Taylor On US$ & Gold
Richard Richard talked once again about deflation and the dollar short thesis; I believe the person who recently began circulating this thesis was Bob Hoye, who we interviewed a couple of months back. As Bob notes, the senior currency has always tended to be the strongest currency in major
post-bubble eras in the past. In any event, Russell pointed to the stronger
dollar, still very low U.S. interest rates, the stock market decline, and
declining commodity prices as all suggestive that we could be heading
toward deflation.
I could not agree with him more. The equity markets are looking forward and
they do not like what they are seeing. What do they see? We won't know
until later, but I think it is entirely possible they are getting a preview
of the second Great Depression within 100 yeas as we have been suggesting
was coming our way. The signs Richard Russell has oft stated are certainly not suggestive of the kind of healthy and growing economy talking head after talking head is suggesting on CNBC.
Friday we saw more strengthening of the dollar and the long bond. As can be
seen from the chart above, the dollar has actually now broken above its
downtrend line that began in 2002 albeit not as yet in a convincing manner. Consistent with recent "strength" of the dollar has been a recent strengthening of long U.S. Treasury instruments. Note the sharp rise in our
the 20-year to 30-year U.S. Treasury bonds which are contained within the
Lehman iShares that trade under the symbol TLT. The rally in the ETF has
allows us to narrow our loss in this Model Portfolio selection from just
under 4% last week to 1.7% this week.
Gold Shares Remain Dreadful Performers, But That Should Soon Change
Gold shares are still acting dreadful. As can be seen on the chart on the
left, both the GoldColony.com Index and J Taylor's Gold Stocks have hit new
lows since about September 2003. I think Richard Russell is probably right
in suggesting gold investments will initially be adversely affected when
deflation gets the upper hand in the economy because people will first
scramble for dollar liquidity before trying to hang on to their gold stocks.
The washout in the small cap gold stocks may be especially pronounced. But
quite frankly, they are so cheap now, compared to what many of these
companies have going for by way of the metal values they already have in
the ground or are in the process of outlining. A couple of examples are
once again mentioned in this weekly letter. But I truly believe this
current period of weakness will most likely be seen as a golden buying
opportunity for junior gold stocks. The succession should be as follows: 1)
Investors scramble for cash by selling stocks, art objects, second homes
and virtually everything they don't have to have to stay alive. They do
this so they can remain financially solvent and hang on to the things they
have to have. 2). Financial institutions begin to default, thus causing a
lack of confidence in retaining fiat money in banks and other institutions.
That leads people to seek the ultimate safety in money, which is beyond any
doubt, gold. It is safe because unlike fiat money, it is an asset money,
not a liability money as is the dollar. 3) As citizens and investors move
from fit to gold, the real price of gold begins to rise dramatically.
(Think Dow/Gold at a 1:1 ratio). As gold rises, the scramble for "money in
the ground" will be increasingly more intense. In the gold shares, the
initial move will be to the major mining firms and then down the food
chain. Ultimately, the frenzy into this sector is likely to be so great
that companies merely with the name "Gold" in them will likely rise
significantly in value, though nominal values for these shares may be much
more temperate than was true during the inflationary Internet mania.
However, what we need to keep in mind during the deflationary era are
"real" prices for gold and gold shares. With prices of virtually everything
dropping, nominal values become of a secondary importance to purchasing
power.
Major Gold Stocks Remain Weak
The chart of the XAU on your left demonstrates the weakness in the gold
share markets last week. However, note the bull market remains very much in tact though the higher trend line displayed was violated on Friday. I would
be concerned if the lower trend line were violated, but at least for now it
appears quite safe. It is likely in my view that we will look back at this
time as an excellent buying opportunity for the gold shares and especially
for the juniors.
Aside from Cash, Gold Is Where We Want to Be
Bob Hoye gave an example of how gold tends to perform so well during
deflationary periods of time. This is important to note because as I said
earlier, most buyers of gold buy the yellow metal as a hedge against
inflation when in fact, historically, gold acts best during deflation.
Quoting Mr. Hoye from his "Pivotal Events" of this past Thursday:
"As the great financial bubble failed in October 1825, the biggest broker,
Poole & Co. in London, was considered too big and important to go under.
"The Bank of England agreed, but the speed of the decline rendered any
assistance impossible and the biggest broker in the world's financial
capital defaulted. On that bubble collapse, initial pressure didn't clear
the market until January 1826.
"The secular contraction, with the usual 3-4 year business cycle
prevailing, endured the typical 20-25 years until 1844. On that post-bubble
contraction, copper's real price went from 137 to 81 as gold's' real price
increased from 107 to 174."
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April 16, 2005
Jay Taylor, Editor of J Taylor's Gold & Technology Stocks
www.miningstocks.com
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