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Introduction
In
times like these when bearish sentiment towards gold is reaching new extremes
again and gold bears feeling comfortable feeding the gold community with
ludicrous mis-information it's good to take a few steps back and take a peek
at the big picture and wonder what critical drivers launched the gold prices
in the first place from a 22 year low of $250 in 2001 to current prices of
$650 in 2007. You might wonder if a tiny little 5 year bull market would be
enough to wipe out the excesses created by the 22 year bear market which took
the gold price down from $850 towards $250, you might wonder if a few years
of increased exploration spending would be sufficient in order to announce enough
new world class gold discoveries being brought into production in order to
replace the gold ounces being produced these days, you might wonder if the
dollar can appreciate from here on the back of an ever increasing US spending
attitude, you might wonder if demand for gold will be decreasing despite the
ever growing appetite coming out of China/India…
Well,
I can go on for a while here but my point is that looking at gold's critical
drivers one could clearly see the way for gold is up, not down. The gold
bears will have a difficult time explaining gold exceeding $1000 before the
end of this decade since their misleading arguments of increased gold supply,
rising rates are bad for gold and reduced demand didn't work for the last 5
years, it won't work for the next upcoming years either. They sound like a
broken record indeed and yes, one day they might be right, most probably
early next decade or so. Listen
to some popular bear tunes over the years:
- Gold prices are at an historic high and will
likely come down (March 2005, gold trading at $430)
- World gold production levels are going up and
will bring down the price of gold should it rise. (March 2005, gold trading at
$430)
- Gold has nowhere to go but down due to
deflation pressures around the corner (November 2002, gold trading at
$320). (The man in question here never admitted he was wrong, he still
sees the rise in gold towards the $730 mark as a bear market rally)
Now
the latest bear tune is the one of rising rates. One noted gold analyst wrote
on Friday June 8:
"As
interest rates go higher and higher, it makes the purchase of any
commodities,
which never pay interest or have yield, a poor judgment"..
Well,
I couldn't disagree more since rising rates as a result of a dropping dollar
is one of the strongest drivers for gold one could imagine. History makes no
mistake about it, the 10 year yield rose from a mere 5% from early seventies
to an astronomic high of 15% in the early eighties! What did gold do during
this period? Indeed it rose from $35 all the way up to $850.
Now
we are here again, the 10 year yield just breached the 5% mark and is heading
higher due to a massive sell-off of US debt. This is gold bullish, not
bearish! (see chapter II)
Below
you'll find a brief overview of all critical drivers for gold and a historic
overview. This gold bull market still has a long way to go. Please remember
that bull markets tend to end in mania and needless to say we're nowhere near
mania these days. The last time we've been witnessing a gold mania was in 1980
when people were queuing in lines in front of the banks in Toronto in order
to buy gold. It was a time when almost 5% of all invested money was in gold
and gold shares vs much less than 0.5% today. The tricky part however is to
stay on board on our way towards mania since the gold bull tries to shake off
as many investors possible before marching on. Please keep in mind that
bearish sentiment heats up every time gold is heading towards its 200 dma, we
just have to go through it and stick with what the fundamentals are dictating
us..
Again,
please review the critical drivers for gold once more and stay the coarse,
your patience will be rewarded big time by the end of this decade!
1
- Gold & Historical Norm
2 - Gold & US$
3 - Gold & Inflation
4 - Gold & Supply
5 - Gold & Demand
6 - Gold & Oil
6 - Gold & Monetary role
1 - Gold & Historical Norm
When
gold (and most commodities) came crashing down from a high of $730 to $540 in
just a few weeks time (2006) many experts declared the end of the precious
metals (and commodity) bull run. But based on what? What's the sense of
declaring the end of a 5 year bull run which followed a 20+ year bear run.
Believe it or not but gold is nowhere near historic highs these days, no
matter what the 'experts' want you to believe. In order to trade in record
high territories based in 2007 dollars we should see gold trading above
$2000,- these days.
Mind
boggling numbers? Well, take a peek at the charts below and judge yourself:
- DOW/GOLD
ratio
- Gold vs its own long term average
Dow Gold Ratio
The
DOW/GOLD chart is a powerful tool in order to determine major turnarounds.
It's simple, when the DOW/GOLD chart tops you buy gold, when the DOW/GOLD
chart bottoms you buy equities. Once you've established your position you can
ride the wave up or down for at least a decade. The DOW/GOLD chart flashed a
'buy' for Gold again in the year 2000 and indeed 5 years later Gold is
already 66% off its lows since then. The DOW/GOLD chart tells you to hold on
to your Gold until a new bottom has arrived in the 1 - 5 area. Well, if it
were all that simple why don't we hear that much about it ?
