Also, as August rolled on, gold fell from a price over $900 to under $800 per ounce. And oil tumbled from a price point near $145 to under $100 per barrel. This is quite a drop. And a lot of observers credit the drop to the strengthening dollar. So what’s going on?

Usually, a currency strengthens when there is some sort of good news about the underlying economy. But is this the case for the U.S. and the dollar?

The banking crisis is still with us, as is the ongoing housing meltdown. And many insiders say that there are still more tough innings in this game. So where is the good news?

Indeed, Kenneth Rogoff, an economics professor at Harvard and the former chief economist of the International Monetary Fund, recently predicted that there is still more bad news to come from the worldwide credit crunch and financial turmoil. According to Rogoff, “The U.S. is not out of the woods. I think the financial crisis is at the halfway point, perhaps. I would even go further to say the worst is to come.”

Rogoff added an ominous prediction, stating, “We’re not just going to see mid-sized banks go under in the next few months. We’re going to see a whopper. We’re going to see a big one — one of the big investment banks or big banks.”

Looks like he turned out to be right on the money.

So if the U.S. financial system is in such a precarious state, is the rise in value of the dollar really justified? Will it be good for the U.S. economy to have a major bank failure? Or on the other hand, will it be good for the economy if the U.S. government has to step in to bail out a large bank? It all seems like a “lose-lose” proposition.

Another well-respected commentator, Richard Russell, who has published Dow Theory Letters since 1958, believes that we are on the eve of world deflation.

According to Russell, the big problem facing the world economy is not inflation, but deflation:

“From what I see, the markets are telling us to prepare for hard times, and a global spate of the worst deflation to be seen in generations. This is why gold has been sinking, this is why stocks have been falling — big money, sophisticated money, is cashing out, raising cash, preparing for world deflation.”

According to Russell, “Smart money is selling into the stock market, day after day.” People and institutions are raising cash. When deflation rules, this will usher in a strong dollar.

Russell offers an illustration for why people are raising cash:

“Look, if you have $5 million and you are receiving only 2% in interest on your money, that’s only an income of $100,000 on your $5 million. Big money realizes that in a deflation, you need a mountain of cash to keep up your lifestyle.”

So Russell anticipates an era of deflation, accompanied by low interest rates. Hence the need to raise cash to support an income stream over time.

Then again, what if the markets are anticipating an increase in interest rates over the medium to long term? Could this be prompting a rise in the value of the dollar? Think of how much new “money” is floating around out in the world due to just the recent creation of credit as the Fed has bailed out insolvent banks and investment houses.

Where has all that newly created money gone? It’s lurking out there, somewhere in this world. And that new money could show up at any moment, bidding up the prices of whatever happens to be the “big thing” on any given day. Thus, while Richard Russell thinks we are on the eve of deflation, we are also confronting the specter of inflation.

The last historical experience the world market has had with high inflation rates and stagnant growth was back in the late 1970s and early 1980s. To combat inflation, then-Fed Chairman Paul Volcker increased interest rates to double-digit levels. High interest rates hit the economy like a ton of bricks, but that was the idea. High interest rates broke the back of inflation for a generation.

You have to look back even further, to the 1930s and the time of the Great Depression, to find the last long-term era of deflation. What do you see? The price of gold and gold mining shares actually increased during the 1930s.

The key to the rising price for gold in the 1930s was the effort by President Franklin D. Roosevelt to raise the nominal price of gold from $20 to $35 per ounce. It was still — in many respects — a gold standard world back then. But in raising the gold price, FDR also indirectly spurred the market capitalization of much of the mining industry.

One thing to keep in mind is this. We know a few things about inflation, both practically and from economic theory. We don’t know nearly as much about deflation. If deflation shows up at the door, will anyone really know what to do about it?

So this prompts the question. Where are prices for precious metals headed? If we encounter deflation, will we just retrace the run-up of the past six years or so? Will we see gold back at $300 per ounce, and silver at $3 per ounce? I doubt it.

I think that we will look back at the summer of 2008 as a time when precious metals had a correction after a relatively quick move upward. To put it in terms of technical analysis, the prices “outran their support.” It’s like the tanks of Gen. George Patton outrunning the fuel trucks in the closing days of World War II. Patton had to stop advancing, while the trucks caught up.

When the dollar strengthened in mid-2008 — for a variety of reasons — it prompted a pullback in prices for precious metals and the related mining shares. If you are cautious, you will hold cash and sit it out. If you are bold, you’ll look for bargains and buy shares.

Long term, I don’t think you will get hurt by buying into share price weakness. Over the long term, precious metals and the mining shares should still continue to rise in a market in which dollars are getting cheaper and things of real value are becoming scarcer.

Regards,
Byron W. King
September 30, 2008

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

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.

Therefore, forward-looking investors might want to take advantage of the current weakness in the gold share market to invest in some of the small mining companies that would be attractive takeover targets.

One of the most intriguing aspects of the current market is the dearth of major discoveries so far in this cycle. This despite record amounts of money spent on exploration since this bull market began in 2001.

