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Syllogistic Reasoning ( Market is Pointing to Gold At $540/oz. )

November 6, 2003

My late father left school at 14 to help support his family. His brother recognised that this was probably a waste of God given talent and, when he was eventually able to, he encouraged my old man to go back to school and then to University; and he supported him financially along the way. The old man completed the last three years of his high school education in one year at night, and then went on to earn three degrees. He was a fairly bright guy.

I learned many lessons from my old man, one of which was when I was still in short pants. He taught me the dangers of syllogistic reasoning, and this is how he put it:

"All cats have four legs. All dogs also have four legs. But it does not follow that, therefore, all cats are dogs"

The question I have been pondering is this:

"How is it possible for BOTH the US$ AND the Gold Price to rise?"

Whilst I have not yet formed a definitive view, I have noted a potential error of logic in the syllogistic reasoning pertaining to the Gold:US$ relationship, which is this:

"Gold is a hard currency. The US$ is a fiat currency. Therefore there will always be an inverse relationship between the movement of gold and the US$."

What if gold is not a hard currency?

As I see it, there are two possible explanations as to why Gold and the US$ could both rise. Either:

  • There is a short term timing issue. Gold is in a Primary Bull trend, and the US$ is reacting upwards within a Primary Bear trend, or.
  • Gold is not (yet) seen as a currency, and has been rising with all commodities in anticipation of an inflationary period. If this turns out to be true, then the syllogistic argument regarding the inverse relationship between gold and the US$ will be demonstrated to have been incorrect.

Before we go one step further, it is important to put a "peg in the ground" here. Flowing from both Technical Analysis techniques and Fundamental Analysis techniques, the gold price seems destined to reach around $540/ounce. This latter conclusion does not look for reasons. It merely recognises a hard "fact" that the Market is pointing to gold at $540/oz.

If 'the market' is right, then when it eventually reaches the $524 level, gold will have caught up on a relative basis with the $CRB index, and when it reaches $540/oz it will also have realised the inherent price of gold that the share prices were already factoring in some months ago.

It follows, therefore, that this article is merely an exercise in mental gymnastics by a guy who is driven to understand the underlying truth of everything. If you have a life to lead, you can stop reading now.

If, however - like me - you are of a curious predisposition, you may want to hang on for a bit longer. There is a potentially fascinating scenario that needs to be explored. ……………………

Of course, it is possible that US$ is merely reacting upwards within a Primary Bear trend. However, in the October 2003 issue of the Bank Credit Analyst that I saw lying on a friend's desk, my eye was drawn to a chart that could offer an alternative explanation. For copyright reasons I can't reproduce it here, but the chart "hit me in the face like a brick".

It was a chart dating back to 1986 showing S&P earnings and "normalised" S&P earnings, and the normalised chart was showing an exponential upward trend.

The gist of the BCA's article was that we have just gone through a liquidity driven leg of the up-cycle, and we are about to enter a profit growth driven leg of the up-cycle.

What I found both interesting and weird was that the trend was exponential in shape.

My old man also taught me about prejudice, and how important it is to avoid judgment calls based on prejudice. We have all been arguing that the equity market is overpriced, because P/E ratios of around 30X are too high and "the market" is therefore wrong. This might merely be the result of a prejudicial viewpoint.

What if the S&P profits DO rise exponentially? Under unique circumstances such as these, wouldn't P/E ratios of 30X merely be a reflection of a market that is anticipating such an outcome.

But how could profits possible rise exponentially?

Here's how:

The economy is awash with money. If consumers have cash to spend (and if artificial barriers to external competition could be erected) then corporations will once again have pricing power. MARGINS could rise - giving rise to an exponential growth in profits.

As an aside, some years ago I was offered a container load of a well known brand of blue jeans at a price of $4 a pair, when these same jeans were retailing at around $150 a pair. Manufacturers do not have pricing power in today's market, but distributors still do. Those who "deliver" the product or the service could contrive to earn the profits at the expense of those who "produce" the products or the service - witness the silver market since the 1940s; and also witness the fact that the farmer receives for his corn a single digit percentage of the final price of a box of cornflakes.

Of course, these exponentially rising profits would merely be a mirage within an inflationary environment, but then what difference will another mirage make in a world which is already living in an economic fantasy?

Of course, if prices rise faster than costs, it follows that salaries will not be rising as quickly, and wage earner standards of living will deteriorate as their wages do not keep pace with inflation.

But here's the kicker: With an ageing population, a large proportion of OLDER citizens are being/have been "forced" to invest in equities. What if corporations - whose earnings are growing exponentially - started to pay dividends on an increasing scale? Investors' (the Baby Boomers) standards of living will be protected at the expense of the younger wage earners - who would have to work harder and smarter to make their way.

Now, let's turn our attention to the US$.

In an environment where US corporate profits were rising exponentially, would not money be flowing INTO the USA? Would you rather invest in the Renminbi or the US$, given that more profits from blue jeans being bought by consumers in the USA are earned by corporations in the USA than by manufacturers in their country of origin?

Yes, there would be inflation in the price of all commodities - leading to increases in costs of manufactured products. But the inflation would essentially justify disproportionate price rises in the distributing countries; and in particular the USA.

Turning now to gold:

If and when the gold price starts to OUTPERFORM the $CRB - as demonstrated by a rise in the relative strength chart of Gold:$CRB to NEW HIGHS - THEN it can be argued that gold is starting to behave more like a currency than a commodity.

I am intuitively and emotionally predisposed to WANT to believe that Gold is the ultimate currency. But, remembering my old man's admonition regarding prejudice, the EVIDENCE does not yet support that argument. Yes, it is possible (and probably desirable) that that situation could one day arrive.

Turning now to the issue of Debt:

In a world of exponentially rising profits, there is an increasing capability to repay old debts. Maybe there is a solution to this problem - based on paying off old debt with inflated dollars of today.

And, so, it seems that the Illuminati and/or the Establishment may still have their bums firmly in the saddle.

Frankly, I don't particularly care. My attention is focussed on my own plate as opposed to theirs. If what they are doing leaves food on my plate, and buys the time to enable the next set of economic drivers to take over, good luck to them.

In the mean time, I will hold on to my gold and silver investments which seem virtually certain to rise, and I will continue with my other wealth generating activities.

The volume of all the gold ever mined can occupy a cube 63 feet on each side.
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