The chart above displays a powerful bull market for gold. But if Bob Hoye is correct, if we measure gold in terms of its increasing purchasing power, we are only in about the third year of a 20-year run. As we have noted before, Hoye has looked back at six major credit expansion/credit contraction periods over the last 300 years and during each of the credit contraction periods, the "real" price of gold has risen dramatically.
That is hugely important for the gold mining sector, because it means profit margins should rise in this environment. Hoye marks the start of gold's increasing purchasing power in 2007. And with the real price of gold rising about 20 years after these major credit contraction periods get underway, that means we may be able to look forward to many more years of rising gold mining profits and rising gold mining share prices.
The logic for this gold bullish dynamic is easy to understand, for those who understand that paper money is by definition a fraud. Bernanke and the rest of Wall Street will be taught a very hard lesson that is logical enough for my mother with a high school sophomore education to understand once the system implodes. You can't create wealth by printing money. In fact, you can do a whole lot of harm by allowing false signals of demand to continue to lead to more and more mal investment from which you are unable to service the debt from which money was created. As the Communist bosses of the USSR found out, they were able to perpetrate a fraud for a long time. Keynesian economics has survived, thanks to the long built-up wealth of a system that was much closer to real capitalism than what we have today. But ultimately, the big lie-that deficit spending and money printing will create wealth-will fail, compliments of market reality. Rising real gold prices are a very important part of this dynamic. The market, not politicians, will seal our fate to move back toward gold and/or silver as money. People are losing confidence in paper money and hence are demanding the real thing. As the real price of gold rises, it will stimulate more gold production, which in turn will meet surging demand for real asset-based money, because real money has intrinsic value unlike fiat money, which has no intrinsic value but only the promise of others to pay their debts. If you understand this very simple concept, which is borne out by history, you will be ahead of 99.9% of Americans who are still following the likes of Abby Joseph Cohen and Crazy Kramer on CNBC.
What evidence do we have in more recent times that the real price of gold rose over a protracted period of time leading to surging gold mining profits? During the 1930s it was most certainly true. As we pointed out in the past, a 15% allocation to Homestake Mining during the 1930s, with 85% in the Dow Jones Industrials would have resulted in virtually no loss during that decade when the Dow fell almost 90% at one point. More recently, we saw the real price of gold rise dramatically following the credit implosion of 2008-2009, as the chart of the Gold/Rogers Raw Materials ratio on your left demonstrates. The Rogers Raw Materials Index is heavily weighted in petroleum products, but it also contains a broad measure of all other items considered essential for "staying alive," including agricultural commodities, base metals, and a small precious metals component.
Now take a look at the chart for gold shares as measured by the XAU. This index is comprised of major gold mining stocks. Initially, when the market crashed in the fall of 2008, gold shares got slammed really hard, along with everything else. They have come back strongly, but based on the "real" price of gold as measured by the Gold/Rogers, it seems the gold shares have a lot further to run, based on where the "real" price already is.
18 January 2010
Jay Taylor, Editor of J Taylor's Gold & Technology Stocks
www.miningstocks.com