Weekly Gold Market Outlook
A Gold & Currency Digest
Breaking Out of the Psychological Box
Conditioned by Bear Market Past
21-Dec-05: If you were surprised at how high oil and
gas prices went then you're probably low-balling your
gold targets too! Were you amazed at how the stock
market has come back in recent years? How about
copper, or real estate, or platinum, or silver?
If these things overshot your targets, gold probably
will too. Isn't that your experience with markets anyhow?
Don't they ultimately always overshoot the early bulls,
or early bears?
This bull is just finding its groove, and I think that instead
of calling for another intermediate correction, this time
we should put on the jockstraps and make the more difficult
call. The crowd is listening at last, even if ostensibly still not
persuaded. Still, for it, the voices in the wilderness can finally,
though faintly, be made out:
'But the money's unsound, the money's unsound'…' The market
knows all about China's growth prospects now.
IT'S IN THE MARKET - probably more than it should be.
What it does not yet want to acknowledge, and to which it still
imputes far too little credit when assessing price volatility, is the
truth that central banking is INHERENTLY inflationary.
But no matter; this is exactly where the upside in gold thrives.
For, until this truth is widely recognized, nothing will change.
Governments will continue to lean on inflationist doctrines in
order to finance the agendas for which they cannot justify a
more visible tax (welfare, wars or subsidies); stock and real
estate speculators will tend to worship inflation (and the
central banks) because of its capacity to stimulate gigantic
booms (business) in these assets; even some gold bugs
would hate to see central banking go - few have admitted
it to me, but nothing drives the returns on gold based
investments like the inflationary schematics of the central
bank (usually these are the moderates that hide behind
the compromise that "some" inflation is okay, or that it is
too risky to completely abolish central banking); the borrow
and spend crowd is addicted to the doctrines of inflation
because the money they pay back tends to be worth less
than the money they borrowed; monopolists rely on inflation
to alleviate the competitive pressure on prices for their
goods - this includes labor (unions are effective labor
monopolies) even though labor usually gets the short end
of the stick during an inflationary boom; and finally, banks
depend on a continuing inflation in bank reserves to multiply
the value of their other assets and deposits, and they need
a central bank to coordinate the overall policy among member
banks. It is an involuntary redistribution of wealth.
But it is also a drug - great for the short term, bad for the long term; it is indeed "the opium of the people." The point is that until the public starts screaming this stuff about the negative long term effects of inflation on money and prosperity (first it must learn to define it correctly) like it eventually did in the seventies, or like it is currently exaggerating the negative effects of growth in China, there is upside - short or long term (monetary conditions are not exactly loose at the moment, but they aren't tight either; more importantly, the markets are probably aware that the Fed isn't likely to get tighter, or continue its current baby-step tightening campaign).
As long as the doctrine of inflation is progressively embraced as a solution to broad based economic ills, rather than identified as their cause, bull and bear markets in gold will continue to mirror those of Wall Street - or any stock and bond market district in the world that relies on this kind of monetary policy to generate its booms.
Pick a place. They're all the same. Inflation has become a religion everywhere today. The ghost of Keynes lives on! By inflation I mean the deliberate policy of expanding reserves and other money substitutes in order to lower interest rates artificially and finance investment / consumption booms (as opposed to relying on good old fashioned savings) - but more broadly it is an increase in the supply of money relative to demand for money such that a decline in the objective exchange value of money must occur.
It is true that this has been going on for over a century, more in other regions of the world.
So what is different today?
Nothing… except that central banks have become more sophisticated (and less restricted)… which effectively means capable of generating larger and longer booms, as is born out in the graph below of stock prices (S&P 500) relative to gold (rather than in inflation prone dollars). What is less obvious is that this is also why the gold bull market in the seventies was greater than the one in the thirties, and why the current one will be greater yet.
Financial cycles never existed in such degree prior to the advent of central bank fiat regimes around the First World War when the central banks gradually supplanted the gold standard in its capacity of providing stable money - not because they actually could do it better, but by force, which is essentially the letter of the law.
War time impels governments to expand its use of compulsion wherever possible, especially in money.
