24 June 1997
In a world in which U.S. Treasury securities are preferred above all other national monetary reserves, and where gold is dumped to meet the dubious goals of European governments in order to join a monetary union whose worth, ex-gold, is questionable, is gold really of any value? Likewise in a world where devastating inflation is a thing of the past and where the entire world economy is emerging from two decades of malaise, can gold even pretend to provide a financing mechanism in any way sufficient to need when compared to negotiable debt securities and stock equities? After all, the quantity of gold relative to world trade, population, and all other measures of human activity is steadily shrinking.
Is gold worthy of investment consideration when it cannot even keep pace with the rate of reported inflation or the CRB Index of commodities futures? In a recent letter James Turk (Freemarket Money & Gold, PO Box 4634, Greenwich, CT 06830) asks the question "Is gold still leading?" Since the U.S. gave up the pretense of maintaining the price at $35 the ounce in 1971, and even before, gold's price has usually been a harbinger of things to come. Gold has tended to make its bear and bull moves before those of most physical commodities and assets.
There have been major exceptions such as in 1974 when the CRB topped out in February and gold not until the end of December, and in 1975 when the CRB bottomed in March while gold did not do so for another fifteen months. These two instances have been explained away by the fact that gold became freely tradable for Americans only on 1 January 1975 and that the enthusiasm leading up to that date caused imbalances which took a year and a half to abate.
1980 is often given as a case in point wherein gold peaked at its all-time (in U.S. dollars) high in January, while the CRB did not top out until 20 November. As I have shown many times, the orthodox top in gold from the Elliott Wave perspective (on which point the grand master, A.J. Frost, agrees) was late September 1980. Nevertheless in 1985 and 1988 gold did lead the CRB considerably, although again in 1992, the CRB bottomed ahead of gold, as did the XAU Index.
Although the CRB Index is not running away at the moment, it is holding within 5% of last year's highs while gold continues to fall. Turk explains the discrepancy in this way: "There are no central banks dishoarding soybeans. No oil company is forward selling today crude oil they hope to produce in 2005." A very telling explanation.
And yet I believe that this observation, reflecting physical gold management policy of the central banks and gold mines since at least 1988, begs the question. Is the forward selling and dishoarding (for which, of course, there is always an opposite side buyer) merely masking what would other wise have been a modest bull market for gold, or does it represent a long term and decisive change of perspective on the part of those—central banks and gold miners—who are perhaps best informed as to the economics and politics of gold? Despite impressive historical analyses concluding that gold has always been and will always be the ultimate money, and studies showing that it holds its purchasing power over time, has fractional reserve banking based upon interest bearing government securities of an issuer which has proven itself to be the borrower and lender of last resort, finally reduced gold to just another physical commodity? Is gold merely another metal like copper and palladium whose price is dictated by producers and industrial users and with no steady investor or central bank hoarding?
Why are many central banks dishoarding and/or lending gold to the market? Why are many savvy and powerful mining houses selling forward production for many years to come in some cases? In both cases the answer seems to be optimization of return on assets and decreased financing cost. Central banks are profit centers for most governments. In the case of the U.S. Federal Reserve Board and its banks, all profits after expenses are returned to the Treasury each year. Countries which are fortunate enough to have a significant asset base in their central banks expect those banks to contribute significantly to the fiscal needs of the government.
We often subscribe to the fantasy of the central banks as the reservoir and safeguard of the nation's treasure, but in fact they are largely trading banks like any private national or international bank. They are expected to earn a respectable return on their assets for their "biggest shareholder." This is their primary "redeeming social value".
Much of the gold hoards of European and American central banks was acquired in the nineteenth century when the gold standard was in effect and when gold was the only asset held by central banks apart from short term cash needs. When all the major world currencies devalued in the 1920's and 1930's ("revalued" gold upward), this was seen as a windfall for the central banks in the devastation of the depression. The gold held by European central banks preserved the credit worthiness of their exile governments during World War II and contributed to the aura of gold's importance in their reserves.
With the advent of floating gold prices and floating currencies, the persistent belief in gold as the ultimate store of value led to a gold frenzy in which gold rose from $35 to $850 in a less than a decade. This was a virtual buying panic as many felt that nothing else had value except gold since everything else "floated" and was subject to political whim.
