© 2013 Crescat Capital LLC
Crescat Capital
The Valuation of Gold July 3, 2013
© 2013 Crescat Capital LLC
Global Debt-to-GDP Imbalance
1 Includes all loans and fixed-income securities of households, corporations, financial institutions, and government.
Source: McKinsey Global Institute
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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.
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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.
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“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.
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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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Source: World Gold Council
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.
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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.
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Sovereign/Central Bank Gold Holdings
Source: World Gold Council
U.S. Treasury Owns The Largest Gold Reserves
The U.S. Treasury Owns The Largest Gold Reserves
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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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© 2013 Crescat Capital LLC
-
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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© 2013 Crescat Capital LLC
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.
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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
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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
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