WHY TO INVEST IN GOLD
Author's note: The following was written to urge friends and family to invest in gold. It is presented in that format essentially as last sent out by me in December 2000 (personal notes omitted). I am happy to say I have had some success in convincing friends and family to invest in gold. Others may want to draw on this themselves and pass the thought along TO YOUR OUR FRIENDS AND FAMILY.
Dear Friend,
I am sure that from our conversations you realize that I think the next recovery in the stock market will be the last one for many years. Once this thing finds a bottom, somewhere between 1100 and 1200 on the S&P in my forecast, it will begin to go back towards the highs it made last spring. I think that this correction and recession will be painful enough that that recovery will take a couple of years, it is even possible to make significant new highs in a few years, but after that things are going to get VERY ROUGH. If I am right a lot of people are going to be wiped out.
Some of the things that are going to happen are very predictable, some are just set in stone. The things I see are as follows:
First and foremost, the world is going to begin running short of oil. Not running OUT in the sense that the wheels stop turning, but short where demand exceeds supply and prices go WAY UP and every economy in the world is affected. I don't mean up as in $30 or $40, I mean ruinously up. This will happen probably around 2010 (2005 at the earliest 2015 at the latest) the growth rate of world economies, politics, and geology control this. None of them is precisely predictable.
Three sites that address this are:
http://www.hubbertpeak.com
http://hubbert.mines.edu/
http://www.dieoff.com - this site is run by a real gloom and doomer, I don't agree with the extreme OPINION about civilization, but he has a lot of good articles ABOUT OIL from other sources and links to other sites. The best article to start with is: "The End of Cheap Oil" (http://www.dieoff.com/page140.htm), by Campbell and Laherrere, which appeared in Scientific American in '98.
In my OPINION the potential reserve estimates put out by the government, through the USGS and others are simply not credible, published for political purposes. There are rebuttals of the estimates on the sites above. It is true that new technologies will come on line, but there are two other major factors: 1) the lag time for them to work into the economy and 2) the fact that they will be more expensive, both on a dollar and energy (thermodynamic) basis.
I don't think civilization is going to end, like some of the people at dieoff.com, but it is going to change dramatically.
Second, the baby boom population, that's us, is going to retire. The positive pressure on the stock market will become negative as older people tend to hold bonds and utility stocks rather than speculative growth stocks. They will also do as you have done and sell their houses, lots of houses. As home values compose most of household wealth in this country and in my OPINION home prices are a bubble in much of the country (people are buying the most expensive house they can afford on the expectation of higher prices) there is a high probability that that housing prices will crash in 5-10 years. I mean CRASH, like get cut in half.
http://www.yardeni.com - among a lot of data here is a curve which shows the population bulge.
The government has hopes of avoiding this by bringing minorities into the housing market. Oh well. A noble goal, but the odds of it happening within a decade are nil in my opinion.
Third, the population of the world is going to continue to grow beyond the long term capacity of the earth to support. This will not directly affect us so much here in the US, but world wide misery is going to mean that people will continue to work for starvation wages to make products for US markets. In my OPINION the pressure will force us to become more protectionist and isolationist to avoid deflation.
Fourth, the Israelis are not going to pack up and leave Israel. Since they have superior weapons (nukes) they are not going to be pushed into the sea, and IMO the Muslims are not going to calm down. This is important because of the attitude the Muslims have towards us as the Israelis' sponsors/protectors. The Muslims do control the bulk of the exportable oil in the world.
Fifth, the oil exporting nations will accumulate vast cash surpluses which they will have to spend and invest. It is true that the Middle Eastern populations are different now than they were in the '70's when this happened before, many of the Persian Gulf States now have large populations of underemployed young males with eager hands looking for "work" to do. But they will still accumulate vast surpluses.
PUT ALL THIS TOGETHER, AND WHAT DO YOU GET?
MY OPINION.
The new energy "crisis" and its "knock-on" effects will dominate investments and investing. The hemorrhage of cash to buy oil in the west will lower standards of living across the board. The vast sums of money that will flow out of the US will lead to devaluation of the dollar and ALL fiat currencies relative to what the oil exporters want to hold. Granted, there will be large US investments made by cash surplus holders, call them oil states, but as at the last cycle, much of it will be direct investment at bargain basement prices, not in our stocks and bonds.
Obviously investments in oil services and alternative energy are indicated. You should overweight in these areas. I would not buy oil producers or reserves. The possibility remains that when the price spikes the politicians will return to tax away the "windfall profits" once again. They are like any other animal, they will hunt where they have had success before. Somebody sitting on producing wells is a target for the taxman. On the other hand, service/exploration companies cannot have their profits taken away as we will have to encourage their work.
Oil/energy is an easy one. The next one is GOLD. Most are skeptical about gold. I am not.
I spend a fair amount of time at a site called Gold-Eagle.com and there is a tremendous amount of information there. There is a Forum where a lot of people with different points of view post there thoughts and opinions and you can get a lot of valuable detailed information. If you find some interest or curiosity about precious metals (PM's) I highly recommend it. The following is strictly MY OPINION.
The "strong dollar" policy of the Clinton Administration has kept the price of gold (POG) down and with it the price of oil. The overvaluation of the dollar is coming unwound as our balance of payments deficit balloons. We will see the price of oil decrease with the coming recession, but that will be for at best a few years, likely less than one. As long as our imports of oil continue to grow and the price of oil increases, which will continue for decades, the balance of payments will continue in ever larger deficit. It is not reasonable to believe that the oil producers will hold assets denominated in depreciating currencies without a hedge.