At the same time that this reinforcement of gold's aura was taking place, the Age of Hedging was being born. With currencies, interest rates and all physical commodities trading relatively freely, or at least with new volatility, futures and forward markets grew enormously to enable both producers and users of all of these "commodities" to cope with volatility. The oil, metals, interest rates, and currency "shocks" of the 1970's, coming at the end of the long economic wave, had an extremely negative effect upon national economies and world trade. Without getting into the economic cycles at this juncture, suffice it to say that it became clear to politicians and bureaucrats and traders that if currencies and interest rate contracts were commodities, so too was gold. If all is relative, all is relative.
So for central banks as well as mining houses, gold came to be seen not as a store of value or a speculative asset but as just another product or asset. Just as a farmer produces corn year in and year out, weather and financing permitting, a gold mine produces gold. As long as the miner can produce it at a profit he may as well lock in that profit by forward hedging just as many farmers do. Just as farmers borrow against their asset base to raise their crop, and hedge it to please their banker, so too did mining houses borrow to expand production throughout the 1980's and 1990's. And since gold is considered excellent collateral, they were able to borrow more cheaply by gold collateralized loans or actual borrowing of gold to be sold now to be repaid at a later date. The enormous growth of great companies such as Barrick Gold Corporation, Freeport Gold & Copper, and RTZ Corporation is a testimony to the wisdom—at least so far—of such an approach.
If gold is just another commodity whose production is seen as little different from farming and whose value as an asset base is no more important than any other asset, what is its "value?" If the hedging of interest rates, equities, currency values and all other major commodities is freely available and with deep markets, does gold still have a meaningful future as a hedge against inflation or deflation? Aren't interest rates and currencies a more lucrative and sensible way to invest or speculate (an investment is a speculation with less leverage!) Isn't gold after all, as has been said many times, a barbarous relic? Lovely perhaps, immutable, undefilable, but ultimately in the dustbin of history so far as finance is concerned?
This is, of course, the judgment and opinion of the market for many years past. We need not raise the specter of manipulation or regulation of gold in coming to this conclusion, although I believe there is ample evidence that it is in the best interests of both central banks and the stock and bond markets that gold be seen to be weak and of dubious value. (A curious example recently was the first time issue of a very large number of one year gold warrants by Dresdner Bank within days of their approval by the U.S. Treasury as a primary dealer in treasuries. Was this merely an astute guess by Dresdner that this would be seen as a signal that they were "with the program" or was it suggested to them?)
If gold has been terminally discredited as a meaningful financial asset and if central bank dishoarding and producer forward selling persists, why should gold ever rise again? Gold is a relatively tiny market compared to the U.S. Treasury bill, note and bond market or compared to world equity or currency markets. Despite the revelations of the London Metals Exchange earlier this spring that the volume of transactions loco London was much larger than at Comex and much larger than previously thought, it is a poor cousin in total value and trading volume. Surely it must continue to be very easy to control the market through central bank and mining transactions?
On the other hand, it is such a small market which is quite depressed and with a menacing overhang of enormous short positions. Much of the futures, forward and options market is used for commercial hedging and as part of ever more complex derivatives strategies; however, there are still large numbers of naked options being written and ever greater numbers of forward sales against which future deliveries must be made or hedged against on the upside.
I do not think I can answer the question whether gold will ever regain its monetary role in any semblance of its former glory. Currency speculation and the income stream of treasury issues held are terribly competitive, especially as the U.S. is seen to be continuing to arise from the ashes of the 1970's and 1980's as a renewed world economic powerhouse and sole (so far) major military force.
But I do think the gold market will probe for any weakness or loss of momentum on the part of the central banks and miners. A smallish market is eminently susceptible to a campaign by a well-financed group in an attempt to run the shorts. With financial markets on a rampage there has been little incentive to do this, except for minor forays by a silver group off and on for a year, but it is natural to imagine that gold is being accumulated in this relatively calm and narrow range market since February. Anything which happens to ruffle the financial markets could serve as the catalyst for a short squeeze of major proportions.
In the meantime, I think it is unwise to adopt any philosophical blinders either pro or con the issue of whether gold is and will always be money or is just another commodity. The markets are overextended up and down, and the levels of complacency and sheer disdain for cycles after the March/April stock market mini-crash and giant recovery is stupefying. If you doubt me and think it is only the financial and general public media who think the good times for investors will never end, just visit around the investment chat sites in the Internet. Anyone with a bearish or even cautious stance is thought to be a fool.
Technical Indicators /The Near Term
Technical analysis (TA) has taken its lumps in many markets in these past few years. TA was, after all, developed and came to maturity during the trading range markets of stocks from the 1960's to early 1990's. A lot of mathematicians and ballistics engineers, who were accustomed to tracking rapidly moving objects with the goal of shooting them down, found a home in price analysis where trading range volatility seemed second nature to them.
