Revenge of Gold, Part III
"We are seeing a gradual but marked change in investor sentiment toward gold and a simultaneous return of gold to its 2000-year old status as a reserve asset…"
We begin with a confession. In our first and only encounter with the voting booth, we pulled the lever for Jimmy Carter back in the ’70s. We learned our lesson and promised never to do it again.
We have been recalling the ’70s in the last few letters. The era was unlike today, of course. Those were the days when graphs of Jimmy Carter’s popularity…consumer confidence…and the dollar…all headed in the same direction – down – and few people could imagine that they would ever turn up. Gold, meanwhile, only seemed to go in the opposite direction – up – and few people (certainly not your editor) could imagine that it would not continue. So different were the ’70s from today that we can scarcely imagine how they were, even though we can recall the major events.
What is hard to remember is how we felt at the time. Today, we are full of pride, confidence and irrational exuberance. Then, the national mood was one of sullen despair, negativity and irrational desperation.
Remember waiting in line four hours to buy gasoline? Remember consumer prices rising at 13% per year? By the end of the decade, the yield on 10-year treasury bonds had soared to over 10%; and who wanted them? Everyone knew they were nothing more than "certificates of guarantee confiscation." Then, barely months after the end of the decade, Business Week famously announced – on its cover – that equities were not just down, but out forever. But, even at 8 times earnings, who wanted stocks at the end of the ’70s?
And yet, we were human then too. Coming to the central question of today’s letter: might we feel tomorrow the way we once felt yesterday?
That is the weakness of the human condition, dear reader. We have strong powers of logic, but weak powers of imagination. Give us a trend and we will put "reasons" in it faster than maggots can find a dead chicken. Then, the "reasons" will help us look ahead to what happens next – extending the life of the trend into the future as if nothing could stop it. But something always does. Just as maggots soon eat their way through dead flesh, so does a trend sooner or later exhaust itself…and have to move on.
Fighting a war against terror in Vietnam was expensive. But it wasn’t just the money that brought American low in the ’70s. It was also one little detail – the terrorists won!
"I remember those years," said a French army officer at dinner the other night. "After WWII and then the war in Algeria, the French military was totally discredited. In the ’60s, it was almost an embarrassment to wear a uniform. People in Paris practically spat on us. It was not so different in America after Vietnam. The army lost its prestige."
But at the beginning of the ’80s, Carter gave way to Reagan, stocks headed up, interest rates headed down and a major change of sentiment began. In a series of little wars and big defense budgets, the Reagan administration rebuilt the military. Meanwhile, stocks climbed over a wall of worry in the early ’80s and eased into a warm tub of rising cash in the ’90s. Gradually, too, the tough anti-inflation Fed of Paul Volcker eased into the accommodating bath of Alan Greenspan. From then on, every crisis that came along was salved with the same healing ointment – more cash and easier credit.
Then, on September 11th, the world changed remarkably.
But this September 11th was not the one you are thinking of. It was September 11, 1989 – the day the Berlin Wall came down. Americans peeked around them and realized they no longer had any competition. The U.S. was on top of the world – in a class of its own, the world’s only superpower. A new glow of confidence began to light up the American countenance. Stocks soon went from making a reasonable rise from depressed levels to an unreasonable rise from reasonable levels. Gold fell as central banks unloaded their reliquary assets in favor of yield- producing dollar assets.
And why not? Could anyone doubt the staying power of the dollar?
Then, the Nasdaq crashed…and another September 11th came along – in 2001. People are beginning to wonder – as Charles de Gaulle did in the 1960’s – how much is a dollar really worth?
"During March 2001," writes Ian Cockerill, CEO of Goldfields, "there was a turning point in the price of gold. What you see from here on out is a gold price coincidently testing new highs and concomitantly creating higher lows. We are seeing a new trading channel, with a general upwards trend, developing.
"In my opinion, this is a systemic response to the increasing risk profile of the world. Over this period we have seen an upsurge in interest in gold from retail investors, especially in Japan and Germany, as well as institutional investors worldwide. Are investors returning to gold because they are nervous?"
Demand for gold outstrips new mine supply, Cockerill points out, by more than 1,000 tons per year. And at current production rates and today’s prices, mines have only enough reserves for about 10 years.
Gold producers used to hedge, by selling their gold before they mined it. But the rising price of gold makes hedging no longer sensible. The forward price, Cockerill notes, is "but a hop skip and a jump from the current spot price."
In a falling market, hedging adds supply – and forces the price lower. But in a rising market, hedging has the opposite effect. Producers who hedged their production have to buy on the open market in order to cover their positions.
The big threat to the price of gold, though, is selling by central bankers. In recent years, central banks have operated an informal Gold Pool – taking turns selling gold. Whether intentional or not, the effect has been to depress gold’s price. And while the terms of the Washington Agreement limit the amount of gold that central bankers are allowed to sell, the threat of future sales continues to menace the gold market.
