first majestic silver

Global Market Outlook to 2003

May 23, 1997

Martin Armstrong is probably the best paid economist in the U.S. He is founder and president of the Princeton Economics Institute (PEI) with offices in Princeton (USA), Sydney, Tokyo, Hong Kong and London. PEI is an advisor to Central Bank's, governments, major financial institutions, and multinational industries - worldwide. At any of Armstrong's conferences, you will meet the likes of people like Lady Thatcher, or other former ministers, or several central bankers from several countries. One may obtain an idea of the extent of PEI areas of expertise by going to their website at

The following are conference notes taken by one of the invited honored guests to the London conference.

Notes on the PEI London Conference in London -

Armstrong presented his global outlook on the markets to the year 2003 - based on his analytical models. I am always interested in Armstrong's views, since I have been following his forecasts on precious metals and the general markets for nearly two years. Quite frankly, he has so far been on the right on the money with his predictions.

Overall the scientific quality of his presentation and reasoning was quite impressive.

Firstly, he reminded the audience of his most important axiom for analyzing the market: WHAT MOVES THE MARKETS IS CAPITAL FLOW. The determinants of money flow are very diverse: tax regulations; currency exchange rates, wages; etc. etc. Armstrong emphasized that as long as the conditions which induced a given capital flow remain unchanged, the capital flow will continue.

20 years ago, 90% of international capital flow was due to trade of real goods (export/import), and only 10% was investment. But current capital flow sources have changed. Today, 90% comes from investment and trade, whereas a mere 10% of capital flow emanates from international trade - the sources have reversed. 10% is just a rough estimate, because the international localization of production units of the multinational industries makes it impossible to precisely know the trade deficit/surplus of any country.

...he reminded the audience
of his most important axiom
for analyzing the market:

The main reason for this shift over the years may be attributed to the floating exchange rate (XR) system, capital being attracted by the mere valuation of a country's currency, and its expected parity fluctuations in the near future. Consequently, asset prices are largely distorted. The 1987 crash is a good example of this distortion. During the Plaza agreements in 1985, the politicians decided to lower the US$. As a result XR volatility largely increased. And when it became evident that the plan would succeed, the tremendous volatility of US$ during the summer of 1987, combined with short-term fear, led foreign investors to pull out of the U.S. stock-market. This caused further increased currency volatility, which ultimately led to the crash. Armstrong gave other historical examples, demonstrated that each time a floating XR system was initiated, the currencies and the general market volatility "got mad".

The main reason for this floating XR system phenomenon is that money became a commodity, and was traded as such. As there is no anchoring of its value, inflation and deflation are not any longer a strict function of money supply, since international capital flows have more influence on its availability than anything else.

The only economical way to stabilize the real economy under these conditions (i.e. floating XR) would be a "regionalization" of money supply, similar what the regional FEDs created after the San Francisco earthquake in 1907 (when the system failed to break, thanks to insurance capital flow from the east coast going to California for its reconstruction). However, the Europeans are just doing the opposite (of what they should be doing) when creating a unique European central bank (CB). This is, economically speaking, counter-productive, and it will ultimately lead to disaster. The central bankers are unable to distinguish between domestic and international capital flows, and their interventions will never address the prime reason of monetary imbalances. The effects of their interventions will therefore likely be perverse. (There's only one example in the past showing a wise CB decision: the 1990s the Swiss CB lowering of the SF interest rate to counteract capital inflow into Switzerland). Other major capital flows at present for industrial investment are: that flowing to the UK due to very favorable tax regulation vis-à-vis the US and Japan; and that going to the US and Canada from Germany, because of fear of Euro volatility.

The mentality of the community of financial investors has changed according to the shift in capital flows outined above. One-third of U.S. debt has a maturity of less than a year. This will further increase volatility. This short-sighted policy was initiated by Clinton, and picked up by all the other Central Banks. A rise in interest rates will explode public debt by next year in the US. The Central Banks' job of regulating the currencies has been stolen by their treasuries - that is to say the politicians who are more interested in short-term "esthetic interventions" than in long-term stability (shifting the public debt from 7% long-term yields to 5% short-term).


Today, Japan holds 33% of U.S. public debt (close to $2 trillion) - whereas in 1995 it held only 7%. Without these capital flows from Japan, interest rates would be 7.5% to 8%.

Inflation is already in the pipeline: PPIs are at 7.5% level for nearly two years, and regional CPIs are over 8%. Understandably, one may wonder how the governments arrive at the official national figures. It is simple. Official statistics are manipulated. GDP growth rate is overstated right now.