In the trending markets of the 1980's and 1990's these tools are not as valuable. Markets can get overbought or over sold and stay that way for a long time during a very long trend. Relying upon price oscillators has long since been a losers' game. In the currency, interest rate, equity, and gold markets one could simply buy and hold (or sell and hold) and not worry even too awfully much about whipsaws from moving averages if ones horizons were far enough out. And market action has encouraged very distant horizons indeed.
In the past year in gold, nearly every technical indicator of price and nearly every timing device has seen limited usefulness. Even when correct, as they often have been, they have rallied gold very little and for very limited periods. This in itself is an indicator of a bear market. Just as all news is bad news in a bear market, so are all indicators bearish.
Friday saw a new contract low for nearby gold futures (GCQ7 - August 1997) as well as a new low close but not new low for 24 hour cash gold. We are now within striking distance ($15) of the 1993 lows for gold after a promising rally from February. I do not think it is a coincidence that gold's February/March rally coincided with the stock market's most ominous days in along while. But now that all is well with the world once more, gold is in disarray. And yet some of the finer gold stocks are 50% or more higher still than in 1992-93, not much by equity-mania standards, but not too shabby. Call it indexing if you will.
For the August contract, the key levels are $336.90 on the downside and $349.60, $354, $357.10 and $360.20 on the upside. The important Gann angles from $35 in 1970, about which I wrote in the Year End Review and elsewhere, is now nearly at $380, and we are below the next lower parallel angle at $350. This is a very bearish position, comparable to the situation at the devastating bottom of August 1976. Although June is statistically the month most likely to have a bottom for gold (September is next), the next most likely cluster of potential turn times is in early July, although with one short term target of 30 June. Given both the key price levels and turn times, a timely close above $349.60 is needed to give rise to any near term hope.
I am holding my long term core position of quality gold producers as well as my bullion and coin position.
The stock market has developed one fifth Elliott wave extension after another since last year, and June 1997 has been no different. This is last wave action. I have had a price target for the cash Standard & Poors 500 Index (SPX) of 901 and time targets of June and early July for some time. The price target was met on Friday on a minor reversal day which is not as compelling as early July. Nevertheless when time and price and pattern come together, one needs only a statistically compelling reversal signal to reverse long to short, and I am watching for one.
At the same time the bond market is showing renewed strength. Technical indicators for bonds are very strong in all time frames from daily to monthly. There is little doubt that bonds will be and are already the beneficiary of a topping (short term) economy and will become the home for funds fleeing a stock market reversal. Merrill Lynch is now 55% weighted in bonds in their asset allocation portfolio with only 45% in stocks. And even in stocks they are weighted heavily to financials, cash cows, and consumer defensives. The bond market is taking Alan Greenspan at his word, or at least his articulated perception. Namely that the economy may be "pausing."
As you know, I am a long term re-inflationist, but if rates do fall and stocks fall too, I will not be a buyer of gold-related assets below $335 basis GCQ7 - August 1997. My bias has led me to believe that any stock market decline would be upon fears of inflation, not a recession. But an economy which could pause or decline after only one interest rate hike would not be a strong economy of the sort associated with inflation. This is, of course, falling into the belief in the Fed's real control of the interest rate markets. Many feel that the Fed has entirely lost it's ability to exert any control over events due to the proliferation of new sources of money supply, and that its only tool is "jawboning". Since the stock market has noisily thumbed its nose at the Chairman since December, one doubts even that jawboning is a viable alternative.
I still believe that most economists are trapped in a historical time warp of "disinflation forever" and are looking at economic indicators of slowdown much as technical analysts have looked at overbought indicators, as discussed above. Both are too quick to call for a change of trend, in my humble opinion.
The fabulous quantities of money which have entered into the system since 1992, along with the tremendous wealth creation from the equity markets will not suddenly cease to be functional. I do not think a crash is in the works. Everyone knows how to play a crash. Get the Fed to loosen and buy, buy, buy. Psychologically I feel that a high level trading range with high volatility alternating with deadly boring periods is the only way that all that wealth can be "burned". Historically that is the kind of market associated with an inflationary rather than disinflationary recession.
But as always, I reserve the right to be wrong!!!!
GOLD FAXLETTER ã 1997 IS PUBLISHED BY TENORIO RESEARCH & TRADING, DR. THOMAS DRAKE, EDITOR, 3 HAWTHORNE CIRCLE, SANTA FE, NM 87501. FAX: (505)989-3351. ANNUAL SUBSCRIPTION: $250 for all Letters, Interim Bulletins, and all special reports.