Older and smarter minds than mine had predicted that the soaring price of gold would produce a new wave of exploration that would, eventually, produce a new wave of major discoveries.

But so far, as Barrick Gold’s CEO, Peter Munk, recently observed, “There have been virtually no new discoveries.” Only Aurelian (ARU: TSX) has landed a legitimate “elephant” deposit bagged. Unfortunately, the carcass of that particular elephant rests entirely within the sketchy outlines of the nation of Ecuador where the locals are currently circling like a pack of hungry hyenas.

It has been our contention that what was needed to light the fuse on the junior exploration stocks would be, in no specific order:

1. Sustained higher gold prices.
2. Improving financials and free cash flow of the major producers.
3. A discovery to heat the blood of the investing community.

So far, we have had (1) and we are beginning to see (2), but (3) has proved remarkably elusive.

Now, don’t misunderstand. You can have a whopper of a bull market in these stocks without the discovery — that was the case in the 1970s bull market. But a discovery that fires the imagination can jump-start things in a big way, no question about it.

Too bad nobody has found one recently.

In short, we appear to have reached the era of Peak Gold. Whereas a major discovery used to be 10 million ounces or more, the threshold for attention-getting discoveries these days has fallen to more along the lines of 1-3 million ounces…and even those are hardly falling off the trees.

Viewed from the perspective of an investor in the junior resource sector, this lack of discoveries means the fuse is lit — starting with straight-up supply and demand fundamentals — for a rocket shot tomorrow. Adding boosters to the rocket, we have a commodities bull market that shows no sign of ending anytime soon and, while the U.S. dollar will periodically rebound, it is not going to somehow reinvent itself as sound money in our lifetime.

Importantly, as you can clearly read between the lines in Chairman Munk’s words, once the majors get cashed up and get serious about replacing their reserves, they are going to have to look downstream to the juniors with discoveries…even if those discoveries are below the five-million-ounce threshold they previously required to even consider taking an ore body into production.

Of course, lowering the threshold on deposit size will require trade-offs. For example, in order to be considered for an acquisition, a smaller deposit will almost certainly have to be near surface and open-pittable. It will also have to be near good infrastructure, and located in a jurisdiction with good laws and reasonable taxation. There is, in this situation, an opportunity and a risk.

Starting with the latter, if your portfolio now includes companies going after deposits in the one- to five-million-ounce range, you need to make sure they are not in a remote location that would require a massive infrastructure investment.

As for the opportunity, while the odds and the amount of exploration spending still favor that we’ll see the discovery of at least one and maybe two monster deposits in this cycle (there are a couple of companies advancing projects with that potential), and early shareholders will make fortunes as a result, there has rarely been a better time to invest in junior exploration companies with modestly sized projects in good locations. That said, you should still be focusing only on projects with at least two million ounces, or the strong potential of same.

In other words, take the opportunity in these down markets to invest in the kinds of junior mining companies that major mining company might want to acquire… That’s where the big money will be made as the gold market gathers steam again.

Regards,
David Galland, Casey Research
June 2, 2008

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

“The infamous Dow/gold ratio just touched its long-run historic average. So which way next amid the Fed’s inflationary melt-up…?”

IF WALL STREET STOCKS can surge 160 points on falling earnings, an 11 percent drop in housing starts, and a 16-year record for consumer price inflation, then so can everything else that doesn’t carry a picture of George Washington.

Crude oil, rice, gold, the euro, wheat, emerging market bonds, copper…anything that’s not stamped with the all-seeing eye of the dollar looks like a great bet once again. The Federal Reserve has seen to that, driving the real returns paid to cash down toward a three-decade low.

Sinking to minus 2.05 percent in March, the real rate of interest nearly equals the very worst returns to cash paid during the Great Greenspan Reflation of 2002-2005. This latest slump in real interest rates also comes thanks to “emergency” rate cuts.

Plus, of course, the worst run for consumer price rises since the start of 1992. And I think the two are more closely related than the Olsen twins:

Rates down, inflation up? Well, what else did savers and retirees expect? The Fed can’t promise to forestall recession forever. But by God, it will try!

So for the meantime at least, there’s truly no fear of deflation here.

Whatever happened to the Fed committee’s much-expected “moderation” of inflation? Running at 4.3 percent yet again in March, the CPI just put in its longest stretch above 4.0 percent in 16 years.

Where’s the “projected leveling out of energy and other commodity prices” it promised only last month? Crude oil recently broke fresh records above $114 per barrel, and rice prices — worldwide — have doubled from where they stood in October.

It’s not just U.S. cash savers being eaten alive, of course, by subzero rates of real interest. Here in London, the real returns paid to savings after tax and inflation have sat in the red for the last five years running. The latest shop price data from Europe now show a 12-year record for German consumers, giving the lie to “inflation vigilance” at the European Central Bank.

But the sudden bull market in everything really stands out in dollar terms. And hoarding cash — the true meaning of “deflation,” as well as the root cause of the current worldwide crisis in banking — has become a sure route to the poorhouse again.

