THE REVENGE OF GOLD
"In due course the Japanese people will own over 70% of the world's gold! Wrap your mind around the implications of that!"
Harry Schultz
The price of gold hit $305 yesterday. "BUY GOLDS!!" says the headline of a James Dines Ad in Barron's.
Dines, whose headline - it seems like it was only a few months ago - was "Buy Internets," now believes that it is gold stocks that are in "RAGING UPTRENDS!"
"If you honestly want to make money, it is obvious that you should be interested in uptrending stocks," says Dines. Internets, as all the world has noticed, are no longer in uptrends. Even "downtrend" seems too gentle to describe the white-knuckled descent of the companies Dines used to recommend. Perhaps "death spiral" would be more appropriate. Many of them went down so far, so fast, they will never get up again. But the trends have changed.
One of James Dines' 61 "Dinesisms," explains the ad, is that "a trend in motion will continue in motion until it actually ends." We will not dispute this. In fact, the crystal elegance of this dictum makes us wonder about the 60 other "Dinesisms." In fact, we have a suggestion for a 62nd one: "The price of gold will go up...unless it goes down. Or nowhere."
Dines thinks he knows what direction gold is going in. "It's an actual fact that golds and silvers are in uptrends," continues the author of three-score and one Dinesisms, "and have been outperforming the rest of the stock market. Serious money is made by getting into bull markets early, before the crowd 'gets it', and precious metals have been sneaking quietly higher, unnoticed by the crowd..."
We've been urging you to buy some gold, too, dear reader. Not because we know something...but because we don't.
There are so many things we don't know, we hardly know where to begin to describe them. We do not know how long the world will continue to accept dollars in exchange for goods and services, for example. Nor do we know how long American consumers can continue to spend money that they don't have. Nor do we know when real estate markets might turn downwards, ending the illusion of additional wealth caused by rising house prices. But in a world with so many unanswered questions, gold seems the perfect thing to own.
There was a time when we thought we could predict what would happen in the markets. But today, even the dim recollection of those days brings a sigh of regret. How could we have been so naïve, back in the 1970s, we ask ourselves? How could we have been so foolish and so cocksure back in the 1980s, we wonder? Ah...but then, we had the confidence of youth...the knowledge of the innocent...and, most importantly, we had hair.
But by the 1990s, we were losing our mane and gaining our doubts. Age and modesty were beginning to catch up to us. Nature, in her majesty, had already found many ways to separate us from our dignity and our money; we had to conserve what little we had left.
When forecasters told us - back in the '70s - that gold would rise to $5,000 an ounce, we believed them. For what would stop it? Government was inflating the currency. Government always inflated currency - if it could. There was no example from history of a currency that had not been inflated away to a bare trace of its original value. Why would the dollar be any different?
The logic of that argument was persuasive then, and still is. But the timing proved difficult to forecast.
In a better world, predicting the course of future events would be much easier. If man were merely the homo economicus that economists think he is, he could be expected to do the rational thing at the rational time.
Back in 1971, for example, the rational thing would have been to sell dollars and buy gold. Gold had an established track record dating back thousands of years. It got excited when compared to paper currencies - jumping up and down with the fashions of the time. But, in terms of what it would buy, gold seemed extraordinarily calm.
Through many generations of trial, and mostly error, humans had discovered that paper currencies eventually drifted away to nothing - unless they were anchored to gold or some other solid rock of value. Thus did the Western money system of the 19th century function so well - the major nations, Britain, France and America, had currencies tightly moored to gold. At the end of the century, the franc, the pound and the dollar were nearly in the same place as they had been at its beginning.
But the 20th century brought changes. "The classical gold standard died like a soldier in WWI," writes James Grant.
Governments yield to emergency like a dieter to devil's food. In war, for example, restraining influences - gold, habeus corpus, and common decency - give way to mass hysteria. We have already described how the emergency of WWI effectively bankrupted all the major belligerents - save one, the U.S.
