Gold, Again

“Nobody expects gold prices to turn up soon.”

This headline from the February 12th Barron’s might some day enter into the pantheon of Great Contrarian Buy Signals.

So far, the movement in the price of gold has been positive, but not spectacular. Gold rose from $261 to $268. It rose $1.60 yesterday. Since roughly February 12th, the XAU mining index has risen from 46 to over 54.

Like its major competitors – the dollar, the euro and yen…the value of gold rests on nothing more than the ‘group feel’ of the market place. In their collective sentiments, people could decide that an ounce of gold is equivalent to two suits of clothes – or only to a handkerchief. Over many generations, however, gold’s purchasing power has averaged somewhere in between – usually at about the price of a single suit. Julius Caesar could have exchanged an ounce of gold for a smart toga and belt. So might I today, provided I didn’t mind looking like a man in a cheap suit. (I asked my colleague, Addison, to verify this. He reports that you can get a suit at Marks and Spencer’s around the corner for just $277 – almost exactly the price of an ounce of gold.)

A good suit, though, would cost at least 2 ounces of gold.

Over time, the supply of gold increases – but so does the number of people in the world, and does the supply of suits. (Gold seems as though it were provided by nature herself…for use as stable money.)

Yet, since WWII, gold has been pushed out of its monetary role. It is regarded as an impediment to central bankers, who – it is argued – need to be free to destroy their national currencies at whatever rate conditions warrant. And, over the last two decades, gold has gradually been dropped by private owners as well as public ones.

But sooner or later the ‘group feel’ that created a 20-year bear market in gold will bottom out. At least, that is the working hypothesis of today’s letter.

The Barron’s article, of Feb. 12th, illustrated the despair into which gold investors have sunk. “It’s difficult to find any positive news in the depressed gold market,” wrote Cheryl Strauss Einhorn. “At around $260 an ounce, the metal continues to trade near its cost of production and almost no one believes it will rally soon.”

“We are an industry incapable of realizing good returns for our shareholders,” the article quoted Ferdi Dippenaar, of Harmony Gold, the world’s 6th largest producer. And “unfortunately,” he continued, “there is nothing positive on the horizon.”

“Brokerage houses seem to agree,” adds Ms. Einhorn, “In another sign of the times, ABN Amro gold analyst Todd Hinrichs threw in the towel and stopped covering the industry a few week ago.”

“I’ve capitulated and moved on. The gold industry is essentially a very difficult place to make a dollar. There is nothing positive. It’s as bad as it gets.”

Mr. Hinrichs decided to switch to covering manufacturing – an industry with room to get worse.

That was only a little more than two weeks ago. Since then, the price of gold has risen $8. And gold stocks have done well. Newmont has gone from around $14 to near $17. Homestake has gained a dollar. And Anglo-gold, which I believe I suggested to you several weeks ago, has risen nearly $4.

What might drive gold higher? The competition, perhaps?

“How anybody would want to own the dollar here is beyond me,” wrote Lance “Crash” Lewis in his commentary on the Prudent Bear yesterday. The Fed is cutting rates. Inflation is increasing. Recession is a real risk – and no one knows how severe it might be. The negative trade balance and private debt have reached frightening levels. The current account has not been so deeply in the red, compared to GDP, since 1816. And private debt now equals 6% of the GDP, a level we have never seen before.

The price of gold, and the price of the dollar, are both set by the ‘group feel’ of the market. The sentiments that have lifted up one money and cast down the other are, of course, subject to change. A man who prefers 300 dead presidents today might prefer an ounce of gold tomorrow; stranger things have happened.

But in this respect, the dollar and gold are not the same. The feedback mechanisms do not work the same way. As the price of gold falls, investment in mining declines. People who might have dug more gold from the ground go out of business. Or they may change the nature of their business. Mark Twain described a mining company as a “hole in the ground with a liar in front of it.” In the recent bubble, several erstwhile mining companies simply dispensed with the hole.

The result: supplies fall. The precious metal becomes less ubiquitous and more precious.

But what happens to the dollar when ‘group feel’ turns against it? It falls…but where? Recession and falling stock prices will almost certainly be accompanied by a falling dollar. The Fed’s reaction will be – and already is – to increase the supply of dollars! Just as there is no limit on how many ‘dollars’ the Fed can create…nor is there a limit on how worthless each of them may become.

The mob of investors, especially foreign investors, heading for the exits, as they suddenly realize their dollars are losing value… may be as hard to stop as a gang of drunken skinheads. If a dollar is not worth a dollar, is it worth 90 cents? Or 50 cents? Or 25 cents. Or nothing at all?

The Gold Standard…like the Golden Rule…establishes a limit. During the Depression, many economists argue, it made recovery difficult because it was so inflexible. During the next depression, the world may have the opposite problem – a money supply that is too elastic.

Daily Reckoning readers with long memories may recall a headline of mine from almost exactly a year ago: “Gold to Rise,” I wrote confidently. The gold price then was over $300…a level from which it declined and has not seen since. So, with that admission, I leave it to you to decide how accurate today’s forecast may be:

Faced with a ‘money’ of no certain value…which can be made even less valuable by its Fed managers…people are likely to turn to the competition.

Gold to rise…sooner or later.

Bill Bonner, American…not English Paris, France February 28, 2001

*** The relief rally didn’t last long.

*** The Fed Funds Rate Theory of Stock Market Timing says that when the Fed is cutting rates, stocks will rise. When the Fed is raising rates, on the other hand, stocks will fall. “Don’t fight the Fed,” chime the pros.

