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By Daniel R. Amerman, CFA
Let's start with two quick questions
for gold investors. We're going to assume, as will be illustrated in detail later
in this article, that 10 to 15 years from now a dollar is worth a nickel, that after
a tremendous bull market gold has returned to more or less its long-term
average value in inflation-adjusted terms (meaning a far higher dollar price
for gold than today), and that as governments struggle financially around the
world, the future average marginal tax rate on gold profits is 50%.
Question
One. If the future dollar is worth five
cents, and gold is trading around its long-term historical real (inflation-adjusted) value, which would
be $9,000 an ounce in future dollars, did you:
A) Make a killer investment that's
really multiplied your net worth? Or,
B) Lose more than 80% of your net
worth, with much of that going to the government?
Question
Two For Extra Credit.
Let's say that gold eventually returns to something close to its long-term
historic average value, and we'll call that $450 an ounce. Which of the
following scenarios gives you a higher after-inflation and after-tax net worth?
A)
Gold is nominally at $9,000 an ounce but in inflation-adjusted terms is only
worth $450 an ounce.
B) Gold goes straight from $1,350 an
ounce down to $450 an ounce with no significant inflation.
The correct answers are B and B. If the dollar becomes
worth five cents and gold eventually returns to its long term average value in
real (inflation-adjusted) terms, then you lose over 80% of your net worth on an
after-tax basis. Also, if gold is going to return to its long term inflation-adjusted
value, you are almost three times better off if gold is selling for $450 an
ounce, than if it was selling for a nominal $9,000 an ounce.
How did you score?
You may doubt the answers right now,
but will come to understand them as we
cover these questions in step by step, irrefutable detail. If you missed either correct answer, or if
anything at all came as a surprise, let me suggest that it is very much in your
long term financial interest to read this complete article, and then learn some
of the professional grade tools that you will need to get ahead in real terms (after-inflation and after-tax). If you are a long-time reader, please also
note that what is quite different in this article from my previous articles on
gold, is that it addresses how gold asset
deflation in purchasing power terms affects investors when they buy into a
precious metals bull market that is followed by substantial monetary inflation.
Gold and silver can be superb
investments for the current times, and when you use a professional level
strategy – then a heavy precious metals weighting can be a key component in not
only surviving the destruction of the value of currencies, but potentially
building multigenerational wealth even
after adjusting for the corrosive effects of inflation and taxes. Also please note that the principles
illustrated herein are not dependent on the specific example of gold regressing
to a long term valuation mean, but are even more important in a spectacular
bull market where gold could hit the highest real valuations of our lifetimes. But whether we are looking at long term
declining valuations or short term soaring valuations, to understand the
difference between the gold investors who will be highly successful, and the
gold investors who will lose most of what they have, we need to look at the
difference between examining gold using professional level methodologies versus
the alluring but deceptive surface level used by so many gold investors.
For this reasonable illustration,
let's start with you. We'll assume that you've been a gold investor for some
time, because you've been looking at the irresponsible financial and monetary
decisions of your government for many years, and you have concluded that the
destruction of the dollar was the most likely result. Unfortunately for us all - you are turning
out to be exactly right. Now you're seeing the madness that has officially
consumed the Federal Reserve with QE2 and the creation of new money in an amount
equal to 9% of the US economy. In other
words, a thousand dollars per household per month, is being created directly
out of the nothingness by the Federal Reserve and then used to purchase
treasury bonds. You believe that the end of the dollar as we know it is indeed
approaching, and you buy still more gold at the current market price of
approximately $1,350 per ounce.
