The Dow gave back almost five days’ worth of gains in one fell swoop.

So should we not have seen a better bounce in gold? Maybe it’s too early to call the Dow.

Further weighing on gold prices were a lifeless bounce in oil and the market’s shift in focus to signs that gas demand is ebbing. Sometimes, however, there is a delayed reaction in gold, which happens more often than efficient market theorists would like to admit. Gold’s fundamentals are still bullish.

Mining costs continue to increase, which pushes up the floor on gold prices.

Several months ago, I calculated that production costs had more than doubled for the gold mining industry since gold traded at under $300 per ounce some eight years ago, and, consequently, that the decision to shut down mines would today occur at $600-700, rather than $300. The supply situation is already tight. It is getting increasingly difficult to replace gold reserves. And of course, there is no end in sight to the readiness of central bankers to inflate, guaranteeing a strong flow of gold demand.

As for the prognosis, I see two possible scenarios for which there is some technical precedent.

Technically, the market is trendless. Neither bulls nor bears have gained much traction since the correction began in March. The seasonal low could be in, but it remains unconfirmed by a higher high.

A casual glance at the chart would tell you nothing except that the market could fall to $750 as easily as it could rally to $1,200. Technicians would call it a neutral pattern, though some may read bullish or bearish biases into how it is developing. I won’t get into that. But one does not have to be a technical analyst in order to grasp some useful truths from the chart.

It is true that history never exactly repeats itself. But there are similarities, or regularity in the behavior of prices, that can help with our outlook.

For example, if you look at the corrections since 2001 in the chart below, you’ll notice that rarely have they lasted much more than a couple of quarters before the bulls took charge again. You might also notice that the first leg in each correction has been followed by a second one that usually fails to make a lower low — 2004 being the exception. The market also likes to brush up against its 50-week moving average before completing the correction.

Moreover, we can even infer a loose relation between the extent of a rally and the depth and duration of the ensuing correction. These things are called “technical” mainly because they have nothing to do with the fundamentals. And let me tell you, it is dangerous to put too much weight on past performance and behaviors when we’re talking about investors and the market.

Notwithstanding, if this were just a typical correction, we could expect to see a second “attempt” by the bears to make a lower low over the next month or two before the bulls break out, sometime in the fall.

But the exception is worth considering, too.

Give The Gold Rally Some Elbowroom!

The market is at an important number and inflection point, which threatens to complicate the situation central bankers face today — their control of interest rates, to be precise.

Naturally, the “powers” will do everything they can to resist this change.

Similar conditions prevailed back in 2004, when gold was trying to break past its old 1996 high, about $425ish, which would reverse the downtrend in the longer-term charts and signal a new bull market — note in the chart below how the moves became more violent once gold broke past this level.

As it is now, the Fed was then about to embark on its tightening campaign, after having talked about it for almost a year… making gold bulls nervous about the impact of higher rates. Of course, the Fed’s job was a tad easier then. There was no series of financial crises to contend with. The stock market hiccupped, but the economy was producing jobs, and nobody much minded the Fed gradually ratcheting up interest rates.

As it turned out, however, it was just enough to keep bondholders happy, but not enough to rein in the effects of the Fed’s previous inflation policy. The bears pushed down on gold prices, but did not realize just how tight the springs were and got caught in a lower chart low before gold whipsawed higher.

The market hasn’t looked back since.

So it is possible that the market could make a lower low, if only to make more elbowroom in the chart for the breakout… sort of like pulling a slingshot back further to get a little more energy out of it.

On the other hand, the Fed’s hand is weaker than it was in 2004-05. Because of this, I have to favor the former scenario, in which the correction low in gold is already in.

Regards,
Ed Bugos
July 29, 2008

P.S.: While we wait for the gold correction phase to end, and the next phase of the gold rally to begin, investors are facing a great opportunity for investment. As you just read, the technical and fundamentals point to the price of gold going up once again. This is the price dip you’ve been waiting for, and now you can really begin making some money in the coming blowoff phase.

The Gold Correction was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Big institutional players in the New York futures market slashed their bullish betting on gold in the week of June 10. Data from the CFTC — the U.S. regulator — shows a net reduction of 11 percent in the long gold positions held by what it calls “large speculators.”

