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Taylor on us Economy, Markets & Gold

May 14, 2002

Growing Trade Tension & A Still Overvalued Dollar

One of the things Ian Gordon has continued to talk about are the prospects for rising trade tensions as the winter temperature heads lower. It is easy to talk about free trade when the global economy is rising. But when people begin to lose their jobs and when elections are on the line, it becomes much more difficult. So, the U.S. which has been preaching to the world about free trade, now appears to be leading the world in the opposite direction. The two headlines above, which talk about bills that provide trade protection for the American farmers and the steel industry are two excellent examples of how we are repeating the same kinds of mistakes that were repeated during the last Kondratieff winter, namely during the 1930's.

One interesting but very important aspect to trade problems in America is the continued "strong dollar, which has been left over from the Clinton Administration. The American banking elite, which has really gained control of American society, has prevailed in rigging the gold price and thus providing a false sense of value for the dollar that they are free to create out of thin air. Talk about a racket! Talk about a con game! The dollar being 30% to 40% overvalued on a trade related basis, means that American mining, manufacturing and agriculture are put at a huge disadvantage. Thankfully at least some Democrat representatives in Congress are beginning to talk about this issue. But if the price of gold had simply been allowed to rise to the $500 or $600+ where it belongs, it would be far less necessary (politically) for the U.S. to impose trade restrictions.

But alas, no nation can fool mother nature forever. It is beginning to look as though the U.S. dollar is finally becoming vulnerable. The dollar index closed this week at 114.18, just slightly above the 113 low point of the past year. Should the buck fall below that level, we might see significantly more weakness.

Why would the dollar suddenly weaken? Because a huge number of dollars are owned by foreign interests who have invested their trade surpluses into the U.S. As returns on investment continue to decline in the U.S. (as we expect they will), why would foreigners not begin to sell dollars and/or stop sending so many of them back to he U.S.?

Money Growth & Loans Slow Down

I squeezed in a GATA Headline from Friday, May 3, 2002 in part to make another point that confirms the Kondratieff winter thesis of Ian Gordon remains in tact. "MZM Growth Plummets" is consistent with what happens when the economy begins to decline. Money is created out of nothing under our fiat currency regime largely through the creation of loans. But as a former banker, I recall how in the mini-recession of the early 1990's we almost completely stopped making loans. We did this because the risks of making loans to our corporate clients had, in management's view, risen dramatically.

Currently, corporate profits are off sharply from prior levels and scores of tech companies have still never earned a profit. Corporations have huge debt levels already which not only make them riskier for banks to lend to but their earnings are being drained by interest expense. Banks are facing huge loan losses not to mention the potential for massive losses in derivatives. This is the kind of environment in which banks decrease their lending activity and also in which corporations stop seeking loans. If this trend continues, we might well expect a contraction in the money supply which would contribute to a more intense period of debt repudiation that typifies the Kondratieff winter. The fact that money growth as measured by M-1 has slowed to almost zero and that MZM (the most liquid measure of money) is plummeting, is consistent with what we anticipate as the Kondratieff winter temperatures continue to drop.

How Overvalued Are Stocks Now?

Given the trillions of dollars shaved off of equity values since March 2000, one might think stock valuations have fallen sufficiently to justify getting back into the market. At least that is what many of the sell side analysts want you to believe. But even if you do not buy the Kondratieff winter story, stocks remain about as overvalued as ever in our history. So, our message in general is that you must STAY OUT of most of those companies main stream investment banking firms are touting, except perhaps for gold stocks and some solid utility stocks. WE of course do think there are some micro-cap stocks in the energy and select technology sectors that will do exceptionally well over the coming years. But aside from these few exceptions, you should stay out of equities.

How overvalued are stock prices? The answer is that they remain at historically high levels. At the end of this week, the GAAP Price Earnings ratio, according to stood at 41.0. In other words, the EARNINGS YIELD is 2.44% which means that for every $100 you spend buying the S&P 500, your investment returns $2.44. Of this return $1.52 is real because it is cash. However, the remaining $0.92 is provided to you in the form of "retained earnings," which in this day of accounting gimmickry and general dishonesty represents an uncertain value.

By contrast, you can buy the 10-year U.S. Treasury and receive a cash yield of 5.11% or $5.11 for every $100 you invest. And, you get some local and state tax breaks that you do not get when you receive dividends from the S&P 500. But most investors are slow to learn, so they keep buying stocks.