But a strange thing happens when the trend turns and gold begins a sustained bull market. Extrapolating from the last 20 years, we can barely imagine it. But, recalling the way we felt in the ’70s, with our basements full of freeze-dried emergency rations…our portfolios full of gold stocks…and our heads full of hair…we can almost imagine it.
No one wants to sell a rising asset. And while central bankers may have a common interest in keeping the price of gold low (coincidentally keeping the price of their paper high), Gaullism has not completely disappeared from the gene pool.
Recently, gold has been outperforming all other currencies and every other major asset category. If the newborn trend continues, even central bankers will grow to like gold. Who knows, instead of selling it, they may become buyers.
Bill Bonner, often accused of being a gold bug, but never convicted…
April 23, 2002 — Paris, France
P.S. "The Fed dumped $20 billion of paper currency into circulation last year," John Myers writes, "cranking the total up to $540 billion. Twice the amount circulating at the start of the 1990s."
That’s not all. "M3 – the broadest measure of the money supply – has skyrocketed a trillion dollars in just the last two years. The total "money of zero maturity" (MZM) – the coupon pass system the Fed uses to lend money to banks – is climbing in excess of 20%."
We’ve seen contraction in the money supply in the past month or so, but money creation through 2001 remained consistent with the Fed’s aggressive rate cut policy. What effect has all this cash had on the gold price?
More bad news for the telecosm. Major telecom companies are reporting lower earnings…lower revenues…and little hope of improvement. Lucent’s revenue, for example, is down a third. And poor Bernie Ebbers! His stock lost another 33% of its value yesterday. Details from Eric, below…
But most investors and economists have written off technology as yesterday’s news. Today’s news is the consumer and his heroic efforts to prevent nature from taking its course. Nature typically ends a boom with a bust. But thanks to the imprudence of American investors, the greatest boom in history has, so far, been followed by such a pathetic recession that, here at the Daily Reckoning, we’re ashamed of it.
Any self-respecting recession would have at least knocked stocks down to at least 15 times earnings. A good recession would have decked them to 10 times earnings. But this puny excuse for recession has left the S&P, currently, at 45 times earnings.
How long can the consumer keep it up, we wonder? We notice his knees getting a little weak – under the weight of debt. And his main asset, his house, may not remain the source of his energy for very much longer.
"Housing Prices on Shaky Ground," says a headline from San Diego. "Small down payments and cash-out refinancing have left many homeowners heavily in debt," says the accompanying article.
"We go through these cycles," says a San Diego-based economist, "they can’t continue for ever."
Over to you, Eric…
Eric Fry, The Daily Reckoning’s Wall Street voyeur…
– To paraphrase one-time presidential candidate Ross Perot, that giant sucking sound you hear is the telecom bubble continuing to lose air. The shares of Worldcom tumbled anew yesterday as the long-distance provider reported late Friday that its revenues and cash flow in 2002 would both be about $1 billion dollars less than previously forecast.
– The stock deflated 33%, finishing the session at the lowly price of $4.01. The shares of fellow telecom company L.M. Ericsson tumbled to an even lowlier $2.74 – a drop of more than 22% – when it warned investors that it would lose money again this year.
– Many other telecom stocks got caught in the downdraft. AT&T, for example, fell more than 5%, and helped to drag the Dow 120 points lower to 10,136. The Nasdaq dropped more than 2% to 1,758.
– Yesterday’s action lends credence to Fred Hickey’s recent observation: "The tech industry’s problems will not go away quickly…History has shown that the last place that investors should keep their money after bubbles pop is in the segment where the bubble primarily occurred. That realization hasn’t yet set in for this generation of investors. It eventually will."
– And now, from the "Times They AREN’T A-Changin’" file: "The New York Stock Exchange is considering taking steps to help shore up investor confidence in corporate governance in the aftermath of Enron’s collapse," reports Gretchen Morgenson of the New York Times.
– One change would require companies whose shares trade on the Big Board to limit participation on their audit and compensation committees to independent directors. "Audit committees oversee corporate accounting practices and compensation committees rule on issues of executive pay," Morgenson explains.
– This proposal, much like Harvey Pitt’s proposed option-grant overhaul, is another idea that makes so much sense that it stands almost no chance of becoming implemented.
– Think about it; would a genuinely independent compensation committee be any more likely than shareholders to lavish obscenely large option packages on management? No, it would not. Winks and nods between friends are often required to get that job done.
– By the same token, a genuinely independent audit committee might be far less likely to bless questionable accounting practices than today’s cozy audit committees. Many investors might be surprised to discover how some companies populate their committees.
– Consider Silicon Valley Bancshares, for example. The company recently added Ms. Michaela Rodeno to its audit committee. Ms. Rodeno is the CEO of St. Supery Winery, a company which also happens to have received a $4 million credit line from Silicon Valley Bank. "Beyond a lack of any formal accounting background," Apogee Research observes, "Rodeno’s addition raises concerns because of the loans that SIVB has extended to the winery. It is not illegal to lend money to a company controlled by or closely associated with a member of the audit committee.
– "But, ideally, from the minority shareholders’ perspective, a member of the audit committee is an individual who has some sort of accounting background and who has not received a sizeable loan and credit line from the company itself."