While we're making assumptions, we
will assume that what I have been writing about for many years comes true, and in
addition to the above, the government uses massive inflation (such as that so
conveniently eventually caused by QE2, QE3 and QE4) to effectively meet the
Social Security, Medicare and pension promises that would otherwise be
impossible. For a nice round number
we'll take the example developed in the article linked below, "Bailout
Lies Threaten Your Savings", and assume that the bottom line is correct
and the dollar becomes worth a nickel.
http://danielamerman.com/Video/BBL1B.htm
Now if gold is currently selling for
$1,350 an ounce, and gold were to entirely keep up with inflation, (which it is
likely to do and even exceed in the next few years), then gold would rise to 20
times its current value, which would be $27,000 an ounce. Which sounds spectacular, but keep in mind
that when we adjust for inflation, the real (inflation-adjusted) value of our
investment is merely constant at $1,350 an ounce in today's dollars.
However, for our example we are not
assuming peak valuation (i.e. selling near the top) but rather a long term
buy-and-hold strategy for an investor who truly believes in the wealth
retention power of gold. So the peak of the crisis came and went some years
ago, we're a more impoverished nation than we were, and this relative
impoverishment is concentrated among the retirees and boomers whose savings,
retirement accounts and investments were shredded in the Great Collapse. We'll assume that a new and poorer financial "normalcy"
has returned, as some form of "normalcy" almost always does
eventually, Zimbabwe notwithstanding. So
we're looking 10 or 15 years out and saying that gold has returned to its
long-term historic average value. Like
it eventually did after the last great gold bull market of 30 years ago that
accompanied the stagflation of the 70s and early 1980s.
The graph below tracks the long-term
inflation-adjusted value of gold, using New York market prices from 1791
through 2009. There are difficulties
involved with the calculation of long term inflation rates, and the numbers
need to be taken as a ballpark range rather than being precise values. Therefore the average shown of $458 an ounce
is likely more indicative of a valuation between, say, $433 an ounce and $483 an
ounce. By coincidence, $450 an ounce, which
is near the middle of the range, is precisely one third of today's price of
about $1,350 an ounce, which makes illustration calculations easy to follow.
So let's take what the value of gold
would be if it precisely kept up with inflation, $27,000 an ounce, and say that
long after the crisis has passed, gold has "regressed to the mean"
and returned to its average value in real terms over the last couple of
centuries, and that's an inflation-adjusted $450 an ounce, which is one third
of $1,350. So we take our $27,000 and we divide by three, which gives us a
value of $9,000 an ounce. (We then check
by multiplying by 5%, and it is indeed an inflation-adjusted value of $450 an
ounce.)
While not quite as exciting as
$27,000 an ounce, $9,000 an ounce sure does look a whole better than $1,350 an
ounce, and indeed, when we divide $9,000
by $1,350, we come up with 667% of our starting investment value.
That is all well and good, except
that there's a slight complication. When
you eventually sell the gold to fund your lifestyle or redeploy the assets, the
government compares the $9,000 sale price of gold versus the $1,350 you bought
it for and sees a $7,650 profit. And the government says that we're in very
difficult times (thanks to the mess it created years before) and we all need to
pay our share, which is now 50%. (The idea the tax rate will "only"
be 50% being a decidedly optimistic one perhaps.) So we take our $9,000, we pay
the government the half it demands of the $7,650 book profit, which is $3,825,
and we're left with $5,175. That's still not too bad as it is almost four times
what we originally bought the gold for.
Except there's this second
complication of our needing to adjust for a dollar only being worth a
nickel. $5,175 times 5% is equal to
$259. That's right, if we buy gold at $1,350 an ounce, and we sell at the long
term average inflation-adjusted price for gold (about $9,000) when the dollar
becomes worth a nickel, and we pay 50% in taxes on our "profits",
then we're left with $259 an ounce in
gold purchasing power after adjusting for both inflation and taxes. If we
compare that $259 with the $1,350 we started with, we have only 19% percent of
our net worth remaining on an after-inflation and after-tax basis. When we
compare the 667% (or $9,000), which is the glittering surface that many
investors would look to, to the 19% (or $259) in real purchasing power that
investment professionals would see as being the end result, the difference is 3475%
($9,000/$259 = 3475%).