And this “reduction in the gross longs may be a further sign that gold is losing its attraction,” reckon analysts at the Swiss banking and wealth management giant.

But less pressure from large investment funds could alternatively signal more loss of froth from the gold market since it shot 54 percent higher in the seven months to mid-March.

Topping out at a new all-time record above $1,032 per ounce — just as the Federal Reserve lent $29 billion to support J.P.Morgan’s fire-sale purchase of Bear Stearns — the gold price has gone on to drop 15 percent of its value against the Dollar.

Versus the Euro and British Pound, the loss has been just as dramatic. And looking at the technical action on its charts, “any meaningful bounce from the 200-day moving average could bring back a lot of money into gold,” the UBS comment goes on.

That’s what “happened last year,” it adds:

The 200-day moving average, as the name says, measures the average price of an asset over the last two hundred days. It’s called “moving” because, as time rolls ever onwards, so too does the average — used by chart-loving technical analysts to see what the deeper, underlying trend is up to.

And why 200 days? Because that’s roughly the number of trading days during one year. So the chart here, therefore, shows both the daily gold price as well as its 12-month trend. And you can see how the 200-day average has indeed acted as “strong support” during the bull market so far.

Well, kinda. Most of the time.

Nine times since gold quit its 20-year bear market in 2001, the price has either bounced off or moved sharply higher through its 200-day average. The following surge — lasting an average of 21 weeks — delivered a 28 percent gain before the price of gold tipped lower again, back toward that ever rising up-trend.

The leap starting in late September last year was the most spectacular, as UBS notes. By the top of March 17, 2008, the gold price moved some 54 percent higher. Might that happen again now?

Two points to note if you’re chasing the bull market in gold for short-term gains to shoot out the lights:

1. Summer Lull — as the chart shows, gold typically moves flat to lower during the middle four months of the year. And even as the global banking crisis hit in August 2007 it still took another six weeks before gold started to vault higher;
2. Pre-Empting the Bounce — prior to last year’s jump — sparked by the U.S. Federal Reserve slashing the cost of borrowing below the rate of consumer-price inflation — the gold price had dipped below its 200-day average seven times during this bull market so far.

Buy gold now, in other words, and a keen market timer might well have to endure a further drop first, even if the apparent magic of the 200-day average does come good once again.

But with the 200-day moving average now just above the $850 level, longer-term investors who’ve been considering a purchase — but were put off the huge volatility of 2008 to date — might want to stop waiting around. Precisely because larger investors are sitting it out, and precisely because technical analysts like the UBS team are pointing to a possible dip before advising you buy.

You see, that price of $850 marked the bottom of gold’s fast & furious sell-off in March. It was also the previous bull market’s top, hit just as Soviet tanks rolled into Afghanistan on January 21, 1980. So a return to prices below that level might actually signal a longer-term drop. If the price is to push higher from here instead, a drop below $850 might be a long time in coming.

Hanging on for another pullback from today’s current gold price and so trying to nick a little extra off your investment outlay might prove expensive, in short. If you’re looking to take a position in gold for longer-term or deeper fundamental reasons, the kind of low-profile flat action we’re seeing this June could offer your best chance to get in.

Just ask anyone who tried to wait for a pullback once the last surge in gold prices had started in Sept. ‘07.

Regards,
Adrian Ash
BullionVault
June 19, 2008

Gold Price Dips was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

You tell yourself that these things are not fundamentally bearish for gold prices. One of them is even bullish. But you know that gold is probably due for a correction anyway, and any one of these, or other factors, is just as good an excuse as any fundamental when confronting a risk-averse crowd.

What do you do? You could weather the storm. You’re in for the long term, right? The trouble is gold stocks can fall a lot during even a typical correction.

Most everyone already knows that markets do not go straight up. If every dip led to higher and higher highs, nobody would ever lose sleep over it. Trouble is, the company could always screw up, or one of those dips could turn into a bear market. I have seen the conviction behind many buy/hold strategies melt at the tail end of a normal correction, just because it corrected invariably worse than expected.

