Wall Street Dive Stokes Gold Bulls
There was lots of second-guessing going
on this past week as gold shares dove faster than Al Gore's latest popularity
polls. The volatility is likely to continue. But the bears' vindication
isn't.
The louder the gold bubble crowd is, the
more confident we grow that this bull market is still young. I won't waste
your time with arguing whether there is or is not a gold bubble, since
we dismissed it as fodder for the developing bull market just last week.
Don't Hold That Punch!
However, we would contend that analysts calling it so fall into one of
either two categories, assuming they've been around long enough for at
least one:
- Those who missed calling the tech bubble
for what it was, and/or
- Those that missed buying the bottom
in gold
Of course it's important to know their
record, particularly if they claim to be some sort of authority on the
subject of bubbles, a theory we can apply to only paper by the way if
we want to avoid sounding, well, ironic. We
don't define a bubble by how fast stocks go up or down, but by how far
they are from reality, if you will. And it is important to think outside
the box if the goal is to determine reality.
At any rate, sharp wild corrections will
naturally follow sharp wild rallies. How
far could a stock, which has tripled, correct and then continue on in
a bull market rendering an otherwise scary correction in
the moment irrelevant, with hindsight?
I don't know. Some would say up to two
thirds of a move might be retraced in cases such as this, applying some
variation of Fibonacci analysis. Some would say that the correction should
at least tap the 200-day moving average.
We don't forecast corrections, though we
do assess them and try to warn our clients if their likelihood increases.
We try to predict bull and bear markets, or trends. As far as our outlook
is concerned, moreover, we're not so sure this correction will be all
that long, particularly since it has been so fast, and since our near
term outlook for the dollar and gold prices is still as bearish as our
long term outlook.
I think this kind of volatility is only
going to grow. The action in Tuesday's session was bullish for gold shares,
and could portend the end of the swoon that began last week. All of the
major gold indexes registered a familiar one day reversal; one of the
kinds of behaviors that has been extremely reliable in signaling the end
to many corrections as well as the end to many rallies, particularly in
the short term. Tuesday's behavior was classic. Most of the shares whose
charts we read all saw a spike in volume after a gap down on the open;
share prices tapped support just under the last highest low in the intermediate
sequence and, if experience serves correct in my interpretation, suggests
this move just defined the low end of a trendline. Almost every gold share
we monitor carved the same signature on the chart. Follow through will
be important, more so to short term traders, but the conviction of Tuesday's
rally even as the Dow continued to unravel is already a good sign, from
the bullish viewpoint.
On May 31st we wrote to our clients (in
Subjective Values) that gold shares were fully valued in the short
term, specifically at $330 gold, yet undervalued in the long term relative
to our outlook for gold prices. We used Newmont as our case study and
calculated that at $300 gold, the shares are worth $28 if priced at their
average multiple of cashflow over the past five years, but at a conservative
8 times (operating) cashflow they are worth only half of today's market
price, or about $15 per share. At $400 that range grows from $25 to $46;
at $500 gold we calculate Newmont's shares could be worth from $38 based
on eight times cash to $71 per share based on 14.6 times cash - its five
year mean.
(The report
is available to subscribers. See our
Subscription
Page for details).
Thus, if you're bullish on gold, and can't
decide if it is better to sell or hold your gold stocks, the questions
to ask are: how long will it take for the price of gold to get to the
$400 - $500 range to reflect better value for my shares? And, in such
circumstances, what is the more valuable currency to hoard: a gold share
or the dollar?
Should gold prices break through $339 they'll
have completed a near perfect five year double bottom. Our confidence
is high that 1999 was the bottom in this market for some time, perhaps
ever. I know that sounds bold, but it's not really.
During late 2000, after a one-year decline
in price from a post Washington Agreement buying spike, the same analysts
calling this market a bubble today saw gold going to $180. The reason
we argued, at the time, they were going to be wrong was that the conduits
that helped sustain the monetary boom had been impaired. Whether
the Fed targets asset prices or not, the fact remains while asset prices
go up, the dollar carries an investment premium that enables a check on
the prices of goods and services, and in turn buffers value of the currency.
To the extent they try and influence this premium we could say they control,
export, hide, or sustain the inflation.
