What's up with Gold?

April 11, 2002

After interest in gold died down with the last failure to push above $300 resistance, suddenly, the metal wakes up to no fundamentals. While analysts attempt to tie this latest rally to rising energy prices and the big boost in consumer confidence, the real question is, "Who's buying all that gold?" After all, inflation appears relatively sedate despite the pop in the CRB Index.

Those who remember the Falkland Island War should recall that gold jumped more than $20 a day as Great Britain responded with its fleet. Within a week, the score was settled. Argentina's military establishment was discredited, paving the way for a change in government. From my historical perspective, the current flight to gold in light of Argentina's current monetary crisis is understandable. Although I have not seen the "Argentinean Factor" correlated to gold, The Wall Street Journal mentioned Argentina's inflation fears and the lines at exchange banks...waiting to trade pesos for greenbacks.

Argentinean investors must weigh risks of holding U.S. Dollars against risks of holding hard assets like gold and silver. Certainly, the dollar incorporates considerable parity risk. Yet, the population still favors dollars over the Eurocurrency or yen...for now. This interest in dollars becomes a self-fulfilling prophecy as demand builds. Dollars are bid higher and the peso weakens. Argentineans remember 300% inflation at the end of the 1980's and they are inclined to take defensive measures like buying dollars, Euros, and gold.

Since the dollar market is so broad, Argentinean participation may not necessarily have the same impact as the more narrow gold market. Let's face it--interest in gold has waxed and waned over the past two decades, but mostly waned. Gold was removed from the front pages of The Wall Street Journal and The New York Times as an economic indicator. In short, gold lost its luster.

However, terrorism and a shift back toward military industrial spending reintroduces inflationary prospects in the United States, Western Europe, and even the CIS. The potential Middle East meltdown adds fuel to the inflationary fire. Lest we forget, the last critical Arab-Israeli conflict spawned the oil embargo that crippled Western economies and prompted the Hunt Brothers' infamous silver squeeze toward the end of the 1970's. Let me remind you that the most successful anti-West campaign ever instituted by Arab nations was the concerted oil embargo with its subsequent stagflation. Who was backing Bunker Hunt in his effort to institute a silver-based monetary standard? None other than the Saudis.

When gold was legalized in the U.S., the price spiked higher and promptly dropped like a stone. There was no way anyone could foresee the speedy surge from $150 to over $800. Are current fundamentals parallel? When we least expect it, can gold eclipse stocks and bonds? Will it take the other metals in tandem? What is the Fed's position?

While OPEC remains substantially in control of world oil prices, its position is considerably weaker than in 1973. There is no Soviet Union. To the contrary, Russia and its oil producing states constitute OPEC's most dangerous competition. Iran and Iraq skate on extremely thin ice in the post September 11th attacks. The United States and Western Europe are not adverse to military intervention as seen in Afghanistan. The majority of the September 11th terrorists were Saudis. The majority of funding for radical Islamic Fundamentalists is Saudi. Yet, members of the Arab League cannot survive without Western money, technology, and support.

Thus, it is not as likely that oil will lead explosive precious metals prices. More probable is a contribution if intermediate OPEC cutbacks push energy higher. This assumes no military action to curb Iraq's lust for weapons of mass destruction. Given the enormous media campaign to justify "taking out Saddam," most military strategists concur that some form of intervention is inevitable. This raises the question, "What will Iraq do with its back against the wall?"

Taking a cue from current tactics, the mindset seems to be one of total sacrifice. Hatred is so intense and rampant that the terror delivery vehicle predominantly involves human sacrifice. Suicide is an option. This suggests that Iraq and Iran will stand against the U.S. Our ability to intimidate these enemies is severely compromised by their ideology.

Ironically, Saudi Arabia appears to be the only Arab state that does fear U.S. reprisal. They know they are the "real" naughty boys. With all the fundamentalism, the Crown Prince cavorts in splendid Western style when he visits his multi-million dollar mansions in the United States and Europe. The Royal Saudi Family is deeply indoctrinated in Western comforts that include every imaginable exotic automobile, the largest private yachts, most ornate private jets, and most lavish living quarters on the planet. The Saudi billions are, for the most part, invested in Western stock markets. Hmmmm...what's wrong with this picture? If you hate the West so much, what's up with the decadence?

The strange contradiction has matured into a genuine conflict of interest. Hence, Saudi Arabia is attempting to save face by proposing a peace plan that the Prince knows is totally unacceptable to both sides. The controversy over Yasser Arafat's detention represents a smoke screen. Everyone knows that this same deal was already offered to, and rejected by Arafat. More obvious is the fact that Arafat is not in a position to control the dozens of factions intent upon Israel's destruction.

