Hard Money Bull Market: The Bulls and Bears of Precious Metals

In this installment of Whiskey and Gunpowder, Pinank takes a look at where we stand in the course of this great new Hard Money Bull Market and the slow, agonizing, but not unprecedented death of debt-based consumption.

Later this week, I’ll check in with you after a field trip to the Bank of England. What constitutes the capital of a nation? We’ve looked at Fannie Mae’s balance sheet and the balance sheet of the U.S. government and found them wanting. But does history have anything to tell us about how good money can replace bad? Stay tuned…

The Bulls and Bears of Precious Metals
by Pinank Mehta

A lot of views are expressed about the recent fall in the prices of gold and silver. Linking the arrest in the fall of the U.S. dollar to the fall in the price of gold and silver is a popular view. The arrest in the fall of the dollar is apparently considered more of a “technical” necessity than a fundamental move. Similarly, the fall in the prices of gold and silver are considered “technical” necessities to relieve the overbought conditions. Some market commentators look to the two-year correction in the 1970’s gold bull market and are now calling for a similar correction! History rhymes, but does not necessarily repeat!

Since I found this reasoning to be quite inadequate and studying the charts not as helpful, I went over the fundamentals once again. The monetary and fiscal policies of the global governments are expansionary and unsustainable. The value of the currencies in terms of purchasing power has been shrinking, and the people are being lied to shamelessly about the extent of price “inflation.” The stock bull of the last 20 years has changed the perception of the masses toward equities (and now real estate) and the concept of wealth. Debt-based consumption is being promoted as economic nirvana!

Hard Money Bull Market: The Last Secular Bull Market

Is there a simpler view to the gold-and-silver story? Assuming that gold and silver are in a secular bull market, I revisited the last secular bull market in the asset class called equities.

Looking at the chart of S&P 500 from 1983-2000 (the approximate duration of the bull market), I observe a few significant characteristics:

*Corrections follow periods of sizable gain

*In the corrections, the drop is sharp, and the markets again start advancing immediately after the drop, a rising trend

*Lengthy periods of declines are virtually nonexistent

*In the early years, the markets were not fancied by the masses, but only by smart money (steady accumulation) — a stealth bull market!

Assuming that gold and silver are in a bull market, how many of the same significant characteristics described earlier for the equities are also observed in the gold and silver charts of the last five years? This assessment has to be made now to guide our investments in real time.

In my opinion, these significant characteristics are observed in the gold and silver charts shown above. A lot of observers calling for a sharp correction in gold and silver due to the overbought conditions are overlooking the fact that both metals were in a corrective mode for most of this year. Gold had just crossed the April 2004 high in November 2004, and silver has yet to cross the April 2004 level of about US$8.301!

Hard Money Bull Market: The Larger Markets

Consider the larger markets (not an exhaustive list at all):

*The U.S. dollar seems “technically” oversold

*Gold and silver seem “technically” overbought

*Official intervention in the currency markets is considered normal

*Global central banks are in a damned-if-you-do-and-damned-if-you-don’t situation with respect to the U.S. dollar component of their foreign exchange reserves

*Fixed-income markets appear to confuse observers about inflation/deflation and growth/recession in the real economy

*Equities seem overvalued considering the poor economic fundamentals

*Risk has been completely discounted, as evident from the very low spread between the strong and emerging countries’ sovereign debt.

It is possible that the generic leveraged, short-dollar trades by hedge funds and others will add tremendously to the short-term volatility, along with the commodity and the bond markets, as these imbalances are resolved.

The bull market in gold and silver has begun, and the safer thing is to let the fundamentals of various asset classes dictate our asset allocation, rather than getting clever in attempting to maximize returns by micromanaging our holdings. Hence, maintaining my core precious metals position is the most logical thing for me to do.

As has truly been said, sitting quietly after making our investments is the hardest part of investing, requiring the courage of conviction in our assessment.

Pinank Mehta is a director with Metier Capital Management Pvt. Ltd.

December 28, 2004