The Day the World Changed
The Impact 14 March 1968 had on Money,
Gold & Mining Shares
Part 3 B
1 March 2006
Part 1 of this article will examine the significance of the London Gold Pool and the global monetary regime from the Bretton Wood's Accords, to the present time. It also examines the shallowness of the digital financial archives. In the age of information, investors, economists and makers of "policy," may not have the necessary information to properly examine our current age of inflation.
Part 2 of this article will examine the effects of monetary inflation on the seven decades of recorded price history found in the Barron's Gold Mining Index (BGMI). Gold mining shares have proven to be a powerful indicator of future financial trends that everyone with money in the markets should be aware of.
Part 3 A & B of this article will further examine the seven decades of the Barron's Gold Mining Index using a charting technique I call The Bear's Eye View (BEV Chart). Using this technique I will prove my thesis that since 1938, US monetary inflation alone has driven gold mining shares to their price extremes, both up and down.
Part 3 B
In this last part of this article, I will be examining the effects of monetary inflation on the BGMI. I have found that monetary inflation not only caused the past bull markets in the BGMI but have also caused the BGMI to crash as much as minus 82% in value. All other factors are moot.
The actual key in understand the BGMI is inflation, but not as you currently understand inflation's effects on the BGMI. We must look at inflation's effect upon all asset classes to understand the historical action of the BGMI. When we do, we see that monetary inflation flows from one asset class to another from one period of time to another. One asset class' inflationary gains are another's asset class deflationary losses.
Realizing this truth, you must understand that gold mining companies are only one asset class, of many, that is fed from, or denied the flows from the wellhead of inflation. The flow of inflation-funding from one asset class to another is dictated by the fads and fashions of any current investment environment.
Here is the key to understanding the BGMI's 67 years of history. Since 1950, it has been a fact of life that the Federal Reserve has been creating inflation flows into the economy. That these inflationary flows have not always flowed into gold mining shares is also a fact of life.
So the current assumption of most people that inflation is at all times beneficial to the gold mining shares is wrong. There are 67 years of BGMI and monetary inflation history that shows this is not so. The above data proves that inflation drives the BGMI up 1,200% and then drives the BGMI down -60% or more as the Federal Reserve's endless flows of liquidity move the from one asset class and then on to another.
Ultimately, the "policy makers" have little control directing where their rivers of "liquidity" will go. That sometimes their inflation flows where they desire it to is just dumb luck. If this were not so, there would have been no need for the London Gold Pool in the 1960s, or the current Gold Cartel with its OTC derivatives market with a notional value of hundreds of trillions of dollars.
Arthur Burns of the 1970s created annual double digit CPI gains. In fact Burns did nothing different than what Alan Greenspan did in the 1990s when Greenspan created annual double digit increases in the financial markets. They both greatly increased the stock of paper US dollars in circulation. However, the Burns' inflation flowed into bread and butter items and so was blamed for the double digit inflation of the 1970s. Alan Greenspan's inflation flowed into financial asset items like high tech stocks and housing, so he is credited for creating great bull markets. The only differences between these two historic Inflationists, is just dumb luck. To believe any different is just plain dumb.
Both were only reckless Inflationists who danced with Madam Dumb Luck. Dumb luck for Burns caused people to hate him, dumb luck for Greenspan made people love him. I don't think dumb luck will treat our new Fed Head kindly.
When a previous hot sector starts to deflate, an increase in liquidity is likely to flow away from this now deflating asset. New liquidity wants to flow on to other assets that are more reasonably valued, and so more easily to benefit from inflation.
The psychology of inflation investment is momentum investing with leverage. New liquidity seeks out inflating asset prices and then jumps onboard. One opens a margin account in 1993 and pays 6% on borrowed funds to purchase shares of Microsoft and Intel. All during the 1990s, both companies almost guaranteed an annual return much greater than 6%. Software and semiconductors increased by factors of 40 and 60 times from January 1989 until 2000. On margin, using inflation, the returns on the past high tech bull market were fantastic!
Buying the deflating gold shares in the 1990s with inflation via a margin account was a losing proposition. Still it could be done if one didn't mind paying 6% on borrowed funds and having to cover the constant margin calls on assets that were deflating at a double digit rate.
The flows of inflation came from the Federal Reserve, but the decision of where this inflationary money was to flow into was made by the millions of people who used the inflationary money, not a few "policy makers."
I suspect that our new Federal Reserve Chairman Ben Bernanke will receive an education when the housing market and NYSE share prices start to deflate again. This is especially so with the housing bubble. Housing is so heavily leveraged with interest only, no down payment mortgages supported with the collateral of unaffordable houses. How are home prices to rise from current levels when the "policy makers" are counting on nearly bankrupt people to take on ever greater levels in unsupportable debt to make the new purchases in housing? Every time I see a massive layoff of employees by a major employer I think of all the mortgages with no paycheck to finance them.
Bernanke may think that dropping money from helicopters will prevent deflating values in housing and blue chip stocks; but I believe that anyone finding the free money would be wise enough to take the free hundred dollar bills and buy gold, silver and natural resource stocks. Time will prove which of us is correct.
I want you to think of the following analogy when you look at my BEV chart of the BGMI. If the world's economy is a high-pressure boiler, and Federal Reserve's CinC inflation the coal that fires the boiler, my BEV chart of the BGMI is the pressure gauge's indication of wealthy people's * acceptance * of the ever inflating US dollar supply from 1939 to present.
Here is how to read the pressure gauge called the BGMI:
BGMI Trending Down - the world's economy, and wealthy people are accepting US CinC inflation. Financial assets are benefiting from inflationary flows. Microsoft, Intel and real estate up - and the BGMI down by significant margins.
BGMI Trending Up - the world's economy; and wealthy people are resisting US CinC inflation. Real Assets are benefiting from inflationary flows and will outperform financial assets by significant margins.
So we must understand that since 1939, there has always been inflation, but inflation has not always benefited the valuation of gold mining shares. Inflation can benefit the valuation of tech stocks and single-family homes also. Every asset class, in its turn, partakes in an intoxicating drinking binge of monetary liquidity from the Federal Reserve, and then experiences the inevitable and painful detoxification process of deflation.
It is no more complicated than that. Looking at the BGMI from November 2000 to February 2006, inflationary momentum is quickly building in the BGMI. The next decade will be the gold bugs' turn to enjoy monetary inflation.
A chart like the current BGMI's is like waving a red flag in front of old el Diablo. One good correction in the BGMI before going on to new highs and the motley crew of momentum investors will flood into gold mining shares as they did in the software and semiconductor in the 1990s. Warning to margin investors in gold stocks - the road ahead can be expected to be rocky.
Real things like commodities, but not real estate, are now due to get a full measure of the Fed liquidity, while the 1990s glamour investments are going to take the cure in the decade to come.
Email this Article to a Friend