Let's quickly review the five
columns:
We
start with $1,350 an ounce gold;
A
dollar becomes worth a nickel (monetary
inflation), and gold exactly keeping up with inflation would mean $27,000 an ounce;
However,
gold at $1,350 an ounce is roughly 3 times the long-term historic average, and
if gold eventually returns to its long-term average real value in
inflation-adjusted terms after 10-15 years, that would be about $9,000 an ounce (asset deflation in purchasing power terms);
The
government taxes us heavily on the decline in purchasing power on our
investment, because the tax code doesn't (usually) recognize inflation (inflation taxes), leaving us with $5,175 an ounce; and
When
we finally multiply by 5% to account for a future dollar only being worth 5
cents in purchasing power compared to today, we are left with the tiny column
on the far right, which is $259 an ounce
in after-tax and after-inflation terms.
It is the ultimate, spendable reality:
what we can purchase after paying taxes.
As illustrated in this reasonable
example, when we compare the $9,000 an ounce value in the "surface"
column, and the $259 "real" value in the spending power column, let
me suggest that there is a 3475% difference between looking at gold performance
using professional analysis tools, and performance when measured with the
simple surface approach.
The sources behind our going from an
apparent huge gain to losing 81% of our real net worth are that (1) the value
of money was destroyed (aka monetary or
price inflation); (2) that gold eventually fell in real terms in a
regression to the mean to its long term average value (aka asset deflation in purchasing power terms), and (3) that even
partially keeping up with monetary inflation created a false income that was
taxed by the government (aka inflation
taxes). When all three parts work together, we take what on the surface looks
to be the best investment decision of our life and we instead lose most of our
net worth.
When (1) the Federal Reserve and
European Central Bank are creating new money out of the nothingness on a
massive basis; when (2) you are buying at the highest gold prices in real terms
in almost 30 years; and when (3) your government is effectively bankrupt and
highly likely to be raising tax rates in the future, let me suggest that what
we just illustrated are three of the most important factors in your life when
it comes to determining what your future standard of living will be for both
yourself and your family.
We do not have to be helpless
victims, however. Right now and the years coming up may indeed be some of the
most advantageous times of our lifetimes to create wealth through purchasing
gold and silver – but we've got to get there using a little different path than
the simplest and most popular strategies.
Gold investors are well aware that
gold is trading at high prices relative to where it has been for most of the
last 30 years, and that while we may have strong opinions about where
investments are likely to go, we rarely have guarantees. Serious investors know that there is a risk in
buying gold at current levels, that gold may return to previous levels, and that
they could lose a good deal of money if that does happen.
Now, I happen to agree with the
assessment that $1,350 an ounce is not bad at all given what the government is
currently doing, in combination with the long term fiscal situation of the US
government. It could even be called
bargain basement when we consider that the US government is massively
monetizing for the first time since the Civil War. And while I don't think $450 an ounce in
nominal dollars is at all likely - the possibility can't be dismissed
altogether, and indeed, explicitly considering the possibility that an
investment will return to a long term average valuation should be one of the
scenarios considered as a part of any responsible investment evaluation
process. (Taking a good, long look at
inflation-adjusted gold prices over the last couple of centuries as shown in
the 1791-2009 graph can be quite compelling, when we consider the potential
inflation-adjusted price of gold in the long-term future.)
Let's go back to the 2nd quiz
question. On the one hand we have gold at $9,000 an ounce, which on an
inflation-adjusted basis is equal to $450 an ounce. On the other hand we buy
gold at $1,350 an ounce, and we could say that it works out that to everyone's
great surprise - Bernanke really is the greatest economic genius in history.
The economy does fully recover. The dollar maintains full value. Social security and Medicare pay in full
without the value of the dollar falling, just like the politicians have
promised us. (Again this is an illustration, not a prediction.) In this
scenario, if we purchase gold at $1,350 an ounce and we sell it at $450, we
would take a $900 per ounce loss. And let's assume that we generate a tax loss
that is usable for us at the current collectibles rate of 30%.