How to choose the best escape route for your savings and wealth? Clearly, real estate’s doomed, for the short to midterm at least. Government bond yields are now so far underwater you’d be killed by the bends if they tried to come up for air.

That leaves commodities and stocks, the classic refuges for inflationary crises. And one way of judging the Dow — free from all dollar distortions — is to measure the index in terms of gold ounces:

Dividing the Dow Jones industrial average by the price of gold gives you a rough idea — over time — of where the real value might lie. It shows how many ounces of gold you would need to buy one unit of Dow stocks.

Hence, gold was a raging sell (in hindsight, at least) when the Dow/gold ratio touched 1.0 at the start of the 1980s. Stocks scarcely looked back for the next 20 years. But by the end of the ‘90s, the real value had shifted again. And gold surged as the Dow sank after the tech stock crash of 2000.

That slump in stock prices compared with gold pushed the Dow/gold ratio down from its all-time top above 42.2 to just 12.6 in March of this year.

That’s pretty much exactly the Dow/gold average of the last 80 years. So which way will the ratio go now?

The Fed’s new “reflationary melt-up” is clearly designed to keep stock prices buoyant. But it’s only adding to the case for gold, too. “I would be very surprised if the Dow Jones industrials/gold ratio didn’t decline to between 5-10 within the next three years,” said Marc Faber of The Gloom Boom & Doom Report recently.

If that call proves right, it might come thanks to gold prices doubling, or stock prices halving, or more likely some combination of both. But while the three peaks to date — of August 1929, January ‘66, and then late ‘99 — took the Dow/gold’s top higher, the floor only held steady, down there at 2 ounces of gold and below.

And the last slump — during the inflationary 1960s and stagflationary ‘70s — took a full 14 years to work itself out. So far in this bear market for the Dow/gold ratio, we’re nine years through to date.

Regards,
Adrian Ash
BullionVault
April 21, 2008

The Ratio of Gold Prices to the Dow Jones was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

“Four charts, one metal, and the whole world wrapped up in trying to price risk and reward in a fast-shrinking currency…”

YOU CAN LINK THE HISTORIC SURGE in gold prices starting mid-August 2007 to many apparently disparate things.

Pick the right link and you might be able to tell whether it’s worth you buying or holding gold today.

One such link is the price of money, as decided by the U.S. Federal Reserve. Gold’s stellar 58 percent gain in the seven months starting Aug. 18 began with the Fed’s first change to U.S. interest rates in 18 months.

Last August’s 0.25 percent cut to the Fed’s “discount rate” — the interest rate it charges commercial banks to borrow short-term funds — was the Fed’s first interest rate cut since July 2003. By the end of March 2008, it became a 3.0 percent cut to the bank’s key fed funds target.

And gold’s initial jump turned into a pole vault…

The real cost of borrowing dollars — or, rather, the real returns paid to anyone saving money today — clearly impacts the demand for investment gold.

You can measure this real rate of interest quite simply. Just subtract the rate of consumer price inflation (CPI) from the fed funds interest rate, as in the chart above.

Then compare this changing value to the price of gold and you’ll see that when the real returns paid to cash sink below zero, investors and savers tend to pay more — or demand more — for gold.

That’s what investors and savers did in the 1970s. It’s what they then did NOT do again until real U.S. interest rates sank toward and below zero during the first six years of this decade.

Why choose gold when real interest rates sink? Because if central bankers, driven by a fear of “deflation” in asset prices and consumer spending, try to stop the public from hoarding cash, then people will seek out reliable stores of value instead, led by hard assets.

Unlike real estate, however, gold bullion remains a highly liquid, easily priced asset that can store huge quantities of wealth in a very small space.

And gold, as the action since August’s first Fed cut reminds us, has acted as a reliable store of wealth for more than 5,000 years. In times of monetary destruction, or so history says, it’s human nature to seek an escape from fast-shrinking currencies:

Another important connection — also related to the Fed’s new rate-cutting cycle — sits in the currency markets.

In particular, look at the euro/dollar exchange rate. Because as the dollar sank versus the euro in the back half of 2007, daily movements in the U.S. dollar gold price were more strongly linked to the euro than they were to crude oil, the broad commodity markets, and even the price of silver — gold’s poor cousin in the precious metals market.

This “correlation coefficient” would stand at zero if gold’s daily movements bore no relationship whatsoever to the euro. It would be negative if gold rose when the euro slipped back (as happened to oil in the fall, albeit marginally, as the chart shows above). The correlation would stand at 1.00 if they always moved together in lock step.

And as of last month, gold and the euro were more tightly connected (with a correlation of 0.62) than gold and crude oil (0.45) or gold and the broad Goldman Sachs Commodities Index (0.29).

What does this tell us? First, the gold price is behaving much more like a currency than it is acting like a raw material. This is unsurprising given what little use gold has as anything other than a store of value.

Barely 15 percent of last year’s total gold fabrication worldwide ended up in either electronics as gold bonding wire, coating for space shuttle windows, or in people’s teeth as dental fillings. But that lack of apparent practical use — which actually grew by 49 tonnes from 1998, to total 411 tonnes in 2007 — doesn’t mean gold is useless.

