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Major Financial Markets Summary

September 2, 2002

Following is a quick commentary of major markets based on some very simple observations of their charts as at the end of this past week.

Bullish Markets

  • U.S. Treasury Debt - 30-Year T-Bond rates broke below a March 2002 trend line this week. They are below the 20 day, 50-day and 200 day moving average
  • Commodities - The CRB closed at 219.20 which puts it solidly above its 20-day, 50-day and 200-day moving averages
  • Gold - Gold closed the week at $312.30 which compares to its 20-day moving average of $310.56, 50-day moving average of $311.65 and 200-day moving average of $302.27

These markets are demonstrating a flight to quality from a still far overvalued stock market. In the paper markets we are seeing a flight to "quality" in the move away from equities to U.S. Treasuries and away from anything but the very top rated corporate debt as credit quality continues to be a concern for corporate America. The move to gold is the ultimate move toward quality as gold is honest money that derives its value not on the basis of the ability of others to pay, but on the basis of its own intrinsic value. Gold is asset money. U.S. dollars are liability money. Hence as doubts grow concerning the viability of the U.S. economy, doubts about the ability of people to honor their liabilities in terms of dollar payments become suspect. Hence, so does the currency itself become suspect.

Commodities like gold but unlike paper money, contain intrinsic value, though other commodities are for various reasons far less suitable for use as money than gold and to a certain extent silver.

Bearish Markets

Last week we saw more news that growth in the U.S. economy and growth in the labor markets are not taking place as the establishment have been predicting for many quarters now. Accordingly, it looks to your editor as though the equity markets and also the dollar may be in for another major decline after what was a rather spectacular bear market rally of the past few weeks.

  • The U.S. Dollar - at 106.79, last week it broke slightly below its 20-day, 50-day and 200-day moving averages and it broke below a mid July up trend line
  • Equities - The Dow, The NASDAQ and the S&P 500 all broke below their 20-day, 50-day and 200-day moving averages last week and have either broken through or are threatening to break through their bear market rally up trend line dating to early July

WILL $2 TRILLION IN NEW MONEY BE ENOUGH?

Richard Russell instructed his readers today to write down the following on their bathroom mirrors. "THE FED WILL DO ANYTHING TO AVOID DEFFLATION" Richard talks about how the Fed continues to count on the consumer to keep spending and the are encouraging him to continue to live beyond his means in order to keep our economy from plunging over the cliff. As we just noted, housing and to a lesser extend auto sales have helped to offset some $7 trillion to $8 trillion in stock market losses so far. Against these equity losses, home values during the same time have increased by about $3 trillion.

Mr. Russell also noted in his Saturday missive that the latest weekly increase in M-3 was $41.9 billion for the week. Annualized, this amounts to about $2 trillion per year or about 24% of the current M-3 total of $8.3 trillion! Bear in mind that our current money supply is the aggregate since the inception of our Republic in 1776. Also bear in mind that money, in our fractional reserve system is created from debt. Debt growth is close to 100% of money growth, but income growth that results from this debt is less than 20%! I DON'T CARE HOW MUCH YOU TRY TO INCREASE THE MONEY SUPPLY, IF DEBT IS GROWING THIS MUCH FASTER THAN INCOME, THE RESULT WILL BE "ECONMIC DEATH THROUGH DEBT STRANGULATION."

Clearly something has gone terribly wrong for the Fed. They have cut interest rates eleven consecutive times but the stock market continues to fall and at best we are having a limp wristed economic recovery. Why is it that this is the first time since the 1930's that at least two or more successive rate cuts have failed to result in higher stock prices and that such a massive infusion of money into the system is failing to trigger a vigorous economic recovery?

The answer I believe is at least in part found in the Kondratieff wave theory of Ian Gordon. It is clear to me by now that at this stage of the Kondratieff cycle, all the policy makers are doing when they lower rates (increase the money supply) is what a man does when he struggles in quick sand. The more he struggles, the more he sinks toward ultimate by way of suffocation. As we pointed out in our August 7th, issue, at this time in our economic history, you get about $1 of new GDP growth for every $4 or $5 of new debt from which money was created. So, when Richard Russell said in today's missive that "They're talking about $3 trillion, rather than the growth at the current $2 trillion will be required to stave off deflation," it is clear to me that these people simply don't get it. Like Dr. North, they do not understand that we have reached a "threshold of lethality" so far as debt creation is concerned. And they do not understand that it is at this point when the Fed has no way out of the mess it created over decades of an undisciplined monetary policy - Thanks to the absence of a gold induced discipline on the creation of money in our fractional reserve banking system. Unfortunately, with each increase in the money supply at this juncture, the cure is worse than the disease. Creating more money is making a very bad situation even worse.

