Gold To Rise

I have a report in my hands that is helping me

understand the gold market. “Understand” is too confident a word. Because the gold market is too complex for mortals.

Is it a commodity? Is the market rigged? Is there a conspiracy against gold? How come the price has not responded to the biggest credit expansion in history?

It was easy to forecast the future of gold in ’73. Nixon had “closed the gold window” two years earlier — meaning that foreign governments could no longer trade their dollars for gold. For the first time in a very, very long time, the dollar was nothing but a piece of paper — with no connection to precious metals.

Nixon had, after all, stopped redeeming dollars for gold for a reason. There were too many people who preferred the metal to the paper. At $38 per ounce, gold was an irresistible bargain.

Rather than devalue the dollar against gold, Nixon simply cut the link between the two…letting the market do the devaluing itself.

Mr. Market took up the challenge with great gusto and resolve. Within seven years, the price of gold had risen more than 20 fold. Mr. Market, you see, is given to excess.

Since then, the price collapsed and has traded in the $300 to $400 range ever since (except for a drop of around 20% in the late `90s). Now gold is $307.

And if you go to Sears rather than Brooks Brothers, you can still buy a suit of clothes for the price of an ounce of gold — just as you could during the Roman Era, when an ounce of gold would get you a decent toga and belt.

We contrarian investors look for aberrations. Nothing seems to be out of order with the price of gold. It is where it ought to be…more or less…in terms of what you can buy with it — but for one very glaring exception.

While the price of gold was in full flower, in the late `70s, the stock market had lost its bloom. The Dow was, believe it or not, within a few dollars of the gold price. You could buy an ounce of gold for $850 at its high. That amount would also get you a unit of the Dow — with enough change left over to buy a unit of the Nasdaq, too, which — coincidentally — opened for business the very same year Richard nixed the gold sales.

Since then, the Dow has risen about 15 times. And the price of gold has fallen in half. So the difference is about a factor of 30. The Nasdaq action has been even more excessive. Nasdaq prices rose from under 100 (from what I can tell by looking at the chart on the Nasdaq web site) to over 4,500. This represents a 45-fold increase. Compared to the gold price, the Nasdaq is 90 times greater than it was in the late `70s.

Something is clearly out of whack. Partly, it is the gold price. Gold was in a bubblish fever back in the late `70s from which it recovered quickly. Its condition has been stable ever since. But the big aberration is in the Nasdaq — apparently it contracted the bubble bug from gold and is now suffering its own fever. Had gold been at the same price in ’78 as it is today, you could have bought three units of the Nasdaq for one unit of gold. Instead, an ounce of gold gets you considerably less than one-tenth of one Nasdaq unit. Even deflating the gold price, therefore, still leaves a 3,000% gap between the Nasdaq and gold.

Regression to the mean alone suggests that the Nasdaq must return to some more modest position vis-a-vis gold. How this will be accomplished is the subject of this letter.

The report I mentioned at the beginning is written by Paul van Eeden, a broker at Global Resource Investments, It points out that for all the many tales concerning gold, the yellow metal continues to function as it always has — as the ultimate money. Alan Greenspan and all the world’s central bankers realize this. “Gold still represents,” said Greenspan in May, “the ultimate form of payment in the world…Gold is always accepted.”

Unlike a commodity, the gold price seems oblivious to both supply and demand. “During the past 10 years,” Paul writes, “the annual supply of gold, including scrap sales, has fallen short of the fabrication demand for gold by a cumulative 2,764 tonnes. This is more than one year’s total supply of gold from mining.” You would think that such a shortfall would boost the price of gold. On the contrary, there appeared to be no correlation.

It is perhaps a happy coincidence that the supply of gold tends to rise at about the same rate as the supply of everything else. GDP and population figures increase at a real, net rate of between 1% and 2% annually. Gold mining, which benefits from technological improvements, increases production at about the same rate. Thus, gold is not only money, but very stable money — it inflates at no greater speed than the things it is used to buy and sell.

Even gold jewelry, Paul argues, is really a form of money. People in ancient times found it convenient to wear their wealth. They still do.

Instead of following supply and demand figures, the price of gold, Paul tells us, tracks, inversely, the world’s reserve currency…the dollar. As the dollar rises, it buys more gold. As the dollar falls, it buys less. So if the dollar were to fall, the gold price would rise.

