recent commentary, such articles not only reflect the sheer idiocy of the author(s), but are in fact completely immoral. Discouraging people from acquiring (and keeping) their gold and silver insurance -- while bankers destroy our wealth with the most insane money-printing in human history -- is identical, conceptually, to discouraging people from getting fire insurance for their homes, in the middle of an epidemic of arson. These bullion Chicken Littles should be both ignored and reviled.

Nonetheless, these despicable fear-mongers have served one purpose in the gold market: they are continually flushing out all of the potential, short-term sellers of scrap gold -- and suddenly the pattern observed by the World Gold Council makes perfect sense.

With gold being ridiculously undervalued (even if we use the inflation numbers of the U.S. government to gauge this), all the ridiculous bubble propaganda generally only has a mild impact on the gold market. It's only when there is a sudden spike in the price of gold that the bubble propaganda becomes plausible to significant numbers of gold holders -- and thus they start selling.

Thanks to this phenomenon, we can rule out one of the warnings of the gold bears: that, at some point in time, there will be a flood of scrap gold coming onto the market. Indeed, without the perpetual, round-the-clock gold-bashing, and bubble propaganda, that would have been a reasonable prediction. However, because the Chicken Littles are ensuring maximum sales of scrap at every price level, gold investors can confidently rely upon the fact (confirmed by nine years of empirical evidence) that there will never be any flood of scrap sales -- apart from the very short-term spikes previously mentioned. In other words, thanks to the propaganda, scrap sales can also be considered as a flat variable.

In fact, there is a persuasive argument to be made that we will begin to see a steady trend lower in scrap sales. If it sounds intuitively absurd that people would start selling less gold, after a quintupling in price, and with the price still rising, we need only look at the Central Bankers: the world's foremost, monetary "experts."

These officials, who are literally "worshiped" by most of the slavish, mainstream media, spent roughly 20 years dumping their bullion at a furious rate, and at fire-sale prices. Now, only after gold has quintupled in price are these "experts" experiencing "sellers' remorse." Central bank sales of bullion have not only ground to a complete halt, but now these esteemed-experts are buying back the gold they previously dumped at a fraction of current prices.

What has prompted the world's foremost experts on monetary policy to engage in the practice of selling (very) low and buying (very) high? In the third and final part of this commentary, I will answer that question, complete my valuation of the bullion market -- and explain why all fixed income investments should be abandoned by rational investors.

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.