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I am pleased to present the following
article written by Mark Lundeen. He explains why the Barron's mining stock
average has outperformed the Dow Jones Industrials since 1920. The analysis
excludes dividends on both averages, which in itself could be an interesting
study. Nevertheless, his conclusions are thought provoking and worth
considering, two of which are particularly important.
First, on an inflation-adjusted basis,
the capital in your stock portfolio (as measured by purchasing power) may be
eroding. Second, after years of lackluster performance compared to historical
returns, the gold and silver mining shares are about to excel. I wholeheartedly
agree with both of these conclusions.
Since 1920 gold mining has outperformed
the DJIA
By Mark J Lundeen
Barron's began publishing data on its Barron's Gold Mining Index (BGMI) in
1938. It's the sole survivor of the now discontinued Barron's Stock Groups
(1938-88). In 1938, the BGMI consisted of two stocks, Homestake Mining and
Alaska Juneau Gold. One of my readers from Australia, Geoff, was kind enough
to dig through old issues of the New York Times, and sent me 18 years
of data on Homestake Mining, which allows me to derive the BGMI going back to
1920.
A note on my Currency in Circulation
(CinC) data is also in order. CinC is comprised of paper dollars and coins
circulating in the economy. Barron's first published weekly CinC data
in its 23 February 1931 issue. My CinC data prior to that date is from A
Monetary History of the United States by Milton Friedman and Anna
Schwartz and is usually a yearly data point. No need to have weekly data when
something changed only a little from year to year. In 1920, the Federal
Reserve would never have dared to increase CinC to a point where weekly values
were required. By 1931, I guess they figured they could get away with it.
CinC is only one measurement of monetary
expansion; and admittedly, not a popular one with economists. But it has a
long history, and its construction is so simple that it resists the kind of
distorting modifications that plagues most long-term government statistics,
such as CPI. CinC also tells the U.S. dollar's 20th century story of
inflation quite well.
Let's take a look at the DJIA, along
with my extended BGMI (courtesy of Geoff), and my extended CinC (courtesy of
Friedman and Schwartz) from 1920 to 1964. I indexed all three to 1.00 for the
first week in January 1920. Looking at these plots allows us to see how many
times the DJIA, CinC and BGMI expanded from 1920 to 1964.
It's interesting seeing how the DJIA,
and the BGMI can be nicely counter-cyclical to each other for years at a
time. But that doesn't mean there aren't long periods where they can't rise
and fall together. From 1954 to 1964, both increased in valuation, but
clearly inflation was favoring the DJIA.
Remember, this isn't science. Science,
and common sense, tells us that exposing gasoline in an oxygen enriched
atmosphere to an open flame will instantly result in combustion every time
it's attempted. But economics and investing don't work that way. Exposing assets to
inflationary flows can lead to rising asset prices, but not always
immediately or every time. Everything depends on how individuals and
businesses spend the new dollars, created by the Federal Reserve via bank loans.
History shows that the consequences of
monetary inflation can be delayed for decades. This favors the "policy
makers," as it's difficult to associate economic consequences with their
inflationary actions taken years or decades before. For instance, Doctor
Greenspan inflated stock valuations to a point where the DJIA yielded only
1.3%. That was over 10 years ago, and we will be suffering the consequences
of his bubble market for years to come. But few link Greenspan's inflationary
actions to our current economic consequences.
We must remember that with the creation
of the Federal Reserve in 1913, monetary inflation has been a constant factor
in the financial markets. Where new money creation flows to, and flows from,
is best seen by which particular asset class is experiencing a bull or bear
market. The Dow Jones Industrials and Barron's Gold Mining Index are
excellent proxies for the two major areas where inflation flows circulate:
1.
Financial Assets: DJIA
2.
Hard Assets: BGMI
Those times when monetary inflation is
flowing into financial assets (DJIA bull markets) are described as times of
"economic growth" by the "policy makers." They can be.
But the soaring valuations at the end of the DJIA bull market are purely an
inflationary phenomenon.
Those times when monetary inflation is
flowing into hard assets (BGMI bull markets) they are described as times of
high consumer price inflation. Rising consumer prices may not be evident
early in the BGMI bull market, but as the bull market in gold mining shares
matures, rising consumer prices become undeniably evident.
