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Bullion as an Investment, Part 3

We have all heard that tired old line that "gold produces no income." Well, neither do (most) stocks.

Editor's note: This is part 3 of a three-part series on Bullion as an Investment. Part 1 was published Friday, and part 2 was published Saturday.

The Superior Choice

In the first two parts of this commentary, I demonstrated to readers that supply to the gold market is essentially flat, and drew attention to the strange, flip-flop of central bankers who were dumping vast amounts of bullion -- at the lowest prices in history -- and are now buying large amounts of bullion (at the highest, nominal prices in history).

What has caused central banks to violate the golden rule of investing ("buy low, sell high")? Simple. These are the same officials who are destroying our (paper) currencies with their money-printing -- and thus they know (better than anyone else on the planet) that gold will continue to rapidly appreciate vs. their own diluted paper.

The tidal wave of inflation which is being unleashed is only just beginning to be felt by the average person. Indeed,


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just reported a 6% month-over-month change in store prices. This translates to an annual inflation rate of 72%, and represents the largest month-over-month price increases in Wal-Mart history.

What this means is that we have every reason to believe that individual gold holders will undergo the same born-again transformation to gold bugs which we have seen with central banks. Thus, we could easily see scrap sales suddenly collapse.

Tempering this trend, however, is the economic reality that ordinary individuals have had their standards of living destroyed by the greed and incompetence of bankers. Because of this, many ordinary citizens may be forced to liquidate some of their bullion -- to simply survive. Indeed, we (as precious metals commentators) would be charlatans, ourselves, if we told people that they needed precious metals "insurance" -- and then predicted that they would never use it.

It is impossible to precisely quantify these variables, but certainly not unreasonable to treat this as a neutral factor: that while extreme volatility will continue to exist in scrap-sales, the overall trend will be flat. After all this analysis, we ultimately reach a simple position: on the supply side, we should expect neither "acceleration" or "deceleration" in the supply of gold.

This means we can answer our initial question (will bullion appreciate in absolute terms?) by focusing totally on the "demand" side: the acceleration (or deceleration) in global incomes. This analysis will be much simpler (and shorter) as it can be laid out very clearly.

The statistic which I will focus upon is GNI (or "Gross National Income") per capita.Global per capita GNI:

2001: $5120 (USD)

2005: $6987

2009: $8751

Looking at global incomes for the entire duration of this bullion bull market (up to the end of 2009), we see that they have increased by just more than 70%. With an acceleration in global incomes of 70%, while there has been zero acceleration in gold supplies, this one piece of data (alone) indicates that since the bull market began, gold has become 70% more valuable (above and beyond all inflation over that span).

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There are two reasons why we don't need to convert these nominal numbers into "real dollars." First of all, we are measuring percentage changes, and deflating these numbers (year-by-year) for the existing inflation would have little impact on the numbers. Secondly, and more obviously, we are buying our bullion based upon the current, nominal value of our paper currency.

As a last note for readers, keep in mind that the change in global, per capita incomes significantly underestimates the increase in wealth, as this statistic does not include any of the increases in the value of the assets held by these individuals. File this away as yet another factor which underestimates the true increase in the value of bullion.

Because this income measurement is being done on a per capita basis, we also need to factor in changes in population -- in order to calculate the total acceleration of global incomes. It's not simply "people making more money," but "more people making more money." While in recent decades, global population growth has averaged around 2% per year, last year, the growth in population was only 1.1%.

As gold bulls, we can afford to be conservative in our estimates, so I'll use the lower, current number instead of the long-term average. This leads to the following equation:

Acceleration of incomes = acceleration of per-capita income X increase in population; or:

70% X 1.1% = 77%

Note that choosing a very conservative number for population growth dramatically lowers our multiplier, and thus dramatically affects our estimate of the real increase in the value of gold. Had I chosen the long-term average of 2%, then instead of estimating the rise in value of gold at 77% over eight years (nearly 10% per year), our estimate would have changed to 140%.

I would also ask readers to note that the eight years in question covered several serious shocks to the global economy, most notably the "Crash of 2008." Yet, if we look at gains in per capita GNI from 2001-2005, vs. 2005-2009, we see roughly a 44% gain for the first four-year period, but still a 26% gain for the last four years (a very respectable 6.5% annual gain).

What this means is that while changes in per capital GNI will fluctuate considerably, that we can rely upon significant, real increases in the value of gold even during periods of global economic crises. Moreover, by (deliberately) using a very conservative multiplier for population growth, we can rely upon the 77% increase in value over eight years as (if anything) a conservative estimate of what to expect in the future.

It is extremely important for investors to understand and realize the appreciation of the value of bullion -- in real dollars -- as it instantly eliminates some of the myths which the gold bears use to try to scare away investors.

Presumably, we have all heard that tired, old line that "gold produces no income." Well, neither do (most) stocks. However, equities are widely preferred by investors over fixed-income instruments (for any investor focused upon "growth"), because the capital appreciation of equities will dwarf the returns of fixed investments (over time) -- if an investor chooses his stocks carefully and competently.

In the case of bullion, there are only "two stocks"-- gold and silver. I have already demonstrated the rapidly appreciating value of gold. As regular readers know, we can expect silver to greatly outperform gold -- due to the destruction of global silver stockpiles, combined with the extreme-and-absurd gold/silver price ratio.

This analysis should result in all rational investors dumping all fixed-income investments, since they are all denominated in the bankers' diluted paper, and no fixed-income investment can equal the rate of increase in the value of bullion. Show me a "bond" that pays 10% per year, and I'll show you a debt that is about to default.

More importantly, this analysis should hopefully go a long way toward curbing the irrational aversion of many investors with respect to holding their own physical bullion. Listening to the lies of the bankers and the bears, most investors have been brainwashed into believing that they face a "double-loss" holding bullion: the supposed "interest" they get paid on banker-paper + the (minimal) storage costs of holding bullion.

In fact, there is not one, single paper currency which pays interest anywhere near the actual rate of inflation. All fixed-income investments lose value, every year, when (real) inflation numbers are factored in. "Bank interest" is the cruelest of banker illusions. Meanwhile, the (roughly) 10% per year increase in the real value of bullion not only more than covers any/all storage costs but generates a real, net increase in wealth for its holders.

Given the unprecedented economic crisis we are now experiencing, and which we can expect (with complete certainty) to worsen in the future, I will continue to advise people to accumulate bullion as "insurance." However, the genuine, objective increase in the absolute value of bullion guarantees to investors that there will be no costs to buying and holding this insurance. Indeed, their "insurance" will likely outperform most of their "investments."

This is the real truth of the bullion market. Investors must not allow any dishonest bankers or shrill fear-mongers to deter them from the only, reliable means to protect themselves from what is to come.

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.