A Real Midas Touch

With a name like Midas, it should come as no surprise that the fund Tom Winmill runs is bullish on gold. After all, it was mythical King Midas of the ancient Greek city of Phrygia who had the Midas touch, the uncanny ability to turn everything he laid his hand on into gold.

Yet, he is no gold bug, asserts Winmill the moment we settle down to lunch at Papoo’s, a family-owned Italian eatery in the Financial District, and order piping-hot pasta fagioli soup. At least, not a typical gold bug.

“Midas is primarily focused on capital appreciation,” he says. “Gold as an asset does not provide capital appreciation. It provides capital preservation.”

Now, however, is an environment in which capital preservation is called for, and Winmill is one of a growing number of financial advisors, fund managers and individual investors around the world who believe that gold will do extremely well over the next several years. But unlike most of those investors, Winmill’s trust in gold is not of recent vintage and was not inspired by the turmoil in financial markets in the final quarter of 2008. Recent market events only confirmed Winmill’s long-standing beliefs. Winmill starts explaining his worldview by pointing to the size of U.S. government debt. The $10 trillion headline figure may be large, but it is manageable since it accounts for around two-thirds of U.S. GDP. But this is only the tip of the debt iceberg. The federal government is much like the Detroit Big Three automakers, whose main problem pushing them into bankruptcy is their unfunded pension and medical liabilities to former employees. The true amount the U.S. government owes, if Social Security and Medicare obligations are taken into account, is around $56 trillion. That’s more like four times the size of the U.S. economy.

“Our generation is paying more into the system than the current crop of retirees is taking out,” explains Winmill. “But that will change when baby boomers begin to retire en masse and present their IOUs to the government.”

There are three ways of dealing with the problem. One is to repudiate these obligations; another is to raise taxes. Neither is politically palatable, even though Winmill doesn’t exclude the possibility of substantial tax increases in nearby years. Still, the more likely solution to this problem would be printing more money and running higher inflation while keeping Social Security and Medicare payments fixed. Inflation running at 6 percent to 8 percent annually for several years will reduce the size of government obligations considerably. Winmill doesn’t hazard a guess when the current period of deflation comes to an end, but when it does, he envisions inflation coming back with a vengeance.

Alternative Currency

Unlike other gold bugs, Winmill doesn’t believe gold is a reliable hedge against inflation or a proxy for the prices of base metals and other commodities. For him, gold has one function only, namely as an alternative currency. By itself, inflation is not going to push gold prices higher, he maintains. Nor is his outlook for other metals in any way bullish — including not only base metals but precious metals, as well, even though silver and platinum prices are often expected to move in the same direction as gold prices.

“Investment demand is the main factor driving gold prices, since demand from jewelers, the only significant users of gold, is extremely elastic,” he explains.

There was a strong increase in investment demand for gold bars in the final months of 2008, Winmill observes, even though we have seen declining inflation and sharp price declines in most commodity markets. This confirms his point that gold is primarily an alternative to the U.S. dollar. Gold prices declined in mid-2008, when the dollar rose across the board, and started to move higher once again at the end of the year, when the greenback recovered from another bout of weakness.