You’d hardly say the European single currency holds zero value, correct? But you try fueling a jet engine or building a highway with euros today and no end of bloggers and financial hacks will step up to say your failed experiment just proves that it’s useless.

That’s why smart institutions such as the Royal Bank of Canada trade gold alongside the euro on their currency desks, rather than handing it to their commodity teams. If you think the long-term decline of the dollar is only set to grow worse, you might want to consider joining them:

As you can see, the gold price in euros has risen by more than 160 percent from its lows of 1999, even as the European currency has surged against the dollar.

The upshot? Don’t be misled by that strengthening correlation between gold and the euro. You would still have better rewarded a bearish view of the greenback in gold than in the European single currency or any other major world money. And while the euro has risen 48 percent against the dollar since March 2003, gold outpaced that gain by a further 97 percent on top.

But just before you open a new Internet window and type “Buy gold” into Google today, hang fire for a moment. Because yes, the dollar’s 12 percent loss versus the euro has somehow created a 28 percent gain for European gold investors since last August. And yes, again, the Fed’s new rate-cutting campaign still has no firm end — let alone a reverse — in sight.

But if everything’s lined up for a fresh surge in world gold prices, why did the market pull back so sharply in the middle of March? Plunging 15 percent from its new all-time record above $1,030 per ounce, the gold market now stands some $100 lower. The euro, in contrast, has risen since then. So too has the oil price.

The latest cut to Fed interest rates lopped another 0.75 percent off the gross returns paid to dollars, as well. So why the big swoon?

“This sharp reversal in price cannot be explained by a stronger U.S. dollar,” notes the team at Virtual Metals in London, writing in the April edition of Metals Monthly on behalf of Fortis Bank. “Gold’s decline measured in euros has been larger than in dollars.

“Nor can [the drop] be explained by a reduction in inflationary expectations, as this hasn’t happened,” they go on. “Instead, it seems to be narrowly based on improving sentiment in the credit markets…”

This chart “shows a close relationship since October 2007 between the gold price and the benchmark Markit CDX investment grade index, which measures the risk of credit-swap defaults,” explain Matt Turner, Gary Mead, and Jessica Cross at Virtual Metals.

In plain English, the Markit CDX measures the cost of buying insurance against nonpayment by 100 big corporate borrowers in the United States. And “As the Bear Stearns panic subsided, the index fell sharply, and so did gold.”

Meaning? Gold didn’t only surge on the Fed’s rate-cutting frenzy to mid-March. It also gained as institutional investors ran for cover amid the world-banking crisis — a crisis yet to end.

No one’s to create at will, gold is also no one’s liability — not if it’s owned outright, rather than as a mere credit on a gold dealer’s ledger. Incredibly, London professionals have told BullionVault that around 97 percent of the world’s gold dealing takes place on this kind of “unallocated” basis, attaching a real risk of default to the vast bulk of day-to-day gold trading.

Perhaps that concern explains why, alongside gold futures and exchange-traded gold trust funds, the latest GFMS analysis notes “healthy growth” in physical gold bullion investments, “mainly in allocated accounts.”

This market in late 2007 “was dominated by institutional and high-net worth investors,” the group’s Gold Survey 2008 goes on. “Many of the latter bought gold as a safe haven, soon after the subprime credit crisis erupted.”

Demand from smaller retail investors, in contrast, “grew over the year (and notably in the last couple of months), but its contribution to total investment remained marginal overall.”

In short, the mass of private investors and savers still have yet to buy gold, or even consider it. So if you were concerned that gold might be reaching some kind of bubble, you might want to consider the absence of “last fools” to date.

You might also want to note that, so far, the threat of U.S. corporations defaulting on their debt obligations has been more imagined than real. Just what happens to the price of insuring corporate risk — and the resulting dash into gold — when debt defaults really do start to turn higher?

Regards,
Adrian Ash
BullionVault
April 16, 2008

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

Quoting a Morgan Stanley analyst endorsing the plan, “This is arguably a good time to consider selling some of these gold holdings and investing the proceeds in financial securities with positive yields.”

According to the same article, the head of the IMF said, “There was an acceptance among the G-7 that resources should be raised by selling gold.”

Gold Bulls Should Not Panic

The media does not understand the situation, as usual.

The reports I’ve seen tend to point out that the IMF holds some 103 million ounces of gold, but leaves out the details of the plan discussed so far. Thus, readers are likely to think that it plans to sell all of it.

Au contraire. According to the recommendations of an advisory panel — this includes Morgan’s CEO, Greenspan and central bank heads from Mexico, Saudi Arabia, South Africa, the ECB and China, “only the gold acquired since the Second Amendment of the Articles in 1978…which amounts to about 400 metric tons” are to be sold. Moreover, it:

“Should be handled in a way that avoids causing disturbances to the functioning of the gold market and, accordingly, should be coordinated with current and future central bank gold agreements so as not to add to the volume of sales from official sources… It would simply take the place of some gold sales that would have been done by other parts of the public sector, other official sellers.” — IMF Survey, Volume 36, No. 3 (Feb. 12, 2007)

Did you get that last sentence? I underlined it for you.