In my observations, investors are more likely to get bucked off a bull market because one of the corrections discourages them than because they took some profits by selling into strength.

Goldcorp, one of the world’s largest miners today, has already seen three corrections of 40-50% on the way up to $45 from its $3 (split-adjusted) share price back in early 2001. That’s a 15-bagger! And it’s not over. Goldcorp will see a few more like corrections, and maybe one that’s even larger, on its way to $150. Hardly anyone who bought at $3 will still be aboard, and even fewer will sell the top:

However, there are ways to improve your long-term returns and reduce the impact of market volatility on your portfolio without ever having to trade in and out of your shares and risk getting bucked off the bull too early. Options! Options allow investors to take advantage of leverage and limit their risk.

They represent a way to benefit from most of the change in the value of the underlying property or shares without ever having to buy. Due to this leverage, they can sometimes increase hundreds and thousands of percent in the space of a week, or even a day, as in the case of Bear Stearns put options when the stock halved that fateful Friday before last. Consequently, they don’t draw only speculators; they draw gamblers ready to stake the farm on getting rich quick by abusing the available leverage.

But gambling is in the method. If you don’t know what you’re doing, you’re gambling. Otherwise, you are speculating, hedging or investing.

Today, I am going to show you how to “insure” a portfolio of gold stocks emulating the Amex Gold Bugs Index (HUI) against an intermediate correction using a few basic option strategies. “Intermediate” just means like any of the other four-five corrections that are most evident in a chart of the seven-year bull market to date.

They averaged 10-15% prior to 2005, but with the accelerated rallies post-2005, they are more likely to look like the 27% correction in 2006 from now on. A correction in the primary (seven-year) sequence would be more like 40-50% or more, which I’ve judged a low-probability event from these levels.

In any case, the first thing to do is nail down a few scenarios you think are likely. That is, try to quantify the risks. Let me walk you through some scenarios.

If last week’s sell-off is the beginning of an intermediate correction in gold prices, which is possible, gold could fall back into the $700-800 range and/or remain range bound until next year.

The “tape” is telling us this IS the likely scenario. The gold stocks traded up with gold, but they lagged it, as if they were tired. And not all of them participated. Many of the juniors sat out the last $300-400 gain in gold. The breadth of the advance was thus narrow and the leadership extended. And the way gold prices came off their peak is itself often a bearish marker, indicating more of the same to come.

I’m assigning this scenario a 35% likelihood and a 10% chance of something worse. The most likely (55%) scenario, in my outlook, is that the bulls will hold the line at the $850-900 level for a few weeks and then continue their unfinished business — i.e., developing a real top well above the $1,000 barrier.

But that analysis goes beyond the purpose of this article.

If you think the likely scenario is an intermediate correction, or worse, the easiest option strategy is to “write” (or short) a call. Writing calls is effectively the same as shorting them, except that options are contracts representing but a “right,” so the short seller is technically the underwriter of the contract. If the underlying asset goes up, he will have to either buy the calls back higher or deliver the asset(s).

If you don’t own the asset, it’s a naked short, and the theoretical risk is unlimited. If you own the asset, your risk manifests in the form of reducing or limiting your profit on the underlying position. Since we are talking about insuring a portfolio of gold stocks against a correction, we are talking about the latter.

In our hypothetical scenario, with gold falling to $700-800, the HUI might fall to the 350 level, plus or minus 25 points — which is about 90 points (or 20%) below the current level of about 440.

A note of caution: In this example, I am assuming that your portfolio of gold stocks mirrors the HUI; if it does not, you are better off writing those calls on the specifically optionable stocks in your portfolio.

Otherwise, there can be no assurance that your risk will be limited.

Last week’s bid on the Amex Gold Bugs Index (HUI) 375 September 2008 call was around $8,960 per contract — or $89.60 per each hypothetical index share. This means that if the gold share index falls below 375 before the option expires in September, you can pocket that entire amount less commission and time value. You start losing money on your underlying position only if the HUI falls below about 350:

439.05 – 89.60 = 349.45 (or approximately 350)

If the index falls less than expected, say to about 400, you might make between $20-60 points per hypothetical index share, depending on days left to expiry, which would likely cover the correction.

