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Source: Yahoo! Finance.  Data through 4-22-11

The global markets surged this week even after the jolt Standard and Poor’s (S&P) issued the US government on Monday.  S&P maintained the high credit rating of the US for the time being.  However, they issued a warning that if the government does not come up with a reasonable plan to cut spending and debt, the US may face a credit downgrade.  Technically, the US should already be downgraded but the rating agencies are slow to anger the government.  This friendly relationship is part of the reason it is surprising to see this shot across the bow.  One significant take away from the report was that S&P gives the chance of a downgrade as one-in-three.  Keep in mind this is the first time that any credit rating agency has even hinted at such a downgrade.  Another notable takeaway was that in S&P’s view, the US financial sector is in worse shape now than before 2008.  Neither of these are shocking revelations to anyone paying attention.  What is surprising is that the comments are being released into the public domain.

Keep in mind that this news was followed with gold and silver surging to highs.  This past week also saw the second largest university endowment turn it’s paper exposure to gold into physical exposure to the tune of $1 billion.  The University of Texas endowment took delivery of $1 billion in gold stating their reasons were to preserve purchasing power and a distrust of paper exposure to metals.  Seeing that major universities and pensions have very little in metals exposure, the move by UT may be a spur to drive gold higher through purchases by other endowments and pensions.   As the dollar continues its decline, pensions (who by nature are intended to provide income) will need to maintain purchasing power for its clients.  According to UT endowment board member and hedge fund manager Kyle Bass, “Central banks are printing more money than they ever have, so what’s the value of money in terms of purchases of goods and services?  I look at gold as just another currency that they can’t print any more of.”

Are Gold and Silver Out of Control?

I am amazed at shortsighted advisors and commentators that are so quick to dismiss the metals because of their, relatively recent, rise in price.  Typically, these are the same individuals that have dismissed gold and silver throughout its rise over the last 10 years.  The claim is usually that the easy money has been made, or that the large rise indicates it is nearing its end.  These are also the same people that were cheerleaders of the stock market rise in 2000, and again in 2007.  They are also the same ones that did not see a problem in housing.  I suppose the metals get dismissed because what is driving them is also what people do not want to see – a crippled economy and failing currency.  Alternatively, it could be they do not understand what is driving (or not driving) the metals. 

It is no secret I am bullish on gold and silver so long as the world stays on the debt-laden money printing track it is on currently.  So, instead of being myopic and looking only at past performance to determine investment worthiness, let’s look at what is likely driving the metals. 

Let’s first dispense with gold being in a bubble as the term is overused. A bubble in terms of investing is a rapid rise in price that investors feel is unfounded.  The rise in gold is far from unfounded, and gold’s ownership as an investment is quite small compared to the global financial assets held in equity and debt securities, and bank deposits.  How can gold be in a bubble if hardly anyone holds it?  Silver is an even smaller holding of all global financial assets.

So what is driving the price up?  The answer consists of the following:

  • Demand is high and supply is shrinking.
  • Few new mines are coming online as until recently, demand for gold was low.  New mines do not happen overnight, but over years.
  • Worries of fiat currencies and the debasement of the global currencies.  This ties-in with inflation.
  • World governments, central banks and sovereign wealth funds are buying.
  • Concern over the viability of some of the ETFs that are “supposedly” holding the metals.
  • In silver’s case, industrial demand is increasing.
  • As emerging nations flex their fiscal muscles, their desire for metals in jewelry will grow. 

Now the question is are these concerns unfounded?  I say no.  Sure there may be stretches of volatility as prices have risen, but the above are real issues.  Also, so long as the world swims in debt and politicians continue to be politicians, it is likely gold and silver will move higher.

What Does a Credit Downgrade Mean?

This past Monday, Standard and Poor’s (S&P) issued their latest report on the credit worthiness of the US government.  Currently, the US enjoys their highest credit rating, and will maintain it in the short-term.  However, S&P stated that in the medium to long-term the US government could face a downgrade if politicians are not serious in finding solutions to the debt and spending problems.  This news was met with a sharp sell-off in stocks (that was followed by a rush up).

But, is a credit downgrade likely, and what would a credit downgrade really mean?

A downgrade is probably not likely since the rating agency has not already given the US a huge downgrade.  Also, it seems pretty clear that the credit rating agencies are “friendly” with the government as I have not seen one executive from the credit rating agencies go to jail, or even slapped on the hand, for their role in the credit crisis.  Recall these agencies were handing out investment grade status to junk mortgage debt clear up until the market bust.  Currently, the US is bankrupt, taking on more debt, and doesn’t appear close to figuring out how to cut spending.  If the US were a private company, it would have a credit rating of junk.  As such, I do not think a downgrade is coming, but it is certainly justified.

If we were to see a downgrade, the major impact would be an immediate increase in the cost to the US government to service its debt.  That means the Federal Reserve would not be able to keep the interest rates that we pay our debtors so low.  If the rate we pay as a nation goes up, it will be that much more of our tax dollars going to interest on debt, and that much less to other budget items.  This issue also feeds into the upcoming debt ceiling debate.  The debt ceiling is the limit on indebtedness the nation can carry.  Historically, like a shopaholic with a budget, the US spends to the limit then grants itself a credit increase.  The debt problem has not gone without notice.  This past week, The People’s Bank of China (largest holder of US debt besides the Fed) issued a statement about concern for our debt.  In the end, the debt ceiling debate is a lose-lose situation.  If we increase the debt ceiling, we are adding that much more debt; and if we do not raise the limit, we will default on our debt.  The Fed and the Treasury have made it clear we will not have an outright default on our debts.  They are committed to printing money.  The more likely outcome is not outright default, but default by devaluing the currency and inflation.  The reality is, whether the US gets downgraded or not, rates will go up and put a squeeze on the US economy.

Are your investments protected against our country’s current monetary policy?  Do you have investments that will hedge your portfolio against high inflation?  Call me to schedule a free review of your current investment portfolio – 913.693.7918.

John P. Chladek, MBA, CFP® is the President of Chladek Wealth Management, LLC, a fee-only financial planning and investment management firm specializing in helping families and couples who are not yet retired realize their financial goals.  For more information, visit

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