When Spain and Switzerland stepped up their selling last year at $700 per ounce, the market speculated that they were covering for some of the other members of the CBGA (Central Bank Gold Agreement) that were coming up short. This idea has substance if you consider that in the first three years of this agreement, central banks have regularly come up short. The cumulative shortfall is over 130 tons to 2007.

Add another 100-200 tons for the total decline in global mine production last year and this year, and more than half of the IMF’s 400 tons is spoken for. Putting aside the fuzzy math, the deal is not yet final. It potentially requires a few amendments to the IMF’s charter and approval by the U.S. Congress.

The U.S. has veto power because it has 16.79% of the voting power, and the charter requires an 85% majority. No one else has much more than 6%, so the U.S. is the only one with veto power. It has vetoed similar proposals in the past. This time could be different. Perhaps it is worth noting that some analysts believe the reason it has not approved gold sales in the past is that some members of Congress know that America does not own the amount of gold it claims. This may not deter approval, however, since the U.S. government could surely come up with 70 tons to keep appearances.

Nevertheless, the media ignore these controversial things.

Neither do they care much for the obvious conflict of interest implicit in the fact that the very same governments that are approving the gold sales happen to be the issuers of the bonds that the IMF intends to buy with the proceeds. That is, the deal allows governments to borrow without pushing up interest rates. It is focused on the more popular rationales motivating the IMF gold sales, such as locking in positive yields, securing a guaranteed source of future income, or funding its future losses.

The IMF has complained that it is losing money because the developing world does not need its help anymore. It is going through an identity crisis as world governments decide what to do with it. No one really talks about disbanding it, unfortunately. So it is evolving as a portfolio manager and policeman:

“The IMF’s income has fallen with the decline in new lending and recent early repayments by some countries. The institution’s income shortfall is projected at about $105 million in the current financial year, ending April 30. It is projected to reach $368 million by financial year 2010.” — IMF Survey, Volume 36, No. 3 (Feb. 12, 2007)

It is one of the ironies of modern-day progressivism that bureaucrats be allowed the pretense of acting like portfolio managers. Since the advisory board’s recommendations alone — just one year ago — the IMF’s gold portfolio earned more than $30 billion in profits. It would take a similarly sized portfolio of government bonds four-six years to earn that amount at today’s yields. Since the new millennium, this gold portfolio has grown by about $65 billion. It would take 15 years to make the same off a 5% yield.

The IMF’s Track Record Speaks Volumes

The last time that the IMF sold a significant lot of gold was not at the beginning of the bear market in 1980 — as it might have if bureaucrats and ministers were actually wise in these matters.

Rather, it sold gold during 1957-70, and again in the 1976-80 period.

It has not sold any gold since.

And you can bet it sold most of that at prices well below $200-300 per ounce, since prices exceeded that level for less than two years over the aggregate 17-year selling period (1957-70 and 1976-80).

In the former period, the rationale for selling was twofold: To replenish its holdings of “currencies” and to invest in U.S. government bonds in order to generate income to offset operational deficits.

This theme, similar to the rationale offered today, was such a bad trade that by the time 1976-80 came around, the rationale for selling gold mutated to reducing its role in the international monetary system.

That’s right; they came right out of the closet.

What, with gold prices at five-10 times their original pre-1970 fixed level, and bond values depreciating ever since the IMF first started buying government bonds at a secular top in the mid-‘50s, who would believe anything else? They locked in yields somewhere in the neighborhood of 3-7%.

Soon after they finished locking in those “positive yields,” they turned negative, and then soared to just about 20% by 1980. The price of gold never again would fall to the values that the IMF received for most of it in that 17-year time frame — certainly in the 1957-70 and 1976-78 periods.

In the Final Analysis

The market should brush this off as another potential bureaucratic blunder.

The deal is not effective until the IMF ratifies it in April and the U.S. Congress approves it.

The real reason for the program is to cap gold prices and bond yields and to fill the dearth of physical gold that seems to be limiting central bank gold sales. It is far from a sound investment decision, given the supply situation and the policies of central banks today in debasing money at a 5-10% annual clip.

The IMF’s charter keeps it from destabilizing the market, but the market is too strong and big, anyway.

The amount of gold the IMF plans to sell is equivalent to about one day in trading volume on the LBMA.

The Nymex saw daily trading volumes peak at the equivalent of 28 million ounces in 2006 — twice what the IMF intends to sell. Heck, China could buy all 400 tons in one fell swoop and call it a day.

That transaction would be worth some $14 billion at today’s value for gold — that is about 1% of China’s $1.3 trillion in foreign exchange holdings. It’s less than one week in new foreign exchange gains. The market may give back some points in the next few weeks, but it may just be that traders were looking for an excuse to take profits after gaining 250 points in the last six months alone.

More significantly, should the bulls brush it off, we could see bullish confidence soar.