The downside is that gold shares brush this correction off and continue to truck higher, in which case you do not participate in any of those gains until and unless you close out your short call position.

It would not be advisable to buy puts in this situation, because premiums are too high to protect you against an intermediate drop, at least in the index. The September 2008 HUI 435 put was offered at $54 on March 20, which means it would cost you about 13% to protect your portfolio from a 15% correction.

It only makes sense to buy a put to protect your portfolio from a much larger correction. If you thought the gold share averages were in for a nasty 40% or more decline, then it would make sense. Effectively, it would protect your portfolio against any losses that exceeded a 20-25% correction.

The nice thing about options is that they are flexible. There is a myriad of strategies available to suit almost any situation. You could write the September 2008 375 call and buy the September 2008 375 put, which would net about $5,900 per contract and cover most of your downside, but eat into your gains more.

Alternatively, if you’re not so bearish, you could write an out-of-the-money put…

Regards,
Ed Bugos
March 26, 2008

Investing in Gold Options was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

“Those who oppose reform may get revolution.”

— John F. Kennedy, speaking of Latin America in 1962

THE EURO HIT FRESH ALL-TIME HIGHS VERSUS THE DOLLAR already this month — and we’re only one trading week in.

So might U.S. investors want to switch out of gold bullion ahead of Easter this year and move into the single currency, instead?

After all, the euro still pays 4.0% interest per year — a feat that dumb gold could never promise or achieve — and with eurozone inflation holding at a record 3.2% year on year in February, the European Central Bank (ECB) is clearly in no mood to start slashing rates now.

“Inflation will not slow as markedly as supposed,” warned the ECB’s Axel Weber last week. Colleague Juergen Stark added that he was “highly dissatisfied” with the current surge in the cost of living.

Tight money to come, right? Well, the gold market doesn’t buy it. Not at $1.52 to the dollar — with European manufacturing squeaking and Mediterranean house prices slipping:

The gold price for French, German, and Italian savers just keeps on rising, gaining for six of the last seven months.

Yet luxury carmaker BMW says it can’t bear a further “sustained rise” in the euro above $1.50 to the dollar. Last week, it cut 5,600 jobs.

Dassault Aviation in France says it can’t compete at this kind of exchange rate, either. “The natural step is to shift to the dollar zone [including most of Asia, remember] or low-cost areas as they have done in the car industry,” said CEO and Chairman Charles Edelstenne to Le Monde last week.

“This could include parts of our factory plant and some research tasks.”

Put another way, Europe has got the worst of both worlds right now — a high-value currency that’s crimping exports, and surging inflation at the very same time. So the European Central Bank needs to talk tough while doing nothing, hoping the inflationary and currency pressures don’t squash the economy both at once.

Good thing the old economies retain such political importance, as well. Right?

“To have an increase in the [voting] quotas of emerging countries — China, India, Brazil — is very difficult because the sum has to add up to 100%,” noted Dominique Strauss-Kahn, head of the International Monetary Fund in late February, “so some others must lose.

“The ones who are going to lose are mainly the European countries, and that is the reason why they may be reluctant [to vote for change].”

The debate goes far beyond the IMF, however, that brave remnant of postwar global planning. All top-level political groupings now face the problem of too many powers, with too much at stake, all wanting to be members of the top few spots in the oh-so-crucial club.

The G-7 group of industrialized nations, for instance, currently invites three eurozone nations to the party — Germany, France, and Italy — as well as Canada, Japan, and the United States.

The United Kingdom gets to tag along too, not least because it’s still vying with China for the No. 4 slot in world GDP, behind the U.S., Japan, and Germany. It also prints the world’s No. 3 reserve currency, the British pound. And my, but how it prints it!

Growing by 12.9% in January from a year earlier, the broad supply of pounds sterling has now been expanding at a two-decade record since March 2005.

No wonder the gold price in British pounds is surging alongside the U.K.’s trade and government deficits. But “When are we gonna get the real players, with the money, in the middle of these [G-7] debates?” asks Jack Welch, former head of General Electric. He was talking to Larry Summers, U.S. Treasury secretary at the tail end of the last Clinton presidency, on CNBC last week.