In this report's charts, bull markets
occur when an asset class rises up to and above the CinC (the green plot of
U.S. CinC inflation in the above chart). Bear markets occur when an asset
class falls from above CinC, to below it. Sometimes inflation occurs without
favoring either asset class, as during the early years of WW2.
Wartime government controls on prices
and rationing of food and manufactured goods kept prices down as CinC
increased significantly. Still from 1942-46, both the DJIA and the BGMI
doubled in value. These gains in both the DJIA and BGMI fell far short of the
increase in the money supply (see table below).
During the excellent bull markets in the
two decades following WW2, both the DJIA and BGMI caught up with CinC
inflation, but as you can see in the chart above, the BGMI lagged behind the
DJIA from 1946-64.
After WW2, something else was catching
up with CinC - consumer prices. Just like today, most academics at the time
blamed "inflation" on rising prices without identifying the source
cause of the cost-of-living increases. But there were those who knew the truth,
and were not afraid to tell the pubic the real reason for rising prices.
"We hope that the government
of the United States, despite the big spenders, and the gold tinkerers,
maintain a sound dollar, a dollar worth saving, a dollar worth earning, and a
dollar that can be traded in any part of the civilized world." -
Barron's World at Work, 02 January 1950, Front Page
Keep in mind this post-WW2 period where
CinC gains far outpaced both the DJIA and BGMI, only to have the DJIA and
BGMI catch up years later. Our current era in market history is very similar
to this 1942-52 period. It's reasonable to expect a similar delayed catch up
to inflation for both the DJIA and BGMI in the years to come. But once again,
these two indexes are running counter-cyclical to each other, as I explain
below, so I expect the BGMI will lead the DJIA for some time to come.
Let's look now at the following chart
from 1920 to 2010. Note how the DJIA (Red Plot) during its 2000 & 2007
market highs never exceeded the green CinC plot. It's evident that since
1965, the general stock market has not kept up with CinC inflation.
* Something significant occurred
between the BGMI and CinC from 1965 to 1991. *
For 26 years, the lows of the BGMI were
set by the rate of CinC expansion. There were five times when the BGMI
deflated from a high, only to bounce off the CinC plot. The last time was in
1989, two years before the BGMI slipped below the CinC plot in 1991. But the
BGMI didn't completely decouple from CinC until 1996, when it finally
collapsed in the face of Doctor Greenspan's NASDAQ bubble market.
I'm not saying the BGMI was a great
investment from 1980 to 1996. It wasn't. But for 31 years (1965-96), the BGMI
kept up with, or exceeded the rate of CinC inflation. That's darned
impressive! When one compares the DJIA's response to CinC inflation from 1920
to 2010, on the whole the Dow Jones Industrial Average has not kept up with
the U.S. government's monetary printing presses.
These results can change greatly
depending on the start date chosen. But choosing January 1920 as the starting
point, only six years after the creation of the Federal Reserve, we have a
long-term view of the impact of the Federal Reserves' inflation on real and
financial assets, during a period when the U.S. dollar lost over 95% of its
purchasing power.
So let's ignore what the
"experts" say about gold mining shares being risky. With the
exception of the WW2 years, market history has shown that since 1920,
quality-gold mining shares are a proven hedge against the Fed's inflationary
predation in the worst of times; and during the best of times, gold mining
shares bull markets have outperformed bull markets in the DJIA.
In my last chart that follows below, the
plots are ratios of the DJIA and BGMI to CinC. Here is what I did.
·
Blue Plot: BGMI / CinC
·
Red Plot : DJIA / CinC
These plots are not recording dollar
values, but how the DJIA and BGMI have increased or decreased relative to
CinC over time. Whenever the blue BGMI or red DJIA plots are at the green 1.0
Line, they have expanded at that time as much as CinC itself since 1920. This
chart is the best method of showing the inflation and deflation (bull and
bear markets) in the BGMI and DJIA since 1920.
Let's look at the three major DJIA bull
markets seen in the chart above:
1.
1921-29: Adjusting for inflation, the 1929 DJIA bull market was the
last DJIA bull market that actually provided investors with superior inflation-adjusted gains.
There is not much else to say about it.
2.
1942-1965: On an inflation-adjusted basis, the DJIA peaked in Barron's
10 May 1965 issue. This was also the last time the DJIA could make it to the
CinC 1.0 line. The DJIA was at 932.52. What the heck, we'll call it a Dow
1000. On a dollar basis, the DJIA would continue attempting to break above
the Dow 1000 four more times until 1982. But in the chart above, we see that
the DJIA was losing ground when adjusted for CinC inflation. What a dollar
could purchase in 1982 when the Dow finally cleared 1000 was a far cry from
what it could buy in 1965 on its first try.