Inflation is not prices. It isn't a change
in prices. It is a "process" that results in too much money first, and
debasement second. The way in which it accomplishes this is more varied
than Marx's imagination. But it always is a process that affects (usually
dislocates) individual valuation judgments within an economy. Interfering
with the mechanism of prices, which Adam Smith called the invisible
hand, is only part of the story, and only the beginning of it at that.
The rest of the story lies in what happens
to the economy's capital structure, and then to its currency once the
investors propping up its value realize how long it will take to heel
the resultant dislocated structure. In other words, how long before
real profits come back (Ed Bugos).
Flash From The Past
When the tech bubble first popped, we realized right away that the US
current account deficit was in danger of halting the dollar's ascent.
The gruesome fate of the stock market suddenly made the current account
deficit seem unsustainable. But many analysts at the time still largely
questioned our objection to a deficit that had been sustained for as long
as their careers probably spanned.
By late 2001 it was apparent to most of
Wall Street that interest rates were going to stay sticky despite the
fall in commodity & asset values, and the government's deteriorating
books weren't going to help matters there. Even if rates could lower,
and they did in the short end, this we argued would only further dislocate
the economy's structure. We argued that stock prices would not benefit,
and that profits weren't likely to come back until the economy was allowed
to heal itself laissez faire like.
In the meantime, the bear market on Wall
Street meant that analysts had to start thinking differently about where
earnings would come from now that stock prices weren't going up every
day, and companies couldn't report windfall investment gains as well as
other shams without getting caught.
A few months ago we wrote about the crumbling
pillars of dollar policy, another conduit that has enabled a check on
prices (or control of the inflation), though this one is deliberated to
certain ends. In this case we've sensed a division in the team that has
traditionally run economic policy, specifically, the US President, Chairman
of the Fed, and Secretary Treasury. Clinton's complicity in this union
was an important element supporting the US strong dollar policy. But equally,
Bush's apparent disloyalty to this team in mismanaging the nation's fiscal
ledger, and proposing his new not so free trade doctrine, are factors
that undermined it, and consequently may have impaired the Fed's ability
to manage interest rates.
America's former "freer" trade position
was a bullish factor for the dollar (or dollar denominated assets to be
precise) to the rest of the world, and helped its standing as an international
reserve currency. That's because Greenspan knows there is a market that
determines what is money, and I believe
this is why the EU understands the importance of freer trade itself today?
The point of the brief historical recap
is that we've argued for an inflation breakdown (breakout to most people)
ever since 2000, and nothing has happened in the past week to change that
outlook, so we won't be getting bearish on gold anytime soon.
In fact, the markets have moved closer
to this inevitability, even as we write. The dollar is three points from
reversing a primary bull market, and gold prices are $18 from beginning
a new one. Wall Street's bear market is still decisively on. Since most
investors continue to remain bearish on gold's longer term prospects,
and bullish on the broad market, of course the noise from that camp will
be louder during each correction in gold shares, and rally on Wall Street.
And although gold shares did trade a little
ahead of themselves, who are we to say if they will stay ahead of themselves
or not. I know I'm not smart enough to guess how smart everyone else is.
But we do think that if gold prices
complete the five year double bottom we see developing on the chart, technically
they are likely to aim for $425.
I'm a technician because it works when
my brain doesn't. But if you're not, it ought not to matter because the
fundamentals seem even more bullish than that tepid target.
Valuation Is A Process
...just like inflation is. It takes a market to determine value and the
market may change its mind tomorrow about the value of something. In our
kind of monetary system, most any determination of value will depend on
how the inflation alters our valuation judgments tomorrow, relative to
the recent past.
If for instance, the major stock market
averages recover into the summer, one could say that the inflation is
working to help bulls revalue the dollar. If the foreign owners of wealth
in the US decide to invest their liquid proceeds in either real estate
or directly into long term fixed projects, as opposed to repatriating
them, one might be able to say that the inflation has been worked to underpin
the dollar.
Any number of scenarios could evolve to
save the dollar before it cracks 108, which is the level that would confirm
our analysis. But the conduits, or tools, which have made life so easy
for policymakers in sustaining the inflation & purchasing power of the
dollar over the past decade, are now working against them.
When I meet with old mining gray hairs
at the soup kitchen they tell me that it's not over; that the government
can sustain the value of the dollar relative to gold in particular. In
my opinion they've underestimated the market. Their eyes may be on the
"crisis" ball that bounces around unpredictably, save to the
privelaged few puppet masters.
