The Battle for $900 Gold

The current "battle" in the gold market is around the $900 level, a fairly steep retrenchment from the recent highs of $1,011. Some investors, their hopes dashed that $1,000 would be quickly and decisively overrun, are seeing disaster in this correction and dropping their gold as they run for cover. Casey Research’s David Galland explains why he doesn’t think we’re seeing a reversal in gold’s good fortune…

So…do we at Casey Research think we’re now seeing a reversal in gold’s fortunes? In a word, no.

I’m not going to go into meticulous detail here, but I do want to share some thoughts with you that may be of some use… if for nothing more than playing them back to me in sarcastic emails several months down the road if we’re proven wrong.

A few key things to ponder as the battle for $900 gold rages…

1. The current correction is not yet exceptional: Since the current bull market began in earnest in 2001, there have been 9 corrections in excess of 8%.

During the three worst pullbacks, gold fell 15.98%, 18.27%, and 27.7%, respectively. And the average of those corrections is 13.6%, so the latest, which touched 18% at its worst, is only marginally worse than average.

Put another way, for the current pullback to match the sharpest correction to date, a drop of 27.7%, gold would have to fall to about $730. Could it happen, again? Sure, why not?

And if it does, rest assured that, just as they did when gold moved down by that percentage in May of 2006 – falling from $725 to $567 – analysts will line up to say that the back of the gold bull has been broken. But if you had listened to the naysayers back then and bailed out at the bottom of that correction, you would have missed a rebound of close to 100%.

I mention this to stress that the fits and starts we are currently experiencing are nothing unusual. Quite the opposite, they’re the norm for any sustained bull market. In the 1970s’ sustained gold bull market, a similar pattern occurred.

The bottom line is that if you are going to invest in the resource sector, you need to take a long view. And, I would stress once again, you have to be invested with money that you can afford to lose a substantial portion of and not be overly concerned. Otherwise you’ll invariably become shell-shocked during periods of volatility and be prone to breaking ranks and selling at the worst possible time.

2. The big gold companies are delivering: One of the largest mining companies in the world, Newmont Mining, just released its first-quarter 2008 financials, the first of the big gold producers to do so.

As we have been forecasting, they had record sales of $1.94 billion, realized a record price of $933 per ounce sold, and saw their cash operating margin soar by 119% from the same period last year. Further, net income was up 444% from Q1 last year. And the company’s cash operating margin rose to a record $537 million in Q108 over the prior record $419 million earned in the previous quarter.

Over the next couple of weeks, we’ll see a string of similar results from the other major producers, offering a stark contrast to the billions upon billions in losses being suffered by the banks, investment houses, housing industry, airlines, etc.

So, what happened to Newmont’s shares on releasing its financials? They fell, albeit modestly, victim to this week’s softening gold price and a dumb remark by the minister of mines of Ghana – where Newmont has significant projects – about the need for mining reform in that country. More on that latter topic momentarily.

The key point is that the increase in the profitability of the gold miners, a prerequisite for the entire gold share complex to get moving, is now materializing.

3. Oil is stubbornly holding on over $100 and food prices are on the rise everywhere. This is simply the most visible evidence of the inflation now gripping the world.

We’ve said for years that there is a very tight correlation between rising oil prices and rising gold prices. While oil prices may moderate at some point – because, again, no market goes straight up or down – the trend is clearly for sustained high prices. This is additional support for gold in our view.

So…given gold’s correction, you might go right ahead and sell your gold. I’m hanging on to mine. And if I’m hanging on to my gold, I’m hanging on to my gold stocks, because that’s where the real juice will be.

When I look at the alternatives and the amount of risk I have to take to get even a 10% return right now, I am comfortable biding my time, continuing to buy gold and gold share bargains with the expectation that the 100%, 200%, 500% gains down the road will catch me up in a hurry.

Good investing,

David Galland
for The Daily Reckoning
May 13, 2008

David Galland is the Managing Director of Casey Research, publishers of The Daily Resource PLUS, a free e-letter offering a concise recap of the 24 hour action in gold, silver, energy, base metals, currencies and more…as well as Doug Casey’s monthly International Speculator advisory, presenting comprehensive, unbiased research on undervalued gold and other resource stocks.

A three-month 100% money-back trial is available that allows you to view all current recommendations and decide for yourself whether the International Speculator is right for you.

"Recession, and its vicious-cycle effect on employment and consumer spending, remains a threat," says Bill Gross of PIMCO. "This recession, though currently mild, and, as of yet, not even officially validated, may not be your garden-variety, father’s-Oldsmobile type of downturn."

