Taylor on us Markets & Gold

The Paper (Financial) Markets

October 22, 2002

Fairy Tail Earnings and Market Manipulation

Last week, fairy tails of higher IBM and Citigroup earnings and quite possibly in our view some equity manipulation from the Plunge Protection Team helped the markets forget some horrible economic news on the employment and factory order front and turn what might have been a devastating plunge in stocks into a furious bear market rally. Unfortunately, American investors have again been made the fools by these kinds of manipulations.

Citigroup's earnings rose because they counted profits on the sale of some Manhattan real estate and because they have been successful in coning consumers to continue living for today without concern for the future. Their credit card business in booming, at least for now. IBM apparently chose not to count the performance of a division that it intends to sell and by so doing eliminate those bad results from its operating results. Such are the games and falsehoods that are still being spun by in America these days.

This false sense of security was largely to blame for a flow of funds from bonds to stocks last week. If there were reason to think the economy was on the mend in a serious way so that even part of the lofty S&P 500 PE ratio could be justified, then higher interest rates would not be so problematic. But the real problem for stocks and bonds will occur when, on the basis of investment returns, foreign investors choose to gather their marbles and take them home. At that moment, a major demise in the fortunes of America is likely to become obvious to all. Having helped usher in the rapid destruction of American industry through a strong dollar policy geared to transfer wealth from those who create it to Wall Street and Washington, those with their ears open have begun to clearly hear the GIANT SUCKING SOUND that Ross Perrot predicted as a Presidential candidate. With mining, farming and manufacturing quickly disappearing, what I wonder will be left of America after the Kondratieff winter cleans our clock and when all our gold has been transferred to Asia and the Muslim countries?

A Double Dip? When?

And how close might we be to a double dip recession? Stephen Roach, Senior Economist at Morgan Stanley has steadfastly refused to give up his belief that a double dip is possible if not likely. Now this past week, John Maulidin is predicting the U.S. will fall back into a recession next year or 2004 but that in the interim we will continue to "muddle" through with very tepid growth. In no way will earnings justify still lofty stock prices so that the father of all bear markets will continue to punish the bulls. John's reason for calling for a double dip recession is that the existing growth is being held up only by housing and consumer spending. Continued growth in these sectors require continually declining interest rates.

Will interest rates continue to decline? I think last week's powerful bond market decline may suggest we have seen the lows in interest rates. Of course lower quality rates have been skyrocketing for a while now and as we noted last week, junk bond defaults are at an all time high. We are only 2-½ months from 2003, so it could be we will escape a double dip this year. However, if interest rates continue to rise, I should think we may see a nasty decline in the economy early in 2003.

BULLISH MARKET: Gold, Commodities ( the CRB & Jim Rogers Raw Materials), and U.S. Treasury instruments. It will be especially interesting to keep our eyes on gold and interest rates. Over the past several months we have seen gold trend higher while interest rates trend lower. Usually, gold moves opposite the dollar. And, as gold rises vis-à-vis the dollar, interest rates tend to rise as money flows out of the U.S. capital markets. So far, interest rates have risen we think mostly because of a move from bonds back into stocks evidenced by a dollar that has stopped declining since mid July.

Actually that raises a very interesting point. Gibson's Paradox suggests that if real interest rates rise, gold should fall while if real interest rates fall, gold should rise. Keynes said this is one of the most well established relationships in all of economics. It seems likely that the work of Harvard's Lawrence Summers in the late 1980's provided the intellectual justification for the Clinton Administration rigging the gold price during the 1990's when disinflationary economic forces combined with massive amounts of new money created to bail out the world, resulted in lower real interest rates. As Reggie Howe pointed out in his lawsuit, from the time these bailouts began, this highly predictable relationship broke down so that while we lower real rates should have resulted in a $500 gold price in fact gold prices fell because of massive dishording of gold from central banks.

So now we shall see what happens when and if real interest rates (rates after factoring out inflation) begin to rise. I suspect that real interest rates will not rise significantly until the bottom begins to fall out of the U.S. economy at which time, the dollar will plummet and gold will surge to much higher levels. In that instance, we might in fact see a natural rather than a contrived aberration from Gibson's paradox. Foreign money flows out of the dollar, sending the dollar crashing and interest rates rising which in turn leads to an economic decline and a massive defaults that threaten the solvency of our banking system. Real interest rates may skyrocket in this situation and gold may rise too because of a loss of confidence in the dollar and our banking system. In fact, the only low interest rates may at that time be for gold loans because of the stability of a de-facto gold monetary system. That of course would not ever be welcome by our ruling elite who would resent mother nature taking away its legalized counterfeiting operation. But in fact a move back to honest money in the form of gold or silver would only happen if the tyrants that rule us were overpowered by nature's laws. For that we can only hope and pray, so that we will have a chance to enjoy freedom in the future.

GOLD

We have seen a bit of a pullback in gold but at its Friday close of $312.50 it remains above its 200-day moving average of $307. However, it has fallen below its up trend line that dates back to the summer of 2001. It is my belief that the establishment have made another run at gold, what with J.P. Morgan derivative problems. However, I do not believe they will be able to control gold much longer. News of increasing demand from India, Asia and the Muslim countries, helps put a floor in place for gold in my view. Interestingly, the Financial Times reported last week that a large amount of gold as well as fiat money has been flowing into Iran for the first time since the 1979 Islamic revolution. And we are reading more and more about the Islamic Dinar in which Muslim countries are planning to use gold as a medium of exchange rather than dollars.

This past week there was a great deal of spinning of economic and corporate news that foolishly in my view, convinced people jump back into equities. Given what I see for the economy as noted above, the wheels are in fact falling off of the wagon so to speak. After this bear market rally in the stock market, we are likely to see a major loss of confidence in the global markets, especially, if as I believe we are heading for a double dip recession.

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

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