“It seems like some of our government institutions are living the last war — for example, the G-7. Four European economies, Canada, Japan, and you guys [the U.S. Treasury], all meet…but the money’s somewhere else.”

“Oh, you know how these things go, Jack,” replied Summers, former president of Harvard University and now a part-time hedge fund consultant in New York. “It’s much easier to get people in than it is to get other people out…

“You want to have a reasonably small group. We worked with the Canadians to set up the G-20 for exactly the reasons you give. And I think [U.S. Treasury] Secretary Paulson is to be commended for the effort he has put into having a regular financial dialogue with China on a bilateral basis.

“I think you’re going to see this kind of evolution. Look, if we want to address this issue of sovereign wealth funds — which I think is a concern, though it’s a concern that has to be kept in perspective — the way we’re going to do it is by having dialogue with the countries that, just as you say, have the money. Some of them are China, some of them are in the Middle East, and I think we do need to recognize more than we probably have before that the distribution of financial power and influence and capacity is pretty different from the distribution of the sort of political congeniality with U.S. interests across the board.

“That means we may need to have a somewhat different grouping for the foreign ministers and the finance ministers.”

Can political and financial power really be split into two different groups…with the United States at the head of both, choosing its allies here, but inviting a different clique of friends there?

Perhaps with Europe gnashing its teeth about the high euro, it’s actually time for the dollar itself to bounce, rallying from new all-time record lows on its trade-weighted index and forcing U.S. gold prices lower.

Sure — it might require higher interest rates from the Federal Reserve, rather than the campaign of monetary destruction begun by Ben Bernanke back in August. Or conversely, those new record lows in the world value of the U.S. dollar might help stoke U.S. export sales so fast that they revive the major Wall Street stock indexes and erase the last five months of losses.

No?

Should the dollar and Wall Street’s collapse continue, meanwhile, some kind of new monetary world order will only continue to look ever more likely. Russia is preparing to price and sell crude oil in rubles, for example, rather than dollars. The ruble might also be used as one means of payment on a forthcoming Iranian oil exchange in Tehran, according to Iran’s ambassador to Moscow last month.

But whatever comes, and no matter what happens to the price of gold, don’t expect the chocolate bunnies of today’s monetary order to vote for either Easter or a heat wave…let alone both at the same time.

Regards,
Adrian Ash
BullionVault
March 7, 2008

The Dollar’s Continued Fall was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

The whole truth is that gold has very few industrial uses at current prices. Gold is worth about 55 times silver and more than 3,000 times copper per unit of comparable weight. If it were as cheap as copper, we would have wired our houses with it, as well as the Internet; if it were even cheaper, you’d probably be sitting on it in the bathroom, as that Commie Lenin advocated.

We don’t use gold in more common applications because of its finer qualities: Relative scarcity, our vanity, to name just a few. And the bulk of gold’s value is still monetary, a fact that its enemies are loath to admit. Consequently, changes in the price of gold tend to reflect mainly changing monetary factors.

Gold bugs can’t ignore the market’s judgment, either. They must acknowledge that the monetary demand for gold had in fact ebbed during the 1980s and 1990s in favor of the dollar standard — a standard launched by default in the early 1970s.

The waning view of gold as money helps explain why gold didn’t keep up with the Consumer Price Index (CPI) through the ‘80s and ‘90s, despite the three-fold increase in narrow money (M1) and the five-fold increase in broad money (MZM). The bears claim this poor record shows just how bad an inflation hedge it is. But their time horizon is both short and selective.

I’ll give the bears credit for identifying the drop in the monetary demand for gold as the reason it lagged the CPI in the ‘80s and ‘90s. But they are hopelessly naïve if they believe that the 35-year-old dollar standard is an evolution in the monetary system, as if it were progress. Gold served as the market’s solution for money for thousands of years.

The government forced the dollar onto the U.S. producer by legal tender and other laws. It forced the dollar onto trading partners by extortion. These partners were already drowning in dollars no longer backed by gold. They had to choose between letting the whole system fall apart and using the new “dollar standard” to their advantage. America had the largest and most developed consumer market in the world at that time, and they all wanted in.

