first majestic silver

Taylor on us Markets & Gold

August 6, 2002


Trillions of dollars have been lost so far on Wall Street, but in my view, the biggest losses are still to come. I say that for at least two reasons.

  • Everything I see suggests the U.S. is heading toward a deflationary experience. What this means is that there will be no pricing power for corporations any time soon which in turn means corporate profits will continue to decline, leading to still lower stock prices. And with declining profits, unemployment will rise and the capital goods sector will not revive any time soon. This would be bad enough for America, which has an equity market still extremely over priced (GAAP P/E Ratio this week was a still extremely high 36.9 times) but unlike Japan and the U.S. during the 1930's we are now a nation hugely in debt. More importantly, a major portion of our debt is to the rest of the world.
  • In fact, that is the other major concern I have is the indebtedness of Americans to foreigners. Helping me to realize just how serious this problem is was Kurt Richebacher's most recent newsletter in which he underscored the almost certain sharp decline to come for the dollar. To keep the dollar from collapsing, he pointed out that America needs to attract capital not only to balance the current account deficit of about $450 billion per year, but that it needs another $450 to$550 billion to balance investment dollars leaving the U.S. for abroad. In other words, against growing signs that returns on investment in the U.S. is declining and that foreign investors are suffering an additional currency loss, the U.S. has to keep attracting $900 billion to $1 trillion of capital from foreign sources just to keep the dollar from declining! Richebacher concludes that "To expect continuous new capital inflows of such size, funding both current and capital outflows, appears ludicrous to us."

Where then to invest? Richebacher suggests the best place to put your money is German and French bonds. Not sure why this Austrian economist didn't mention gold, but with respect to German and French bonds, we are in general agreement. When paper money evaporates into the thin air from where it was created, the U.S. will be among the worst prepared to rebuild its currency upon real money, gold. The Euro also has about a 15% backing of gold for its paper money should it find it necessary to restore confidence in its currency by formally backing it with gold. However, even if you assume all the gold reportedly in the U.S. Treasury is there (It almost certainly is not all there) the U.S. has less than 1% backing for the dollar. To bring the dollar into line with the Euro in terms of real money to paper money, the dollar would have to depreciate against the Euro to an astounding 93% before it would be comparably valued in terms of real legitimate asset money! Moreover, countries like France and Germany have considerable amounts of gold in their own Treasuries over and above their share with the European central bank. So I think Dr. Richebacher in a way is suggesting you invest in gold by placing your money in currencies that can be converted to gold when the laws of nature and the market prevail over Anglo American political elite who wish to cheat the world for their own benefit.


If you are wondering about the weakness in the gold shares lately, I do not think you should be overly concerned. I glanced at the price of Homestake immediately following the Wall Street Crash of 1929. The biggest plunge took place on October 24, 1929. At the end of that week, Homestake closed at $83.50. Over the next three weeks, Homestake closed at $76.00, $72.50 and $65.00 respectively. In other words, during the three weeks following the crash, Homestake dropped 22.15% of its value. But from there the stock rose to $417 by July 20, 1934! So that gold investment did extremely well in a depression and while U.S. Treasury bonds were in a bull market! Let us suggest that gold is likely to do even better in an environment where Treasury rates are rising and bonds are in a bear market as we expect they will be when forcing capital exits the U.S.

We are guessing that margin calls led to a significant sell off in Homestake as desperate investors were forced to sell anything of value to make good on their debts. We have recently started to see some of this in the U.S. and in fact that could also be part of the reason the XAU has recently been so weak.


The Philosophical Underpinning for Manipulating Gold & Other Markets

Suspicious trading patterns in both the gold market and stock markets have been more and more frequently observed by seasoned trading pros. Some people, including your editor believe that the our federal government has become clandestinely involved since 1987 when according to a Wall Street Journal article the system nearly collapsed. The article pointed out how fear and panic gripped Wall Street such that there were absolutely no bids for the strongest companies in America. Specialist firms, which are those who are supposed to make a market by buying stocks when no one wants them, were quickly going bust.

