first majestic silver

Taylor on us Markets & Gold

July 1, 2002

We entered 2002 with the view that the U.S. stock market was extremely overpriced, that the dollar was also very much overvalued and that gold was extremely undervalued in relation to the huge amount of paper money that has been created since the last high for gold back in 1980.

Now, despite lower equity prices since the start of the year, we think stocks remain hugely overvalued as does the dollar when measured on a trade-related basis. At the close of the first half of 2002, the GAAP (which is the one that has always been used until the manipulators of 2002 chose to use a more liberal cash standard) PE ratio for the S&P 500 was still at an exceptionally high 40.1 times. In other words, the Earnings Yield (retained earnings + dividends) stood at a measly 2.50% compared to a 10-year U.S. Treasury of 4.80%. Triple A corporate bonds of this maturity are providing yields far above 5%. The competition between stocks and bonds, so far as yields are concerned isn't even close. Stocks are very expensive because a $1,000 investment in the S&P 500 will buy you only $25 while that same $1,000 invested in a U.S. Treasury will fetch you $48 in returns. To further put the magnitude of U.S. equity overvaluation in perspective, it is important to realize that the average PE ratio for American stocks has over time been about 14 times, with stocks below that level about 50% of the time. So the major indexes are still grossly overvalued, though the Abby Joseph Cohen's of this world continue tell you otherwise.

So, except for gold stocks and other special situation stocks like the energy and essential tech issues in our Model Portfolio, we really don't want to own stocks.

But neither do we want to own U.S. Treasuries, which is why we hold the Prudent Safe Harbor Fund. This fund, managed by our friend David Tice, is up 18.67% so far this year. It holds some gold bullion and short to medium term Treasury instruments denominated mostly in currencies other than the U.S. dollar.

With the U.S. stock market continuing to sell at historically high levels, we do not think we are anywhere close to a bottom in stock prices. That is why we continue to hold the Prudent Bear Fund, which shorts the stock market and owns gold mining shares including most of those listed on our Portfolio Scorecard.

And because we think the dollar and equities are vulnerable to a sharp downturn in the market, we also continue to like gold and gold shares. If you are not able to buy a good number of the shares on our list, let us suggest you buy the Tocqueville Gold Fund by itself or the Tocqueville Fund and some of the shares listed on the Portfolio Scorecard at the back of our newsletter.


One of the most frequently asked questions Ed Taxin asks me on his radio show is, what would it take to cause me to change my view on the stock market. My standard answer is that I would have to see the strongest companies in America selling at PE ratios of under 10 times and Earnings Yields (dividends + retained earnings) providing a yield of 10% or at least 30 basis points higher than the yield on 10-Year U.S. Treasury bonds. Obviously with the S&P 500 currently selling at 40 time earnings, we are a very long way from that point. These are the kind of values that follow true capitulation in the markets, when virtually every last bull has been wiped out of action. When the common feeling among the masses is that stocks are the worst investment possible, that will be when these kinds of values are realized in the market. That will be the time when we think of turning bullish on stocks. But we think we are quite a few years away from that time, especially as government seems committed to intervening to lessen the pain and thus to restrict the ability of markets to return to a truthful equilibrium as quickly as possible.


The only way you could possibly justify current stock prices is if you could make a case for a dramatic turn around in corporate profits. We have long recognized that corporate profits and the spin coming from the Abby Joseph Cohen's of the world were largely phony. Now that is becoming obvious to everyone as accounting revelations show that corporations were inflating their numbers. In some cases, as with WorldCom, this appears to have been outright fraud. If this were a case of one or two dishonest companies, you might not have to worry about the next shoe to drop. But the persistent restatement of earnings downward is looking more and more systemic. Indeed as Stephen Roach noted yesterday, Trevor Harris, the Morgan Stanley resident accounting guru …"believes that corporate America still has a long way to go on the disclosure front - perhaps as long as another year." In other words, until all the companies have had a chance to complete current fiscal year audits.

So, the profits we have been given and those which are built into the existing S&P 500 Earnings Yield are highly suspect so that the current P/E ratio in fact may even be higher than the 40 times noted above! In addition, we have all the other economic problems endemic to the Kondratieff winter, such as world wide oversupplies and decreasing demand, leading to shrinking profit margins. And we have a huge and rising debt load in virtually all sectors of our economy. And now, thanks to the advice of subscriber Michael Riley, we were made aware that the Federal Government, which had reported a surplus (though not an honest one) actually on an accrual basis, ran a $515 billion deficit for fiscal year 2001 according the U.S. Treasury's own web site! So Federal debt too is skyrocketing. Profit margins are declining. Capital expenditures are falling sharply, workers are being laid off en mass. The dollar has begun to decline but still has miles to fall before it is fairly priced on a trade related basis. None of these factors portend for a positive outlook for rising corporate profits, which is necessary to sustain long term economic growth.