For example, to calculate the dollars' lost purchasing power over this
period, look at the 17-year price gains for an issue of Barron's, and what
the post office charged to mail a first class letter. My chart's inflation
adjusted loss of 77% for the DJIA in August of 1982 is not so far off.
3.
1982-2000: These 18 years are often described as the greatest DJIA
bull market in the history of the DJIA. However, when we take Doctor
Greenspan's monetary inflation into account, this is not the case at all. On
an inflation-adjusted basis, the DJIA peaked in Barron's 10 May 1999 issue as
it reached 0.87. This is 13% below the 1920-1999 increase in CinC. While we
are at it, let's also take a look at the highs of 2007. The DJIA, again on an
inflation-adjusted basis, peaked at 0.71 in Barron's 01 October 2007 issue. This
time the DJIA fell below the 1920-2007 increase in CinC by 29%.
In other words, monetary inflation has
created a situation where investors are losing purchasing power as their
"investments" increased in terms of a flawed
currency. So not only is the government stealing our wealth with inflation,
but has the nerve of taxing us on our "capital gains" that are
frequently real capital losses when viewed in terms of purchasing power.
There is one more item to cover in the
above chart. I placed four dashed red ovals on the green 1.0 CinC line. These
were episodes of market history where both the DJIA and BGMI were dithering
below the rate of CinC inflation, just before one of them (but never both of
them) began increasing at a rate far above the rate of CinC inflation. The
DJIA only managed to do this in the 1920s, but the BGMI has managed to
increase at rates greater than CinC inflation twice, with the second time
lasting from 1965 to 1996.
Who knows what will happen next? But
it's a reasonable assumption that the BGMI will continue increasing at a rate
that exceeds CinC inflation, long enough to drive the BGMI plot far above the
CinC's 1.0 line.
Currently the DJIA is in a deflationary
cycle, where "monetary inflation" wants to flow out from the stock market.
Still the "policy makers" continue their futile attempt to inflate
the deflating Dow Jones. On the other hand, the BGMI is in its inflationary
cycle, when "monetary inflation" naturally flows to gold mining
shares.
It's significant that with no promotion
from Wall Street, and frequent ridicule from the "experts," the
BGMI in nominal terms has still managed to increase by 420% from January 2001
to September 2010. This as the DJIA has declined by 2.01% in the same period.
When taking CinC inflation into account, the results are even more startling.
Gold and silver mining shares are only a
tiny segment of the general stock market. In 2010, the global bond and stock
markets have serious structural problems. Bond and dividend yields are at historically low levels
at a time when discussing sovereign debt default is no longer taboo. We have
a perfect situation for another round of panic selling of financial assets.
If in the event that
trillions-of-dollars of "liquidity" should begin draining in
earnest from financial assets, hard assets would benefit, causing explosive
gains in gold mining shares that may be as great as they were in the early
years of the 1930s. Why not? In many respects our situation 80 years later is
actually worse:
1.
Financial leverage in banking and finance greater
2.
Stability of global currencies is missing
3.
Higher debt loading in the private and public economy
4.
Higher public participation in the financial markets
5.
Confidence in government's management of economic issues is fading fast.
Unlike the 1930s, people know that Washington lies to them all of the time.
The potential for explosive gains for
all classes of mineral production, including exploration companies, are
exceptional.
Mark J Lundeen (mlundeen2@comcast.net)
James Turk
GoldMoney.com
Free signup a Goldmoney.com
James Turk is the
founder of the Free Gold Money Report and of GoldMoney.com. He is also the
co-author of The Coming Collapse of the Dollar (www.dollarcollapse.com).. Copyright © by James
Turk. All rights reserved.
Copyright © 2008. All rights reserved.
Edited by James Turk
This material is prepared for general circulation and may not have
regard to the particular circumstances or needs of any specific person who
reads it. The information contained in this report has been compiled from
sources believed to be reliable, but no representations or warranty, express
or implied, is made as to its accuracy, completeness or correctness. All
opinions and estimates contained in this report reflect the writer's
judgement as of the date of this report, are subject to change without notice
and are provided in good faith but without legal responsibility.
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