Puerto Rico Bankruptcy, Looming Pension Crises Underscore Value of Gold

 | May 04, 2017 | 12:00 PM EDT
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Debt and pensions issues are revealing themselves to be major threats to the U.S. and global financial system.

The announcement on May 3 that the financial oversight board of Puerto Rico has effectively declared bankruptcy and defaulted on $70 billion worth of the U.S. territory's bonds brings into focus the severity of the debt problem. Meanwhile, bankruptcies of Long Island Teamsters' pensions as well as Canadian mortgage lenders make us consider the vast scope of the problem.

However, with great turmoil comes great opportunity.

Puerto Rico is now the largest bankruptcy in the history of the U.S. municipal debt market. Yet the event is barely mentioned in the news of the day.

Congress has recently increased the government's ability to raise the debt limit. Interestingly, the time limit was extended as opposed to a numerical level to be reached. It is estimated that the U.S. will sink a further trillion dollars into debt before the issue is again brought up for review in the fall. Realistically, the math says that this debt is unsustainable and sometime in the near future we will have the type of market correction that was seen in 1929 or 2008.

Now is not the time for doom and gloom, though. The real question is how to turn this problem into an opportunity.

The solution lies within the problem. Debt has been vastly overused and now must be either repaid, forgiven or some combination of the two. This is where gold regains its luster as real money.

With a global financial system anchored by currencies backed only by the intangible good faith and credit of the issuing government, gold stands apart. Gold is not reliant on the good faith and credit of any government. Gold carries no counterparty risk. It is a real asset, it is a tangible asset and so it can be used to support fiat currencies that are failing under the excesses of an unsustainable debt burden.

Once the value of gold is re-established in the marketplace it then becomes a question of price. This is where the opportunity lies for the savvy investor.

We believe that the price of gold as measured in dollars is very undervalued by several metrics. Gold reached an all-time high of $1,900 an ounce in August 2011. With the yellow metal now trading around $1260 that is a 34% discount. Plenty of upside potential remains just to realize past performance.

Gold is often used as a hedge against inflation pressures. Gauged against inflation metrics in the U.S. since the 1980 gold price peak, gold should be trading somewhere around the $2,300 level. Obviously, we are well below that metric.

Real interest rates have been credited in some circles for the recent rally in gold. Recent studies have shown a very tight correlation between negative real rates and a rising gold price. Real rates continue to be negative as inflation pressures begin to rise and nominal rates rise less quickly.

Another benchmark we can use to measure gold by is the M2 money supply. The reason for this is that a money supply backed by gold would engender substantial faith and credit as opposed to the current system backed by nothing. According to Jim Rickards, author of "The Death of Money," a U.S. dollar 40% backed by gold would require an ounce of gold to be valued at $9,000. This is certainly major upside potential.

Many other benchmarks can be employed to support different theories about what the value of gold should be or will be in the future. But there are really two fundamental questions, what is my risk and what is my potential reward?

In the current financial environment of historically elevated debt and stretched equity valuations, Strategic Gold believes that an investment in gold bullion is both prudent and possibly very rewarding. Where is the price of gold headed? We echo Alan Greenspan when he answered that question, "Measurably higher."

David Yoe Williams Jr. is a principal at Strategic Gold, a Naples, Fla.-based firm that buys and stores physical gold for investors.

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