*** It is a simple theory, alas fatally flawed by the feedback mechanism of all natural systems, or what George Soros calls ‘reflexivity’.

*** When stocks are rising and the economy is roaring… investors can look ahead to the moment when the Fed decides that inflation, or irrational exuberance, or the wealth effect threaten the stability of the markets. The higher stock prices are bid up, the more likely the Fed is to switch to a tightening bias and deflate the bubble.

*** Now, the opposite feedback menaces investors – the more enthusiastically they respond to the ‘Rate Cut’ relief rally, the less likely it is that the Fed will cut rates.

*** Ray Devoe: “Later today commentators on CNBC and the media will be dissecting Mr. Greenspan’s testimony to get some indication of what he really meant. I don’t see why they bother, since he really means to say nothing at all.”

*** “Greenspan has become a cult icon, idolized by stockholders for providing the background for their financial rewards,” Devoe continues. “Two recent very flattering books about the Fed Chairman make him appear a Pope-like figure…infallible. But it would serve you well to keep in mind, Mr. Greenspan gets only the same information everyone else gets – just a day or so earlier. He is human, not infallible, and can make mistakes.”

*** “If for some reason Greenspan actually does cut rates,” writes Bill Fleckenstein, “which I don’t expect – that may hold the market up a little bit longer… In any case, it’s very possible that we could see a dramatic acceleration from here, where all the indexes get in gear to the downside. That’s something I still expect at some point, in part because the S&P and the Dow are still ridiculously overvalued.”

*** After the Dow shot up 200 points on Monday, investors seemed to lose faith. The Dow closed down 5 points yesterday. The Nasdaq suffered more damage – closing down 100 points, under 2,000 for the first time since May ’99.

*** The big losers of the day were the big techs and Internets. Cisco, for example, fell below $25 – down $2 for the day. JDS Uniphase said it was laying off 10% of its staff; the stock fell 15%. Gateway lost 6% after Merrill downgraded the stock to ‘neutral’.

*** Goldman Sachs, too, offered investors helpful advice…changing its rating of from ‘market outperformer’ to ‘market performer’. The stock continued to sink, losing another 25 cents yesterday to close at $2.19. It was $30 last spring.

*** eToys went all the way down – it filed for Chapter 11 bankruptcy protection. Expect a new rating from Merrill or Goldman any day. How about ‘market vanish’?

*** Despite the losses, these Big Techs are still overpriced. Juniper sells at a price equal to 67 times earnings. Cisco is at 41 times earnings.

*** Analysts also revised downward their targets for the major indexes. Jeff Galvin of Credit Suisse First Boston had a target of 4,000 for the Nasdaq by year-end. He now thinks that 3,000 would be more likely. Lehman Bros. strategist Jeff Applegate lowered his target for the Dow too – from 13,000 to 12,500. “The future’s not ours to see,” Doris Day once warbled. But 1500 is probably a better guess for where the Nasdaq will end the year. The Dow, meanwhile, is more likely to be around 8,000 than 12,000.

*** Analysts, as I’ve pointed out many times, don’t have a clue. Last year about this time, analysts’ projected earnings growth for the Big Techs in the first quarter of 2001. They came up with an average growth figure of 28%. Then, over the year, the forecast was revised downward to 14%…then to 4%…and is now -19%. Mr. And Ms. Analyst change their minds…but only after Mr. Market changes his.

*** Philip Morris lit up yesterday; the stock rose 3.8% to $8.26.

*** Nike just did it – dropping nearly 20% in price.

*** Internets fell offline… down 7%.

*** The big winners yesterday were – would you believe it? – gold mining companies. Gold rose $1.60 as the dollar slid back. Lease rates have doubled in the last two days – to 4.12% for one-month contracts. The CBOE gold index rose 7% yesterday. Is another short squeeze developing? More below…

*** The Conference Board reported that consumer confidence slipped again in February…the 5th month in a row. It is at its lowest level since June of ’96.

*** Lynn Carpenter: “To think I’ve been complaining about U.S. beef. It isn’t as robust and tasty as it used to be- thanks to the low-fat ninnies who gave marbling – and taste – a bad name, but at least it’s still beef…” Lynn reports that in response to the mad cow scare here in Europe, Canada is now exporting 160 tons of viande de cheval (horse meat) every week to France and Germany – a historic high.

*** “Hoorah, for the Dayaks!” several Daily Reckoning readers e-mailed in response to yesterday’s missive. “They are fighting an oppressive government,” wrote another on the discussion board “…and fighting the oppression of a civilization that tries to make us all think and act exactly the same. As a US citizen, I root for the underdogs.” What being from the US has to do with rooting for underdogs, I don’t know. Still the Dayaks appear to have garnered support for their campaign of violence – thousands of miles away.

*** “Are you English?” asked Jacqueline, my new French tutor last night. “I’ve had clients from all over the world,” said the red-haired woman of about 65. “I like them all, except maybe the English.”

*** No matter where you go, people manage to find some group not to like. The French blame the English for the Mad Cow disease…and just about everything else. “The English think themselves so superior,” she elaborated without invitation. “Are you sure you’re not English,” she asked again, suspiciously, “you have an English accent, not an American one.”

*** Of course, the English return the French sentiments, with interest. “The wogs start at Calais,” an English friend puts it.

The Daily Reckoning