Crescat Capital The Valuation of Gold...Otherwise, money printing just creates outright inflation....

© 2013 Crescat Capital LLC

Crescat Capital

The Valuation of Gold July 3, 2013


Global Debt-to-GDP Imbalance

1 Includes all loans and fixed-income securities of households, corporations, financial institutions, and government.

Source: McKinsey Global Institute

2


Resolution of the Global Debt-to-GDP Imbalance

The global debt-to GDP imbalance reached historic unsustainable excess in the wake of the 2008 global financial

crisis. The imbalance is still excessive and only in the early innings of being resolved. It is being resolved with fiat

money printing by global central banks to combat otherwise deflationary debt deleveraging. Money printing helps

to deliver nominal GDP growth to deleverage overall debt to GDP with inflation and possibly some real economic

growth to go along with it. By printing money and artificially suppressing interest rates, central banks can spur real

economic growth, but only if low interest rate financing is applied to productive investment in economy as a whole

while wealth is extracted from fixed income savers. Otherwise, money printing just creates outright inflation.

One risk of money printing is that a critical mass of investors flee stocks, bonds, and fiat currencies all at the same

time in favor of inflation-protected assets like gold. This would force central banks to monetize new and existing

debt at ever increasing rates. Historically, this phenomenon has manifested itself as hyperinflation in many different

countries around the world. Hyperinflation has been launched from even lower debt-to-GDP and money printing

levels than we have in the world today. If we can transition from a deflationary to an inflationary environment

gradually, however, we could enjoy a period of rising real economic growth with only moderate inflation that could

resolve the debt-to-GDP imbalance over time. Investments in stocks could do quite well in that environment,

particularly ones that make productive use of long-term fixed rate financing. Gold should also do well in that

environment, particularly starting from today’s market price, which is extraordinarily undervalued, as we will show.

In either case, one should be prepared now for rising inflation, and one should also have protection against

potential hyperinflation, particularly given the valuations that the market is giving us in precious metals today.

Stocks, meanwhile, offer opportunity on both the long and short side globally.

3


What is the difference between money and debt? • Sovereign fiat currencies constitute the widely accepted

understanding of money today.

• We can measure the core amount of fiat currency using monetary

base figures reported by central banks.

• Government and other perceived high quality credit are also

considered money today.

• But debt and fiat currency do not meet the classical economic

definition of money if they do not offer a “store of value”.

• Both debt and fiat currency depreciate in real value when their

supplies are increased relative to the growth rate of the real

economy.

• Precious metals have endured and performed for centuries as

money that retains a long-term store of value and protection against

rising inflation, debt collapse, and fiat currency debasement.

• Over shorter time frames, precious metals can be over- or under-

valued on a real basis if they are not accurately discounting future

inflation.

4


“Gold is Money. Everything Else is Credit.”

- J.P. Morgan The lesson of economic world history over hundreds of years in country after country is that precious metals

represent the only form of true money capable of maintaining a store of value over long time periods. Time

and again, countries have swung back and forth between gold- and silver-based monetary regimes and fiat-

monetary regimes with the value of debt and fiat monetary regimes being destroyed each time with inflation

and/or hyper-inflation with precious metals returning to fully constitute the real monetary base. China is a

serial offender with epic rises and falls of its fiat/paper monetary systems that each time reverted back to

precious metals after the value of paper money was fully destroyed by overprinting. Each occurred during a

major imperial dynasty: Sung (960-1126) Chin (1127-1234), Southern Sung (1127-1275); Yuan (1260-1360);

Ming (1368-1644).

Today, China is a command economy in the midst of world record real estate and credit bubble. China

currency is likely to go bust in a big way, and few are expecting it. China’s central planners have been stuck in

a loop of excessive, poor quality, and unnecessary infrastructure building that has driven the bulk of China’s

economic growth in the last decade. It has been funded by ongoing cycle of money printing and bank

bailouts. Westerners have been getting sucked into helping fund the China Ponzi scheme for years, based on

the false notion that China’s growth model is sustainable. It isn’t. It is poised to unwind badly. The problem

of fiat money is always the same. Sovereign-based fiat monetary systems lend themselves to excessive credit

expansions which lead to bubbles, busts, that ultimately lead only to more money printing, currency

devaluation, inflation and/or hyperinflation. After substantial currency devaluation and inflation, precious

metals re-assert themselves as money. This time will almost certainly prove no different. What is unique

about this cycle is that today we live in the most leveraged fiat-based debt bubble in world history.

Gold is the cheapest it has ever been relative to the global fiat monetary base. Silver is even cheaper.

