Back Up the Truck on Gold

Gold has fallen $34 since its peak on April 1 – what gives? Has the yellow metal fallen out of favor…or is this merely a pause in its uptrend? Doug Casey weighs in with an answer, below…

Since reaching a recent peak of $427.25 on April 1, gold has dropped about 7%, with most of the action happening in the last few days. Silver, which peaked at $8.29 on April 2, has come down even more, losing about 14% to $7.15 as I write. These moves have apparently scared a lot of people (mostly latecomers in the market) and they’re wondering if the steep drop signals an end to the metals bull market.

In my view, the fall shouldn’t concern anybody but a futures trader who was long and who didn’t have a close enough stop-loss. Markets fluctuate more or less randomly in the short run, which helps account for why 95% of futures traders walk away losers. People with such a short time frame shouldn’t be in the markets; they should go to casinos.

Gold Bull Market: The Longer View

The skilled speculator and the experienced investor, however, take a longer view. The key is to identify major trends in the markets, understand why they’re occurring, and stay with them for as long as possible. Jitterbugs that worry about daily movements will eat their capital up with commissions, fees, taxes, and bid/ask spreads in the process of whipsawing their accounts to death with the vagaries of their own psychology.

I don’t have a crystal ball, but I do have a sense of market history. Most of the people that were active players in the last real gold bull market, from August 1971 to January 1980 (which took gold from $35 to over $800) are now either dead or retired. Most of the players in today’s markets only know of gold as a dog, dropping from over $800 to under $253 in July of 1999. Those few who even watched it came to see every rally over a 22-year slide as nothing more than a selling opportunity.

Understandably, people tend to predict the future by the past. So they expect both bull markets and bear markets to go on forever. Right now, most of those who’ve even noticed gold has moved from $252.80 at the bottom to its present levels see it as just another rally in a never-ending bear market.

How do I know they’re not right? Well, nobody can know that until long after the fact. But I’ve been long both the metal and gold stocks since the late 90’s (I was early; generally speaking only liars buy at the exact bottom), and I’m planning on staying long for the indefinite future, but at least several years. Why am I so bullish? The purpose of this article isn’t to make a definitive case for gold, but I will list six outstanding factors worth noting.

Gold Bull Market: The First Three Factors

1. THE FOREIGN TRADE DEFICIT. The U.S. is currently importing about $500 billion more than it exports every year. That’s been going on for many years, so there are trillions of U.S. dollars now held outside of the U.S. Since U.S. dollars are only "legal tender" within the U.S., whether foreigners continue holding them depends on whether they have confidence in the dollar. Confidence can vanish like a pile of feathers during a hurricane. I would suggest that they’re becoming increasingly aware that the dollar is, in fact, an "IOU Nothing" on the part of the U.S. Government, which is itself bankrupt.

2. U.S. GOVERNMENT DEFICITS. The U.S. Government is also running $500 billion domestic deficits, and that number is not only grossly understated – because of (a) off-balance-sheet spending; (b) cash rather than more appropriate accrual accounting; and (c) the adding of Social Security funds into the general revenue – but it’s likely to go way, way up. Why? It’s being financed with some of the lowest interest rates in history, and when rates cyclically rise to more normal levels (forget about the 15% long rates of the last generation – which I expect will be exceeded), the deficit could reach a trillion. That’s not counting greatly diminished tax revenues and the greatly increased government spending that always accompany a recession. And I think we’re heading for something worse than a recession.

3. THE WAR. My guess is that the adventures in Iraq and Afghanistan are, for reasons I won’t go into now, going to get much, much uglier. And likely spread to other parts of the Islamic world. The U.S., which has troops in over 100 countries, isn’t going to withdraw; it’s going to become more involved. This could be a $200 billion-per-year drain, on top of the regular Defense Department and Homeland Security budgets, for many years to come.

Gold Bull Market: The Second Three Factors

4. SUPPLY/DEMAND. Although most of the gold that’s ever been mined is available (either as bullion, coins, or jewelry), the fact is that more is being consumed than is being mined each year by a substantial margin – by about 640 tons in 2003 alone. Most of this deficit has been made up by sales and loans from Central Bank inventory, compounded by forward sales from gold mining companies. The loans and forward sales constitute a short position of substantial size that will have to be covered. And my suspicion is that, at some point in the next few years, Central Banks will go from being net sellers to net buyers.

5. THE REAL PRICE. At $35 in 1971, gold was artificially suppressed in price by government edict. By the time it reached $800 in 1980, it was caught up in a speculative mania. Since then it’s been able to achieve something of an equilibrium. But $400 today is really only worth about $75 in 1971 dollars – so it’s quite under-priced. And, in real dollars (whatever they may be), gold isn’t down just 50% from its 1980 peak; it’s still down about 85%. I expect the conditions that drove the bull market in the 70’s are going to be much, much stronger this time around.