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IN GENERAL, STOCKS REMAIN HUGELY OVERVALUED

The S&P 500's PE ratio at the end of this past week stood at a still historically high 37.2 times which equates to an earnings yield of only 2.69% of which 1.72% is paid out in dividends. So stocks remain outrageously expensive. Interestingly, the dividend yield has been increasing, but it remains far, far below what one would expect at the bottom of a bear market. But at least the dividend portion of the earnings yield is certain and tangible. The retained earnings portion of the earnings yield remains highly suspect in a day and age when morality is no longer defined by the Ten Commandments, but in accordance with what is deemed right in the minds and hearts of each individual. No wonder government is stepping in to take our freedom away!

Despite the $7 or $8 trillion of equity losses so far, a report by Comstock Partners suggests the small investor keeps piling into the market. At the same time various measures talked about by Richard Russell demonstrates that the really big money keeps coming out of stocks as the little guy pumps more in. This continues to be a tragedy in the making of an epic magnitude. It is the immorality of our Wall Street firms, who refuse to examine the evidence of an overvalued stock market that keeps sucking average folks into stocks in the midst of what we think will be the worst bear markets ever. Stocks are hugely over valued but like the used car salesmen that can't help himself, Abby Joseph Cohen and her peers keep on pumping and dumping. This kind of irresponsible action on the part of Wall Street has resulted in the following two statistics, which your editor finds astounding:

  • At the end of the first quarter of 2000, there were 4,000 mutual funds -- today there re 4,800 mutual funds
  • Shareholder accounts numbered 154 million at the top in 2000, but have actually increased to 169 million today

FOLKS, THIS IS NOT CAPITUATION! When markets reach their bottom, you can expect to see people running as fast as possible away from stocks and also a return P/E ratios under 5 or certainly 10 times, and dividend yields for strong companies in the 6% to 10% range. In fact, we agree with Richard Russell that current valuations, like the 37 P/E ratio for the S&P 500 is more akin to historical bull market tops than bear market bottoms! This suggests to your editor that this bear market has a long, long way to travel.

GOLD

As noted above, gold remains bullish with its spot price slightly above the 50-day moving average and also above its 200-day moving average. We always take it as a given that the policy makers are doing all they can to trash gold and hence bolster confidence in their bogus currency, led by the U.S. dollar.

When will the day arrive when the huge short fall in mind production can no longer be met with dwindling gold reserves is the $64 trillion question. While I was in London I spoke to a very talented man who works with Frank Veneroso. He told me it was his speculative view that the central banks have already granted the bullion banks (named as defendants in Reggie Howe's lawsuit) the right to repay them not in gold but in paper money. This would then provide more time before "the fecal matter hits the rotary oscillator" in the gold markets.

Unfair as that would be to Americans and citizens of other countries that may have lent gold out, it would be consistent with the dishonest handling of our national gold treasury by our policy makers. I think the hunch of my English friend is most likely correct. But the fact remains, gold mines are producing far less gold than is being taken off the markets. So, sooner or later the price of gold may well explode to levels well beyond the imagination of even the most ardent gold bulls, given the enormous inflation of paper money that is not only huge but accelerating at this very moment.

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CAN GOLD REALLY DO WELL IN A DEFLATION?

A very astute investor on the west coast and a friend of mine sent me the following e-mail message this past week. He is worried about our contention that gold can do well in a deflationary environment. That is a troubling concept to many investors who have only experienced gold performing well in an inflationary environment during the 1970's. For the benefit of all subscribers here is my friend's question followed by my response.

"With respect to the most recent hot-line update:

"As Ian Gordon has pointed out, gold does very well during the inflationary Kondratieff summers when inflation is THE problem. But it does even better during the Kondratieff winter, when deflation implodes a countries currency to oblivion."

"As I observed previously, Prechter is in direct contradiction to this premise, based as best as I can see, on following the course of events and charts from the LAST Kondratieff in 1930's ..

"Some resolution is needed between the contention on the one hand that Homestake and gold was a good hedge and a profitable position in the 30's deflationary depression, and on the other hand Prechter's claim that gold did not start to rise until the economy began to recover in the 30's.

"Perhaps the difference lies in the fact of the underlying debt which the U.S. is in this time around .. but that is pure speculation on our parts that 'this time is different' if Prechter is correct (?).

"This needs to be nailed down, it seems to me. As I said before, the divergence between yourself and Prechter is worrisome especially since you both seem to accept the Kondratieff cycle/validity, but come to divergent conclusions on the issue of gold."

