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REASONS
WHY GOLD WILL RISE (revisited)
As
the slow “dog days” of summer are upon us, why not a reflection on
why gold still makes sense? The first article under my pen name “25
Reasons Why Gold Will Rise” was published in November of 2002 (much
gratitude to the Moriarities). The entire motivation for the compendium
of justifications was disagreement and disrespect for the few shallow
reasons offered by the press & media. The only reason they seemed to
understand was MidEast
violence. Not the Iraqi conflict, but the Israel-Palestine ongoing
endless version. Do they even recall this overused reason now that the
focus of MidEast
violence has moved 1000 miles east and 1500 miles southeast? Probably
not. They
overlooked a cluster of monetary reasons and economic fundamentals
behind an imminent gold rise and USDollar decline. They did not get it
right then; they do not get it right now.
Let’s
revisit the listed reasons why gold has risen, as forecasted 20 months
ago. They are still relevant for further price appreciation.
Since the time of its writing, two additional reasons have been
captured, worthy of addendum.
1.
Real rate of interest has been near zero since Oct2001
For over a
full year, a 1% Fed Funds target, and a 1.0% to 1.2% floating yield on
the 3-month TBill has prevailed. Since spring 2003, when the Fed issued
its last rate cut, negative real rates have been a driving force for
gold. With a low-ball CPI in the 2% to 3% range short-term rates have
remained negative. Naïve gold watchers, usually gold bashers, point to
real rates normalizing toward zero or even turning positive. Perhaps
they should check the CPI, up in the last year much more than the measly
25 basis points ordered by the Fed in late June. The Consumer Price
Index is ridiculously low in the true measure of consumer price
inflation. Real rates have actually turned deeper negative, and will
likely continue in this pattern. Given the paltry yields offered by
short-term TBills, gold will continue to receive a lift for some time
into the future.
2.
Rise in foreign holdings of US assets increases our vulnerability to
foreign abandonment
The
accumulation recently by foreign entities, principally central banks,
has gone parabolic in the last year. The percentage of new Treasury
issuance gobbled up for foreigners has risen a few percentage points to
45%. The total foreign accumulation of US financial assets in 2002 was
almost $400 billion. In 2003 they gathered another $600 billion. Better
yet, in the first half of 2004 alone, they collected over $1600 billion
in additional assets. In the last couple months, Asians have noticeably
withdrawn their demand. This could portend trouble ahead, and a strong
motivation to own gold.
3.
Money supply increased over 40% since Jan 2001, close to 100% rise since
1991
The money
supply continues to rise steadily but not yet parabolically. Since Dec
2002, the M3 has risen by 7.8%, which is above the GDP growth rate.
However, in just the first seven months of 2004, the M3 has risen 3.9%,
which marks an acceleration. Furthermore, an estimated 25% of that
increase in the monetary base owes to Fanny Mae and the cast of
uncontrollable mortgage funders.
4.
Return to federal deficits from recession and wartime economy, security
spending
An economic
recovery usually brings about a gradual removal of red ink to the
federal balance sheet. Not this time. Well, the claim of recovery has
sounded less than honest, if not totally fallacious, even politically
expedient. To me, it is ludicrous and fraudulent. Federal deficits have
remained quite steady, in the $400 billion range for the last three
years. The Iraqi War has resulted in $70 to $100 billion costs last
year, and about the same this year, with no end in sight. Whenever the
federal budget is cited, one should be certain to mention that the
Social Security Trust Fund is routinely pilfered to pay for today’s
federal bills, even as future bills escalate. Coming years will see more
dreadful deficits from additional commitments like the Medicare
Prescription Drug bill, which will add roughly $550 billion over three
years to the deficit. In the next few years, talk will emerge of
eventual and inevitable US Treasury default.
5.
Rising world tension, desire for safer safe haven, the geopolitical
threat to peace
In the last 20 months, Iraq
became a new theatre for conflict. Open season was declared on oil
pipelines. Saudi Arabia became a site for terrorist violence, a
prediction of mine made in January 2003. Al Qaeda broadened its target
zones to Bali
and Spain, racking up several hundred more victims. Chechnya
never went away. Israel erected a wall to quell easy access from
neighboring zones. Geopolitical peace is nowhere to be seen, except in
South America,
Australia,
and Asia.
