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Every weekend I put 50-60 economic and market data points into a spreadsheet that I have kept for many years. My goal is to identify the best arguments for deflation, inflation, and hyperinflation. If I know which 'flation is around the corner, then I can prepare...I hope.

Anyway, I also follow the precious metals. With the recent decline in gold and silver prices I thought I'd share my estimates for percentage gains from current prices, based on various scenarios. The comments below are copied from a Seeking Alpha post here:

If you want me to explain any of these admittedly cryptic descriptions, holler.



The theoretical percentage upside for gold and silver are both compelling, as my estimates below suggest.

But if forced to pick just one precious metal, I'll take silver. Silver is consumed, whereas gold is hoarded. In 2005, global per-capita above-ground gold bullion was 0.8 ounces, -17% vs. 1940 levels of 1.0 ounce for ever man, woman, and child.

Silver, though, was 0.2 ounces in 2005, -96% vs. 1940 levels of 4.4 ounces.

Estimate #1: Dow-Gold @ target 501%
Estimate #2: U.S. currency collateralized by U.S. gold 270%
Estimate #3: Federal Reserve liabilities collateralized by U.S. gold 938%
Estimate #4a: U.S. Monetary Base ($M) @ 40% U.S. gold backing (1914 Federal Reserve Act): 294%
Estimate #4b: U.S. Monetary Base @ 100% U.S. gold backing: 885%
Estimate #5: Debt due foreigners collateralized by U.S. gold: 1489%
Estimate #6: U.S. national debt collateralized by U.S. gold 5113%
Estimate #7: Global public debt collateralized by world central bank gold 3132%
Estimate #8: MZM collateralized by U.S. gold 3556%
Scenario #9: M2 collateralized by U.S. gold: 3188%
Estimate #10: M3 collateralized by U.S. gold 4862%
Average 2203%

Estimate #1a: Gold-Silver: 294%
Estimate #1b: Dow-Gold & Gold-Silver: 4949%
Estimate #2: Dow-Silver: 4944%
Estimate #3a: M3 Funds Flow: 717%
Estimate #3b: M3 funds flow & 50% of average annual mine supply (363M oz.): 2149%
Estimate #4: Funds Flow: Gold to Silver: 215%
Estimate #5: Funds Flow: (Global Stocks + Bonds) to Silver: 6831%
Estimate #6: Silver @ Gold Stock + Bond Value: 16957%
Average 4632%
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This went totally over my head, Hewitt.

But it does remind me of a question I've been musing. Gold miners took on a lot of debt during the boom (unjustifiably, considering how little cash they were able to generate with the use of it). Now they're looking vulnerable to even worse cashflow as gold prices tumble.

So ... if this foreshadows miner bankruptcies (major bankruptcies?) in the near future, could that hurt gold production, reduce gold supply, and result in prices going back up?

What do you think?

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Ditty -

As with stocks, I try to evaluate precious metals in terms of reward vs. risk.

Mohnish Pabrai describes this thinking as: "Heads, I win; tails, I don't lose much."

The late Leon Levy, the founder of the Oppenheimer Funds, related the importance of this mindset in his excellent autobiography The Mind of Wall Street: "Indeed, I can be wrong more often than I am right, so long as the leverage on my correct judgments compensates for my mistakes. At least that is how my investments have worked out thus far."

And Berkshire's Charles Munger: "To us, investing is the equivalent of going out and betting against the pari-mutuel system. We look for a horse with one chance of winning and which pays you three to one. You're looking for a mispriced gamble. That's what investing is."

With gold and silver, I create various scenarios that these two PM's will sell for if X or Y happens. Then I compare the estimated upside to the chance of loss.

As you point out, gold and silver sell for about their cost of production, which means producers on the right side of the cost curve will stop mining, which reduces supply and drives prices higher. So from a micro-economics perspective, PM's should be at their approximate lows.

Now I want to estimate how high prices may climb. So let's look at a few of my gold calculations.

Estimate #1: Dow-Gold. Current ratio is 12x. During prior periods of market stress this ratio has fallen to 1x. If the Dow falls to 2x, then gold will sell for $7,568, a 524% gain from current prices.

Estimate #2: U.S. currency is $1.2 trillion. Meanwhile, U.S. gold is 261.5 million ounces*. If U.S. currency is 100% backed by U.S. gold, then gold will sell for $4,553, a 275% gain. (Formula: $1,190,500,000,000/261,499,377).

The most ambitious scenario is if the global markets demand the U.S. to collateralize our $16.8 trillion of debt. If so, then we are looking at $64,000-an-ounce gold, a 5,195% gain. (Formula: $16,796,000,000,000/261,499,377).

Some of these prices are so high, it's hard to comprehend. On the other hand, in studying 5,000 years of economic history, I don't know any fiat currency that achieves immortality. So somewhere along the line the global paper money system will change, I suspect.

If you want me to explain any of the other gold or silver calculations, let me know.


*Maybe, maybe not.
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