Fast-forward to today: After a couple of decades of experimenting with this system, it is no longer working to anyone’s satisfaction. In order to maintain their trade advantage, America’s trading partners have to inflate at an ever faster pace (than the Fed) and soak up increasing quantities of dollars. This scheme always was untenable, but now it’s falling apart. There’s even talk of the need for a new global reserve currency.

So far, the media spotlight has been on the euro as contender, but the media will see that is untenable too. Gold is really the only alternative to the dollar. But that’s a lesson the gold bull market has yet to teach. Let me know when you can use the euro on the streets of Bombay or in a Wal-Mart in California as easily as you can use the U.S. dollar, or at least when the price of gold stops outperforming the euro. Then I might consider taking it seriously. Meanwhile, we’re likely heading back to where this story left off in 1980.

Playing with Numbers

Before I delve into a rudimentary analysis and probably futile attempt to value gold, let me admit that I don’t know how high it is going to go. No one really does. We’re all just guessing. A bull market in gold basically means that gold’s monetary allure is on the rise. That is, market participants are beginning to prefer it again — either as a hedge against inflation (investment), a measure of monetary value, a means of international settlement, a monetary reference point, or even as a genuine medium. These reasons all constitute what I mean by “monetary demand.”

Of course, no such thing as a bull or bear market in gold would exist if gold were already money, because the total demand for money does not fluctuate very much. On the other hand, the total demand for a particular kind of money may. The bull market in gold is a byproduct of the decline of the dollar standard. Not surprisingly, it is outperforming the CPI again.

If the CPI were an accurate measure of changes in the value of money, and the monetary demand for gold were constant, the CPI-adjusted gold price might represent some notion of fair value for gold prices. But the CPI is anything but a reliable measure of change in money values. Chances are it understates this problem.

Is a Gold Correction Coming?

I have been forecasting “Gold: $2,000-2,650” for many years now. My early forecasts, back in 1999 and 2000, called for a straight-up move to $2,000 per ounce. That forecast overestimated the willingness of investors to grasp the gold story and underestimated their addiction to the prevailing monetary policy, and I scrapped it in 2001 in favor of a more drawn-out affair.

I adopted the view that this bull market would last 10-15 years and include two-three sequences.

We are now on year seven of the current advance — the first primary sequence. There is little doubt in my mind that the dollar standard is on its way out and that the monetary demand for gold will return to the levels of the late ‘70s. But the exact prognosis is anyone’s guess.

As a trader, I can tell you that nothing goes straight up. The market tends to change the rules just when most people have become accustomed to a particular set. Hence, every bull market contains surprisingly violent corrections. These corrections convince many latecomers that the bull market has ended.

None of the corrections we’ve seen in gold during the past seven years qualify as this type of correction. The rise in gold prices to this point has been steady and sustainable. For much of its rise, gold has been in a stealth bull market. But the gold price advance is no longer stealth. It’s not as spectacular as oil’s advance or some of the base metals’ advance in 2006, yet. But the chart says it wants to go parabolic.

That’s the good news. The bad news is that such moves bring in weak hands, which set the stage for a big correction. Remember this whether you want to trade the trends or buy and hold.

Regards,
Ed Bugos
February 6, 2008

The Price of Gold was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

In December, the gold price raced off to record highs for the first time in almost three decades. Now it looks to be closing in on 1,000 U.S. bucks. That is four digits. It will also be four times the 1999 low.

The market has added dollars to the gold price for seven consecutive years now, making it the longest-lasting such stretch in history without more than a 25% correction. Even in terms of magnitude, it is the best move since 1979-80. This suggests two things right off the bat. First, it is a bull market; second, the market needs to blow off more upside if it is to give the bears anything more than 25%.

(Although, this latter idea does rest on a few other premises.)

John Kaiser of the Kaiser Bottom-Fishing Report believes the market is nearing a flashpoint where the skeptical public finally turns into believers and comes rushing in. It’s pure mathematics from his point of view. He reasons forecasts for gold $2,000 are more plausible now that it is but “a mere double”!

It may be a little early to say that gold bugs have been proven right.

Undoubtedly, it is getting tougher for the bears to argue that they have been wrong.