Well,
as said before the DOW/GOLD chart isn't useful at all in order to predict
yearly price movements. It could very well be that next year will show a
higher reading than this year instead of an expected lower reading thereby
losing confidence as being a reliable indicator. Unfortunately that's the
same analogy as denying that higher temperatures will arrive in summer based
on a single day temperature drop in spring. The problem is that the DOW/GOLD
cycle has a wave length that's so big that we humans have a hard time to
figure out where to position ourselves into this cycle. Nevertheless many
veteran analysts such as Richard Russell and John Hathaway do refer to this
cycle. Indeed history does suggest that the DOW/GOLD ratio bottoms
periodically in the 1 - 5 range. The Dow/Gold ratio topped in 2000 far above
40 and is heading down now (current reading at 18.8). If the DOW/GOLD ratio
can live up to its expectations than we can expect a new DOW/GOLD bottom
later this decade or shortly thereafter.
Gold vs its own long term average
Another
favorite bear tune these days concerns 'record' high gold prices which would
be a characteristic of gold's exhausted bull run. They argue that gold's
monthly averages have reached all time record highs which should be taken as
a warning sign. Well, nothing could be further from the truth since bull
markets tend to end by making new 'REAL' highs and needless to say gold is
trading nowhere near new 'REAL' highs these days. In order to do so gold
should be trading above $2000 levels. The
chart below tells it all!
2 - Gold & US$
Gold, a serious hedge against a depreciating dollar?
Gold
is often referred to as the anti-dollar so thereby given the status of a
'currency' . Gold is referred to as the anti-dollar since it is a perfect
hedge against a falling dollar. The chart below makes it painfully clear that
gold is a perfect hedge against a falling dollar indeed. The chart shows the
inversed dollar against gold during phase I of the bull market in gold. (till May 2005)
Now
another favorite bear tune these days concerns a broken relation ship between
the dollar and gold so they argue (the bears) that a dollar decline is no
guarantee for a further gold appreciation. Well, nothing could be further
from the truth since gold's performance compared to the dollar only got
better ever since May 2005. What does that mean? It simply means that gold
could appreciate even on its own without the support of a declining dollar.
Sure enough a further dollar decline still fuels the gold price higher. The
numbers do speak for themselves. The dollar is trading around the same levels
as in December 2004 while gold appreciated by more than $200 over that period
of time.
Conclusion: Gold is a perfect hedge against a depreciating dollar.
Since
the US is living far beyond its means (in order to finance the exploding US
deficits an inflow of foreign capital to the tune of $3 billion dollar each
single working day is required) the only way for the dollar is to go down.
You don't have to be a rocket scientist in order to see that the exploding
trade deficit in the chart below is not sustainable:
As
said above in order to keep the dollar at current levels an inflow to the
tune of $3 billion each day is required, now who is financing all this debt?
Well,
it's no secret that (specifically Asian) foreign Central Banks have been massive
buyers of US debt which is illustrated well in the chart below:
What
we see here is an ever increasing pace of appreciation of Central Bank FX
Reserves. This is clearly not sustainable and simple logic tells us that all
what is not sustainable simply stops. In other words, without foreign support
the US$ is in deep trouble.
Now
if the soaring trade deficit wasn't already bad enough, the picture only
worsens when looking at total US debt which clocked an alarmingly $44
trillion last year. The
chart below speaks for itself:
As
you can see here total US debt is growing faster than its national income.
Ever tried to run a business which its debt grows faster than its income?
Well, needless to say you would be heading straight into bankruptcy.
Is
that what worries major dollar holding nations? Is that why they're looking
for dollar alternatives? How is the US going to solve its debt problem? Can
they solve it? Or is it already too late? Well, serious questions indeed and
you may wonder why authorities have chosen the path of denial and continue to
present an 'all is well' good news show. Or maybe the authorities are telling
the truth and the picture painted above is extremely exaggerated to the
down-side. Well, facts are facts and the simple fact is that the US is
addicted to an inflow of foreign capital to the tune of $3 billion dollars
each single working day and when that foreign support stops the US$ is in
deep trouble.
Now
shifting away from dollars toward euros isn't really a dollar bullish
development, in other words, the dollar seems to be heading lower, a view
which is shared by China's deputy central bank chief who said last year:
China Raises Red Flag On Dollar
"The
exchange rate of the U.S. dollar, which is the major reserve currency, is
going lower, increasing the depreciation risk for East Asian reserve
assets," wrote Wu Xiaoling, deputy governor of the People's Bank of
China, in an academic paper. Wu is ranked by Forbes as the 35th most powerful
woman in the world. END.
