A leap of faith with gold

“Gold continues to climb... stoked by inflation worries,” says a headline in the International Herald Tribune.

Yesterday, it touched a new record – $1,050 – even as the dollar rose, oil slumped under $70 and stocks dipped very slightly.

Well, what do you expect?

The US added $1 trillion to its monetary base in the last year or so. The federal government is running a deficit of $1.7 trillion this year. And along comes Barack Obama with an idea to stimulate employment; spend more money!

This time, Obama’s plan is a kind of ‘cash for workers’ programme... in which businesses get a tax credit for hiring new employees.

Gold investors must think the new programme will be the straw they’ve been waiting for. Government has piled bales of costly new initiatives on this poor camel’s back. Still, he stands up straight.

So, is gold at $1,000 a bargain... or a trap? Or both.

Where’s the inflation? We don’t see any inflation. What we see is deflation.

Barclays Capital says gold could go to $1,500. Don’t know where they got that number. It could go to $15,000 for all we know. Or it could go down, too.

Our guess is that it will go down enough scare the bejesus out of speculators. Then, it will soar.

But, hey, we’re just guessing, along with everyone else.

Sooner or later gold is probably headed to the moon. We’re sticking with the yellow metal. We don’t want to miss that ride.

But when?

Ah... we’re going to stick our necks out and say “eventually”. We’re sure we’re right about this. Just don’t ask us for more precision; we have none. And what bothers us is that between eventually and now there could be a lot of time and a lot of trouble.

And one trouble that could come up pretty fast is another crash in the stock market.

If the stock markets of the world take another dive... like they did last year... gold will probably go down with them. Not as much, but down nonetheless. So, if we were speculating... we’d probably be short gold and short stocks too. We’d bet against bonds too – even though we think they will probably go up in the short run.

The smart, long-term money – in both stocks and bonds – is probably on the short side.

What seems fairly sure is that this recovery is a fraud. It’s a mountebank and a flim-flam.

And now approaches a moment of truth; earnings announcements. Stock market investors bid up shares on the theory that sales and profits would rise. Will they?

Sales are going to be disappointing... and earnings will be even worse. If so, we’ll see analysts begin to change their expectations... and announce that the results are “not as bad as expected”.

If we get a few really bad announcements, with results much worse than expected, it could sink the rally. Then again, if we’re surprised with exceptionally good reports... it could send the market in the other direction...

Maybe the economy is not sinking into a chronic depression, after all. Could we be wrong?

Ha ha... are you kidding, Of course, we can be wrong. When we were younger we were uncertain about things. But now that we’re older, we’re not so sure.

Here is what we’re pretty sure about:

1) The credit cycle has topped out.

Americans are saving – think of the poor boomers, ten years older but not a penny richer than they were in 1999.

Stocks have gone nowhere but down in real terms.

Houses hit a high in 2006... now, they’re off 30%... and still going down.

Jobs? Forget it... there are already 15 million people who are unemployed and about 200,000 more every month. The job market is unlikely to recover for another 6 to 13 years – that is, after many of the boomers are retired!

And if you are lucky enough to have a job, you’re not likely to get a raise... not with so much spare capacity in the labour market.

Under those conditions, a consumer boom is very unlikely.

But before we carry on, let’s just get some more news on gold...

This insight from gold expert, Dominic Frisby, in Money Morning. He points out that gold is the best-performing asset class right now:

“We have had an amazing six months in just about every asset class, except the US dollar. Oil is up, copper is up, bonds are up, stock markets are up, even our miserable, doomed housing market is up. Yet most are way off their all-time highs.

“Gold, on the other hand, is at record highs. It remains by far and away the best-performing asset class in this post-bubble environment, as I have repeatedly said it would be. And it didn’t even get a mention on Newsnight. Not even a raised eyebrow from Paxman.

“ Champagne will no doubt have been drunk last night. But it will only have been on some dingy City back road or some tributary of Wall Street. A couple of coin dealers, a futures trader and a wizened old gold bug who remembers the 1970s will have toasted the currency of kings and staggered home with grins on their faces. But for the rest of them, this landmark will pass unnoticed.

“It amazes me how many people are unaware of this market, let alone participating in it. What happens when they finally enter it? What happens when pension funds and investment trusts start buying gold?