– A second entry in the "Times They AREN’T A-Changin’" file also comes to us courtesy of Silicon Valley Bancshares, or more precisely, RBC Dain Rauscher’s recent "analysis" of SIVB.
– Last Thursday, SIVB released a first-quarter earnings report that reflected deteriorating profitability from ALMOST every angle imaginable. But RBC analyst, Joe Morford, seemed to let his imagination run wild when interpreting the results. For example, Joe writes, "Both deposit levels and the margin stabilized and showed signs of improving in the quarter."
– But in fact, "deposits in the March quarter tumbled 6% from year-end 2001," Apogee Research calculates. Net interest margin also fell markedly. "On a year-over-year basis, net interest income dropped 40%, non-interest income slid 29% and net income plummeted 60%," says Apogee. "About the only line items showing any growth whatsoever were the compensation and benefit lines. Compensation and benefit expenses jumped 7% year-over- year…"
– It’s hard to understand how anyone could characterize SIVB’s grim performance as a "sign of improvement."
– Is Mr. Morford simply an incorrigible optimist, or is there some other rationale for his "Outperform" rating and positive attitude?
– Well, as it turns out, there may be a more nefarious explanation. For starters, as the nearly microscopic disclosures state at the end of the RBC report, "RBC Dain Rauscher Inc. managed or co-managed a public offering of the securities of Silicon Valley Bancshares within the past three years." In other words, RBC has conducted investment-banking business for SIVB in the recent past. Presumably, therefore, RBC would like to conduct investment-banking business for SIVB in the future as well. And it is harder to get that business when you write unkind things about a company.
– Secondly, buried deep in the seemingly boilerplate disclosure statement was the following disturbing statement: "The author(s) of the report hold(s) a long position in the common shares of Silicon Valley Bancshares."
– In other words, the analyst, Joe Morford, owns the very stock that he is purportedly "analyzing." As an owner of the stock, what other conclusion could he possibly reach than to recommend buying it?
– Welcome to the new and improved era of candid corporate disclosure and unbiased Wall Street research.
Back in Paris…
*** "Seismic" says the Figaro. "Seismic" said the Echo. (I’m not making this up.) The tectonic event that left mouths gaping in France over the weekend was the election results. Jean-Marie Le Pen – a sort of George Wallace/Pat Buchanan character – came in second, knocking the French left completely out of the race.
*** Le Pen has made a name for himself in France by being opposed to immigration. Even though we are immigrants here at the Daily Reckoning headquarters in Paris, we don’t take it personally.
*** That’s the problem with American politics, dear reader. We would not stoop to voting ourselves, but we can’t help but feel a little responsibility for the lame-brained politics of our countrymen. Here in France, by contrast, politics are pure entertainment. And few politicians are more entertaining that Le Pen.
*** "Le Pen was a lieutenant in the French army during the Algerian war," explained a friend. "He tortured prisoners…and once, he was so disgusted by reporters questions that he turned around and pulled his pants down…mooning them."
*** "I mean," he continued, "this is serious. The left is totally left out. There could be big trouble."
*** Le Pen is the "law and order" candidate. He is also the anti-Europe candidate. Many people voted for him because they are tired of rising crime (usually blamed on immigrants from Africa…or gypsies!) and tired of being told what to do by the European Union. They’d rather be ordered around by French politicians than German ones.
*** Le Pen is a abomination, of course, but what politician isn’t? It takes a certain kind of man with a special kind of aptitude to do the work. Any man may enter politics…just he might try out to become a fighter pilot. But like a man with a weak stomach in the centrifuge…a decent man in politics is soon sickened and disqualified.
*** "Bonjour Papa," said a voice on my way to the office this morning. There, standing in front of the supermarket was our local oracle. I will begin at ground level to describe him to you, for nothing about him is what you might expect. He wore a pair of white leather shoes followed by white socks pulled up almost to his knees. Into these socks he had stuffed the cuffs of his shiny black pants which led up to the hem of a florescent green jacket of the sort worn by highway workers. His head was nestled into the neck of the jacket – which was several sizes too big for him. All I could see of his head was his round little face – which looked a little like Yoda in Return of the Jedi. For upon his head, he wore a motorcycle helmet, for no apparent reason, of course.
*** It was early, so I went into the Paradis bar to do a little drinking…I mean, thinking. The strange little man followed me in and sat down opposite me. So, I took advantage of the occasion to pose a question:
"What’s going on in the gold markets?" I asked. "Is it a new bull market? Are the central banks ever going to stop selling?"
"My parents are dead," he began his reply. But what question was he replying too? I wasn’t sure. "And my brothers don’t want to bother with me…"
"But what about gold?" I reminded him…
"Well, that’s the thing. I have no one to take care of me. So, I buy gold louis’ [a popular gold coin] whenever I can. I don’t know whether gold is going up or going down. But I’m sure it’s not going away."
*** At that point, the manager of the bar came over and asked him to leave. "You’re annoying the customers," he explained, shooing him out the door.