6.
Glass-Steagal Law repeal now heightens risk of financial cluster failure
in progress
The law was instituted immediately after the Great
Depression in order to protect from systemic ripple effect damage,
extending from banks to brokerage houses to insurance companies. Now all
three are vulnerably linked. The topic receives little if any attention.
Giant financial conglomerates like Citigroup and JPMorgan possess
dangerously large and unregulated derivative books. Each owns a major
brokerage arm subsidiary. Citi owns a major insurance firm. Following
the World
Trade
Center
attack, insurance companies have been under enormous strain. As a group,
they publicly state justification for rising insurance premiums to be
increased risk of attack and disruption. If the truth be told, it is
more due to severe drops in their income from fixed income investments,
since Treasury yields are pathetically low. Brokerage houses are the
tail on this dog. The two critical pieces are banking (loaded by
derivative risk) and insurance (strained by low yield income and
continued terrorist risk). If one arm falls, the others are dragged
down.
7.
World perception of American institutionalized dishonesty
A new wrinkle to US lack of pursuit for truth came in
February 2003, as the US
put forth questionable arguments and documents to justify Weapons of
Mass Destruction existence in Iraq. The current administration alienated
European leaders and NATO. We parted ways with a stodgy inactive United
Nations, which had its own massive fraud controversy with Iraq’s Food
For Oil Program. In the last 20 months, US prestige has fallen more due
to the ongoing war, its narrow coalition of support, and regular
pipeline attacks. At the time of the last article, our prestige was
under assault by a string of fraud cases, led by Enron and WorldCom and
mutual fund controversies. The stock bust in 2000 had its aftermath.
8.
Likelihood of systemic banking shock waves from debt collapse and
derivative chain reaction
Derivative
books have continued to grow. Exact measurement is impossible. It would
not be surprising to learn that in 20 months, the notional value of
US-held derivative might have increased by 20% or more. During this time
span, two bond revolts occurred, one in July 2003 (led by Fanny Mae
convexity), another in March 2004 (led by a false start in jobs growth).
Since bonds comprise at least 75% of derivative portfolios, they should
be closely watched to signal trouble in the highly leverage arena of
derivative trading. Low rates are kept low, in part by leveraged
contracts to protect the entire financial system.
9.
Reduction of USDollar usage as both store of value, banking reserve
asset
Several developments have undermined the USDollar as
primary store of value in hard asset reserves. The euro has risen 40% in
20 months, as European and Middle East
(OPEC and Arabs) have turned increasingly to diversification. Asians and
Russians have also publicly announced a diversified intention, which
includes gold. Islamic nations have begun to tinker with bilateral
commerce settlement in Gold Dinars. China last autumn opened its first
Gold Exchange. The winds are blowing away from the USDollar as the
primary reserve currency.
10.
Sharp increase of savings across Asia
in the form of gold
The Chinese move to open a Shanghai Gold Exchange marks a
critical event. Rumors run rampant on a constant basis that China
is accumulating gold for a future bank system foundation. Promoting gold
for citizen savings only reinforces the direction seen as coming. Rumors
even include China eventually backing their yuan currency with gold.
Those who spread such stories should beware that a quantum jump in their
currency exchange rate would cause two immediate effects. Their export
business would be harmed badly. A rise versus the US$ but more stable
exchange rate with the euro would preserve export potential to the
European Union. Their import cost for raw materials and energy supplies
would also drop in price. At some point, when their middle class grows
even more, such a compromise might be welcomed.
11.
Islamic world is planning gold-centric international commerce,
distancing from USDollar
The Gold Dinar is openly discussed in the Islamic world.
It is unsure whether Iran
and Indonesia
have followed through with stated plans to settle on trade with gold.
Other bilateral agreements are either hatched or in the works. Some Arab
nations are deeply in debt, such as Saudi Arabia (the #1 nation in per
capita debt). Other Islamic nations and Arab emirates continue to sock
away large surpluses annually. The Middle
East
continues to see strong gold demand. Whether a more formal gold-backed
system of commercial settlement occurs among Islamic nations, in
defiance of western standards, we will see.
12.