Gold should be bought on any dip, especially those subsidized by gold-unfriendly policies.

Regards,
Ed Bugos
February 12, 2008

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

“Who suffers most from inflation? Who suffers most from rising prices? It’s the poor, not the rich. The rich can protect themselves from inflation; poor people can’t.”

— Jean-Claude Trichet, head of the European Central Bank (ECB)

THE FINANCIAL TIMES CHOSE JEAN-CLAUDE TRICHET — head of the European Central Bank (ECB) — as its 2007 Person of the Year.

OK, so Time magazine had to settle for Vladimir Putin — the former KGB spook now rehearsing his puppeteer skills at the Kremlin. But was the FT’s shortlist really that bad? Couldn’t Lindsay Lohan clear a space in her party schedule to claim the award instead?

At least the inebriated actress delivered as promised last year, denting only good taste in the process. Monsieur Trichet’s inflated celebrity, on the other hand, now threatens to cost the world dearly.

Trichet’s No.1 task as president of the ECB is supposed to be delivering “price stability” to the 320 million citizens of the eurozone (Malta and Greek-speaking Cyprus joined the fun on New Year’s Day).

Put another way, his 2% inflation target means €1.00 of living expenses today should cost no more than €1.02 by this time next year. But anyone shopping in euros last Christmas, however, found the cost of living 3.1% higher on average than in December 2006 — or so says the Eurostat agency.

Europe’s festive inflation outran even November’s seven-year record. It came close to undoing almost 14 years of inflation fighting by the ECB and its pre-euro ancestors. And things had been going so well too!

For 2007 as a whole, consumer price inflation in Europe averaged 2.14%. But curiously, that’s exactly the rate it hit in September, before racing higher as Christmas drew nigh. What changed in the summer of Trichet’s star year? “One of his strengths is his ability to manage a crisis — he enjoys that,” says Olivier Garnier, adviser to the ECB chief in his former life at the French Treasury in the early 1990s. And by golly, but Trichet got a crisis to relish this summer!

Relaxing in the sleepy French fishing port of Saint-Malo, Jean-Claude Trichet awoke one August morning to find “the first financial market crisis fought by BlackBerry from the beach” surging across the Atlantic toward him, gushes the Financial Times.

“As the ripple effects of the collapsing U.S. subprime mortgage market caused global finance to seize up, the ECB announced it would unilaterally pump in unlimited overnight liquidity: In the end, it added almost €95 billion ($136 billion, £69 billion)…

“Initial shock at this unexpectedly radical intervention gave way to admiration of [the ECB’s] steady hand,” the newspaper goes on, hardly able to contain its praise.

“As the drama unfolded, the ECB appeared to be setting the pace among central banks. In the ultimate compliment, the venerable U.S. Federal Reserve and the Bank of England copied the tactics of an institution not yet 10 years old.”

Hurrah for Trichet! Three cheers for unlimited liquidity! Hosing Paris and Frankfurt with overnight loans, Monsieur Trichet secured his place in history as “one of the few to emerge from the turmoil with his reputation enhanced,” the FT declares. He certainly helped save the blushes of BNP Paribas, proximate cause of the interbank lending panic when it suspended three investment funds on Aug. 9 after the “complete evaporation of liquidity” in the subprime U.S. mortgage bond market.

But our brave little pompier actually hosed so much cash into Europe’s money market, he’s since felt the need to mop up the puddle 14 times in the last 14 weeks, draining a total of €390 billion in Christmas week alone.

In the 456 weeks between the ECB’s birth and October, by contrast, the bank drained “excess” liquidity from Europe’s money market only a total of 21 times, offering government bonds in exchange for cash.

It’s a pity, in fact, that Monsieur Trichet didn’t think to take a couple of euros out of the market before last summer’s turmoil began…

Under the European Bank’s first president, Wim Duisenberg, the ECB’s open-market liquidity auctions averaged €64.6 billion. Since “Tricky” Trichet took over on Nov. 1, 2003, that’s more than trebled to €204 billion.

Indeed, our chart seems to show how the real hosing came to end when the world’s money markets froze back in August. But the number of ECB auctions helped pick up the pace, reaching 7.8 on average per month, versus 5.5 averaged per month during the preceding eight years. The average value, meanwhile, has risen to €136 billion, from €130 billion between 1999-2007.

Was this flood of short-term liquidity really needed to help save the world’s financial system? Funnily enough, said Trichet himself to the European Parliament on Dec. 19, “There has been little evidence that the financial market turbulence since early August 2007 has strongly influenced the dynamics of broad money and credit aggregates.

“Indeed, the expansion of loans to households and nonfinancial corporations has remained robust, which may suggest that the supply of credit has not been impaired.”

No fooling, Jean-Claude!

Controlling growth of the money supply is supposed to make up one half of the ECB’s policy tool kit. Indeed, capping the number of monetary units in circulation used to be the “first pillar” of the grand anti-inflation stance it adopted at the dawn of Christendom’s third millennium.