There will continue to be extreme pressure by the US to try to influence Middle Eastern politics and economic policies, and these will be at times successful. The price of gold has been held down by overt action of certain Persian Gulf States. For example, after the "Washington Accords" created a brief spike in the price of gold (POG) in 1999, Kuwait turned over its entire hoard of gold, 85 tonnes, for leasing out in the forward market. It is hard to see how this was in Kuwait's best interest. It is widely believed that the US called in a chit for the rescue of Kuwait from Iraq in '92, and hard to find any other motivation. The populations of the Middle East have an inherent cultural bias towards gold as an investment or saving vehicle.
While gold is rising as of this writing 12/21/2000, and one should expect it to rise until fear of world wide recession takes hold, I expect gold to drop down in that recession for the last big buying opportunity for several decades. I REPEAT, I EXPECT THE POG TO DECLINE IN THE COMING RECESSION. It may test the lows around $250, but I expect it to hold around $265-270 (note, March 8, 2001: I was wrong here, it did test the lows, but held, we may well be on our way). The conflicts and economic displacements of the coming years will make it silly for a wealthy Arab to fail to buy gold. Yes, they will invest, and yes, we will try to influence them. The wealthy in the Middle East are very insecure politically. They do not have a lot of friends. Most of them really do not like us, and other than our role as protector of some Sheiks, we really do not have a lot of leverage.
The economic dislocations will make OPEC less willing to price oil in dollars. If American resolve declines and we are less willing to involve ourselves in a deteriorating world situation we will have even less leverage to keep gold down.
The oil states and their people as individuals do not need to invest large sums in gold to drive that market through the roof. We have had a lag in the price of gold relative to oil this time for several good reasons. Primarily because the large deficits the oil states have been running for the last 20-plus years have to be addressed, not erased, just addressed, before they will begin to build cash surpluses. Signs are we are seeing a turn in that market (http://gold.org, - go to "Demand Trends" articles for increasing Saudi purchases), plus anecdotal evidence, comments of traders that Middle Eastern purchases of physical bullion are increasing. The lag will not be forever.
The annual market for gold is about 4,000 tonnes per year. Production plus recycling is about 2,500-3,000 tonnes per year (neither exact production nor consumption is known on a worldwide basis). Central Banks have been "dishoarding" and leasing the difference for several years which is what has kept the price down. At $300 per troy ounce, 32,150 troy ounces per tonne, the total value of the world gold market is about $38 billion dollars a year. At 10 billion barrels a year and $30 /bbl, OPEC will take in $300 billion a year. In a commodity market, just a 5% shift in the supply/demand balance can send prices skyrocketing. That would require about $2 billion dollars, or less than 1% of the OPEC cash flow to be diverted to gold. Once the Western Central Banks lose the incentive, courage, ability or stupidity (take your pick) to "dishoard", supply and demand will go WAY out of balance, and the POG will skyrocket. There are many signs that the leasing and forward sales of gold by producers has peaked and is decreasing. A short squeeze, such as in October of 1999 will develop any time the dishoarding/leasing stops or if demand grows beyond the capacity of the banks to dishoard in an orderly manner. If the dishoarding/leasing does not get the price back under control, does not reinstate the false market, the POG will not look back.
The continuing decline in the price of gold depends on the continuing compliance of a few Sheiks being able to outweigh the non-compliance of wealthy states who do not like us. Why do you think we are going so far to keep Saddam Hussein from getting his hands on cash? Can we keep the lid on forever? Maybe, but I think its a lousy bet. There are enormous incentives for the West to keep the price down. The problem is that while westerners are selling their gold, the East is just buying and smiling (other than instances like the Kuwaiti "help"). If they did not have control of the oil which we must have and the cash it generates, it would not matter, but they do!
Technically, even if you do not buy my analysis, gold has bottomed out on the charts. The price cannot go a lot lower without restricting production, which it arguable has already done to a certain extent. The risk is very low. Merrill Lynch's Bill O'Neal says gold will go to $295 next year and does not believe it will see the $254 low again. Goldman Sachs picks American Barrick Gold, ABX, as its number one stock for 2001. (I like Meridian Gold, MDG, Harmony, HGMCY and some others)
I don't expect that anyone who reads this will immediately run out and buy gold or gold stocks. But keep these things in mind, and as you see them begin to take place and the POG make a steady advance, consider buying some stocks or bullion for a hedge. It could protect your retirement. Also keep in mind that when it explodes, you had better already be on board the train. It will be hard, if not impossible, to run fast enough to avoid the damage to come.
The market is seriously out of balance and the lid is being kept on by dishoarding, and dishoarding only (through direct sales and leasing). When the policies shift to neutral, when the dishoarding stops, the price will explode. Major nations have committed themselves to continuing the dishoarding (Switzerland, England), certain Sheiks are helping, but it cannot go on forever. Maybe a year or two, maybe less, the speed of recovery from the recession, and worldwide demand for oil will be critical. The Middle East is the key.
Keep an eye on gold.
I'll be happy to talk to you about which stocks I like and why or discuss any other aspect. Picking a bottom is difficult, but I believe if we have not arrived, we are close. And close to wrenching economic changes all over the world. Please, at least read the article "The End of Cheap Oil". This is serious business.
Your Friend,
Miner46
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