Has the Dow seen its lows for the year, as Richard Russell says? Is the housing crisis over, as the Wall Street Journal says? Is the credit crunch over, as Warren Buffett says?

As the song says, "it ain’t necessarily so."

House prices are going down. They’ll take the American consumer down with them. The "crises" may be over…but the long, slow, slump is still ahead.

We left Paris this morning on the 6:43 train. The train glides out of the Gare du Nord…then eases its way out of the city. Once clear of the suburbs, the Eurostar’s Casey Jones opens up the throttle…pretty soon, the train is traveling at more than 200 mph…so fast that if you try to look at something out of the window, it is gone before you have a chance to study it.

Arnold Schwarzenegger came over to France recently. He took a little train ride with France’s president, Nicholas Sarkozy, and had the same experience.

"Wow…" or words to that effect, he is reported to have said, "I didn’t know trains went so fast."

Americans ought to get out more. We’ve been living and traveling outside the United States for the last 14 years. It’s a big world…there’s a lot to see. And what we see is a world that is changing fast…growing…evolving…experimenting…

…and leaving America behind.

We don’t know whether high speed trains are a good idea or not, from an investment standpoint that is, but American infrastructure seems to be on "a pot-holed highway to hell," as an English writer put it in the Financial Times last week. In the Eisenhower years, the interstate highway system was the envy of the world. Now, foreigners laugh at U.S. infrastructure.

"While the U.S. real estate market cools, India, Singapore, Korea, Malaysia are all building like mad," Free Market Investor’s Christopher Hancock tells us. "And demanding dazzling amounts of concrete and steel to make it happen. China alone plans to add another 1,000 skyscrapers to the Shanghai skyline by 2011…and to double its demand for steel by 2031.

"That’s equal to using all the steel sold in the West today!

"For the entire steel industry, it’s nothing short of a ‘second coming’…and a huge opportunity for in-the-know investors, if you move on this while there’s still time."

The lack of high-speed trains is just emblematic of a deeper problem in the United Sates – a lack of savings and investment for the future.

The Daily Reckoning doesn’t pussyfoot around the implications of it. Sell America, sell its money, sell its property, sell its shares, sell its foreign policy, sell its bonds. Yahoos and members of Congress will say we are ‘unpatriotic.’ Investment pundits will say we are stupid. Selling America is not a smart thing to do, as the greatest investor of all time, Warren Buffett, reminds us.

But as to these charges, we deny the first and await the market’s judgment on the second. America needs a correction; it would be unpatriotic to deny it to her. Besides she will be a better, strong, more decent and civilized place when people stop spending more than they afford…start saving again…and return to minding their own business. And Buffett, himself, is now coming to Europe looking for places to put his money.

In the short run, we could see a revival of the dollar. European interest rates held steady – with the key lending rate of the European Central Bank at 4% – while Bernanke cut the Fed’s rate seven times. Under those conditions, it’s amazing that the dollar didn’t fall more.

Now, inflation has dipped down in Europe…allowing the ECB to cut, if it chooses…while the Fed’s rate cuts seem to have come to an end. With no more obvious reasons for the dollar to fall…it has stabilized. Next, it will fall for reasons that are less obvious and more important. But our view on America is long term…and it comes tethered to our views on inflation and oil…and practically everything else. So let us begin by looking at Philadelphia. The City of Brotherly Love used to make things and sell them at a profit. From this healthy exchange, Philadelphians, like so many other Americans, were able to raise their own wages and living standards to not only the highest levels in the world…but the highest levels the world had ever seen. Never before in human history were ordinary people so rich.

Naturally, this led to a certain amount of self-satisfaction…which led to complacency…which led people to think they’d be all right no matter what they did. Then came a series of events and trends that seemed to prove they were right. China began making things at much lower cost. Wal-Mart distributed these things to Americans at low prices. Instead of keeping merchandise in inventory, retailers switched to "just-in-time" systems, which further allowed them to cut costs. In real terms, prices of raw materials plummeted too.

Then, the Fed lent money below the rate of inflation. Normally, the Fed’s easy money policies – in addition to lending at 1%, it has been increasing the money supply twice as fast as GDP for 20 years – would cause consumer prices to soar. But after Paul Volcker wrung inflation out of the system in the ’80s, China helped keep the squeeze on – holding prices down despite a huge increase in the supply of dollars.