Gold remains in a very bullish phase. On Friday it closed in New York at $310.90, ahead of the 50-day moving average of $293.68 and above the 200-day moving average of $283.78.

On Friday, gold closed in New York at $310.90, which is slightly above what GATA believes is the new line drawn in the sand by the Gold Cartel. We continue to believe odds favor this gold market "being the bottom half of the first inning of the first game in a seven game World Series." In other words, if you are wondering whether it is too late to get into gold, our answer is a resounding "NO, THE GAME HAS BARELY BEGUN!" However, having expressed our bullish sentiment we do have a couple of major concerns we would like to express.

First, we think it is entirely possible that the Gold Cartel may have one more major trick up their sleeves before they cover their short positions. They may well have a sufficient amount of gold left in their coffers to trash the gold price once again by dumping gold and engaging in multiple high profile pre-announcements that central banks from various countries will "sell, sell, sell" so as to scare the "beegeebers" out of a growing number, but still very small group of bullish gold speculators.

Secondly, we share the concerns of James Sinclair, the legendary gold trader who made a fortune during the bull market of the 1970's. Mr. Sinclair is concerned that the huge short position of the gold mining industry and their bullion bankers could result in utter chaos in the gold markets such that government intervention may be bad for those of us on the long side and for gold mining companies themselves.

Sinclair believes that when the price of gold rises to around $354, a sudden demand for something like $30 billion worth of gold (97.5 million ounces) will suddenly hit the market such that the price of gold will skyrocket to levels hard to comprehend at this time. According to Sinclair, this is the level at which call options sold by the mining companies and the bullion banks will suddenly be in the money.

A call option provides the holder of the call with the right to buy gold at the strike price, in this case at around $350. As the price of gold rises to say $354, so that transaction costs, etc are overcome, about 97.5 million calls will be in the money. At that time, the holders of the call options will quite naturally exercise their options and demand delivery of gold. The mining firms that have written those calls will suddenly have to go out into the markets to buy gold to deliver it to the option holders. They will not be able to produce that much gold in such a short time frame.

This is exactly what Bill Murphy termed the "Gold Derivative Neutron Bomb." When it detonates, the price of gold is going to explode straight off thechart because the amount of sudden demand will simply overwhelm the markets. Will the Central banks then step in and lower the boom with huge amounts of gold dishording? Who knows. We can't be sure how much gold the central banks have left. We know there is less on their balance sheets than they pretend is there simply because of the "Enron like" method of accounting for gold loans. Our Treasury lies about gold because it pretends gold it has lent out is still in its coffers!

Why is this a problem for those of us who are bullish on gold? For starters, we need to know to what extent gold mining firms have this hidden derivative risk profile. Which leads me to say, I will do the best I can next week to determine which of the companies on our list may face this risk. For the most part, we have steered clear of gold mining firms that are on the short side of the market. That is why companies like Anglogold, Placer Dome and Barrick Gold are absent from our list. Newmont does now have some hedged positions which it inherited from the acquisition of Normandy.

Overall, Sinclairs concerns should be hugely bullish for those of us long gold. But we must be careful because if the gold price suddenly rises to $1,000 or so, government may do anything, rational or not to try to settle things down. Their concern for our Constitutional rights may well take second or third place to their goal of keeping control of money and power, even those rights are not granted to them in the Constitution.

Is J.P. Morgan Chase Closing Their Gold Derivative Business?

Based on two independent sources, Bill Murphy of GATA, reported that J.P. Morgan Chase is planning to close their gold derivative business. On the same day Bill also learned from those inside the industry that the head trader at J.P. Morgan Chase was fired. With the consolidation of J.P. Morgan and Chase, this company combined holds about 2/3rds of the gold derivative markets. In other words, as the gold price gets away from J.P. Morgan Chase and the other members of the Gold Cartel (defendants in Reggie Howe's lawsuit), J.P. Morgan Chase stands to lose tons of money.

Major institutions allow traders to run free as long as they make money. But when the markets turn on them, they are the fall guys. If the rumors published by GATA are true as I believe they are, it provides some rather clear handwriting on the wall, that gold is ready for a dramatic rise.

Pure gold is non-toxic when ingested.
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