Our $900 loss allows us to reduce
our tax payments by $270 ($900 X 30%). If we take the $450 we got in sales
proceeds and add the $270 tax loss benefit, we've got $720. This equals 53% of
the $1,350 that we originally spent, meaning we took an after-tax and
after-inflation loss of 47%.
We previously calculated that with a
dollar being worth a nickel and gold going to $9,000 an ounce (which also
returns us to the long term average inflation-adjusted value of $450), that we
end up with $259 in after-tax and after-inflation terms. Which represented 19%
of our original investment. If we compare ending up after-tax and after-inflation
with 53% of our net worth intact, to having only 19% of our net worth intact,
we see that selling gold at $450 an ounce can indeed leave us with almost 3
times the after-tax and after-inflation net worth that we would have if we sold
gold at $9,000 an ounce under the assumptions shown. (Raising the tax rate from
30% to 50% to make the examples uniform would just increase the advantage to
$450 gold).
This may seem to be highly counterintuitive,
but it all comes back to what I have been educating investors about for years
now, and that is about how simultaneous monetary
inflation and asset deflation can
work together in an environment of inflation
taxes. When you have asset deflation
(in purchasing power terms) in a time of overwhelming monetary inflation, no
tax losses are generated, and instead you're paying substantial taxes on
illusory income. Remove monetary inflation, and the same exact level of asset
deflation leads to deductible losses you can (hopefully) use, with this tax write-off materially reducing the "hit" from
the loss. This explains how you can do almost 3 times as well through selling
gold at $450 an ounce and taking a $900 pretax loss, versus selling gold at $9,000
an ounce and taking a $7,650 profit - so long as the true (inflation-adjusted) value
for gold is the same.
Rephrased, when real asset deflation
is masked by monetary inflation, it is inflation taxes that can destroy nearly
2/3 of your real wealth, as opposed to a fully tax-deductible asset deflation
loss with no monetary inflation.
Last year, I was one of the six
experts who participated in Jim Puplava's Great 'Flation Debate (along with
Marc Faber, Peter Schiff, Robert Prechter, Harry Dent and Mish Shedlock), and
in the aftermath of the debate I prepared the simple ten minute video tutorial
"Can Theory & Jargon Destroy Your Net Worth?" (linked below). What the video teaches is just how radical
the difference is between seeing the world in simplistic terms (inflation or
deflation), versus using the tools of professional wealth management to see
what was illustrated herein:
simultaneous monetary inflation and asset deflation in an environment of
inflation taxes.
http://danielamerman.com/Video/Jargon.htm
Avoiding mistakes, such as
accidentally losing 80% of one's net worth in real terms, is a very good reason
to learn and understand these concepts.
Monetary inflation, asset deflation and inflation taxes are three
powerhouse wealth destroyers - and the investor who is unaware of how these
fundamental forces work is the investor who is most vulnerable to their
destructive onslaught. Conversely, if one
learns not only of their existence, but studies how these destructive forces
work in close detail (the financial application of "hold your friends close and your enemies closer"), then you
can do something quite fascinating: turn each one of them to your advantage.
Extraordinary peril can be turned
into extraordinary opportunity when we understand that each one of these
powerful forces are in fact not
universal wealth destroyers, but rather each acts to redistribute wealth
between individuals. Monetary inflation redistributes wealth from some people
to other people. The ending implications of asset deflation powerfully
redistribute wealth from some people to other people. Inflation taxes
powerfully redistribute wealth from unknowing investors to government.
As a redistribution - each one of
these can be reversed! That is, an
individual through his or her actions has the ability to change their personal
financial profile so that all three wealth destroyers act to redistribute
wealth to them, rather than slashing their wealth.