6. GOLD AS A CURRENCY. Take your pick: a piece of paper with less than zero intrinsic value, or a tangible and relatively rare metal that has been viewed as a store of wealth over thousands of years? In addition to holding the physical metal, new services such as that offer electronic transaction services based on gold will revolutionize the ways you can buy and sell the metal.

In essence, you want to own gold because of all these reasons. But above all, you want to own gold because it’s the only financial asset that is not simultaneously someone else’s liability – which is why I expect Central Banks around the world will increasingly be selling dollars and buying gold in the future.

I believe we’re looking at a gold bull market of historic proportions in the years to come. Retrenchments such as we’re seeing now are not only normal, but trivial. You should use them to buy bullion and aggressively add to your mining share positions. Despite returns of 5-to-1 almost across the board in these stocks, there’s every reason to believe that when the gold bull really gets under way, these stocks will be wilder than Internet stocks were in the late 90’s.


Doug Casey,
for The Daily Reckoning
April 21, 2004

Editor’s note: Doug Casey, author of bestseller Crisis Investing, has been seeking and finding incredible opportunities around the world for over 25 years. He has lived in seven countries and visited over one hundred more, actively – and successfully – speculating in international stock, bond, commodity and real estate markets.

If you’re interested in gold and other natural resource stocks, take a moment now to learn more about Doug Casey’s International Speculator – for over 25 years one of the world’s most respected monthly newsletters on natural resources:

International Speculator

"It’s fairly apparent that pricing power is gradually being restored and, as I’ll indicate tomorrow, threats of deflation, which were a significant concern last year, by all indications, are no longer an issue for us."

Alan Greenspan was answering questions before the Senate Banking Committee. It was as good an occasion as any for him to make such a remark. He had no clue. But none of his interrogators would notice. Even if they had put his head in a vise and turned the screw as hard as they could, they would not find out anything more; Greenspan knows no more than we do.

Mr. Greenspan has lured the entire nation to stitch itself up in debt. A person who is deeply in debt loves inflation – because rising prices cut him loose from his obligations. What the debtor fears is deflation – a sinking economy and rising value of money – since it makes it harder for him to repay his debt. Already, with the lowest interest rates in nearly half a century, and unemployment at only 6%, bankruptcy rates are near record highs. Imagine how the voters would howl with unemployment at 10%…and prices falling!

How could the gods resist such an invitation to irony? It has been handed to them, engraved with the initials A.G., on a golden platter. Only minutes had passed after Greenspan’s declaration of victory when the enemy, deflation, fired another round. The Dow deflated by 123 points. Bonds let some air out, too. And even gold went down…sinking once again below the $400 mark.

The dollar, on the other hand, went up. And so did oil.

A world of inflation is one in which things become expensive and currency becomes cheap. Debts, defined in terms of currency, are lightened by the in-rushing gas. But what if the gas leaks out? Couldn’t one expect that those things most blown up out of proportion would be the same things that would shrink the most?

Is gold expensive? Well, not compared to the cost of a new suit; it is just about where it ought to be. Is oil expensive? Not when compared to the cost of an automobile. Oil and gold have merely followed the modest upward bent of consumer prices.

But stocks, and real estate in certain areas, have followed a more immodest course. An ounce of gold would have bought, say, four suits in 1980; now it buys just one. But a basket of Dow stocks – which would have bought the same four suits in 1980 – will now buy a whole closet full of them…about 25, by our rough guess.

In a deflationary period, which is more likely to be deflated – gold or stocks?

We will take a guess. Stocks and real estate – the assets most puffed up by inflation – are most likely to become cheaper in the great deflation Alan Greenspan tells you not to worry about.

As they used to say in the Soviet Union: ‘nothing is to be believed until it is officially denied.’ Now that deflation has been officially declared not to be a problem, our guess is that it will be a big one.

Here’s more news from Addison:


Addison Wiggin in Baltimore, Maryland…

– "Well, before that report on inflation, I was very satisfied because I don’t think rapid growth, which is what we’ve been having lately, is inflationary," said Bob McTeer, President of the Federal Reserve Bank of Dallas. "That particular CPI report was disturbing. And if we have more of those then we’ll have to say that inflation may be coming back…"

– Bob ‘let’s all join hands and go buy an SUV’ McTeer carried on: "When we talk about employment growing, when we talk about retail sales growing and we worry about inflation, I think that’s misplaced," McTeer continued. "But the CPI measures inflation…and it is one month…and I’m hoping it will be just one month and that it will go back to the benign state that it was in."

– Oh how the wicked winds change. Not six months ago, Fed governors were warning of the dreaded ‘declining rates inflation.’ Deflation is the enemy, they told us, and we must use every tool at our disposal to fight it…inflate or die, they said. But yesterday, Greenspan told the Senate Banking Committee that "deflation is no longer a threat." And McTeer appears to have grown a bit of an economic conscience…

– The markets, far from celebrating this monetary triumph, tanked. Immediately following the declaration, the Dow lost 123 points, closing the session at 10,314. The S&P followed suit, dropping 17 points to close at 1,118. But the big loser of the day was the Nasdaq – it shed a full 2%, closing at 1,978.

