Yesterday, something interesting happened. Precious metals went up, while the dollar went up. Everyone is amazed. But, the news shouldn't really be surprising, because it is nothing new. Gold and silver have never been tethered to the dollar, or anything other than the principles of supply and demand. When looked at in the long term, they have been rising against a falling dollar, but, also, against a rising euro and pound, for over 8 years now.

All the world’s Central Banks - most notably the Federal Reserve (the Fed), but, also, the European Central Bank [ECB], the Bank of England [BOE], the Bank of China [BOC] and the Bank of Japan [BOJ] - have been heavily printing paper money in the last few years. All have increased their M3 money supplies by staggering percentages (see shadowstats.com). Making matters worse, the central bankers are now accepting mortgage backed paper from their friends at major politically connected banks, as collateral for cash and/or government securities. Problem is, the mortgage backed bonds are suffering high default rates.

There’s no way to avoid the inevitable. No amount of lying will avoid basic truth. Our money is losing its value. Yes, the dollar has been temporarily up against other paper currencies, in the past few weeks, but that gives little solace. The rise does not reflect the positive factors operating inside the American market, but rather the fact that things are worse in Europe now. Both the dollar and all other major paper currency, is down against itself. American consumer prices have leaped up to double-digit levels, and the government is lying about it. You can read an in-depth discussion of the Bureau of Labor Statistics use of so-called “geometric” weighting here.

Simply put, regardless of what Ben Bernanke says, high levels of inflation can no longer be avoided. Even if forthright intelligent men suddenly took control of the Fed, the Treasury, and the private banking world, too much damage has already been done. We will endure higher inflation and lower growth levels as a result. The situation, now, will be much worse than back in the so-called stagflation era of the 1970s. To make matters worse, many years of bipartisan economic mismanagement will provide either a recession or an outright depression, at the very same time as inflation is rising. It is a terrible combination, but one that can no longer be avoided, at the societal level, no matter what we do.

But, can we do something to protect ourselves and our families? During the last 8 years, precious metals have appreciated more than 3 times against the dollar, but have also risen substantially, against every other paper currency in the world, including the euro, pound, franc, crown, drachma, dinar, and rupee. Many tunnel vision analysts tell us that the value of gold and silver is tethered to the dollar’s relative value in terms of other currencies. This is incorrect.

Like all commodities, gold and silver are priced in dollars. A major change in the value of the dollar can positively or negatively influence overall demand because it makes precious metals cost more or less in terms of other currencies. But, overall supply and demand is the key to the cost of any commodity, not the value of paper money. When demand exceeds supply, as it does now, the price of an item will rise in the long term.

In today’s double-speak world, with the availability of 99 to 1 leverage in the fantasy futures world, those fundamentals can be manipulated out of whack, in the short run. However, in the long run, values will always be based on supply and demand.

This is most basic of economic principles, and the one so many analysts are quick to forget. Precious metals are like fine wines, needing adequate time to age and reach full favor. The wise buy precious metal for the long term, not with the idea of trading for short term profits, and they don’t buy on leverage. It is especially unwise to trade gold and silver with high leverage, as some hedge funds were doing recently. They are now badly burned, having lost billions, after a recent manipulation on the COMEX fantasy futures and spot markets, in New York, created an artificially low price. That foolishness created a shell-shocked gold investing community, and played right into the hands of those people who are corrupt, and well connected enough, to get away with market manipulation.

Some lessons, hopefully, were learned by the folks who got burned. One cannot make money, in the long run, on leveraged trading of gold bullion, or futures, unless:

1) You have inside information on the manipulations

2) You are a genius in technical analysis at a godlike level never before seen in humans

3) You have a working crystal ball

Need I remind you that persons in the first category are criminal co-conspirators engaged in a felony? If, like the rest of us, you do not fit into one of these 3 categories, you should not buy precious metals for the short term. Look at least for the medium term, and, preferably, for the long term.

Very similar, though less severe, macroeconomic conditions existed back in the 1970s era of so-called 'stagflation'. Similar, though much smaller problems, had to be overcome. It was the second phase of precious metal decoupling from paper currencies. Prior to 1974, the dollar and most other currencies were officially tied to gold through something we call the 'gold standard'.