It is almost certain that the dollar will fall in the months ahead. Because the U.S. dollar price depends on the success of the U.S. new paradigm economy. America has a huge balance of trade deficit — the largest ever recorded by any nation in history. It can only be financed by foreigners who are willing to invest in stocks, bonds and other U.S. dollar capital assets. As long as Wall Street seems to be going up…foreign investors will probably be willing to invest their money in the American miracle. But when Wall Street goes into a decline, as is now happening, they will switch to more promising investments. This will cause the dollar to fall against major foreign currencies — and the price of gold to rise in dollar terms.

I don’t know how high gold will go…or how low the Nasdaq will go, but it seems likely that an ounce of gold will buy more of the Nasdaq in the future than it does today. Regards,

Bill Bonner

Paris, France February 23, 2000

*** Yesterday, Mr. Market did not do as I expected. Instead of rallying in the morning, he waited until late in the day. The Dow ended the day up 85. GE, a bellwether stock, rose 4 1/4.

*** But there were only 1,362 stocks advancing, opposed to 1,654 declining. And there were 38 new highs, compared to 207 new lows! What kind of a rally is this?

*** It’s the kind you get in a bear market. Weak. Unconvincing.

*** Even more unconvincing was the rally in the Nasdaq, which left the index down 31 points for the day. Both the Internets and the biotechs were down.

*** AOL, on which so many hopes for the future of the Internet seem to rest, fell below $50. The magic seems to have gone out of the AOL/Time Warner deal.

*** If the Nasdaq fails to rally decisively…and soon…it will be FINI for the great bull market and bubble of 1982-2000.

*** What might happen next? Just look at recent bubbles for comparison. Gold rose 1,500% from ’72 to ’80. Then it fell back 63%. Japanese stocks rose 540% from ’82 to ’90. They too subsequently fell by 62%. The Nasdaq gained 1,200% from ’92 to 2000. If it falls 60%, the index will bottom out in the 1,800 range. That will represent a loss of capital equal to approximately $3 trillion.

*** What we’ve been seeing is a series of rolling tops. First, the A/D ratio turned down on April 4, 1998. Since then, just about every index and every sector has topped out — transports, cyclicals, retailers, financials. The Dow itself peaked last month. Since then, it is down 11% already. And only four of the 30 Dow stocks are up for the year.

*** And now…maybe…the final peak has been reached. The Nasdaq may have topped out on Feb. 17 — last week. It’s too early to know for sure — but that is what yesterday’s limp Nasdaq market seemed to be telling us.

*** It’s just a matter of time. Because the Nasdaq boom is based on a lie: that this time it is different. But it’s not different. A chart in “Barron’s” shows the sales growth of the S&P tech sector over time. In 1976 the group had sales growth of 13.9%. In ’77 it grew at 14.3%. The next year sales were up by 18.9%. And in ’79, sales rose 16.1%. Pretty healthy sales. But these figures gave the techs a P/E ratio of about 13 for the period. Meanwhile, fast forward 20 years. In this great boom of the Internet era, the techs showed sales growth that was weak in comparison: 9%, 11.3%, 7.4% and 15.8%. And the P/E ratio? It rose from 27 in ’96 to 63 in ’99.

*** NY Fed chief William McDonough said that the Fed will continue raising target lending rates “as long as demand for funds remains strong.” Translation: until it hurts.

*** Gold did nothing yesterday. But March palladium contracts went wild — up $115. I’m not making this up. This is no Internet stock. This is a metal, tangible not digital. And yet Stillwater, a company that produces palladium, barely budged. Clearly, investors do not trust the palladium price — and neither should you. More on gold below.

*** Freddie Mac, the government-sponsored mortgage lender, reports that housing prices rose 25.4% over the last two years. Howard Bill believes that this “represents as much or more `wealth effect’ than even the stock market.” He goes on to calculate that it will take 15 years of zero growth in stock prices in order to get prices in line with GDP growth over the last 20 years. The equivalent figure for real estate is between 5 and 10 years — that is, the number of years of no growth in real estate prices in order to give economic growth an opportunity to catch up.

*** As hot as Wall Street was last year, there were other markets that were hotter. Take Moldova, for example, where stocks rose 781% in local terms. Or Cyprus, where they were up 688%. Bulgarian stocks, meanwhile, rose 434%. And those in Turkey went up 385%.

*** But, of course, not all foreign markets prospered. Stocks in Bangladesh went down 11%. And those in Uzbekistan fell 43%. I offer no opinion on these foreign markets — I just thought you ought to know.

*** Likewise, I have no opinion on the current practice of the police in Kinshasa. Agence France-Presse reports that police are stopping women wearing trousers in the streets. The women are “beaten, humiliated”…sometimes stripped of their trousers in public. It is considered, need I say it, indecent for women to wear the pants in the Congo.