But the idea of actually using Bundesbank-style discipline to deliver German-style low inflation soon lost out to watching “broad economic data” instead. Now playing second fiddle to what Wolfgang Munchau of the Financial Times tellingly calls “the real-world view” of economic growth, consumer prices, and trade-weighted exchange rates, the ECB’s initial money-supply target — under which the broad M3 measure of liquidity would grow by no more than 4.5% per year — has quietly slipped from the ECB’s speeches, press releases, and official statements.

Unloved and unmentioned, it’s come to look like some ridiculous ex-spouse…still bent on sending a Valentine’s card each year but using his left hand to scrawl “Guess who…?” Since the euro became flesh at the start of 2000, however, actual growth in Western Europe’s money supply has outpaced the “reference value” by more than one-third. It met or fell below that target for barely 10 months.

And right now, the quantity of euros in circulation — both physical and digital — is growing at a pace 2 1/2 times faster than the ECB’s initial prescription, taking the eurozone back to the runaway credit inflation of the late 1970s.

No wonder, then, that “At a global level, the risks for [price] inflation are on the upside,” as Monsieur Trichet told the Bank for International Settlements (BIS) in Basel, Switzerland, on Jan. 7.

No wonder, either, that the gold price in euros has exploded as a result. The citizens of France, Germany, and Italy saw the gold market scoot higher toward €600 per ounce as Monsieur Trichet’s year of 2007 reached its end.

Will his policies at the ECB cap inflation — and stall the surging value of gold prices — in 2008? Here at BullionVault, we think a fireman hosing a burning house with kerosene would have a greater chance of saving the furniture.

“There is a danger of second-round effects on headline inflation,” as the FT’s Person of the Year told the BIS. Perhaps he was thinking of Berthold Huber — head of Germany’s IG Metall union — promising his members “a mega year” for pay awards, starting with demands for an 8% increase in the steel sector.

Or maybe Jean-Claude Trichet was thinking of the six public sector unions now threatening to strike over higher wages and pensions in his homeland, France…or the failure of above-inflation pay awards in Italy’s public sector to prevent fresh strikes this month…or maybe the current wage talks in Spain, where annual pay awards are still linked to inflation — which is currently running at 4.1% from this time last year.

In Germany, even the very poorest workers — those who “suffer most from inflation,” according to Trichet himself in an interview with EuroNews last year — have come to expect an inflation-beating pay raise this year. The Social Democratic Party is pushing for a minimum wage of €7.50 per hour (some $11) in the world’s third largest single economy. Sharing power with Angela Merkel’s Christian Democrats in her “grand coalition,” the SDP might just force the issue too.

Several big unions, however, are pushing for an even greater “second-round effect” of the ECB’s failed inflation busting, worth a massive €11 per hour (more than $16).

In short, “There is no room for complacency [on inflation],” as Monsieur Trichet, a former member of France’s militant PSU party, told his audience in Basel. But what else beyond complacency would explain the surging M3 money supply…now growing fast enough to match the surging rate of monetary expansion in the United States and not far behind the wanton inflation of Britain and China?

It’s the poor — and the poor middle classes, especially pensioners on fixed incomes — who pay most when money loses its value. Top earners, led by Europe’s hottest financial hotshots in Frankfurt and La Defense, can look after themselves.

Not least with a flood of central bank money so great, it needs mopping up by the very firemen themselves!

So for all the good he’s done defending the value of euros, Trichet may seem a weird choice for 2007 Person of the Year. But for saying one thing and doing another…and for helping the forces of inflation to mass, even as he claimed to stand firm against them…he has corralled the spirit of our financial age better than even Ben Bernanke at the U.S. Federal Reserve.

Jean-Claude Trichet, we salute you. Truly, you are the man of the moment!

Regards,
Adrian Ash
January 23, 2008
BullionVault

Euros, Gold and the FT’s Person of the Year was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Oil and Gold Still Rising

My Outstanding Investments colleague, Kevin Kerr, and I both expect to see a price increase to $150 for a barrel of oil, and even $200 oil would not shock us. Expect to pay $5 or more for a gallon of gasoline within 18 months, as well. It is part of the Peak Oil future, and that future is now. Darn, we were hoping to have more time. But then again, our society has been wasting time for two generations, since the early energy warnings of the 1970s. And while we are on the topic, we expect to see gold at $850 per ounce in the not-too-distant future. Then $900 and $1,000 within 18 months, if not sooner.

If we have your attention, we regret having to say all of this because it means that the U.S. dollar will be losing value in a precipitous drop during 2008. It will not be a pretty sight. Just imagine the loss of purchasing power and the associated destruction of capital that our society collectively will experience as this occurs. Imagine a scenario of asset deflation and price inflation. What can you do? We’ll discuss that later in this article.

Superheroes, Light and Dark

Yes, oil and gold have risen in price and will almost surely rise some more. In the marketplaces and bazaars of the world, where oil and gold are traded, it is as if a well-muscled superhero is leaping into the sky, blue tights shimmering and dark cape flowing, yelling, “Up, up, and away!” But is this masked character, rising upward and representing the prices for oil and gold, one of those good superheroes who are dedicated to helping mankind? Can higher prices for oil and gold somehow be good for us all? Or are we dealing with one of those evil superheroes, a vicious soul who has been corrupted by the darkest forces of the universe?