Stephen Roach of Morgan Stanley suggests investors should mark July 31st on their calendars. Why? Because that is the day when benchmark economic statistics are going to be revised on the basis of more complete and accurate stats. And according to Roach, the revision this year is likely to result in "a significant downward adjustment to GDP growth over the three-year revision period, 1999-2001."

Roach says downward revisions will take place on three fronts. Capital spending, foreign trade in services, and personal income. He says that these are going to be quite significant revisions. For example, during 2000, some information has already been put out which suggests non-defense capital goods are now estimated to have increased only 5% rather than the 10% previously estimated. With regard to trade during 2000, he says the surplus will be revised by $10 billion or 13% to $69 billion. And personal income will be revised downward by $100 billion! Roach says that based on a back of the envelope calculation, he would not be surprised if aggregate growth were to be lowered by at least 1% in these years.

So now the world is finding out what we have suspected all along, namely that the growth touted by the Clinton administration during the 1990's was exaggerated and in large part bogus. We live in a period of time when people have chosen to deny the existence of the Creator so that they can believe what they want and do what they want. They don't like the notion of objective reality or objective truth. So increasingly, we have this notion in America that each and everyone can declare their own truth. And so we do. The result? We get Greenspan and Rubin rigging the gold market to create a phony dollar. We get these same men and countless Wall Street milionaire sell side analysts misleading investors daily as they touted "new paradigm" nonsense and "click per eyeball" statistics to justify stock multiples that were hundreds of time sales - never mind profits - there never were any! And at the very top of our government and corporations, our leaders have intentionally engaged in misleading accounting lies, so that wealth could be lifted from the pockets of average working people who in fact are those who actually create wealth! The problem is for the increasingly dishonest American population, the laws of the universe have not gone away. Eventually, objective truth WILL INEVITABLY prevail. The cost of these sins of the past was something in excess of $2 trillion of equity losses in the first half of 2002 alone.


Following the revelation that massive fraud had been uncovered at WorldCom, the markets looked like they were getting ready for a total melt down and gold had begun to rise very significantly. But one thing the plunge protection team learned following the 1987 market crash. They CAN intervene to keep the market from plunging over the cliff. But non the less, they have a problem. By keeping the market from falling over the cliff and thus purging itself of excesses, intervention leads to a false sense of security and thus sucks unsuspecting investors into the continuing purchase of overvalued assets. Eventually, as we are seeing now in the stock market, intervention cannot keep stocks from plunging in value as the weight of the secular bear market is slowly but surely leading to huge losses.

And so, with little if any doubt, the plunge protection team came back into the market this past week. They averted an immediate disaster no doubt by buying equity futures and by dumping gold on the markets when the markets were very thin. They have prevailed once again nominally in the short run. But longer term the tide is turning against these leader who wish to use market intervention to defy the truthfulness of markets. Of course, the frequency of these kinds of interventions are becoming ever greater and the amount of new money the Fed has to keep pumping into the economy to keep the dollar and U.S. economic fib alive, is growing rapidly. Can there be any doubt that the U.S. government is nearing the end of this con game?

At the very end of this week, the gold cartel trashed the gold price when the Asian markets were closed and when few people were around in New York. The result was that the price of gold closed in New York closed at $313.90, just a smidgen below its 50-day moving average of $314.74, but still above its 200-day moving average of $293.18.

My good wife Teresa told me Friday she hoped and indeed expected the gold cartel would trash the price of gold on Friday because it was the end of the quarter. Working for a mutual fund herself, she is aware how the people in this industry think at window dressing dates such as quarter and year ends. So she told me before she went to work that she expected the plunge protection team might enter the futures markets to cause the price of equities to rise and that they would also slam the gold price. Teresa was glad about this because she wanted to be able to buy some more gold shares for her mother's account. Teresa got her wish and actually I was kind of pleased too because it meant the Calls I wrote on GoldCorp might not be called away from me after all. Since I am bullish on gold and especially on GoldCorp, I want to continue owning it. Of course I wrote the Call simply to pocket some income.

Given our longer term bullish view on gold, I think we have to view these manipulatory actions as providing us with a gift to buy gold at an even cheaper price than its already bargain basement price. In other words, we will allow the Cartel to work FOR us rather than AGAINST us, since we are confident gold will eventually prevail over the dollar.

As for gold, the bottom line is this. The U.S. economy is in very poor shape. Equities are extremely overvalued as is the dollar still. In fact, George Soros suggested last week that the dollar may soon plunge dramatically in value. No matter how much the government intervenes (which Soros urges it to do) the U.S. dollar is inevitably headed over the edge of the Grand Canyon. When that happens you will be glad you have purchased your "golden parachute" at prices made possible thanks to the Gold Cartel.

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