Britain, France, Germany, Russia - all were on the brink of destitution in 1919. They had lost millions of young men, and billions of dollars, but they had not completely lost their senses. A movement to re-establish the gold standard began almost as soon as the fighting stopped. But it wasn't until early 1924 that Germany ended its hyper-inflation by tying the mark to gold. Then, on the 28th of April 1925, Winston Churchill - then chancellor of the exchequer - announced that the pound would be once-again convertible into gold, as it had been before the war - and at the same rate!
"Why did he do something so stupid?" John Maynard Keynes asked. Answering his own question, Keynes said he believed Churchill was led to his biggest mistake (perhaps even worse than his Dardanelles campaign in WWI) by his own advisors - notably, Norman Montagu, England's chief central banker at the time.
The rate was too high. During the war years, Britain had expanded its money supply and run up billions in debt - most of it to the U.S. The general price level in Britain had doubled between 1914 and 1918. Unemployment increased in the post-war years. And exports, even by 1924, were still down 25% from their levels of 1913.
A reasonable man might have concluded that the pound - loosed from gold - would likely float lower. It did. But then, a bull market in the pound in the early '20s produced a "sensational" run up in sterling. By 1924, the pound was once again trading at pre-war levels.
Taking the bait, Churchill fixed it by law. The result was disastrous. "The revenge of gold," declared the French newspaper, Le Temps.
Churchill realized his error almost immediately.
"Something terrible is beginning to happen to the economy," he said, adding "If that happens I hope Norman Montagu will be hung."
"It was the biggest mistake of my life," Churchill later said to his doctor.
General Foch, returning from a visit to London in June 1925, described the situation:
"England's government coffers are full. But the economic situation is poor...and its industry is operating at half-speed. From every side, you hear complaints that British producers can't possibly compete with foreign suppliers..."
Churchill's mistake had far-reaching consequences. As England grew weaker, Germany grew stronger. Another French commentator: "We thought Germany had been sidelined for a long time, if not forever. But barely 7 years after the war, she has become an even more dangerous rival."
Churchill's mistake did nothing to enhance the glory of gold. Many believed it was the gold standard itself that was at fault...a few even blamed it for the '29 crash...or for the inability of the government to correct the Great Depression that followed.
Alas, the gold standard had entered a bear market...
More to come...
Your editor, always trying to connect the dots...but no longer so sure what picture it will give him...
Bill Bonner
THE REVENGE OF GOLD, PART II
"It will be desirable to select as the standard of value that which appears likely to continue to exchange for many other commodities in nearly unchanged value."
William Stanley Jevons
Recall the 1970s.
Back then, the future of the financial world seemed to depend on the money supply...as it seems to hinge on the consumer today. People watched money supply figures the way they watch consumer confidence tallies today.
As the money supply rose, it seemed inevitable that commodity prices...particularly gold...would follow. A man with a little imagination didn't even have to open the newspaper. Because he knew that government controlled the money supply and that no government could resist increasing it. Ergo, the dollar would fall like a stone in a well...and the price of gold would soon hit $5,000.
What made the '70s were the years preceding - the 1960s. A war on terrorism, '60s-style...in Vietnam...had escalated into a full scale war - in fact, if not in law. Congress had never bothered to declare war...and never bothered to raise the funds to pay for it. With the additional burden of the Great Society programs at home, it began to look as if the federal government was living beyond its means. Foreign dollar holders began to wonder.
The gold standard of the 19th century had "died like a soldier" in WWI. It spent some time convalescing, disastrously in England's case, in the interwar years, only to get drafted and shot again in WWII. But the habit of monetary rectitude was so firmly established that it was hard to break. The U.S. government had organized a Gold Pool, by which major central bankers conspired to keep the price of gold below $35.20 an ounce. Managed by the Bank of England, member nations supplied gold - which was sold at critical moments to keep the price down.
But General de Gaulle noticed the weakness in America's financial position in the mid-60s. In 1968, France pulled out of the Gold Pool arrangement and demanded gold in exchange for its dollars. Soon after, other nations began to wonder too. How could America continue to print so many dollars and still maintain the dollar's value at $35 per ounce of gold?
It couldn't, of course. Three years after de Gaulle broke ranks with the London price fixers, Richard Nixon was obliged to "close the gold window" at the Fed. Henceforth, a dollar was just a dollar - a piece of paper with no value beyond what the world is willing to give to it.