The first phase of decoupling had already happened, back in 1933. President Franklin Roosevelt was elected in the midst of the worst economic downturn in history. That downturn had occurred, much like our current problems, because of irresponsible behavior involving the U.S. Treasury and the Federal Reserve. During the 1920s, they had printed far more dollars than they had gold to back them. So, in 1933, a law had to be passed, banning private ownership of gold bullion. The government was acutely low on gold, and was forced to confiscate it from its citizens.

This, of course, was a manifest violation of the Constitution that had, for so many years, had forbid the government from destroying private property rights. Indeed, the Constitution dictates that no money, other than that backed by gold and silver, should ever exist in the United States of America. But, after having packed the U.S. Supreme Court with his own appointees, and given the emergency situation at hand, the Court looked the other way, and allowed it to happen.

After 1933, the gold standard was limited to trading between sovereign nations. You could no longer trade in your dollar for 1/20th of an ounce of gold. This massive change of conditions caused the first major dollar depreciation. The value of the dollar dropped almost immediately by 75%, in terms of gold. It probably would have fallen by much more, had the government not set the new price for inter-governmental gold trading at $35 per ounce, or its equivalent. This new gold value was a vast increase from the previous $20 per ounce level, and was designed to stem the dollar outflow from the United States, to foreign nations holding dollars.

Meanwhile, the U.S. dollar continued to depreciate. Some years later, the USA “lucked out”, in terms of economics, by exiting WWII with the world’s only intact major industrial economy. In the wake of overwhelming U.S. military and economic power, and a vast depreciation of war stricken currencies, dollar depreciation was relatively limited. People believed in the USA, and the full faith and credit of the United States of America really meant something back then. The “golden age” of the paper dollar (but mostly without gold) was underway.

After a bout of traditional American overspending on wars, social programs and other pork projects, however, by the 1970s, things were, once again, beginning to fall apart. Nixon’s decision to sever the dollar completely from gold helped speed things along. In the early to mid 1970s, the dollar was rapidly falling against most European currencies, including, particularly, the German mark. The former German mark now is the bedrock upon which the “euro” has been built. So, it is instructive to use the dollar/mark conversion ratio, back in the 1970s, for demonstrative purposes.

On January 6, 1971, you needed 3.65 German marks to buy 1 U.S. dollar. By August 26, 1974, you needed 2.63 marks, a devaluation of over 28% in a three year period. Now that the dollar was largely a fiat currency, with no real backing by gold or silver, U.S. supplies being insufficient to support the overwhelming number of dollars already flooding the world, its value could only be measured by the faith of its people, and by extension, the rest of the world, in the success of the overall American economy.

Between 1971 and 1974, the London gold fixing rose from about $37.87 to $106.76 per ounce, or 282%. As you can see, the change in the relative value of the dollar versus the mark was considerably less than both changed against gold. Both the mark and the dollar fell, dramatically, against gold.

By April 1, 1977, you needed 2.39 marks to buy a dollar. On April 21, 1980, you needed only 1.85 marks. This was a net drop of about 23% more, in comparative paper money value, in a period of another three years. On April 3, 1978, London fix for gold was $148.10, but, by April 21, 1980, you had to pay $850 per ounce, or 574% higher than three years before. Once, again, the value of gold increased 551% more than the mark had appreciated against the dollar.

Why did this happen? The answer can be found in the supply and demand factors for gold, and, secondarily, in some levels of hidden overall inflation, both governments must have been very eager to hide. Then, as now, both Germans and Americans were experiencing high levels of financial instability and fear. The demand for gold, which is highly elastic and depends on human sentiment, soared. The supply is highly inelastic, and cannot be expanded. Physical limitations on how much you can mine exist because both a very rare and difficult to extract. So, prices soared.

The longer term price of precious metal is not based on the relative value of the dollar versus other paper money. As I have said many times before, long term prices are always based upon fundamentals of supply and demand. Everything else you hear is worthless market chatter, and you must tune it out. If you don’t, you’re going to lose money.

As noted, in my last article, U.S. investment demand for gold has increased by 850% to 940% from 2007 to 2008. Demand is currently running at a 141.1 ton per year rate, and rising. By the end of 2008, it is probable, given the upward curve of investment demand increase, that the USA will consume 250 tons of investment gold in 2008, compared to 16.6 tons in 2007. This, of course, is in addition to amounts consumed by jewelry fabrication and dental demand. Investment demand will probably reach close to 1,000 or more tons if the current trends continue, and economic disruption drags on into 2009. This is now very likely.