Bank for International Settlements has targeted the US dollar for a
corrective decline
Leaked internal reports indicated a desire to weaken, if
not bring down, the Soviet Union
back in the 1980 decade. They were seen by the BIS as a threat to world
security. In the 1990 decade, similar reports indicated a desire to
remove the unstable dynamic to the world economy owing to the
uncontrollable growth in USDollar creation and its excessive
appreciation. This is a shady organization, not corrupt, but rather
secretive. The BIS serves as the central bank for all major central
banks. They have tremendously powerful means to effect change, by
restricting credit flow and managing large leveraged portfolios. It is
reported that they would like to see a hard asset like gold more
involved in the world monetary system. Little can be verified. So take
this assessment as conjecture.
13.
Reversal of miner hedges, end of gold leasing, reducing supply
In the last 20 months, total gold miner hedge book
forward contracts are reported to have declined by between 30% and 40%.
Their contract buybacks continue, which might provide an ironic support
to the gold price, offsetting the gold cartel assaults. As for gold
leasing, it has not ended by all accounts; lease rates continue to be
tiny. Skirmishes continue with members of the European Union. While
small nations like Netherlands
(I believe) expressed lost interest in gold sales, Germany and
Switzerland continue the practice of gold dumping. It is unclear how
much gold remains in Fort
Knox.
Actually, what remains of our national gold treasure is reportedly
guarded at West
Point.
14.
Dismantled mining supply apparatus, from systemic price below production
It still takes a long time to bring a revived mine into
production. Fifteen years of neglect did not completely end in 2002,
when gold reversed in price. In the last 20 months, numerous little gold
companies, and many larger companies have opened shuttered mines. Many
properties have made early steps toward returning to production,
bringing permits up to date, hiring operators, obtaining funds, and
completing environmental impact studies where required. A shortage of
operators and equipment is reported in the field in Canada.
15.
Paradox: high gold price
leads to higher demand, and high price leads to lower supply
This
statement is hard to prove. Demand was nearly non-existent for gold at
the autumn 2001 low. Demand is growing nowadays. Gold fever has come and
gone, sure to return. In the last cycle, people were lined up around
street corners in 1980 to purchase gold coins at the peak price. Expect
the same this time, over several rounds of price jumps. Paradoxically,
as the gold price rises, cash is taken out of gold miner operations to
pay down forward contracts before they burn acidic holes in balance
sheets. Gold reserves have not markedly increased in the last 20 months
from new discovery. In fact, new deposits seem in most cases to be of
low grade, with between 5 and 30 grams per ore ton. Despite a $140 rise
off the gold low price, no acceleration in supply brought to market has
occurred. My claim is that both demand and supply for gold are
inelastic.
16.
Trade tariff resumption discourages global trading village concept
Trade friction has grown with numerous international
court cases, and even more national court cases. The USA
instituted a 2002 steel tariff on foreign imports, which was lifted last
year. Europeans have cited several protected group items from the USA in
violation, like jewelry. Recently, Asian shrimp and clothing were cited
by our courts. Globalization brings with it severe price differences,
job displacement, and undercurrent conflict. Given the shortages widely
reported for steel and cement, and games played in Chinese ports over
soybeans, expect protectionist winds to blow hard and regularly. My
expectation is for much wider trade war between China and the USA.
17.
USDollar correction to relieve the trade imbalance could result in a
currency crisis
The USDollar has declined about 40% versus the euro and
almost 10% versus the yen in the last 20 months. The US
trade gap has risen from the mid to upper $30 billion range. The new
range is the mid to upper $40 billion level. In spring 2002, my
prediction was made that the US$ would correct sharply, but the US trade
gap would not improve, and might even widen. Doug Noland of Prudent
Bear, in a recent credit report, claims monetary trouble not on the
periphery, but in the core. Poorly qualified borrowers can easily find
credit. Large retail purchases are easily financed with zero deals.
International credit subsidies have created a systemic risk of currency
crisis not evident in previous years. Massive federal deficits, massive
current account deficits, unprecedented central bank intervention, these
have rendered the world monetary system unstable and imbalanced. Forget
the crappola from the Fed about flexibility advantages, which is denial
at the extreme in rationalization of their incredible failure. A
currency crisis is in the cards in the not too distant future.