Thus began a remarkable experiment. No nation had ever made a sustained success out of paper money. Instead, each episode reads like a cautionary tale. The dates, names, places and circumstances change - from Imperial Rome to Revolutionary France - but the moral of the story remains the same: paper money is not merely a mistake, but a kind of sin; like bestiality, it is unnatural...like larceny, it is repugnant...like sloth, it is ruinous.
Nothing in the experience of the '70s suggested that this time would be any different. The price of gold rose from $35 an ounce in 1971 to over $800 in 1979. Silver ran up from under $5 to nearly $40. Oil went from under $15 a barrel to over $30. Who could doubt that the process would continue? With no golden anchor to moor it, the dollar would soon float out to sea and disappear over the horizon.
But tides go both ways. Just about the time people became convinced that gold would continue to float higher, the water level dropped. The decade which had been the best time ever to buy gold was replaced by two decades in which gold was nearly the worst investment a man could make. From more than $800 an ounce in 1979 dollars, the price fell to less than $275 an ounce in 1999 dollars.
But, there is a lot of ruin in a nation, dear reader - more than can be drawn out in a single decade. Besides, markets do not destroy people right away, they toy with them first...flattering them cravenly before knocking them down.
Twenty-three years after gold reached its peak, people no longer watch the money supply figures. Who cares about them? No matter how many dollars or yen or euro central bankers create, people seem to want more of them. Nor do they seem to care that nothing but bad intentions stand behind the paper.
In attempt to gin up economic growth, Japan is increasing its money supply at the fastest pace in 30 years. In January, the Bank of Japan's monetary base was clocked at a 35.7% annual rate of increase. Just a year earlier, it was falling. "I genuinely fear hyperinflation in Japan once banks slow down the write-off of bad debt," said an analyst to Grant's Interest Rate Observer.
Meanwhile, in Europe, de Gaulle's successors seem to want to get back in the Gold Pool. The European Central Bank recently announced that it would sell gold at auction.
It has been the fashion of the last few years for central banks to sell gold and buy yield-producing dollar-based assets. Central banks still have many tons of gold - the legacy of the gold reserve years. Central bank sales have kept the price low, and the threat of greater sales discouraged buyers.
Charles de Gaulle has been dead for many years. Barring some incredible breakthrough, he will stay that way. But while the general may have been sui generis, Gaullism (the annoying trait that makes a man break ranks in order to secure an advantage) is probably widespread. In a gold bear market, central bankers may readily stick together, taking turns offering their gold for sale in order to keep the price down. But when the tide turns...and the price of gold rises...Gaullism is sure to rise too.
More tomorrow...including why the banks will not sell their gold.
REVENGE OF GOLD
"We are seeing a gradual but marked change in investor sentiment toward gold and a simultaneous return of gold to its 2000-year old status as a reserve asset..."
Ian Cockerill
We begin with a confession. In our first and only encounter with the voting booth, we pulled the lever for Jimmy Carter back in the '70s. We learned our lesson and promised never to do it again.
We have been recalling the '70s in the last few letters. The era was unlike today, of course. Those were the days when graphs of Jimmy Carter's popularity...consumer confidence...and the dollar...all headed in the same direction - down - and few people could imagine that they would ever turn up. Gold, meanwhile, only seemed to go in the opposite direction - up - and few people (certainly not your editor) could imagine that it would not continue. So different were the '70s from today that we can scarcely imagine how they were, even though we can recall the major events.
What is hard to remember is how we felt at the time. Today, we are full of pride, confidence and irrational exuberance. Then, the national mood was one of sullen despair, negativity and irrational desperation.
Remember waiting in line four hours to buy gasoline? Remember consumer prices rising at 13% per year? By the end of the decade, the yield on 10-year treasury bonds had soared to over 10%; and who wanted them? Everyone knew they were nothing more than "certificates of guarantee confiscation." Then, barely months after the end of the decade, Business Week famously announced - on its cover - that equities were not just down, but out forever. But, even at 8 times earnings, who wanted stocks at the end of the '70s?
And yet, we were human then too. Coming to the central question of today's letter: might we feel tomorrow the way we once felt yesterday?