My Response:

In fact the price of gold was fixed for Americans at $20.67/oz. Then reflecting the realty of the global market forces of supply and demand for gold, after taking the gold from the American people, Roosevelt devalued the dollar by increasing the leading monetary asset of that time, namely gold by nearly 69% to $35/oz. The depth of the depression was commonly believed to have been in 1932 or 1933. In January 1934, the price of gold was increased by decree from Roosevelt to $35, so it is correct to say that gold did not rise before the economy bottomed out. However, IT IS NOT CORRECT TO SAY THAT DEMAND FOR GOLD DID NOT RISE UNTIL AFTER THE ECONOMY BOTTOMED!

In fact, quite the contrary was true. In 1932 Hoover's Secretary of the Treasury reportedly warned his boss that so much gold was being demanded from the U.S. Treasury by U.S. citizens and from people abroad in exchange for paper dollars that the U.S. Treasury would soon lose all of its gold. That's why on January 31, 1934, Roosevelt forced American citizens to give up their gold or face a $10,000 fine and 10 years in jail. And as an aside, I think it is interesting to note that one day after the gold was stolen by the government from the American people, Roosevelt increased the price from $20.67 to $35. And get this! With the 69% revaluation of gold from $20.67 to $35, the government booked a $2 billion profit which it socked away in THE EXCAHNGE STABALIZATION FUND which according to GATA to this day is being used to manipulate the gold price.

But the point I am trying to make is that in the midst of the deflation, people were trashing paper money and demanding gold. Why? Because they KNEW, just as Japanese people today know that their money would not be safe in the bank. They instinctively opted for gold - an asset money rather than paper money which is a liability money!

Prior to the confiscation of gold, many Americans began gold and also Homestake Mining shares as a proxy for gold, just as investors are now doing. From 1929 through 1940, the closing year end prices of a share of Homestake Mining shares were as follows:

1929 - $78.50
1930 - $80.625
1931 - $128.00
1932 - $150.00
1933 - $315.00
1934 - $376.00
1935 - $486.063
1936 - $422.00
1937 - $471.00
1938 - $513.50
1939 - $468.00
1940 - $$404.00

While the DOW was mercilessly hammered in the Great Depression, Homestake Mining relentlessly appreciated.

Again, bear in mind that these huge increases in the price of Homestake came when major DEFLATIONARY forces were taking place. American bought gold shares as a proxy for gold because they were not allowed to by gold. But gold was in huge demand as money around the world when the value of the dollar was actually buying more! The fact is that as huge numbers of people and businesses were defaulting on their dollar obligations, people preferred to get paid in gold rather than paper because gold was an asset money while money that would retain its value even as massive defaults rendered paper money worthless.

JAPAN IN 2002 - According to Miningweb.com, demand for gold in Japan is dramatically for reasons that are very similar to reasons for a rise in demand for gold in the U.S. during the 1930's. Japan is about ten years ahead of the United States in its Kondratieff winter. It has been in a decade long deflation which, along with a permissive monetary policy like that of the U.S. has lead to an increasingly insolvent banking system. Understanding this danger to their money, the Japanese people are opting to store value in the form of gold rather than electronics credits and checking accounts in the banks. So in fact, the Japanese people are acting very rationally by turning their yen and dollars and other currencies into gold.

The Miningweb reported last week that "Year on year figure show imports of 60.5 tones of gold or more than three times higher than in the first seven months of 2001. It had tailed off a few weeks ago, but in July demand began to rise dramatically once again. The fear is that as the U.S. economy slows, Japan's fortunes will plummet still further because exports to America has been about the only bright spot for Japan. So despite a horrid deflation in Japan now for many years, people demand gold they know it will retain value even as paper money vanishes into the thin air from whence it came.

In my view, the message is quite clear. Gold will rise when people lose confidence in paper money. That process is well under way in Japan and Argentina (see chart below showing that the peso price of gold soared more than 260% THIS YEAR) and elsewhere though it has only just barely begun in the U.S.

As the world's reserve currency, the U.S. will be the last paper currency to fall, but when it does, there will be no place to hide accept gold and to a lesser extent perhaps silver and other commodities which also hold some intrinsic value. Now, as we expect the Dow and other stocks to plunge to valuations akin to other bear market bottoms ( at least another 50% or more from current levels) and as the economy continues to tread downward, we think gold will have its day. And because sooooooo much paper money has been created and soooooo much debt in the process, I fear defaults levels will be cataclysmic. And because so many units of currency have been created, not only in the dollar but in virtually every currency around the globe (this time there is no currency tied to gold), the price of gold vis-à-vis paper money will shoot to the moon. Accordingly, it may be possible that many if not most of the penny gold stocks listed on page 16 of our monthly newsletter will be quoted in numbers akin to those of Homestake in the mid 1930's. As such, those who own gold should be better able to offset paper losses, which will be beyond comprehension to most investors.

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The Federal Reserve Bank of New York holds the world's largest accumulation of monetary gold.
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