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The Global Monetary Base Has Been Growing At a 15% Compounded Annual

Growth Rate Over the Last 10 Years – China Has Been the Largest Money Printer.

Monetary Base Growth Forecasts Inflation With a Lag.

-

2,000,000

4,000,000

6,000,000

8,000,000

10,000,000

12,000,000

14,000,000

16,000,000

Global Monetary Base (Millions USD Equivalent) (Top 80% of World GDP Countries)

Poland

Sweden

Canada

Mexico

Australia

Indonesia

South Korea

Saudi Arabia

Turkey

Brazil

Norway

Hong Kong

Russia

India

Switzerland

Japan

United Kingdom

Eurozone

United States

China Source: Global Central Banks

The global monetary base continues to expand at a brisk pace to monetize the record unsustainable level of debt to GDP. China, contrary to

most people’s understanding, is the world’s largest money printer based on its narrowest reported monetary aggregate. Japan, the highest debt-

to-GDP country in the world, is challenging the U.S. and China by accelerating its monetary base expansion to twice that of the U.S in the

relative to its GDP. The Eurozone and UK also lead the world in absolute levels of fiat money printing.

6


The Global Gold Supply Grows At Only

Approximately 1.7% Annually.

100,000,000

1,100,000,000

2,100,000,000

3,100,000,000

4,100,000,000

5,100,000,000

6,100,000,000

1900

1903

1906

1909

1912

1915

1918

1921

1924

1927

1930

1933

1936

1939

1942

1945

1948

1951

1954

1957

1960

1963

1966

1969

1972

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

2008

2011

Above Ground Gold (Ounces) 162,500 Metric Tons as of 12/31/2012

Gold is hard to find and produce. It exists in the earth's crust at approximately .005 parts per million.

Source: USGS & World Gold Council

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28,000.00

29,000.00

30,000.00

31,000.00

32,000.00

33,000.00

34,000.00 12/1

/2000

4/1

/2001

8/1

/2001

12/1

/2001

4/1

/2002

8/1

/2002

12/1

/2002

4/1

/2003

8/1

/2003

12/1

/2003

4/1

/2004

8/1

/2004

12/1

/2004

4/1

/2005

8/1

/2005

12/1

/2005

4/1

/2006

8/1

/2006

12/1

/2006

4/1

/2007

8/1

/2007

12/1

/2007

4/1

/2008

8/1

/2008

12/1

/2008

4/1

/2009

8/1

/2009

12/1

/2009

4/1

/2010

8/1

/2010

12/1

/2010

4/1

/2011

8/1

/2011

12/1

/2011

Total World Central Bank (Metric Tons)

Global Central Banks are 800-Pound Gorilla Buyers of Gold Who Will Drive

The Price Substantially Higher, Particularly When The U.S. Eventually Jumps In

Source: World Gold Council

We expect central bank gold buying to accelerate rapidly as central banks augment their QE with gold asset

purchases. We hope Bernanke and Yellen get the memo and pay particular attention to the low valuation of gold

relative to the USD monetary base as they consider their range of QE asset purchase options.

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0

100

200

300

400

500

600

Central Banks That Have Increased Their Reported Gold Reserves in the Last Five Years

(2008 to 2012, metric tons)

For Now, Russia, China, Turkey, India, Saudi Arabia, and

Mexico Lead the Charge Along With the Bank For

International Settlements, A Central Bank Vehicle Dominated

by U.S. and Western European Interests.

9


Countries With The Most Gold to GDP Today

0%

10%

20%

30%

40%

50%

60% In

dia

Port

ugal

Sw

itzerlan

d

Germ

any

Fra

nce

Hypo-E

uro

Neth

erlands

Austr

ia

Belg

ium

Saudi A

rabia

Gre

ece

Turk

ey

Russia

Slo

vakia

Italy

Sw

eden

Spain

Fin

land

Pola

nd

United S

tate

s

Slo

venia

EC

B

Luxem

bourg

Japan

Malta

Chin

a

United K

ingdom

Bra

zil

Irela

nd

Mexic

o

Indonesia

Kore

a

Austr

alia

Esto

nia

Hong K

ong

Canada

Percent of GDP in Central Bank Gold Reserves

Source: World Gold Council & Bloomberg

Notice that many European sovereigns have solid gold-to-GDP levels which they could use to exit the

euro and re-form their own currencies. India would be the biggest beneficiary of a rise in the price of

gold.

