Lies, Statistics and...Er, Gold
John Mauldin, intrepid analyst and regular contributor to The Fleet Street Letter, plumbing the depths of deflation, conspiring with central bankers (not), predicting a rise in the gold price… and pondering the average length of the mini-skirt.
Now for the question on everyone lips: what lies in the future for the yellow metal, that barbarous relic?
First, let me say… I am no gold bull. Indeed, I have been bearish to neutral on gold for over a decade. However, a number of economic trends are causing me to re-think my position. I believe the case I lay out is one you will not have read from the usual gold bug suspects.
Buried in reports that the economy grew in the 4th quarter of least year was this astounding number. The GDP price deflator, a gauge of inflation tied to the report, fell at a 0.3% annual rate in the fourth quarter. That’s the biggest decrease since the first quarter of 1952 and followed a 2.2% pace of increase in the previous three months.
Holy predictor of deflation, Batman! We are on the verge of watching inflation slip below 1% within a few months. That is not an environment in which the Fed is going to feel the need to put on the brakes and raise rates.
Wait… I can hear what you’re thinking. "You are telling us on one hand that deflation is coming but now you may be turning bullish on gold? Isn’t it inflation that is supposed to be good for gold prices?" Inflation is one factor, but as we will see, there is another.
My long term disinterest in gold stems from the fact that every time gold gets around $300, some central banker threatens, or actually does start, to sell gold. As an investor, I am not interested in investing in something that has an artificial "ceiling" to it.
However, the roof might be cracking, so maybe we can see a little ray of opportunity. I have reviewed a lot of gold studies. Many of them breathlessly predict gold going to $1,254 or some nonsense; or they can confidently suggest their numbers show a fair value for gold far above where it is today, and we only need to buy gold (presumably from them) and wait for the market to agree with their view.
These reports are full of charts and graphs showing the relationship of gold to everything but the kitchen sink. Invariably, they are all bullish relationships. If gold comes back to "trend," on this relationship, it will be at an all-time high.
Most of these relationships are non-existent, in my opinion. The relationship of gold to the S&P 500 or oil or whatever may be interesting, but it has absolutely no bearing on the price of gold. None. Zero.
I am reminded of the observation that there is a statistical correlation between the length of skirts and the rise in the Dow. If there was such a correlation, then Argentina would be the world’s most valuable stock market.
The reason, we are told, that gold has not gone to its fair price, are those nasty central bankers. It is a conspiracy, and we need to put a stop to it.
In my opinion, there is no conspiracy. Central bankers in most countries simply do not like gold. To them, it is an asset from the Dark Ages, one which does not pay interest. In the case of some of the central banks, they need the cash.
To them, gold is not money. Even a firm which has its roots in the gold movement has recently abandoned the fervor of its founder. Nowhere is this more starkly illustrated than in the year-end letter from Blanchard and Company. Blanchard was started decades ago by Jim Blanchard, and was one of the premier gold bullion dealers. Jim was a good friend and business associate, and I miss him as he is now walking streets of gold rather than selling them.
But, as was noted here in The Daily Reckoning, Jim’s old company wrote the following: "Effective as of January 1, 2002, Blanchard and Company is changing its business practices and policies in order to limit its exposure to falling gold prices, and recommends to its clients that they do the same. As of that date Blanchard will not maintain inventories of gold bullion or gold bullion products, nor will it market gold to, or solicit gold sales to, Blanchard clients.
"Gold is no longer a hedge against inflation, devaluation of the dollar or falling stock prices," continues the mailing from Jim’s old company. "It is no longer a store of value. The very idea of gold’s intrinsic value – value that is not dependent upon the actions or promises of any government – is publicly questioned by senior central bankers, and by the heads of major financial institutions."
I believe they and the central bankers are wrong. And clearly the market does as well, or gold would fall dramatically. Gold is the scale upon which the actions of central bankers are weighed. It is a neutral currency, an arbiter of the value of all other currencies.