A law can only be implemented by the threat of force - and monopolies basically borrow this force from the state in order to protect themselves from competition by their more eager and productive rivals. The United States was one of the last to abandon gold in 1933, but the Federal Reserve Act of 1913 had already cemented the budding banking cartel, while legal tender laws effectively forced the sellers of goods within the enforceable sphere to accept the Fed's banknotes - i.e. gold is explicitly not legal tender. Repeal these laws and you will see how quickly and voluntarily the market chooses to embrace the sounder money: gold. The gold standard was thus brushed aside by political considerations - and people were easily sold on the virtues of elastic money - so when faced with the choice of letting the banks (or government) fail, because they carried on an inflationary boom for a little bit too long, the crisis was ultimately decided in favor of the sophisticated financial alchemists.
So nothing is different.
But now we've begun the third bull market in gold since the creation of the Federal Reserve in 1913, and you will see shortly why I think it is going to be bigger than all the rest, as controversial as that still sounds. As you look at the data, keep the Fed's mission statement in mind: "…to provide the nation with a safer, more flexible, and more stable monetary and financial system." I don't know how any student of financial history could buy it.
Be that as it may, the students of finance in 1933 did not have the benefit of hindsight data like we do today.
In the graph below (of the S&P 500 / Gold ratio) notice that the booms in stock prices relative to gold became increasingly larger throughout the 20th century, AND that each time they came all the way back to their pre-boom levels. Strange, hey? Stocks are supposed to go up over the long run. They do, in dollars. That's an easy trick. We can do it in any country where they haven't outright abolished capitalism - i.e. free markets.
I have tried to make the case in the past that 95% of the increase in the Dow in the 20th century is the result of the effects on the value of the currency of the more than 200-fold increase in the nation's money stock.
Bull and bear markets may be born of earnings fundamentals, but the extent of their volatility is determined and dare I say overwhelmed by the monetary fundamentals. Bull and bear cycles would still exist, in the absence of inflation, but they would be less volatile, and the real gains would be larger and hold better in the long run.
What Caused Me to Upgrade our ST Gold Price Targets?
I raised my short term target on gold because: 1) the market has been overly conditioned to expect corrections after intermediate rallies of between 20 and 25 percent, in my opinion; 2) I sense a new inflection point, or a new expansion in the bullish crowd at the expense of the bearish crowd; 3) the upside achievements in some of the other commodities and assets, and the action in gold prices despite a comeback in the US dollar exchange rate this year, as well as continuing reflection and research, has made me wonder whether perhaps I'm being too conservative… i.e. whether my own psychology has been conditioned by the past bear market (1981-2000) for example; 4) I do not expect the current advance to peak out until the current stock market trend has rolled over, and the Dow is off a couple of thousand points; and 5) the Bernanke appointment confirmed our wildest bullish fantasies: all of the reasons that I appealed to in order to argue against the possibility of an unwanted deflation have basically been crystallized by the Bernanke appointment, as if Bush was trying to prove us right.
The gold bullish facts about Bernanke are his inane fear of deflation and academic conditioning in the virtues of fiat money inflation. Unlike Greenspan, as I've said before, he cannot even lie about being a gold bug.
In Bernanke there isn't even a hint of Mises or Rand and very little private sector experience.
Consequently he won't be the challenge to gold that Greenspan was, psychologically at least.
Keynes, a well known opponent of the gold standard, rationalized the doctrine of inflationism via the concept of the "Liquidity Trap." The concept means something different today, but in its original form it is almost precisely the same argument proposed by the deflation camp and presented as the "dollar short squeeze" hypothesis that I took to task last year - it consists in the effects of speculators hoarding cash, forcing interest rates to rise.
There are differences of course, but it is eerily the same concept.
Today's deflation argument is to central bankers what the liquidity trap used to be, which is why Bernanke likes to lean on it. The Bernanke appointment to the chair of the Fed is very significant because the weakness in the deflation argument is precisely Bernanke-ism. I realize that the public is told that he is an "inflation targeter," which sounds like "inflation fighter." However, that inference is no truer than the claim that the Fed exists to stabilize prices and reduce financial volatility. An article produced by Robert Blumen, who went through a series of Bernanke's speeches and Fed research reports on the subject of deflation back to 1999, is an excellent analysis of the inflationary bias in Bernanke's principles: www.lewrockwell.com/blumen/blumen10.html
I would highly recommend it. The author does not touch on the flaws in the concept of "inflation targeting," but I can do that at a later date, or will find an article which has done it already. In any event, Bernanke's nomination was and is very bullish for gold, short and long term. I never expected it - since it was the most dovish choice.
Thus it caused me to seriously reconsider my upside targets.
Ed Bugos
Editor - The GoldenBar Report
www.goldenbar.com
December 21, 2005
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