18.
Accelerating worldwide currency turbulence
The number of days with over 100 basis point currency
moves in the euro and yen are a commonly used measure of instability.
Exact data is not at my disposal. To the currency observer in FOREX
activity, it seems clear that the number of days with big moves
described has steadily risen. Last week after a putrid July jobs report,
all three (euro, yen, sterling) registered volatile uplift days, just
like when the lousy June jobs report was released. Hardly a month passes
without several days with 100-bpt movements. Last autumn, following the
Qatar G-8 Meeting, currencies started flying, as ministers gave vague
signals of consensus desire to see the US$ much lower. This past spring,
big movements went counter-trend, as the US$
appreciated with strength at the time of the false favorable jobs growth
reports. Currency volatility is much worse than in the recent past. They
signal greater monetary earthquakes dead ahead, in much the same manner
as smaller and more frequent tremors among the earth’s tectonic
plates.
19.
European currencies offer more attractive alternatives to USDollar, with
Swiss Franc leading
This claim is debatable really. The European Union has
small federal deficits among its member nations, although we arrogant
Americans like to insult and denigrate the old continent. They are
stodgy and crusty, while we are insane and steroid-driven. The EU
possesses a reported 15 times greater amount of gold to back their
currency. The EuroBond offers typically a hefty premium over US
Treasurys, of approximately 1%. Until the Spain
terror incident at the Madrid train station, the EU was regarded as free
from terrorist threat. The Swiss Franc, aka swissy, for a century was
the primary reserve currency. It has risen with the euro, or perhaps the
perspective should be that the new euro has risen with the more mature
swissy. The gains in the euro and swissy have been around 22% and 18%
respectively over the past 20 months. Look for the swissy to regain its
premier status.
20.
The calendar date Sept 11th marked the turning point for USDollar in two
critical years
The World
Trade
Center
attack was a critical event. The shock & awe attack of Baghdad was
another critical event. The resignation of Treasury Secy O’Neil was a
milestone event, after controversy over budgets, debt obligations, and
deception of Congress on estimated Medicare Drug costs. Enormous
surprises on trade gaps, budget deficits, and lackluster job growth
continue to dot the calendars as the US$ weakens. The US balance of
trade seems unfixable. After the glow of patriotism faded in the
following months after the WTC attack, fundamentals behind the US
Economic weakness came under the spotlight.
21.
Rising costs from entire energy complex (crude oil, natural gas, heating
oil, gasoline)
Crude oil has risen 70% in the last 20 months. Attacks on
pipelines, an unstable Saudi
Arabia, labor disputes in other producing nations, legal warfare in
Russia, all these stress the energy complex on the delivery side of the
equation. Reports from energy experts concerning Arab lack of excess
capacity contribute to the speculative interest. Simmons goes so far as
to say that Saudi’s largest oil fields are near exhaustion. Natural
gas usually sees a price reduction in summertime, but not this year,
even with the benefit of mild weather which has lessened air
conditioning demand. Gasoline has ripped through the $2 barrier per
gallon in many states. Attention has been drawn to energy systemically.
Debate rages on impact to the economy and households.
22.
Commodity trend reversal has begun, the beginning of a new longterm
trend
Since November 2002, copper has exploded in price (+70%),
steel prices have tripled in certain products, lumber has doubled, and
cement has risen 20%. More importantly, cement has gone critical with
outright shortages, only to stall some large construction projects.
Grains and soybeans are up more in the past year than in decades. Yes, a
commodity trend reversal has not only begun, marking a new age of
shortage. The long-term trend has become firmly established. Shortages
are so acute, owing to China’s
development and Greece’s Olympic venue construction, that trade war
seems a greater likelihood with each passing month. The focus is likely
to be on construction materials and food supplies. The gold versus
USTNote has begun to signal a trend reversal as well, away from
paper-based securities and toward hard asset investments.
23.
Kondratieff Winter is gathering speed and force
Chairman Greenspan relished the opportunity to defend the
world against a K-Wave winter. His wish is being granted. The Great Fed
Reflation Initiative is a dismal failure, although such a view is hardly
the consensus. Many destinations of expanded money supply are
unproductive. New money has gone to greater debt and questionable
housing speculation. The real economy inside the USA
has taken on serious damage. Rising costs have encouraged increased job
outsourcing to lower cost locations like Asia.