Why are Middle East politics important to gold? Islamic custom ritualizes gold ownership. Historically, Islam and Judaism derive from the same roots. Biblically, both sprung from Abraham. The Arab nation(s) are the children of Abraham's son, Ishmael and Isaac's son, Esau. The Israelites are descendants of Abraham's son, Isaac and his son Jacob. Both cultures perform the circumcision; Jews, eight days after birth and Muslims at 13 years. Muslims bestow gifts upon their men during this rite of passage...primarily gold.

Arab affinity for gold is well documented. When faced with economic uncertainty, they have converted cash into hard assets. This, too, bodes well for the yellow metal if the situation intensifies. At last, gold could regain stature as a crisis hedge.

Technically, I was teased into the long side when a symmetrical triangle appeared in February. The market busted below the formation before rapidly bouncing back. The decline appears to represent a 50% retracement. With this latest rally, the technical interpretation is positive. Some view the entire action from the January spike forward as a bull pennant with an upside 32600 target.

Support appears at 29100. A failure below this level would plunge a large number of speculators into the abyss. Near-term volatility obscures a more telling monthly perspective. The continuation chart displays a rounded bottom with a breakout over the averages. The fulcrum resistance can be identified at 32750. This is just $1.50 away from the first objective noted on the short-term chart.

A breakout above 32750 points to a new high just under 37000. Gold hasn't seen this much upside action since the latter half of the 1980's. That rally was marked by steady progress until meeting $500 resistance. The Crash of 1987 helped support gold to the extent that liquidity could move into the metal. Following the 1988 U.S. drought and a failure for renewed inflation, gold simply lost its grip.

I suspect European central banks will be less enthusiastic about dumping more gold even as prices rise. There is an odd inverse relationship between a central bank's willingness to sell and rising prices. Unlike a normal speculator who likes to sell at higher prices, governments historically unload at interim bottoms. Of course, one could argue that inventory is left over from a time when gold was fixed at $40 per ounce. That's like arguing in favor of holding IBM until it reaches its 1950's lows.

There are three major players in today's market. Mining companies provide new supplies and hedge liquidity. Gold loans are incentives for speculators selling premium against borrowed gold. Premium sellers have no interest in seeing gold achieve their strike. Some gold advocates cry foul because they believe premium sellers manipulate gold to prevent their paper form going into the money. Then, central banks are the swing suppliers that facilitate the gold loan transactions. Again, according to gold bugs, the banks intervene to keep gold artificially low.

The term "artificially low" is a misnomer. The price is the price. It cannot be artificial. While players can attempt price manipulation, gold's value will only respond if these participants buy or sell with sufficient force. Their conviction makes the market. In all cases of manipulation, market forces eventually intercept the manipulator(s). This is to say that other participates eventually overwhelm the manipulation.

Understand that when governments allegedly manipulate prices, it is called an intervention. Currency intervention is a perfect example. When Europe's central banks decide the Euro is too weak, they manipulate the price with rhetoric or actual transactions. The same is true for the pound, yen, and U.S. Dollar. Why should gold be any different?

Greenspan's Stand

A good many people have been trying to determine Fed Chairman Greenspan's objectives relative to gold. After all, isn't it a non-issue? One need only page back to Greenspan's earlier writings to glean a striking dichotomy between his pre-float position and current monetary maneuvering. In 1966, he wrote a brief paper explaining how the demise of gold was a prelude to monetary trickery. He was already criticizing a quasi gold standard that existed in 1966 and blamed the Great Depression upon draining British gold reserves coupled with the U.S. attempt to lower interest rates to accommodate the Brits.

With his 1966 attitude, it is hard to imagine Greenspan absent gold. We do change. After all, I've been a gold bear since 1980 as noted in my book, The New Precious Metals Market. Greenspan's article is particularly interesting because he makes the argument that wealth transference is the leading cause of inflation pressure. He appears to be exceptionally anti-welfare. This clashes with his later behavior to curb employment as an inflation fix. For anyone interested in Mr. Greenspan's former perspective, it can be accessed at the following web link: http://www.321gold.com/fed/greenspan/1966.html

It is an important retrospective because leopards don't change spots. When considering the speed with which Greenspan tightens and his staunch position against inflation and over exuberant investing, his article sheds old light on the Fed's leading personality. He cannot openly support a gold standard, but he sure knows why gold has been an effective monetary standard and he has obviously come out against the present free-wheeling lack of standard practiced by the current global monetary system.

As Greenspan nears the end of his dominance, I have a sense that he fears a meltdown. He was not a proponent of deficit spending. He warned that a backless currency was highly vulnerable to confidence crises. Like Volker before him, Greenspan knows how to play along...no matter how unpleasant the prospects.

Gold is using for heat dissipation in some cars.

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