Now
what do you think foreign countries holding large chunks of US dollars will
do or planning to do once realizing the US$ is losing confidence fast? Sure
enough they will start diversifying out of the dollar into eg euros and/or
gold. Already by end of last year we saw statements from several countries
just doing that:
UAE considers cut in dollar reserves
Peter Garnham
The
United Arab Emirates, the second-largest Arab economy, signalled on Monday
that it might cut its holdings of dollars by almost half, highlighting a
recent trend of reserve diversification away from the US currency. END.
Costello seeks orderly $US withdrawal
John Garnaut Economics Correspondent
TREASURER
Peter Costello has called on East Asia's central bankers to
"telegraph" their intentions to diversify out of American
investments and ensure an orderly adjustment. Central banks in China, Japan,
Taiwan, South Korea and Hong Kong have channelled immense foreign reserves
into American government bonds, helping to prop up the US dollar and hold
down American interest rates.
Mr
Costello said "the strategy had changed" and Chinese central
bankers were now looking for alternative investments. END.
Chinese plans to diversify reserves into gold provides further support
Marketwatch.com Nov 09
There
was further support in comments from Peoples Bank of China Governor Zhou
Xiaochuan who said at a Frankfurt conference that China has very clear plans
to diversify its currency reserves, which now stand at more than $1 trillion.
A wide range of instruments are under consideration, including gold and oil. END.
So
a depreciating dollar seems to be inevitable coming years but what if the
dollar depreciates in a disorderly way, could it morph into a dollar
(financial) crisis then? Well, sure enough no-one knows but serious warnings
have been surfacing lately which shouldn't be taken lightly:
WASHINGTON -- Democratic lawmakers warned on Thursday that
U.S. reliance on foreign countries to purchase U.S. debt could lead to a
financial crisis as they faulted the Bush administration's economic
stewardship. "If the United States does not begin to take steps to
reduce its unsustainable dependence on foreign borrowing in an orderly way,
there could be a run on the dollar that could precipitate an international
finance crisis and a sharp increase in interest rates," a report issued
by Democrats on the congressional Joint Economic Committee and House of
Representatives Financial Services Committee said. END.
Investment
advisor Bridgewater isn't too optimistic about the dollar either:
Bridgewater's Hennecke Comments on Dollar, Yuan, Yen, Gold
Martin
Hennecke, a senior manager at independent investment adviser Bridgewater Ltd.
in Hong Kong, comments on the outlook for the dollar, euro, yuan, yen, Swiss
franc and commodities. Hennecke spoke in German in a televised interview.
"What concerns us most right now is the U.S. dollar and the decline of
the housing market, the crash of the real estate market. Many of the
companies that build houses have started to reel. That will have a global
effect and could lead to a dollar crash.'' END.
Well,
pretty hard words right? But former FED chief Paul Volcker seems to agree
since he raised one of his strongest warnings by end of last year concerning
a potential dollar crisis, he was very specific and mentioned a time frame of
within two and a half years:
Reviewing the systemic case for gold investment
AME Info Nov 19
So
far the US has organized an orderly devaluation of the US dollar which has
fallen by almost a third in value this century. However, in all market
mechanisms there comes a tipping point where a trend becomes a rout - and it
has to be said that expecting global creditors to continue to accept falling
real debts is not sustainable.
This
is why an authority as eminent as Paul Volcker forecasts a dollar crisis
within the next two-and-a-half years, and why he
is unwilling to extend that timeframe according to recent statements. END.
Now
it seems that almost all financial heavyweights see a shift from dollars into
euros. Alan Greenspan recently told a conference sponsored by the Commercial
Finance Association to see a shift from dollars to euros among central banks
indeed:
WASHINGTON (Reuters) - Former Federal Reserve
Chairman Alan Greenspan said on Thursday that both private investors and
central banks were shifting away from the U.S. dollar and toward the euro.
"We're beginning to see some move from the dollar to the euro, both from
the private sector ... but also from monetary authorities and central
banks," END.
Well,
seems Greenspan is right:
U.A.E. Central Bank Is Selling Dollars, Buying Euros
Dec. 27 (Bloomberg) –
The
United Arab Emirates will convert 8 percent of its foreign-exchange reserves
to euros from dollars before September after the U.S. currency slumped this
year, the country's central bank governor said.