It is not likely that American gold buying propensity will turn similar to that of the Vietnamese, but, if it ever did, U.S. demand would eventually reach over 21,500 tons per year. This compares with a total mine production of 2,475 tons in 2007, and a supply deficit, last year, of about 1050 tons. Last year’s supply deficit was filled by scrap gold sales, as well as both sales and swaps out of the holdings of various central banks, around the world. Even if American investment demand caps out at 250 tons, the deficit will increase significantly this year over last.

Demand is not only increasing in America, but all over the world. The worldwide gold deficit will be very likely to far exceed 1,300 tons this year. For example, in just the last few days, reports say that the Royal Canadian Mint asked several brokers and banks if they could borrow 400,000 ounces of gold (see here). Mitsui & Co., Japan’s second largest brokerage house, and a global metals dealer, said, on August 25, 2008, in its Refining Monitor,

"The Gold Market has changed remarkably over the last four weeks…The pickup in physical demand has been a characteristic across not just India, but also Europe, the Middle East, Asia and the United States. Volumes are returning to levels that were more reflective of conditions back in 2006… Indeed, gold Krugerrand coins are also in limited supply, with many retailers reporting a depletion in stocks Where supplies are not exhausted, significant delivery delays exist." (source)

Last year, in the wake of a rising euro, and a good economy, there was almost no investment gold buying by Europeans. This year, everything has changed. Europe, a previously “sleeping giant” of gold-buying potential, is beginning to awaken, in the face of a stressed economy and a declining euro.

People in so many places have so much more paper money than ever before. This money is chasing the same amount of goods. Never before did people demand such quantities of gold and silver for jewelry, investment and industry. The supply and demand factors are much more favorable now than they ever were, in the 1970s. Out of control North American demand is combining with a huge and ever increasing demand in places like China, India, Vietnam, Saudi Arabia, Qatar, and the UAE. With the exception of the Arab ruling elites, all these gold and silver buying nations were poverty stricken in the 1970s, and weren’t on the gold-buying map. More than 3 billion Asians, in lands where precious metals are revered, are now empowered with increasing wealth. They will continue to get richer, at an ever increasing rate. They will also continue to increase consumption of precious metals, as well as other raw materials.

It’s not my job to take out a crystal ball, and tell you the future. I can just collect and disseminate the facts. My particular talent is only in tuning out senseless market chatter. Once you have the facts, free of the market chatter, you can think for yourself. Are we merely going to repeat the 1970s? Will gold and silver rise over time, until they are finally capped at their inflation adjusted peaks from April of 1980 (which are $2,300 and $141 per troy ounce, respectively)? Or, will they go a lot further?

Each of you is endowed with a large measure of logic, reason and common sense. It’s God’s gift to you, unique to your species. Use it! The only thing that stopped you, up till now, was the deafening roar of market chatter. We’ve tuned out that noise, and you can concentrate on the hard facts. Let me sum them up. There are 3 billion Asians who love buying precious metals. They didn’t have much money, back in the 1970s. They’ve now have a lot of paper money, and their economies are growing at 9-10% per year clips, even after trying to slow down that growth! Meanwhile, we’ve got the single worst economic crisis in U.S. history, short of the Great Depression. The USA is still the richest country in the world, in terms of paper money, and its gold buying is exploding.

Times are also starting getting tough in Europe, and Europeans are starting to buy gold, for the first time, in years. The U.S. Mint cannot keep up with it. The Canadian Mint is making the rounds, hat in hand, begging for gold! The Indian wedding season and Hindu gold & silver buying holidays, historically the biggest season of the year, for precious metals, is right around the corner. Meanwhile, India’s shelves are completely bare. Even Indian bank vaults are entirely empty. The American and European economies continue deteriorating. Bullion is commanding big premiums over spot, and people are losing faith in the economy. There is every reason to believe that the situation in both America and Europe, will continue to deteriorate, to a greater or lesser extent, for quite some time to come.

So, are precious metals tethered to the U.S. dollar? If it goes up, must they go down? Or, do they have a life of their own? Will they travel only to the inflation adjusted levels of 1980, or will they eventually travel far beyond that? I don’t need to give you these answers. You already know them.