As no less noble a character than Batman once inquired, as he looked over a room full of devices that he was considering adding to his battle rattle, “Does this come in black?” Thus, to bring Gotham toward the light, its mythical warrior-savior wears the color that absorbs all wavelengths and reflects none. The Dark Knight wears black. How gothic.

Hard Questions About Oil and Gold

Ask yourself, dear readers: Are the prices of oil and gold rising for simple reasons? Are the upward price trends merely tactical events in the daily battle space of the market place? Or are oil and gold now subject to certain inexorable forces of history, no longer governed by the old rules of a political and monetary world that is now obsolescent, if not obsolete? We have to wonder. These are hard questions.

Will the political leadership and monetary authorities interpret the fast-rising prices of oil and gold as warning signals of imminent and profound trouble? What about those who hold positions of trust and responsibility within the media, business, academe, and even religion? Will this nominal and — we regret to say, somnolent — leadership cadre ignore these key signals, while they waste time counting their retirement points and dismiss these glaring klaxon signals of rising prices as mere “trading activity,” or worse?

However ineptly the leadership interprets or misinterprets the message, there is no denying that there is trouble within our economy, if not within what passes for energy and “money” in our world. At Outstanding Investments, we work to position ourselves and our investments away from the troubles. That is what distinguishes the investment community from the rest of the sorry lot. We are playing with our own money on the table. We don’t want to lose it.

But still, we have to ask if leaders anywhere can act in time to change things for the better. Is there time to plan and implement change, no matter what it is that must be accomplished (and that is very much)? Does the leadership cadre have the knowledge, let alone the wisdom, even to understand the message and the problem?

The End of the Postwar Era?

When we see the prices of oil and gold rise so quickly and inexorably, we wonder if these trends reflect some profound underlying change to the firmament of our national and political existence. A few weeks ago, while I was in Houston for the conference of the Association for the Study of Peak Oil & Gas (ASPO), I had a conversation with a retired employee of the CIA. Our conversation drifted to the question of whether or not the global political construct of the world post-World War II was finally coming to an end. After 60 years of running on the formerly immense momentum of that victorious war, is it all finally grinding to a halt as the U.S. literally runs out of oil and its currency disintegrates in relation to gold? The former Soviet Union encountered severe oil shortages, ran out of money, and all but imploded within a matter of months. Is there some law of nature that declares that something similar could not happen to the dramatically overstretched U.S.?

Through the Eyes of Leo Tolstoy

Look at the basics. Clearly, the prices for oil and gold are rising. That is the easy observation. But are we witnessing a fundamental transformation in the alignment of all mankind, similar in a way to that observed and described by the Russian novelist Leo Tolstoy? Are the prices of these two critical commodities, oil and gold, reflective of the broader themes of war and peace, mankind’s ability to both hate and love, the artificial and the natural, the erotic and the sublime? Where will it all end, and how will it play out?

As the prices rise for oil and gold, are we seeing both sides of a clash between the most profound forces of God and nature? In the rising price trends for oil and gold, are we observing two opposing pathways through life? One era is ending, that of cheap energy and strong dollars. Another era is beginning. What era will that be? Yes, our oil and gold-mining stocks go up while the dollar-based world around us grows poorer. Would it not be better for our stocks to go up while the dollar-based world grows richer? Oh, if only it could be so.

Can You Buy Your Way out of Trouble?

In a Peak Oil world, you might not be able to buy your way out of trouble. Not even if you are rich. Yes, that’s the bad news, and it is very bad. And if you move all of your investments to foreign currencies, along the lines of what our old friend Jim Rogers has announced he is doing, you may still suffer the effects of the declining value of the dollar. If the U.S. economy is, as the analogy goes, the world’s economic locomotive, then this train is about to derail. Think of the looming Citigroup disaster as the financial warm-up act for the last great concert of the Woodstock generation.

Take long-term monetary mismanagement by the Federal Reserve, plus fiscal decadence at home by the U.S. Congress, and an unaffordable war abroad, and you have the ingredients for economic disaster. Stand by for a domestic recession, as the value of the U.S. dollar drifts downward. There will be pockets of prosperity, in export-related fields, such as some high-tech and large capital goods like commercial aircraft (thanks, Boeing). But if you don’t earn a living building Dreamliners, we suggest that you get out of debt fast, and out of dollars faster.

At Outstanding Investments, we think that some protective moves include owning gold or shares in gold miners. Or you could invest in one or more of the foreign currency or commodity-backed FDIC-insured certificates of deposit (CDs) that our friends at EverBank offer. We have to note that Agora Financial has a business relationship with EverBank, through which we promote EverBank products. But still, we assure you that we would not even mention the EverBank CDs if we did not believe that they are suitable investment opportunities for our readers. Check them out.

Until we meet again,
Byron W. King

November 15, 2007

Oil, Gold, Batman and Leo Tolstoy was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.