The
U.A.E. has started ``in a limited way'' to sell part of its dollar reserves,
Sultan Bin Nasser al-Suwaidi said in an interview in Abu Dhabi on Dec. 24.
``We will accumulate euros each time the market appears to dip,'' as part of
a plan to expand the country's holding of euros to 10 percent of the total
from 2 percent today, he said.
The
Gulf state is among oil producers including Iran, Venezuela and Indonesia,
looking to shift their currency reserves into euros or sell their oil, which
is currently priced in dollars, in the 12-nation currency. END.
The
simple truth is that gold protects against a declining dollar, the central
bank of QATAR figured it out already:
Qatar Triples Gold Reserves to Protect Against Dollar
2007-03-15 04:19 (New York)
March
15 (Bloomberg) -- Qatar tripled its gold reserves in January from the
previous month to protect against a weakening dollar. Qatar joins oil
producers including Iran, Venezuela, Indonesia and the United Arab Emirates,
looking to shift their currency reserves out of dollars or sell their oil,
currently priced in dollars, in euros…END.
One
month later Qatar's gold reserves were expanded even further:
Qatar gold reserves up more than fivefold in Jan-Feb
Qatar
central bank gold holdings rose more than fivefold during January and
February, central bank data showed, even though gold prices only climbed 4.5
percent during the same period. Gulf Arab oil and gas producer Qatar, which
said last year it wanted to diversify its foreign exchange reserves away from
the dollar.
Qatar
pegs its currency to the dollar, which declined about 10 percent against the
euro last year. That helped spur Qatari inflation to 11.83 percent last year,
the highest rate on record. END.
So
there it is, a peg to the dollar spurs unwanted inflation so how to deal with
it? Well, what about de-linking de dollar? It seems that this is the way to
proceed indeed for many:
KUWAIT DOLLAR KUWAIT GIVES UP DOLLAR PEG
date: 20 05, 2007
KUWAIT,
MAY 20 (BNA) - The Kuwaiti dinars Exchange rate against the US$ will be based
on a basket of major currencies as of today, the government has decided. The
decline in the exchange rate of the dollar against most major currencies,
which coincided with the move to link the dinar to it on January 5, 2003 had
a negative impact on the countrys economy, he said. The central bank has not
managed to reduce the effects of the decline which has brought down the value
of the Kuwaiti Dinar against major currencies, except the dollar, he added.
He said this had contributed to a rise in inflation. END.
Syria dumps dollar peg
Tuesday, June 05 – 2007
Syria
has become the second Middle East nation to de-peg from the ailing US dollar,
Bloomberg reports. Syria's currency will instead be linked to a broad range
of currencies starting mid-July, according to Syria's Central Bank. The
dollar slid 10% in 2007 and central banks worldwide are increasingly looking
to diversify their forex reserves to other currencies. END.
U.A.E. May Be Next to End Dollar Peg
June
5 (Bloomberg) -- The United Arab Emirates may be the next Middle Eastern
country to stop pegging its exchange rate to the U.S. dollar, according to
trading in currency forwards. The second-largest Arab economy may follow
Syria and Kuwait, which both said in the past two weeks that they would dump
the dollar peg to curb rising import costs and inflation
END.
Last
week the FED reported that foreign central banks were net sellers of US debt
indeed what resulted in the 10 year Treasury note yield to jump to its
highest level since mid July:
Foreign central banks net sellers of U.S. debt-Fed
Thu Jun 7, 2007 4:30pm
NEW
YORK, June 7 (Reuters) - Foreign central banks were net sellers of U.S.
Treasuries last week, Federal Reserve data showed on Thursday. END.
Now
what kind of implication you think a US treasuries sell off would have? Sure
enough rates will go up and inflation fears will kick in:
Wall Street plunges on inflationary pressures
NEW
YORK, June 7 (Xinhua) -- Wall Street plunged Thursday on inflationary
pressures as bond yields rose.
Worries
on inflation was stirred as the U.S. Labor Department said Wednesday unit
labor costs rose at higher-than-expected 1.8 percent in the first quarter
while the European Central Bank lifted its key interest rate 4 percent.
The
yield on the benchmark 10-year Treasury note jumped to 5.13 percent, hitting
its highest points since mid-July. END.
As
said above the fact that rates are rising now is being touted by the bears as
the death knell for gold. The argument goes that rising rates makes the
dollar more attractive for investors thereby supporting the dollar's
strength. A stronger dollar translates itself into lower gold prices they
say. Although this might sound logical it is totally wrong. Just think about
it for a moment. What is the primary reason for selling US bonds? The answer
is simple, investors dump bonds because they are concerned that the yield
being offered does not compensate for the expected loss in buying power of
the dollar (inflation). This lowers the price and drives up the yield. The
chart below tells it all:
So
if this is all so bearish for the dollar then why is the dollar heading
higher lately you wonder?