That is the weakness of the human condition, dear reader. We have strong powers of logic, but weak powers of imagination. Give us a trend and we will put "reasons" in it faster than maggots can find a dead chicken. Then, the "reasons" will help us look ahead to what happens next - extending the life of the trend into the future as if nothing could stop it. But something always does. Just as maggots soon eat their way through dead flesh, so does a trend sooner or later exhaust itself...and have to move on.
Fighting a war against terror in Vietnam was expensive. But it wasn't just the money that brought American low in the '70s. It was also one little detail - the terrorists won!
"I remember those years," said a French army officer at dinner the other night. "After WWII and then the war in Algeria, the French military was totally discredited. In the '60s, it was almost an embarrassment to wear a uniform. People in Paris practically spat on us. It was not so different in America after Vietnam. The army lost its prestige."
But at the beginning of the '80s, Carter gave way to Reagan, stocks headed up, interest rates headed down and a major change of sentiment began. In a series of little wars and big defense budgets, the Reagan administration rebuilt the military. Meanwhile, stocks climbed over a wall of worry in the early '80s and eased into a warm tub of rising cash in the '90s. Gradually, too, the tough anti-inflation Fed of Paul Volcker eased into the accommodating bath of Alan Greenspan. From then on, every crisis that came along was salved with the same healing ointment - more cash and easier credit.
Then, on September 11th, the world changed remarkably.
But this September 11th was not the one you are thinking of. It was September 11, 1989 - the day the Berlin Wall came down. Americans peeked around them and realized they no longer had any competition. The U.S. was on top of the world - in a class of its own, the world's only superpower. A new glow of confidence began to light up the American countenance. Stocks soon went from making a reasonable rise from depressed levels to an unreasonable rise from reasonable levels. Gold fell as central banks unloaded their reliquary assets in favor of yield-producing dollar assets.
And why not? Could anyone doubt the staying power of the dollar?
Then, the Nasdaq crashed...and another September 11th came along - in 2001. People are beginning to wonder - as Charles de Gaulle did in the 1960's - how much is a dollar really worth?
"During March 2001," writes Ian Cockerill, CEO of Goldfields, "there was a turning point in the price of gold. What you see from here on out is a gold price coincidently testing new highs and concomitantly creating higher lows. We are seeing a new trading channel, with a general upwards trend, developing.
"In my opinion, this is a systemic response to the increasing risk profile of the world. Over this period we have seen an upsurge in interest in gold from retail investors, especially in Japan and Germany, as well as institutional investors worldwide. Are investors returning to gold because they are nervous?"
Demand for gold outstrips new mine supply, Cockerill points out, by more than 1,000 tons per year. And at current production rates and today's prices, mines have only enough reserves for about 10 years.
Gold producers used to hedge, by selling their gold before they mined it. But the rising price of gold makes hedging no longer sensible. The forward price, Cockerill notes, is "but a hop skip and a jump from the current spot price."
In a falling market, hedging adds supply - and forces the price lower. But in a rising market, hedging has the opposite effect. Producers who hedged their production have to buy on the open market in order to cover their positions.
The big threat to the price of gold, though, is selling by central bankers. In recent years, central banks have operated an informal Gold Pool - taking turns selling gold. Whether intentional or not, the effect has been to depress gold's price. And while the terms of the Washington Agreement limit the amount of gold that central bankers are allowed to sell, the threat of future sales continues to menace the gold market.
But a strange thing happens when the trend turns and gold begins a sustained bull market. Extrapolating from the last 20 years, we can barely imagine it. But, recalling the way we felt in the '70s, with our basements full of freeze-dried emergency rations...our portfolios full of gold stocks...and our heads full of hair...we can almost imagine it.
No one wants to sell a rising asset. And while central bankers may have a common interest in keeping the price of gold low (coincidentally keeping the price of their paper high), Gaullism has not completely disappeared from the gene pool.
Recently, gold has been outperforming all other currencies and every other major asset category. If the newborn trend continues, even central bankers will grow to like gold. Who knows, instead of selling it, they may become buyers.
Bill Bonner,
….often accused of being a gold bug, but never convicted...
The Daily Reckoning
www.dailyreckoning.com
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