A response to Blanchard's gold bullion report
We have been asked by some of our subscribers to give an opinion of the
recently released report on gold bullion by the Blanchard Economic Research
Unit of the precious metals sales firm Blanchard (New Orleans, LA). This
report was published, among other venues, on Gold-Eagle. Ordinarily, we do
not read economic-related reports since the focus of our work is technical
and not fundamental, but we were given a tip by respected sources that this
controversial report is must-reading for the gold investor.
The 7-page report is entitled, "The Fed Funds Rate, Stocks, Bond and Gold
Bullion." It is available for viewing from the following Internet link:
http://www.economicresearich.net/bulletin35.html. We will not cover every detail of the report, only the conclusions, so we leave it up to subscribers to read this report when time permits. The report was very well written and the arguments were crafted masterfully, the facts are compelling and the thesis is very persuasive right up until the end. The analytical eye discovers by the end of the report just where this economic thesis is heading - it is a
critical appraisal for investment grade coins at the expense of going bearish
on gold bullion.
The first five pages of this report basically builds a strong case that interest rates, which are currently at multi-year lows, are due for a rise
and that such a rise, aside from hurting bond investors, could shock both the
stock market and the economy. The report quotes a number of respected
sources and makes a powerful argument that Fed Funds interest rates will
indeed see a rise beginning sometime this year. Considering interest rates
are at extreme lows and can't really fall much further without a correction,
they'll get no argument here. So far, so good.
Then Blanchard throws a curve ball of sorts when addressing the state of
the market for gold bullion. One would think that a firm whose business is
selling gold and silver would be perennial bulls on the yellow metal, but not
so in this case. In an extremely odd and unprecedented sales strategy, the
country's most famous gold coin firm did an about-face last year and
published an extremely controversial sales piece (in book form) titled "Gold
Bullion: Caught in a Bear Trap." This followed a period of undeterred
optimism on gold's prospects for higher prices, an outlook which reached its
apogee with the Y2K non-crisis. Ironically, Blanchard's change of opinion in
the desirability of gold as an investment coincided almost precisely with the
orthodox bottom in the long-term gold bear market. Blanchard went bearish on gold in wave 2 of gold's emerging bull market. There are typically five
waves in any rising Elliott Wave price progression, and according to Elliot
Wave expert Robert Prechter in his seminal work "The Elliott Wave Principle," the second wave of a 5-wave bull market is typically when bearish sentiment is at its highest even though the trend has turned up. In true Elliott Wave fashion, Blanchard has conformed to this scenario).
Blanchard proceeds to make the case that the "price of gold respond[s]
to increases in the Fed Funds rates by stopping in its tracks." The report
also quotes two university economics professors who wrote a study entitled,
"Gold Price Targeting By the Fed." The report claims that the Fed responds
to a 10% increase in the price of gold by raising short-term interest rates
(the federal funds rate) within the 52 week horizon until the rising gold
price is stopped in its tracks. Blanchard conducted its own independent
study to verify the conclusions of the university study and found that
"during the four periods from 1985 to 2001 in which the Fed raised the
Federal Funds Rate, the price of gold declined each and every time."
The clincher to Blanchard's argument is found in the following statement
on page 6: "The problem is, one of the traditional diversification vehicles,
gold bullion, is unlikely to perform well in the face of a rising Federal Funds Rate. In fact, a strong case can be made that, in view of the evidence over the past 17 years, it is very nearly impossible for the price of gold to increase during any period in which the Fed Funds Rate is climbing." To put
it simply, Blanchard is arguing that gold prices won't rise as long as
interest rates are rising, and that the Fed can control the price of gold
simply by tweaking interest rates. This represents a huge departure from
classical thinking on the interest rate/POG relationship since Austrian
Economics teaches that gold prices are the ultimate barometer of
inflation/deflation, not interest rates. True, interest rates are highly
sensitive to inflationary/deflationary pressures in the economy, much more so that other financial instruments. But gold is the quintessential economic
barometer in the classical/historical view and no amount of interest rate
manipulation can ultimate contain gold prices, either to the upside or the
downside.
To buy into Blanchard's line of thinking, we would have to throw out the
better part of 150 years of economic history in this country and focus
exclusively on the past 17 years (which is apparently what Blanchard would
have us do since they refer only to the period 1985-2002). This is
nothing less than economic tunnel vision, and like driving a car, investing
with tunnel vision can have disastrous consequences. What about the late
1970s, when interest rates and the price of gold rose in tandem?
Blanchard wraps up its analysis by stating, "The evidence overwhelmingly
shows that gold bullion is not positioned to be of help to investors." The
report then adds, "one investment area has in fact performed very well over this same period of uncertainty in the U.S. and world economies and financial markets: the market for Mint State U.S. Gold Coins." Blanchard concludes its report by stating, "Right now, [the best] form of gold ownership is clearly Mint State Gold."
In our opinion, this is not the best of advice. Allow us to say that we have nothing against Blanchard and have found them to be a reputable and
established gold coin firm with high standards. Our problem is when a highly
esteemed sales firm decides to go into the business of telling its customers
(existing and potential) not only WHAT to buy, but WHEN to buy it! This
should be left to the financial forecasters and professional investment
advisors. Blanchard's job is to sell the customer what he or she wants
(presumably gold coins, whether bullion or numismatic), not give them timing
and investment advice that may or may not be in their best interest as
investors. In our opinion, this sales strategy can only backfire on
Blanchard when their forecast for a gold "bear trap" fails to materialize.
One final potential pitfall in the Blanchard report is their heavy touting of mint state rare collector coins. In our opinion, this is not the best time to heavily commit to collector coins since the market for collectibles hasn't finished bottoming, and also since collectibles tend to follow the broad trend during deflation (down). Since K-wave deflation is still underway and is not scheduled to end until sometime in the middle of this decade, collectibles for the most part (in our opinion) should be avoided. Actually, Blanchard would have done better to recommend gold bullion as a financial hedge and investment and avoid spotlighting numismatics for the time being.
While we agree with Blanchard's conclusions regarding stocks, bonds and
interest rates, we cannot agree or endorse their conclusions regarding the
state of the gold bullion market or that of investment grade coins. We leave
it to the reader's discretion as to what types of coins to include in a
well-diversified investment portfolio, but it surely should include some form
of gold bullion coin.
Clif Droke
April 1, 2002
Clif Droke is the editor of the weekly Bear Market Report, a combined
forecast and analysis of U.S. stocks and indices and international precious
metals stocks, and is the author of numerous books on trading and technical
analysis (most recently Gann Simplified, published by Traders Library). For
a FREE COPY of the Bear Market Report send e-mail to: cdroke9819@aol.com or write: The Bear Market Report, Clif Droke, P.O. Box 3401, Topsail Beach, N.C. 28445-9831.
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