10/14/11 Paris, France – Nothing much to talk about in the markets yesterday.
We had been expecting a bigger sell-off in the price of gold. The metal went down, about $300 if we recall correctly, but not as much as we expected.
In the last major bull market in gold, in the ’70s, the price declined by about 50% before going on to set a new record. The pullback in 1974 caused investors to question the premise of the whole bull market. Many dropped out and missed the big payoff.
Markets always test their admirers. The old-timers — such as Richard Russell — refer to the “50% principle.” A bull market can be expected to retrace as much as 50% of its gains…before going on to fulfill its destiny. If it goes down more than 50%, however, the bull market may be over.
Unfortunately, these are not hard and fast rules. Just old timers’ tales.
Still, they are useful for understanding how markets work…and for keeping you from making a big mistake.
This gold market barely corrected 20% of its gains. Is that all there is? We don’t know. Doesn’t seem like enough. We didn’t feel tested at all; did you?
That was part of the reason we thought the economy was sliding into a Rip Van Winkle slumber. It would be a real test.
Imagine that China slows down. Imagine that Europe lurches from one crisis to another. Imagine that the US economy follows Japan down that long, slow, slumpy road. What do you have?
Falling prices for almost everything — including gold. And with falling prices for other assets, investors, savers, insurance companies, pension funds all put their money into US Treasury debt. This keeps rates low and it allows the US to fund its deficits almost indefinitely. The economy never recovers, but it doesn’t die either.
Bernanke and crew may want to do something dramatic and foolhardy. But they wouldn’t have to. As in Japan, they could just bide their time…
Pretty soon, people would come to think that the world economy had entered a more or less permanent phase of low growth and low inflation. And then, what would happen to the price of gold? It would fall. People buy the inert metal to protect themselves from very ert humans. But if the humans who run central banks and Treasury departments sit still, why hold gold?
The logic of the gold bull market is that the feds have done, and will do, stupid and disastrous things to the monetary system. Perhaps they will. But as long as they are able to finance large deficits painlessly, they have no reason to do so. Instead, they will take economist Richard Koo’s advice and use deficit financing to pay for fiscal stimulus projects. Infrastructure projects…transfer programs…tax the rich…bread and circuses for the poor — this could go on for a long time.
When speculators and savers realize that they need not hold gold to protect themselves from the feds, they will sell it. The price will fall — perhaps below $1,000. Then, we will have a real test.
If the economy is stuck in a low-inflation phase, why own gold?
If the feds do not have to print money, why would they?
If prices — in dollar terms — are stable or going down, why not just stick with dollars?
We can see the headlines now:
“Investors give up on gold.”
“Even gold-bugs are disappointed by the yellow metal.”
“No need for gold as world economy enters 7th year of stable prices.”
And then, you, dear reader. What will you do? The logic of the bull market will have disappeared. Will you give up on gold too?
In the near term, things are actually looking up for gold. In fact, since it didn’t fall as much as we expected…perhaps our Japan-like disinflationary slump has been delayed…or derailed?
Right now, the central banks are all itching to meddle. Bernanke’s “twist” program is a waste of time. It merely takes the Fed’s money and switches it from short-term US Treasury debt to longer-term Treasury debt. It is a very bad idea — leaving the Fed itself exposed to huge losses. But that’s another story. But it is unlikely to have any advantage for the economy. Mortgage rates are already the lowest in half a century. Pushing them down a little more isn’t going to make any difference.
Several members of Bernanke’s FOMC group are already calling for more forceful intervention — some form of QE III. If the economy deteriorates, there is bound to be more action from the Fed.
Meanwhile, the Europeans are “recapitalizing” their banks. So are the Chinese. The capital has to come from somewhere…or they have to invent it. The more new money they create, the less their old money is worth…and the more attractive gold becomes.
Bill Bonner
for The Daily Reckoning
Bill Bonner
Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America's most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind The Daily Reckoning. Dice Have No Memory: Big Bets & Bad Economics from Paris to the Pampas, the newest book from Bill Bonner, is the definitive compendium of Bill’s daily reckonings from more than a decade: 1999-2010.
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BB wrote: ” Bernanke’s “twist” program is a waste of time. It merely takes the Fed’s money and switches it from short-term US Treasury debt to longer-term Treasury debt. It is a very bad idea — leaving the Fed itself exposed to huge losses.”
How does that saying go again: “Don’t fight the Fed.”
The big money is fleeing to the safety of long term Fedgov bonds. And you want to fight them?
Bill can you write some more about the output of mines declining and this decline on the supply side affecting the gold price as well. This could have just as big an impact having to spend more dollars, i.e. the loss of value of the dollar, when it comes to buying gold.
This is a huge part we are missing and it needs more attention if we wan to predict the gold price in years to come. ps. What do you think the gold price will be in 5, 10, and 20 years ?
Whether or not the demand for gold increases (due to inflation of paper money, banks investing reserved more in gold, etc, etc) the supply is getting les due to my reasoning above and therefore gold has to go up, but how much up is the question ???
ps. Do you still hink silver will out perform gold ? I believe silver will really pick up the more the world population starts to trade on a daily basis in silver rounds (coinage) instead of paper.
The crack down on the Liberty dollar(http://libertydollarnews.org/pommo/user/subscribe.php) was in my opinion due to government wanting to force everyone to buy their over-priced silver eagles instead, besides the fact that any competition at all to their fiat money is a threat in general. Wonder which private mints they will target next.
Investors can price in tension & fragility in the system. Even if things are looking stable temporarily, the tensions built up in a broken system won’t let smart investors stand still. Also, the world is not centered on the US & the Fed. What will the BRICs do? What will others do?
“If the feds do not have to print money, why would they?”
because they do have to. because every single dollar bill that comes into existence does so with an interest rate attached to it. the only way the interest payments can exist is if more money is printed. and the only way the interest on that money can exist is if more money is printed. and so on forever. amen.
“Falling prices for almost everything — including gold … The economy never recovers, but it doesn’t die either.”
the problem with this line of reasoning is that it conflates the economy with the currency. they are not the same thing. the currency is a debt pyramid scheme that requires ever-increasing debt acquisition to function. if that debt acquisition is interrupted then the currency doesn’t merely contract, it begins to implode. it continues to implode until more someone somewhere acquires more debt thus beginning the cycle again. it is inherently unstable.
“The big money is fleeing to the safety of long term Fedgov bonds.”
and oh boy is that whacked. big money can’t get their infestment income from business activity but they’re going to get it from taxation? is that gonna be a disaster or what?
There is nothing logical about the market period and it sure is not free.
Chris, supply really doesn’t matter as yearly production doesn’t affect much the stock of gold extracted during the last 3000 yrs.
BB, I actually don’t understand the logic of your post.
What was the reason for gold to go up from 2001 to 2008? They weren’t even printing money, and things were stable economically.
On the contrary, from now on I see reasons for gold to go up, up, up, whether they stop printing money for 1, 2 or 3 years. Why? Because of the (geo)political/economic/demographic uncertainty. Sleeping with (most of) your money in USD is like sleeping with an old grenade that is “unlikely” to blow up in the short-to-medium term, under your pillow.
Of course they were printing money – how else do you think they achieve a 1% interest rate?
“If you’re not printing money, you’re not doing it right, baby!” – Ben “The Helicopter” Bernankster.
“it is inherently unstable.”
you bet! Gman, I usually agree with 100% of your comments.