The US Economy appears to be growing. However, the more accurate picture
can be seen with the real economy, where manufacturing jobs were shed on
a massive basis over 20 months, and only recently have shown any
substantive gains, even if paltry. In 18 months ending in December 2003,
western Pennsylvania lost a whopping 140 thousand jobs in the mfg
sector. Mfg alone accounts for 19% of the US GDP. If one removes
electrical power generation, the mfg sector accounts for roughly 10%.
Debt levels have grown in magnificent fashion, setting the stage for
debt stress failure to come. Consumer debt has grown almost 7% since
late 2002. The Chinese trade surplus with the USA has grown over the
same time span by an even greater amount. New money either is devoted to
debt burdens or shipped to Asia.
Does anyone notice such a disastrous report card for the Fed Reflation
project?
24.
Divergence toward deflationary credit-based economy, inflationary
cash-based economy
Retail sales have begun to falter. Evidence lies with
department stores, clothing outfits, restaurants, and automobiles.
Credit offerings have remained attractive with eye-catching zero deals.
Demand has faltered anyway. Pent-up demand is absent for cars and
housing, and probably exhausted. Car sales have lagged badly, only to
present Detroit
with historically high inventories. In mid-July a reported 3.5 million
unsold vehicles lined assembly plants, dealer lots, and rented mall
parking lots. As the car sector goes, so goes the economy. Carmakers
face production cuts or profit-eating incentives. The housing market
continues strong in certain regions (e.g. California), while stalling in
others, and retreating in many areas (e.g. Denver). The cash-based
economy refers to markets for gasoline, crude oil, food products,
construction materials, industrial metals, which are showing robust
price appreciation. The trend for rising commodity prices is clear.
25.
The parallel between gold’s rise in the 1970’s and 2000’s has many
components
The parallels are more clear now after 20 months. The
last convincing piece was rising energy prices for comparison with the
economy three decades ago. Rising production costs are obvious, in
common with the 1970 decade. Talk of the possibility of stagflation has
begun to hit the media publications and airwaves. Similarities are
noticeable between gold’s early stages of appreciation in the mid
1970’s and in the last two years. The parallel is not perfect though,
since China
was not a principal trade component for either supply purchase nor
export sales.
(added)
26. Major gold producing nations are seeing production costs rise in
dollar terms from domestic rising currency, which has resulted in
sharply declining profit margins, and may force shutdowns in mine
operations
The key case in point has been South
Africa, the home of the worst performing gold miner companies. Take a
look at AngloGold, Harmony, Gold Fields, and Durban Deep. Their charts
are flat to down, except for a strong AngloGold (AU). As a group, they
have not kept pace with the HUI index rise. The South African Rand
currency delivered a shock to SA producers, as it bounced back strongly
after clear manipulation from major banks in previous years. The ZARand
has regained its footing in the past year. The fallout has been higher
production costs, a fly in the ointment to investors. Over a year ago,
my analysis called for looking elsewhere from South Africa. Labor
concerns and duplicity from marxist demands signaled trouble. My
concerns were well placed on national purchase values on nationalization
buyout, and community mandates levied against producers. As foreign gold
producers attempt to ramp up gold mining operations, they must deal with
a currency appreciation versus the USDollar. Australia and Canada have
had to deal with the effect as well.
(added)
27. Major smelters are seeing energy costs rise in dollar terms, as the
cost of natural gas has increased, which has resulted in the shutdown of
many large facilities
Over a year ago, a large aluminum smelter shut down in Washington
state, and moved operations abroad. They cited higher natural gas prices
and costs generally. It takes a tremendous amount of energy to separate
target metals like gold, copper, silver, from mineralized ore. Profit
margins for miners suffer more cost damage than clean corporations which
only require space heating and electricity. They use more energy than
the majority of industrial plants beyond the steel niche. Smelting is
very energy intensive. Actual field drill operations require diesel
power plants, whose costs have risen also.