As an example, some of the
strategies illustrated in detail in my Gold
Out Of The Box DVDs start with a potentially heavy precious metals
weighting, but there are more components than just metals, and the strategies
are designed from Day One to allow one to shift in the four stages of
crisis: the ramp up to crisis, the peak
of the crisis, the immediate aftermath, and the longer-term aftermath. Having multiple components that are designed
from the very beginning to potentially shift over time may seem a bit complex -
but there is a professional grade reason for that: the opportunities and perils with monetary
inflation and asset inflation/deflation shift at each stage.
| Click Here To Learn About A Free Mini Course That Will Teach You How To Turn Inflation Into Wealth. |
Unfortunately, it is not quite as "easy" as merely shifting investments for changing monetary inflation
and asset deflation points of opportunity over the four stages. The problem is that selling assets typically
causes a taxation event, and in an environment of high inflation the
"haircuts" associated with paying multiple rounds of confiscatory inflation
taxes each time assets are redeployed, can cripple an otherwise brilliantly
executed investment strategy. Even
partially reversing inflation taxes is not an easy challenge, and if you wait
until you are ready to sell an asset that is carrying a fat inflation-based
"profit" - it is probably too late.
If you are going to redeploy assets in multiple stages, or pull monetary
inflation and/or asset deflation profits out during stages three or four when
you need that money to support your future standard of living - without handing
everything you have over to the government - you had better have your eyes wide
open and be carefully planning for these redeployments and cashing out events
from Day One.
The difference between
"accidentally" losing 80% of your net worth, and turning three perils
into three profit opportunities as you potentially multiply your real net worth,
comes down to a matter of vision. It comes
down to seeing with perfect clarity the 3475% difference in vision illustrated
in this article. It means seeing the
problems so well that you can also see the opportunities within each problem.
To gain that vision there is a first
step and it isn't something anyone else can do for you. The first step is education.
1. This article, "Hidden Gold Taxes: The Secret Weapon Of Bankrupt
Governments", removes the complexity of asset deflation, and provides a
simpler, step by step overview of gold, inflation and inflation taxes.
http://danielamerman.com/articles/GoldTaxes1.htm
2. This two minute video,
"Deadly Danger Of Dow 50,000", takes a very quick look at how
simultaneous monetary inflation, asset deflation and inflation taxes could
devastate stock investors in the same inflation/tax environment shown herein.
http://danielamerman.com/articles/DeadlyDow.htm
3. A free book, the "Turning
Inflation Into Wealth Mini-Course" can be received in installments via
e-mail subscription through the website below.
It covers the essentials of developing your inflation vision, analyzes a
historically successful inflation fighting strategy, and illustrates an
inflation tax reversal strategy in detail.
Do you know how to Turn Inflation Into Wealth? To position yourself so that inflation will
redistribute real wealth to you, and the higher the rate of inflation – the
more your after-inflation net worth grows?
Do you know how to achieve these gains on a long-term and tax-advantaged
basis? Do you know how to potentially
triple your after-tax and after-inflation returns through Reversing The
Inflation Tax? So that instead
of paying real taxes on illusionary income, you are paying illusionary taxes on
real increases in net worth? These are
among the many topics covered in the free “Turning Inflation Into
Wealth” Mini-Course. Starting simple,
this course delivers a series of 10-15 minute readings, with each
reading building on the knowledge and information contained in previous
readings. More information on the course
is available at DanielAmerman.com or InflationIntoWealth.com .
Contact Information:
Daniel R. Amerman, CFA
Website: http://danielamerman.com/
E-mail: mail@the-great-retirement-experiment.com
This article contains the ideas and
opinions of the author. It is a conceptual exploration of financial
and general economic principles. As with any financial
discussion of the future, there cannot be any absolute certainty. What
this article does not contain is specific investment, legal, tax or any other
form of professional advice. If specific advice is
needed, it should be sought from an appropriate professional. Any
liability, responsibility or warranty for the results of the application of
principles contained in the article, website, readings, videos, DVDs, books and
related materials, either directly or indirectly, are expressly disclaimed
by the author.
Copyright 2010 by Daniel Amerman