“I remain among my ‘cleverer’ friends (some of them owned Northern Rock) the eccentric who bought gold. I am still waiting for the day when they come to me asking for mining tips. Long may it be before they do so.

“In any case, it's important to enjoy the moment – we often forget to. But, come the morning after, as our wizened man from the 1970s will tell you, one would advise some caution. Gold has made a daily close at all-time highs, but we need to see a couple of weekly closes above this level to confirm things.

“As I’ve often said, I still expect gold to go a lot higher in the longer term – at the moment I expect $1,400 by spring 2010. But it won’t get there in a straight line, and for now, the positions taken by the futures traders on the Comex suggest a top. If stock markets do turn down, they will take gold and gold stocks with them.

“However, it all depends on the US dollar. It has behaved in recent years as the inverse of everything else (stocks and commodities rise, the dollar falls and vice versa). Try as it may, the dollar has been unable to break out of its downtrend.

“But now anti-dollar sentiment is reaching hysterical levels. One website is running a countdown to the end of the dollar – now just over a month away, apparently. Even Middle East journalist Robert Fisk joined the fray yesterday when he reported in The Independent that the Arabs, Chinese, Japanese, French and Russians have been having secret meetings to trade oil in some alternative ‘basket’ currency.

“How many times must we hear this? Last time it was Iran, and before that it was Venezuela. Meanwhile the Russians and Chinese are continually making noises about ‘abandoning’ the dollar. If the body you are buying oil from wants some other currency than US dollars and you only have US dollars, then you do a currency exchange. It takes a matter of seconds. What’s the problem? Why all the scaremongering? I know a bloke on Oxford Street who’ll do it for no commission.

“Nevertheless this story did the rounds yesterday and no doubt helped – along with the Australian interest rate rise – give gold the impetus it needed to move above its old highs. Enjoy it while it lasts.”

*** What else do we know?***

2) We know that a period of credit contraction is deflationary. Prices go down as demand falls. Buyers disappear from the malls that once knew them, while the factories that produce stuff grow dusty and quiet.

2) But we know the feds hate falling prices. And we know they are taking extraordinary actions to get prices to go up. So far, their efforts have been a giant flop. Prices are falling in the US at the fastest pace since the ‘50s.

Most of the feds’ efforts have been directed towards keeping the bankers fat and happy... and getting themselves a bigger share of America’s output. They took funds designed to relaunch the US economy, for example, and used them to buy themselves a big position in the auto, financial and insurance industries.

3) We know too, by the way they conducted themselves in those affairs, that the feds have become much more aggressive... throwing their weight around in the private sector as never before.

What we don’t know is how this affects markets in the short term. So far, consumer prices are falling, but the stock market is enjoying a bounce. It is a real, new bull market? Or just a bear market bounce?

It is probably a bear market bounce... but it has been going for long enough that we have to at least consider the idea that it is a genuine bull market. That’s why the numbers from this quarter are important... they’ll tell us if the companies themselves are expanding earnings fast enough to justify investors’ optimism.

4) We know too that there is a whole lot of ‘flation going on. We are just unable to tell you what kind of ‘flation it is.

The monetary base is way up – it increased by $1 trillion in the last 12 months. But the money-in-circulation has barely budged. The feds give the banks overnight loans at practically zero-interest. Then, the banks lend it back to the feds at nearly 4% more.

What happens to it then? Well, what do you think... it is wasted on typical federal government scams and humbugs.

So, relatively little of the money actually ends up in the consumer economy. And so, we can’t tell you whether the ‘flation will have a ‘in’ prefix or a ‘de’ prefix.

They’re just two letters. But they will make a whole alphabet of difference to the economy and to your investments.

5) Most important, we are dead sure that the people running America’s financial policies are jackasses. We say that with all due respect, which is probably not much.

They have only one idea – and it is a bad one. They think economies are improved by more consumer spending. They don’t seem to care why consumers occasionally cut back on their spending.

All that matters to them is finding ways to get the consumer shopping again. So they try tax cuts and government spending... bailouts and boondoggles... zero-interest lending and federal takeovers... cash for clunkers, cash for houses, cash for employees...

... trillions of dollars-worth of claptrap and folderol. But what a nuisance! The fool consumer still won’t shop!

But they’re determined to keep trying. That’s why we can be pretty sure that, eventually, they’ll get inflation rates up. One way or another. And then, gold at $1000 will seem like an outrageous bargain.



Bill Bonner