NEWS
TIDBITS
The
Federal Reserve FOMC meets tomorrow and Wednesday. Fed Funds futures
contract prices in an 94% chance of a 25 basis point hike. Wholesale
inventory levels for June rose by 1.1%, with sales unchanged. We have
the largest rise in computer inventories since Sept 2000. Warren Buffett
increased its Berkshire Hathaway bet against the USDollar to $19 billion
at the end of the first half of 2004, as stated in a regulatory filing.
The estate of recently deceased Susan Buffett intends to sell 1,200 to
1,500 of company class A stock over the next two years to pay taxes,
expenses and other cash bequests. The remainder of her stock holdings,
which would have a value of several billion dollars, would be
transferred to the Buffett Foundation charity, of which Susan Buffett
had been president. German drugmaker Boehringer Ingelheim said US
regulators had widened the approved use of its arthritis drug to include
treatment of rheumatoid arthritis, the most common form of arthritis in
which joints are damaged by wear and tear.
Internet
portal Yahoo said it will drop a patent lawsuit against web search firm
Google, which will increase the size of its planned initial stock
offering. Extra IPO shares will be allotted to Yahoo in order to pay for
a technology license used to display ads alongside search results,
Google's main source of revenue. Citigroup said it would buy the Knight
Trading Group derivative business for $225 million, as the world's
largest financial services company expands its options trading. Knight
disclosed it will increase its share buyback program. US computer maker
Hewlett-Packard sought to bolster its position in the IT services
sector, agreeing to a $297 million cash offer for Britain's Synstar.
General Electric has agreed to pay $850 million for the credit-card
operations of the retailer Dillard's, in a move to advance GE's plans to
expand its private label credit-card business. FedEx said it has agreed
to buy parcel coordinator Parcel Direct for $120 million in cash to help
it serve catalog and online retail customers looking to deliver packages
to homes. US insurer Conseco, which emerged from bankruptcy last
September, said $5 million in fines, which its subsidiaries would pay to
regulators to resolve a probe into market timing, would not affect
company earnings.
Yukos
delivery agents announced refusal of their credit, at the same time that
Yukos assets are reported as frozen in their main oil producing unit
Yuganskneftegaz. A Shi’ite Muslim uprising forced Iraq to shut its
southern oil output, renewing concern over tight supplies. A unit of
Conoco Phillips has signed a 17-year deal to sell 2.3 trillion cubic
feet of natural gas from the Corridor production sharing contract in
Indonesia (owned with Talisman Energy). United Airlines, 20 months into
a complex bankruptcy case, has asked the US bankruptcy court for another
extension of the deadline for filing its own exclusive reorganization
plan, this time until the end of the calendar year. Recently, United
said its extended debtor-in-possession agreements required it to stop
making payments into its pension plans until exit from bankruptcy. Delta
Air Lines, racing to slash costs to avoid bankruptcy, said lower yields
and higher fuel prices have eaten into 2004 cash flow, prompting it to
turn to cash reserves for certain obligated payments.
Warfare in
Iraq over the weekend has resulted in 360 insurgent deaths near the holy
city of Najaf, where loyalists to Al Sadr are concentrated near ancient
Shi’ite shrines. US soldier casualties were not reported. In an
unofficial CNBC poll of over 3600 viewers, 45% believe we are losing
ground against terrorism, 32% say we are making progress, and only 23%
tilt toward winning. In movie box office, “Collateral” took the lead
at $24.4 million, “Village” next with $16.6M, then “Bourne
Supremacy” with “14.1M.
TODAY’S
MARKET
Today the
Dow Jones Industrials rapped up at 9815 (+0.7), S&P at 1065 (+1.2),
Nasdaq at 1775 (-2.3), TENS yield 4.244% (+2.7 bpt). Currencies closed
with Euro at 122.70 (+0.20), JYen at 90.57 (-0.12), Can$ at 75.91
(-0.26). Metals finished with gold at 401.2 (unch), silver at 673.7
(-4.5), copper at 124.15 (-3.55). Energy ended with crude oil at 44.84
(+0.93) on shutdown of southern Iraqi oil, natural gas at 569.3 (+11.2),
unleaded gasoline at 124.01 (+0.93). Prices are at major futures
contracts.
Jim Willie CB
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