The DOW Industrial Average is not overvalued when related to the national debt, or to the price of real estate. Only a DOW greater than 10,000 would be a bubble. Presently we see asset inflation, mainly because nobody knows what money is really worth. The subsequent increased volatility of financial assets leads investors to turn back to real estate, which is happening right now. The real bull market is a function of the volatility and direction of money flow - and "capital will roll like a can on the deck of a ship in a storm". Uncertainty of the real value of money will drive volatility close to historical highs near or in 2003.

The real bull market
is a function of the
volatility and direction
of money flow - and "capital
will roll like a can on the
deck of a ship in a storm".

The critical turning point in the present leg of the market is expected by mid-1998 (June-July) which will be the peak in the real economy. This will likely lead the US$ higher - up to 134-145 Yen by then. The ultimate peak in financial assets will come in 2003 at the peak of volatility. Meanwhile, Armstrong expects a high into June-July, followed by a correction into mid-1998, then up again. If the market rallies until September/October, the correction will be greater in severity. And if the market rallies to 10,000 by June 1998, expect a 30-40% correction.

Crude Oil is poised to rise, the present correction being only visible in the spot, not so much in the futures.

Precious Metals will be the last thing to rise with volatility. The present bear market could last into early next year. Regarding gold, the danger of Central Bank sales will then disappear - as the participants in the Euro will then be defined. The lows in Gold are now in place in terms of US$ (1985) and Yen/DM/SF (1995).

Anticipate markets to progressively synchronize in beginning a bull market.

The lows in Gold are now in
place in terms of US$ (1985)
and Yen/DM/SF (1995).

Gold will rise for the same reasons as other assets: uncertainty due to increased volatility. Gold is the most sensitive asset to uncertainty.Its minimum target is $1,000-1,200/oz., which would simply bring it in line with other assets. The uncertainty factor could well cause it to soar to $4000-5000/oz. In case the market perceives a danger to the present currency system, a potential target for gold would be $10,000/oz. This danger could occur in 2003 at the very top of the stock market bubble. Volatility will be so high that many market participants will run to cash. If we had a fixed exchange rate system, there wouldn't be any of these problems. However, with a floating XR system, and unstable volatility, cash means nothing - and many will turn to gold.

Gold's minimum target
is $1,000-1,200/oz...

Peak volatility will have a tremendously negative impact on the economy: it will become too expensive to hedge currency risk. Companies will no longer be able to hedge this risk anymore. Today, some Japanese companies earn more money with currency leverage than with production. But once the US$ resumes its decline, the reverse will be true, and they'll loose money. The same goes for Europe and the Asian Tigers. Most industries are unable to handle the risk inherent in floating currencies - in fact its not their job. With increased volatility, things will get worse: there will be job layoffs, and many will be financially decimated in the end. The real economy will be unable to grow. In consequence to the ensuing decline, all will be forced back to some sort of fixed XR system. Not necessarily gold - it could also be some sort of fraction of world GDP determined by a truly independent international agency, but DECIDEDLY NOT by politicians. Interestingly, Armstrong considers the closing of the gold window in 1971 as a government default, leading to the present situation with markets "going nuts" due to the lack of stable currency reference.

Regarding Silver, he believes that once the bull movement gets in gear - it would advance it to $18/oz. level - after some hesitating resistance around $10-12/oz area.

----- end of summary -----

After Armstrong's lecture, I had the opportunity of a short private chat with him. I asked him about his thoughts regarding "the FED's force-feeding of its Treasury bonds to European & Asian Central Banks" - therefore unsettling the somewhat uneven exchange of goods flowing to the US versus debt leaving the US. In our discussion, Armstrong (as a true scientific economist) didn't share this somewhat finalistic reasoning. Firstly, the Central Banks have to adapt to flows of capital, and compensate surpluses or deficits; secondly nothing prevents European or Asian consumers from buying goods manufactured in the U.S. Its the deflationary environment in Europe and Japan which keeps them from doing so, not any kind of obligation due to the U.S. government. The deflationary environment is the consequence of European social structure and interest payments on domestic public debt. This completes the vicious circle in which we are imprisoned. The Euro in its present version won't help much to break it.... Only an inversion of capital flow could do this job. Today, it looks like the trigger could come from Japan (i.e. recovering Yen).

Gold is still being mined and refined at the rate of almost 2,600 tonnes per year.
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