If you lived in Japan, you would not be talking about gold conspiracies. You would have simply watched gold recently rise 50% in your currency. No wonder mama-sans are buying gold in large amounts. When the leaders of a country clearly declare their intention to devalue their currency, it is time to head for the hills.
Where can you go if you are Japanese and you don’t want to lose buying power? Large investors flee into dollars or some other store of value. Smaller investors flee to gold.
In fact, in most countries of the world, gold is in a major bull market. Gold is up sharply in terms of Euros. The bulk of that rise is owed to the 20% decrease in the price of the euro, and the rest is due to the rise in gold in terms of dollars.
Gold has not risen in the US because the dollar has been rising faster, in terms of the rest of the world. When central bankers in Europe sell their gold, they are getting a lot of euros. The incentive is for them to sell, especially if they think the dollar is too strong and will come down over time. And especially if they do not want to own gold.
As the dollar comes down, so will the price of gold in terms of the euro. If you as a central banker do not want to own the metal, then it is better to sell high. That means now. As long as gold is high in terms of the euro, there will be pressure from central bankers selling.
For there to be a sustainable bull market in gold, there needs to be a break in the King Dollar. Period.
I have been arguing that the yen is on its way down. No sign of the dollar dropping there. But the yen could be part of the problem in another way.
Many observers worry about the Japanese repatriating their huge dollar investments in US stocks and bonds, causing the dollar to drop, as well as the stock and bond markets. That would cause gold to rise, maybe even sooner than I think. That is possible, but it is not my main concern. Mine is just the opposite.
With the Japanese government committed to a weak yen, it is likely they pursue "reform" so as to avoid increasing the price of the yen. It is just as possible that they inject capital into their banks in such amounts that not only do the banks not need to repatriate dollars and turn them into yen so as to shore up their balance sheets, but that they have excess yen to purchase dollars (and perhaps euros) to hedge against a dropping yen.
This, along with the rest of the world dealing with the huge deflationary pressures running rampant throughout Asia, could actually create a stronger dollar. Indeed, it could be a bubble. We all know what happens to bubbles.
What could be the catalyst for the break in the dollar? The current accounts or trade deficit. I know, I know – the bears have been pulling this one out of the closet every year or so, and like the boy who cried wolf, nothing has happened.
The world continues to buy our goods, stocks, bonds, businesses and real estate to finance our buying binge. It is now running almost $500 billion through the last quarter, according to Morgan Stanley.
They estimate that the trade deficit could be almost 6% of GDP in 2003, which would be 50% higher than ever seen. We would need almost $2 billion per day from foreign sources. This is unsustainable. Just as Amazon.com could not grow their stock to the sky by borrowing and spending far more than they make, the US will one day have to pay the piper. On balance, the US owes $2 trillion dollars to foreigners, net of our investments overseas. That number has been growing dramatically for the last few years.
At the projected 2003 rate, foreigners would own everything not nailed down in the US in a few decades, which clearly cannot happen. Something will have to give, and that something is either the dollar or a massive reversion in US dollar outflows. We will need to export more and buy less on a huge scale for this to happen.
But the dollar being strong makes international sales more difficult in the face of cheaper competition whose currencies are weak. And it makes cheap foreign goods more attractive to those of us with strong dollars. As long as foreigners keep selling us things so cheap, it is hard not to buy. Like I often tell the waitress, take this plate from me before I eat some more!
The question in your mind is, "How far will the dollar fall?" The answer is hard to gauge. There are a lot of variables. One of the biggest is the Japanese. Could we see the dollar rise against the yen and fall against much of the rest of the world? Yes, that is quite possible.
If we do not see a bubble, we could see the dollar drop as much as 20% or so against the euro and other strong currencies. For a lot of reasons, I rather doubt it goes much further, unless we have another major recession and Europe is in a growth cycle, which is hard to imagine now.