Wall Street played an important role too. It came up with innovative ways to pass the Fed’s money along to American households – allowing them to spend money they never earned.

The whole thing was almost too wonderful. No matter how much Americans spent…it seemed as though there was always more where that came from.

From 1980 to the present, the savings rate fell from over 10% to under 1%. Debt grew twice as fast as incomes – except for financial debt, which grew three times as fast.

Now, the factory jobs have packed up and moved to Asia…there are few left in the Philly area. In their place, are jobs in health, education and finance…that is to say, in the service industry. And today, we get word from Philadelphia that inflation-adjusted wages are down from $17.25 per hour in 2001 to only $16.59 today. More people are forced to take part-time work – because they can’t find fulltime jobs. And the number of hours worked by Americans is falling nationwide.

In Europe, wages are substantially higher – in part because the euro is high (EUR)…and in part because unemployment is high (fewer low-wage jobs exist). Not only that, Europeans work fewer hours. As reported in this space, the average salary in America is now about $38,000…compared to $42,000 in France. But the typical American also only gets two weeks off, whereas the typical Frenchman gets five weeks of holiday. Doing the math crudely, which is the only way we do math, we find an hourly average wage in France of $25.50!

Today’s Financial Times mentions a 36-year-old man in Philadelphia who has had to take a job at a deli counter, earning only $7 an hour. Our two daughters, meanwhile, both hold unskilled, part-time jobs in London – working at a pub and a health food store – where they both earn $12 an hour. And both are eligible for free public health care.

*** China reported consumer price inflation over 8%. Ah yes, dear reader, those happy circumstances that permitted the typical Philadelphian to enjoy Everyday Low Prices at Wal-Mart are gone. Now, inflation has been globalized…along with the labor market, the food market, and the oil market. The Chinese want higher wages. And their inputs – raw materials and oil – are rising in price too.

"Cheap clothes may soon become a thing of the past," reports MoneyWeek.

"Simon Wolfson, the chief executive of Next, warned that clothes prices may have to rise by up to 5% to offset rising costs from China and Europe. The strong euro and demands for higher prices from Chinese manufacturers mean that ‘we will begin to see higher costs coming through in spring, summer next year. The way that retailers are going to have to cope with this is to pass the increase on.’

"That 5% may not sound like much, but we haven’t seen clothing price inflation in more than 10 years. And once the price of clothes starts going up – well, nothing will be getting cheaper any more."

Well, it was fun while it lasted – The Great Moderation, that is. The United States could emit pieces of green paper without causing consumer prices to go up. Because globalized wages and finished product prices were falling fast enough to offset it.

But inflation is back. Like spring pollen and sulphurous pollution, it is darkening the air in China. And now people in Europe and America are beginning to rub their eyes and sniff, too. Gasoline hits new records – along with the oil price – every week. Food prices are so high that many nations are taking emergency action to control them. Soon, consumer price inflation will be a problem for nearly everyone.

*** Oh…yes…the oil market. Nations don’t have friends, said one savvy strategist, they only have interests. And since the beginning of the Industrial Revolution, one primary interest of ambitious nations was securing supplies of energy.

Alan Greenspan told the world that the war in Iraq was largely "about oil." John McCain says that if we didn’t have to import oil it would "prevent us from having ever to send our young men and women into conflict again in the Middle East." Sounds like he thinks the war is "about oil" too.

But one thing the war in Iraq has shown is that American cannot control its oil supply – even when it is fool enough to send in armed troops. The price of crude was only $26 a barrel when the war began. It was $126 yesterday.

*** "Yes, there’ll be many more crack-ups," said a young hedge fund manager who came over for a drink on Sunday, "but in the long run, the emerging markets are going to grow much more than the U.S. or Europe. That’s where I want my money."

He put his money into India, primarily. The results were spectacular – until 6 months ago. Then, almost all the go-go markets went. Still, looking at the big picture, over the long term, he is probably right. The emerging markets are probably a better place for your money than the United States.

The fundamental conceit of Americans over the last 50 years was that the foreigners were so hopelessly incompetent that even if we gave them a helping hand they could never challenge us. But now they are challenging us…and beating us at our own game. They invest more, save more, and produce more than we do – even the communists. Meanwhile, we focus on soft service industries – health, finance, and education – where the actual return on investment is hard to measure and often negative.

Until tomorrow,

Bill Bonner
The Daily Reckoning

P.S. Capital & Crisis’ Chris Mayer tells us that India is still rife with opportunity – you just need to know where to look.