10


Sovereign/Central Bank Gold Holdings


U.S. Treasury Owns The Largest Gold Reserves

The U.S. Treasury Owns The Largest Gold Reserves

11


0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1918

1920

1922

1924

1926

1928

1930

1932

1934

1936

1938

1940

1942

1944

1946

1948

1950

1952

1954

1956

1958

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

Value of U.S. Gold Reserves / U.S. Monetary Base

Gold Is Historically Undervalued Based On U.S. Reserves

To USD Monetary Base

The U.S. monetary base has been backed at least 1:1 by the value of its gold reserves twice in the last 100

years: 1934 to 1942 (on a gold standard) and again in 1980 (not on a gold standard). In prior periods, gold

and silver have served as the global monetary base.

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-

2,000

4,000

6,000

8,000

10,000

12,000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Price Per Ounce of U.S. Gold Reserves in U.S. Monetary Base $

Gold Is Worth $10,000/Ounce Today Based On The Value Of U.S. Gold

Reserves Priced in U.S Monetary Base. This Is The High End Of Crescat’s

Valuation And Target Price In Today’s Dollars (Real Price) For Gold

Market and global central bank forces can combine to realize this value:

1. Fed can buy gold in free market with printed dollars (QE) both increasing its gold reserves and

driving up the price of gold.

2. Private investors around the world can buy gold, driving its price in dollars up.

3. Non-U.S. central banks around the world can print their own money, buy gold.

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-

500.00

1,000.00

1,500.00

2,000.00

2,500.00

3,000.00

3,500.00

4,000.00

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Price Target for Gold Based on Global Monetary Base of Top 80% of World GDP Countries Converted to USD/ Total World Gold Supply

Gold Is Worth $3,400 Per Ounce Today Based On The Global Fiat Currency Monetary

Base Compared To Total Above Ground Gold Ounces. This Is The Low End Of

Crescat’s Valuation And Target Price For Gold In Today’s Dollars (Real Price)

Source: Global Central Banks, USGS, World Gold Council

The target price will continue to increase in line with the dollar value of the global monetary base until

inflation is perceived and global consciousness shifts from deflation to inflation, at which point money

velocity will spike, and the price target for gold will almost certainly be achieved in a parabolic step function.

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Why Would Central Banks Want to Buy Gold?

• Excessive debt to GDP is resolved most easily and conclusively by surreptitious inflation

through fiat money printing.

• Buying gold strengthens a Treasury’s balance sheet.

• It is the best form of central bank asset purchases (quantitative easing or money printing)

because it uses expensive fiat money to acquire cheap real money.

• It is like an all-stock cash flow accretive acquisition.

• It’s a net positive present value transaction, capturing a value arbitrage.

• It is a much better way to devalue a country’s debt and money than to buy other countries’

overvalued Treasury bonds.

• Central banks will likely need gold again in the future to collateralize their sovereign bonds

and fiat currencies.

• The outcome is almost certain: central banks will secretly print money and buy gold

because it is in their own best interest.

• In game theory, the extremely high probability of this outcome is driven by the

preconditions for what is called a prisoner’s dilemma.

• It is a reflexive process that feeds on itself.

• Best to buy precious metals now while they are historically cheap on a real basis relative to

global fiat money printing and the future inflation that can be discounted today.

• Best to buy precious metals now while hedge funds and investing masses have been shaken

out and/or are short and are about to be squeezed by central bank buying.

15


Investment Process – Dynamic and Reflexive

Global Macro Investment

Themes

Data-Driven Fundamental

Analysis

Proactive Investment Execution

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Current Macro Themes

•New Oil and Gas Resources

•Digital Evolution

•Nanoscale

•U.S. Housing Recovery

•Global Fiat Currency Debasement

•China Infrastructure Bubble

•Aussie Housing Bubble

•Resolution of the Global Debt-to-GDP Bubble

17


Crescat Capital LLC, through its wholly owned

subsidiary Crescat Portfolio Management LLC, is an

investment adviser registered with the U.S. Securities

and Exchange Commission. Reported returns are

purely historical, no indication of future performance,

and may be adjusted subsequent to third party

accounting verification and audit. The information

contained herein does not constitute an offer to sell

nor the solicitation of an offer to buy interests in any

fund. Such an offering is made solely by means of a

fund private placement memorandum as presented by

a fund principal. The information contained herein is

not being distributed publicly, is confidential, and is

not to be redistributed to any other persons without

the prior permission of Crescat Capital. Only qualified

investors will be admitted as limited partners to a

Crescat fund.

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Contact Info

Crescat Capital LLC

1560 Broadway, Suite 2270

Denver, CO 80202

Office: 303-271-9997

Fax: 303-271-9998

Kevin C. Smith, CFA

CEO/CIO

[email protected]

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Crescat Capital The Valuation of Gold...Otherwise, money printing just creates outright inflation....

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