In one sense, 20% is not that much. But a 20% drop in the dollar could mean a rise of gold to the high $300’s or maybe even a spike to $400.
When does this dollar correction happen? I seriously doubt it happens this year, without some unforeseen external event and probably not until we are well into 2003. But the gold market could begin to smell the drop and rise in anticipation. There is just no way to know.
But that is the reason gold will rise. Not some intrinsic hidden value of gold. Not some relationship with the S&P or oil or silver or whatever. It is that gold is basically a currency play. When the dollar drops, gold will rise in terms of dollars.
When that will happen is anybody’s guess…
for The Daily Reckoning
March 06, 2002
PS. How to play for a possible rise in gold? You could of course buy bullion. But the more profitable way would be to buy gold stocks or gold mutual funds. If you send me an e-mail at John@2000wave.com I will give you a new way to play the gold market that should do well for you even if I am wrong.
In the meantime, if you have lost money to the bear market, my friend Lynn at The Fleet Street Letter has some important news for you: "It wasn’t necessary," says Lynn,"you’ve been lied to by investment professionals and the media."
In fact, one investment group made 53% returns on their total portfolio while the market plummeted.
George Bush wants steelworkers’ votes in the worst way – by offering a 30% tariff on imported steel.
Every hand grenade and every bubble has a pin.
And every dumbbell finds a way to blow himself up, sooner or later, if he gets an opportunity. U.S. tariff barriers worked wonders in the Great Depression. They set off a round of retaliations from other nations and collapsed the level of world trade to a fraction of what it had been in the late ’20s.
America may be the world’s only military super-power. But it is also the world’s biggest debtor and it’s bound to find a way to humble itself sooner or later. The U.S. buys nearly a billion and a half more dollars’ worth of goods and services from foreigners than it sells to them. The resulting trade gap is filled when the foreigners return their money to the U.S. in exchange for stocks, bonds and other capital assets.
This arrangement has been heaven for Wall Street (selling U.S. dollar investments to foreigners)…but it has been hell for manufacturers. The high dollar makes it very hard for them to compete on world markets.
That is why the manufacturing sector fell for 19 months straight – even as U.S. consumers continued to buy (they were buying from overseas manufactures!). It’s why U.S. corporate profits recently experienced their sharpest drop ever recorded. And it’s part of the reason why "GTM faces problem of 1 million units of excess capacity," as a Financial Times headline put it yesterday. GM’s worldwide selling power is shrinking.
We have no quarrel with this situation. But neither do we believe it is permanent. Bush, like Smoot and Hawley before him, may have found a way – the worst possible way -to make a major change.
Eric… how’s the bull market doing on Wall Street?
Eric Fry in New York…
– Well Bill, even in the technologically advantaged, hyper- productive and hedonically calibrated Greenspan economy, stocks sometimes fall. Perhaps the Maestro got a little tired waving his wand and dropped his arm for just an instant.
– Whatever the reason, the Dow Jones Industrials slid 153 points yesterday to 10,433. The Nasdaq, however, eked out a 7-point gain to 1,866.
– Despite the disappointing day on Wall Street, a smattering of hopeful economic statistics put a smile on investors’ faces. For starters, the Institute for Supply Management (ISM) delivered its second straight crowd-pleaser: the ISM’s service-sector gauge jumped nearly 20% in February to 58.7.Next up, the number of "planned" job cuts by corporations dropped nearly 40% in February, according to outplacement firm Challenger, Gray & Christmas. Of course, unplanned job cuts remain an open question.
– As CEO John Challenger himself, observed, "Even though February job cuts showed a significant decline, there is no reason to think the job market is rebounding. The fact that cuts remained above 100,000 is a strong indicator that employers are still focused on contraction."
– The ISM report confirms Challenger’s cautious assessment. Not one of the 17 sectors within the ISM non-manufacturing index reported increased hiring in February.