– Gold and silver didn’t seem too pleased, either. The ancient metal of kings fell $2.60. The mining stock arena – fearing rate rises – also took a pummeling: the HUI index of mining stocks broke below 200 for the first time since the 13th of October 2003, losing nearly 7% on the day. Silver lost 26 cents to close at $6.93 an ounce…down $1.37 from its April 2 peak.

– But the meddlers at the Fed aren’t the only ones with an inflation problem. "Just as rising oil prices created a problem in the United States three decades ago, rising prices for energy and other raw materials have rippled through the Chinese economy," explains the New York Times. Wonks in Beijing – no better than their Washington counterparts – aren’t likely to scream ‘pao mo’ just yet, but they openly admit their economy is overheating, and are trying to cool the flames. Trouble is, who’s really going to pay the price?

– "Prices for orders placed now will not show up in most American indexes for months," the Times piece continues, "But as prices begin to rise in the United States, concerns are growing that China will become an exporter of inflation." How so? Demand for raw materials in China is rising…likewise prices…but are Chinese manufacturers going to eat the difference? Not likely…they’ll pass it on in the form of even higher prices to the U.S. consumer.

– Here at the Daily Reckoning, we have been expecting all this ‘inflation’ to find its way into the gold market. It hasn’t – in fact, it’s fled the scene. Gold has fallen hard for most of the month…down $34 from its April 1 peak of $427. What gives?

– "Retrenchments such as we’re seeing now are not only normal, but trivial," opines our old friend Doug Casey. "These moves have apparently scared a lot of people, mostly latecomers in the market, and they’re wondering if the steep drop signals an end to the metals bull market.

– "In my view, the fall shouldn’t concern anybody but a futures trader who was long and didn’t have a close enough stop-loss. I believe we’re looking at a gold bull market of historic proportions in the years to come…" [More from Mr. Casey in today’s guest essay, below…]


Bill Bonner, back in Venice…

*** "Florence is much nicer," said a Lebanese friend over dinner last night. "Here in Venice, everyone is trying to rip you off. We went out in a gondola yesterday. I just wanted a quick little trip, but it cost 100 euros. And you can’t seem to get a decent dinner for less than $50. Everything is so expensive. And it’s like Disneyland around here. The whole town is nothing but tourists. The only Venetians you see are involved in the tourist trade. Besides, there’s nothing to do here. There are no movie theatres. No theatres of any sort that we have seen. No big parks. Just churches. And how many churches can you look at before you get bored? You can shop, but everything is too expensive. Florence is better."

*** We have not been to Florence. But Venice has a certain appeal. Yesterday, we visited San Marco’s church and the Carrer museum, with its marvelous collection of Venetian coins, at the opposite end of the plaza.

"Look at those gold ducats," we encouraged the boys. "See what good shape they are in. Gold never fades. Or deteriorates. Or rusts. Those coins are more than 500 years old. But if you had just buried them in your back yard 500 years ago, they’d be as valuable today as they were then."

"But Dad," Henry replied. "What would be the point of that? Aren’t you supposed to use your money to make money? Why would you want to wait 500 years just to get the same amount of money back? Wouldn’t you have done better buying some stocks or something?"

"Let’s go get a drink," Dad replied.

*** This morning, we enjoyed our café lattes at the water’s edge on the Giudecca canal. As Elizabeth read aloud from Mrs. Oliphant’s history, a idea of Venice began to take shape.

For all her faults and shortcomings, Venice has her charms. Dead men tell no lies, we recall. Venice is an old city with lots of dead men. More to come.

*** Our friends at a new Internet-based weekly, "What We Now Know," give us an unusual eye-witness report from Iraq, as related by a "Mr. X":

"As far as what’s happening over here…first, in Fallujah, the Marines were doing well until they ran out of gas, literally. The real reason the Marines had to start their truce/cease-fire strategy is because the coalition forces are running extremely low on fuel right now. We first heard about it maybe 10 days ago or so from some Army 5th Group Special Forces guys who were complaining to us, saying how even THEY had been ordered to ration fuel…

"In Baghdad, where we work, I’ve never seen the city this dangerous. It wasn’t even this bad last spring, during the actual war. We knew things would get worse before June 30th, and they have. Things will probably continue to get worse…

"The Army is just making things worse for the coalition. The Army is intent on having its presence seen and felt in Iraq because they think that will make everyone think they are in charge. What they don’t seem to realize is that a large military presence is the one thing, pretty much the only thing, the Iraqis can’t tolerate…

"Until the Army realizes all of this – which it seems like it never will – things will only get worse. And in response, the Army will just increase its presence.

"That’s not to say all hope is lost. Slowly but surely, things are actually getting better for the Iraqi people. Everything except security and safety, of course…"

The Daily Reckoning