I believe the bull market in gold is part
of a healing process that will end once the vast majority of investors
understand why gold is money. I see the market rejecting the government's
models for the economy throughout that process.
The Sky is Falling... It's a Bubble
The process of revaluing gold is still young. We haven't even seen the
point of recognition.
Instead we hear warnings from the professional
investment community about the danger of gold bubbles who sound like Chicken
Littles running around telling us the sky is falling just when the sun
is rising.
Their timing is impeccable, though it is
the same thing they've been saying all along. It's just more perceptible
this week because gold shares are down nearly 20% by the average index
(before Tuesday's close).
The technical resistance points that controlled
the 5 year bear market in gold shares were blown away last month, particularly
those pertaining to the shares of producers that aren't hedged.
Obviously, if gold prices are still in
a primary bear market and the dollar is still defined by a primary bull
market sequence, gold equities probably got ahead of themselves by jumping
into a new bull market with both feet. In our view that was just the first
punch. The question in determining the value of a gold share is
not what will happen with India, or Iraq, or North Korea, it is what will
happen to the dollar, and thus gold prices?
For in the end, a gold company's profits
are determined largely by the price of gold.
Consumer demand for Jewelry can fall all
it wants. Bearish analysts say that India is an important consumer of
gold and that the higher gold prices go, the less gold will be bought
in India. I would argue that while Jewelry demand has been an important
component underlying gold demand in the nineties, investment demand is
likely to replace it in the new decade, even within India at some point,
but especially around the globe.
If we weren't counting on investment demand
to make a secular recovery in the gold business, there is no way on earth
we'd be so bullish on gold prices.
However, to the extent that new enthusiastic
shareholders of gold mining companies haven't factored the rising risk
premium that all stocks are increasingly having to contend with, into
gold shares, this sector can fall along with a major stock market collapse
at first, depending on its nature (severity), and depending also on how
gold prices and the dollar react to it. Tuesday's bullish foot prints in
gold shares on a reeling Dow is reason for optimism.
If the market factored in a $330 gold price
a few weeks ago for most gold shares, it is factoring less today. But
at that point where Wall Street's demise cracks the dollar's primary support
at 108 (for the dollar index), and gold prices bust through $339, it is
likely that gold shares will be undervalued, even in the short term.
The case for $180 gold will appear as it
does in every correction we've had so far but it is going to require new
highs in the value of the dollar against other currencies, as well as
the relative to the commodities that have been made scarce by the policies
supporting the dollar over the past several years. But there is little
indication, technically, that the plausibility of a recovery in the dollar's
primary bull trend is anything other than... maybe we get a bounce off
support before it hurls towards 100.
Deflation is a pipe dream. I mean that
scientifically. Some prices will fall. But anything worth more than the
currency it is denominated in is likely to rise in value relative to it,
as a result of the atypical protracted bust side of the prior 20 year
long monetary boom, and the nature of our monetary system. This is particularly
true to the extent that a market still determines what is money.
And it is true so long as the Fed exists.
In fact, it has been true as long as the Fed has existed. And it is why
the gold business is a growth story.
So why would we sell our modest 30% allocation
in gold shares because of a little bit of volatility?
We would if they became overvalued relative
to our outlook. But since we expect gold prices to make it through $339
and head towards $425, sooner than most think, we feel they aren't.
If we are wrong about our targets for gold
prices and the deflationists get their $180 gold then gold equities are
indeed overvalued today. Being wrong about that obviously means we disagree
with that outlook. Still, while this correction could grow deeper for
gold shares, it would require either a crash in the Dow, or a significant
recovery in the dollar's value... an outcome that recent action on Wall
Street appears increasingly likely to prevent.
Ed Bugos
Editor - The GoldenBar Report
www.goldenbar.com
June 13, 2002
The
Goldenbar Report: is not a registered
advisory service and does not give investment advice. Our comments are an
expression of opinion only and should not be construed in any manner whatsoever
as recommendations to buy or sell a stock, option, future, bond, commodity
or any other financial instrument at any time. While we believe our statements
to be true, they always depend on the reliability of our own credible sources.
Of course, we recommend that you consult with a qualified investment advisor,
one licensed by appropriate regulatory agencies in your legal jurisdiction,
before making any investment decisions, and barring that, we encourage you
to confirm the facts on your own before making important investment commitments.
Email this Article to a Friend 
Printer Friendly Version