I recall at that time of the collapse speaking to a friend of mine who headed the broker/dealer lending unit of a large multi-national banking firm where I was also working at that time. He told how the banks were being guaranteed repayment of loans made to the specialist firms so that they would again be able to support the market on the NYSE. I believe it was at this time that the concept of a Plunge Protection Team was born in America. Subsequently, significant evidence is to strongly suggest this group has also been involved in intervening in other markets including the gold market. The intention may have been noble, but I believe we are now beginning to see how this kind of intervention creates its own problems. Constant intervention as soon as markets begin to melt down had removed the notion of risk, thus leading investors to think equities and a host of other dollar markets were a sure way to "Easy Street."

But wait! Isn't America supposed to believe in free markets? Are we not diametrically opposed to market manipulation? Don't we believe that the markets will provide the most efficient answers and allocate scarce resources far more efficiently than a central planning agency ever could?

Sadly, a growing number of Americans no longer understand the virtues of free markets. And I am convinced that interference in the market is exactly the reason why: 1) Various financial bubbles were blown up in the first place and 2) why it is taking much longer than it should for the existing equity (and next real estate) bubbles to collapse. Constant interference in the market is why as Richard Russell points out, until recently, we have not had any "90% down days." It is why people keep asking if we have had capitulation yet. They still think this equity market is going to come back and they are constantly thinking they have to get back in, less the miss the big move up.

If the market were allowed to work efficiently, rather than being stimulated with Trillions of dollars of new money on Greenspan's watch, the equity market would have come down long before Greenspan's irrational exuberance speech in 1996. The extreme overvaluations would never have taken place and we would not now have to suffer the national pain of adjusting America and its expectations back to reality. It was one heck of a party for the Clinton folks. Now we suffer the hangover.

The philosophical underpinnings for manipulation of the markets do exist and I believe they are actually made in good faith even though they are contrary to the free market values upon which America was built. The proponents of manipulation use a more respectable word. They call it "intervention." But one intervention begets another and then another until the markets are so far from equilibrium that intervention becomes so excessive that the only way you can describe it is as "manipulation."

In a 1998 question from Congressman Ron Paul to Robert Rubin during Congressional hearings on International Economic Turmoil, Bob Rubin said the following:

"We have long recognized that helping prevent extreme market fluctuations from generating self-fulfilling losses of confidence that could unnecessarily destabilize the real economy is an appropriate objective of government policy. We also recognize that government action is often required to create the conditions for markets to work at their best."

The current administration is philosophically more averse to intervention than the past which is no doubt the reason why it refused to bail out Argentina when that country started to fall apart. Philosophical aversion and more of a belief in free markets was no doubt also the reason why Bob Rubin's request to the Bush administration was also rebuffed. But now we are seeing what happens to "the heroin addict when he fails to receive his next fix." Panic is setting in over virtually all of South America. Now O'Neil is talking about bailouts for our neighbors to the south.

But I think we have one major problem with this picture. The U.S. is the world's largest DEBTOR NATION! How are we going to keep bailing out the world when in fact our own financial house suggests we could be the nation that may soon need a bailing out?

The problem is that once you begin to intervene in markets, that intervention leads to further and further interventions until the markets are so far from equilibrium that a major disaster is all but certain to take place. Perhaps the greatest distortion of all was the rigging of the gold price from 1994 onward because that sent out a signal to the world that the dollar was a much stronger currency than it in fact was and that the U.S. economy was far more productive that it in fact has proven to be. Intervention in the market that sent out false signals combined with fuel being poured on to the fire by Alan Greenspan led to the greatest financial bubble in history. The adjustment back toward market equilibrium will, I fear be very difficult.

The world’s gold supply increases by 2,600 tons per year versus the U.S. steel production of 11,000 tons per hour.
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