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Gold Market Update

January 19, 2001

Remember when everything was turning Japanese? In the 1980's corporations studied Japanese manufacturing practices and tried to emulate their superior ways. Remember when the American economy reined supreme? In the 1990's foreigners set up research facilities in the U.S. to gain insights to American entrepreneurship and technological innovation. While much was accomplished in each of these decades, each also brought speculative excess that ended with historic stock market crashes. In fact, the technical moves in the 1990 Nikkei Index is incredibly similar in magnitude and duration to the moves in the Nasdaq in 2000. Over a ten-month period starting with the all time highs, each index had an initial sell-off, followed by a bounce and subsequent sell-off to new lows. The rest of the bear move in the Nikkei is history, while the rest of the move in the Nasdaq is the future. A continuation along the Nikkei path yields the following pattern: 1) Nasdaq rallies from a low of 2292 on January 2, 2001 to a high of 2750 in May 2001; 2) Nasdaq then declines along a series of lower lows and lower highs from the May 2001 high to the ultimate bottom of around 1500 in April, 2002.

On January 3 the Fed announced an unscheduled 50 basis-point cut in the Federal Funds rate. Back in 1998, the Fed cut rates three times and engineered the bailout of Long Term Capital that rescued the global financial markets from a possible meltdown and sealed Alan Greenspan's legacy as the "Maestro" in Bob Woodward's new book. There is ample reason to believe that the current round of rate cuts will not have the efficacy of the 1998 cuts. In 1998 domestic consumption and investment spending was strong. Commodity prices were falling and precipitous currency devaluations made cheap imports cheaper. Add to this the increase in money supply provided to ease Y2K paranoia and the result was the longest expansion and the greatest stock market bubble of all time. Today petroleum prices are double the 1998 levels, capital is drying up, the wealth effect has reversed and consumers have turned cautious. Should corporate earnings continue declining and unemployment claims continue their upward trend, the highest debt levels in a decade will become increasingly difficult to service. The foreigners who have funded record trade deficits may also decide to repatriate. While the Nasdaq crash is eye-popping, it is still just a sector of the U.S. economy and the broader market indexes have not shown the same degree of weakness. After factoring in earnings and stock price declines, average S&P 500 P/E valuations are still about 25% above historical averages and double the levels of the 1990 recession. The contraction that has already gripped the manufacturing sector could easily spread to all areas of the economy. The year 1967 was the only time in the last 40 years in which a yield curve inversion was not followed up by a recession. Now Mr. Greenspan gets a chance to earn the title; is he the Maestro, or just another Horn Player.

So what the heck is wrong with gold? It's down 3.0% to $263.90 for the first two weeks of the year. Such a constructive year-end trend has decayed into a decline that threatens to take out the twelve month lows. The slowdown in the U.S. economy has prompted a flight to the Euro. As the gold price has waned, the Euro continues to rise. Wait!! Is this the same Euro that was worth just 83 U.S. cents 10 weeks ago; the same Europe that is hampered by stodgy corporate governance, cumbersome labor laws, high tax rates; the same European Central Bank that must make policy for such a disparate membership? Nothing has changed in Euroland and this is definitely not a flight to quality. It is always amazing to watch markets ignore the negatives during a rise and ignore the positives during a fall. Nonetheless, the poor new-year beginning for gold is a disappointment. Other factors that could be creating selling pressure is the record low in the South African Rand combined with unverified rumors that corporate activity in South Africa is being financed with gold loans. There may also be some pent-up Central Bank selling that was withheld from the market late in the year. On the demand side, it is clear that investors have not recognized the need for wealth protection. A November 28 Wall Street Journal article points out that despite the substantial Nasdaq decline, mutual fund money continued to flow out of value and into growth and technology. Gold mining shares are showing relative strength, as they have not followed bullion's new-year moves below the 45 day trend line. Defensive investments now stand the best chance in years of stealing the show from the Maestro.

A one-ounce gold nugget is rarer than a five-carat diamond.
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