But what exactly might they be right about?

Gold Is Sounder Money!

The market has once again started looking at gold as money, rather than as a mere commodity. The following excerpt from the Jan. 8 Financial Times article, “Gold Is the New Global Currency,” highlights this increasingly frequent theme in the leading financial papers:

Gold’s rise shows investors are nervous. That is an important message for central banks contemplating interest rate cuts. The Fed must show it is not prepared to allow inflation to take off. Keynes called gold a barbarous relic. It has life left in it. But it is in the interests of business and consumers that its most bullish fans are proved wrong.

I like this quote because it highlights two important and typical contrasting insights.

The first underlined sentence reveals the most important rule that the Fed and its peer central bankers are breaking, which is one of the main factors driving gold prices higher today. The second underlined sentence reminds gold bugs that their clairvoyance is unwelcome and unhelpful, just in case they feel any vindication in others’ misery. This will continue. As legendary broadcaster Ed Murrow once said, “Most truths are so naked that people feel sorry for them and cover them up.” This is one of those.

But that won’t make it go away.

The fact that getting rid of a dishonest monetary regime might cause depression is a bad reason to stick with a system that promotes that injustice in the long term. But if central bankers want to preserve such a system, above all, they must avoid prompting too many headlines like these:

• “The Helicopters Start to Drop Money” — Financial Times, Dec. 12, 2007
• “Cheap Money Is ECB’s Answer” — Wall Street Journal, Dec. 12, 2007
• “World Bankers Resort to Firebreak” — Telegraph, Dec. 15, 2007
• “Flight to Gold as Investors Lose Faith in Money” — Telegraph, Jan. 6, 2008
• “Bernanke Opens Door to ‘Substantive’ Rate Cuts” — Wall Street Journal, Jan. 11, 2008

One of the mainstream criticisms of the Bernanke Fed is that it should have lowered interest rates sooner and more aggressively. One reason it didn’t was because Bernanke had tried to fight the spreading of the idea that the Fed was going to continue inflating. But that resolve is now buckling under peer pressure. We are probably not yet at the inflection point where the public has become convinced the Fed will inflate endlessly, but recent actions are not helping to discourage this expectation.

So prices will continue to rise, eventually resulting in unemployment and some sort of depression.

The pundits will call it stagflation.

If the Federal Reserve fails to heed the aforementioned rule by then, it’ll lead to hyperinflation, or worse. So far, there is no reason to believe that it plans to abandon the inflationary policy.

What with squadrons of central bank choppers swarming like locusts over the major cities on both sides of the Atlantic, hurling bank notes into the thinning air as gold, oil and wheat prices charge to record highs, it would seem rather that central bankers believe money should be able to grow on trees.

Central bankers continue refusing to accept the idea that the cause of these crises is their very own inflation. In a recent interview I read, an old partner of Milton Friedman’s, Anna Schwartz, was the first of her kind to point out that Greenspan was responsible for the current crisis by keeping rates down too long. But she said that mistake is behind us now and the current Fed should step up to the plate and inflate like mad in order to prevent making the mistakes of the 1930s Fed.

What were those mistakes?

Apparently, Washington and the moral ethics of Fed officials prevented the Fed from inflating after the 1929 stock market crash. This thinking is a prerequisite for central bankers. They ignore the fact that the ultimate cause of these crises is the intervention required to manipulate interest rates.

That is, inflation.

Until they change their thinking (they probably won’t), and while the pool of skeptics about this evil remains large, gold has nowhere to go but up. We will continue to have booms and busts and crises, and price and interest rate spikes, and wars, and so on as long as paper money backed by nothing remains the motive power of the world economy. Thus is the general message of gold bugs.

Don’t shoot the messenger.

My forecast for 2008 is a $1,200-1,400 high for gold that will break the bond market’s back, and make stocks cheap again. I am also looking for an intermediate bottom in the dollar, big corrections in the energies and base metals, and a global recession. It is still timely to buy the dips in gold prices and to accumulate sound gold mining assets — though good share values are becoming more difficult to find.

Regards,
Ed Bugos
January 22, 2008

The Naked Truth was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.