– If, therefore, we were to follow Tuesday’s various economic reports to their logical conclusions, we would deduce that companies in the service sector are making few plans to fire employees and no plans to hire. That doesn’t sound like a recipe for robust growth, but it is an improvement.
– Some of the financial markets are also signaling renewed economic vitality of some kind. The oil market in particular, has been on a tear. While the stock market’s recent spectacular rally (until yesterday) has been stealing all the accolades lately, the oil market deserves at least polite applause.
– The price of crude jumped 72 cents Tuesday to top $23 a barrel for the first time in five months on continuing evidence that the recession that never occurred has nearly ended.
– The bond market tells a similar story of incipient economic strength, as the 10-year Treasury yield has been inching higher for weeks now and seems to be setting up camp in the neighborhood of 5%.
– The signs of a tentative economic bounce are indisputable, but the height and "hang time" of any actual recovery remains very much in doubt. More than likely, inventory rebuilding and "relief consumerism" following the post-9/11 economic chill have been boosting the latest economic statistics. Therefore, it’s fair to wonder, "Will it last?"
– While we at the Daily Reckoning try to imagine where we might be heading, a handful of economists and Washington think-tank types earnestly debate with one another about where we have been.
– Recession, yes or no? That is the question with which many overpaid bureaucratic minds are grappling. After all, now that the immediate economic crisis has passed, what better time to engage in frivolous sophistry?
– "Amid burgeoning signs of recovery," Reuters reports, "U.S. Treasury and White House officials on Monday questioned if the downturn in the world’s largest economy actually constituted a recession.
– "Said Randall Quarles, the U.S. executive director at the International Monetary Fund, ‘There is now a chance that there may not even have been [a recession]. The recession has been extraordinarily mild and short.’"
– The official arbiter of business cycles, the National Bureau of Economic Research, says that the U.S. slipped into a recession during the second and third quarters of 2001. "But hold on just a minute," say the economists. GDP declined ONLY in the third quarter – not in the second and not in the fourth. So maybe there wasn’t really a recession after all. The debate continues to rage.
– After the opposing parties have resolved this particular issue, I hope they train their sharp academic minds on weightier questions like the following: 1) If I back my car into a shopping cart in a supermarket parking lot, is that really an accident?; 2) Is pudding "food" or "junk food"?; 3) What would the market capitalization of Global Crossing be today if the NASDAQ were trading at 18,000 instead of 1,800?
– These and so many other pressing questions have yet to be resolved.
– Fortunately, many important investing questions will be resolved in the 10-K filings that are heading our way over the next few weeks. But more on that topic in tomorrow’s Daily Reckoning.
Back in Paris…
*** Consumer spending is holding up thanks to rising home prices, or so they say. But are home prices really rising?
*** "The media reporting problem with home prices," writes Bob Bronson, "is [due to the fact that] they are reporting the ‘average home sales prices,’ which has been rising because they include a larger mix of higher-priced homes, which upwardly distorts the true trend in home prices. But in fact, home prices are already declining on a national basis…. Furthermore, as was recently reported in the Financial Times about Britons, common sense tells you that Americans cannot make themselves richer by simply selling homes to each other.
"And all of this is consistent with our previously posted forecasts of a slow motion Great American Housing Bust, where we point out that high-end home prices peaked in 2000, and we fully expect that aggregate home equity will eventually decline by at least 50% during the deflationary economic BAAC Supercycle bear market period, with the typically house price declining about 5% for every $100,000 in its peak price."
*** "Further," notes John Mauldin, "the economics team at Morgan Stanly uncovered a statistical quirk [with January’s home sales]." While headlines shouted that existing home sales grew by 16% and lauded the growth as proof of an economy on the mend, "it seems home sales actually fell from December to January by 17%."
*** "But in a world of seasonally adjusted numbers," Mauldin continues, "this counts as a 16% increase, because it is more than expected for this time of year. What do you make of that? A little seasonally adjusted salt turns a 17% fall in to a 16% gain… I need some of that salt for my bank account."
More from Mauldin below…