Well,
the thing is that no market goes up or down in a straight line and neither
does the dollar. Since the dollar is subject to heavy short selling it can
recover every now and then upon short cover rallies which takes the dollar
back to its 200 dma again. The
overall trend remains down, see chart below:
So
we should be a bit patient here in order to see the dollar's current bear
market rally running into exhaustion before it will resume its downward path.
An inevitable dollar panic sell-off seems not to be far away once the dollar
breaches its long-term support at 80 to the downside.
A
dollar losing another 20-30% of its current value would launch the price of
gold into new all time highs ($850+)..
A
lower dollar supporting higher gold prices is a view supported by ABNAMRO
Bank, they reported lately:
ABNAMRO sees strong gold prices in 2007 and 2008
LONDON
- Prices of key precious metals will surge this year and next because of
contracting mine supply, an expected decline in the dollar and lower sales by
Europe's central banks, ABN-AMRO said on Thursday.
Average
gold prices were likely to jump to $695 an ounce in the current year and to
$740 in 2008 from $604 last year, it said in its latest Global Mining report.
Supporting
themes were a dollar weakness, positive supply-demand fundamentals
underpinned by constrained mine supply, demand growth, geopolitical tensions
and the fact that signatories to the European gold agreement were unlikely to
meet their full 500 tonnes a year allocated gold sales, it said. END.
John
Embry of Sprott Asset management is a bit more optimistic, he said in his May
submission for Investor's Digest:
John Embry: Expect a try for a new gold record by year end.
The
fundamentals for gold are strengthening on an almost daily basis and are
inexorably underwriting a sharp upward move in the price in the very near
future. The fact that the price explosion has not occurred as rapidly as
logic would dictate is a testament to the power of the central banks and
their accomplices, the large bullion banks. However, the price is moving
higher despite their best efforts, and a multi year high, exceeding the peek
in May 2006 could be expect shortly, to be followed by an assault on the all
time highs (US$ 850) before year end. END.
JP
Morgan seems to share the view of new all time highs in the medium term:
Gold may touch $1000: JP Morgan
Bloomberg / Mumbai June 08, 2007
Gold
may rise to more than $1,000 an ounce as demand from India, China and
exchange traded funds increases and production of precious metal falls,
according to JP Morgan Chase & Co., the third-largest US bank.
Gold,
which has risen 5.2 per cent this year, may reach $850 an ounce in the
"medium term,'' on the way to $1,000, analysts from JP Morgan led by
John Bridges said in the report dated June 6. They didn't specify what the
medium term was. END.
Now
please don't think that the investment case for gold is build upon a crashing
dollar only since many other critical drivers for gold are pointing towards
much higher gold prices as well indeed. Yes, inflation, supply and demand are
all contributing to higher gold prices as well and last but not least when
investors figure out that central banks only own half the amount of gold they
say they own then gold could explode to the upside towards levels hard to
imagine today. In the end this might be the strongest driver for gold since
there is no way to return the central bank's leased gold to its vaults
without launching the gold price into a 4 digit number. We will shine a light
on this subject in a separate essay in which we will deal with GATA's view
that says the central banks only own half of the gold they say they have. If
GATA will be proven right then gold prices could soar to a few thousand
dollar per ounce indeed.
You
get the picture? Gold's fundamentals are strong and are pointing towards gold
prices exceeding the $1000 mark with ease before the end of this decade. Now
what do you think your junior gold shares will be worth by then? Please
remember that the biggest moves in gold mining shares in the seventies
occurred in the 78/79 period. It's my strong believe we will be witnessing a
strong run in gold mining shares once investors realize that gold is on its
way towards new all time highs indeed so we might need to be a bit patient
here. Nevertheless times like these do provide excellent 'BUY' opportunities
since one could load up on many high quality junior gold mining shares almost
for free. At the Gold Discovery Letter we do track promising junior companies
which we believe could be huge winners before this decade is out. If you
would like to participate you could opt for a free trial subscription (one
month) HERE
Next
chapters will deal with inflation, supply, demand and monetary role. (for
subscribers only)
Please
feel free to send comments to:
ehommelberg@golddrivers.com
Stay tuned,
Best Regards,
Eric Hommelberg
Editor, the Gold Discovery Letter, the Gold Drivers
Report
www.golddrivers.com
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