Wednesday, December 28, 2005

Gold To $1,300 - Schmidt.



Ned W. Schmidt,CFA,CEBS


Moneyization: The global financial phenomenon of individuals and businesses moving their funds to monies in which they have the highest confidence, or money in which they have a higher store of faith.

Or, Thoughts on Journalists & Gold

One can not help be regularly disappointed with the popular media. The business media, however, should be a step above the norm, as they should largely be reporting facts. Unfortunately, journalists feel compelled to filter the news through the sieves they consider brains. Business Week has historically been above average, but even they often cross the line from journalistic reporting to immature financial forecasting. Recently the SPECIAL DOUBLE ISSUE of Business Week arrived in the mail. Headline: Where to invest in 2006. Really exciting stuff was the implication. Like the occasional recipe, it turned out a dud.

Perhaps the lengthy discussion of the meaning of Gold and Silver prices at their current lofty levels was missed. Some journalist, with a serious investment knowledge deficiency, was allowed to write a few words on Gold. Here is the sum total of what I could find that Business Week allowed to be written on Gold in this SPECIAL DOUBLE ISSUE:

"Skepticism abounds over the sustainability of current prices, the highest in two decades. Given the runup, a pullback is a strong possibility - and some say it may be smart to make purchases if gold falls below $450. Still, don't bank on the $800-an-ounce record set 25 years ago, and keep in mind that prices fell below $300 during the 1990s."(Weber,2005,p.123)

There you have it folks, the research is done and you can sell your positions. A journalist, acting in the role of amateur investment analyst, has decided your Gold investments are futile. Bear in mind also that a few issues before this same publisher of journalistic business research recounted the glories of Google. Well one of them, Google or Gold, is going to fall below $300. In fact, one of them is going to fall by $300. And Gold is not the likely candidate!

Journalists and many investment professionals do not understand that the critical issue in this era is not growth versus value, inflation, or Google. Gold's price rising to cycle highs in so many national monies is the manifestation of the moneyization process. Investors around the world are moving to the money, Gold, in which they have the highest faith. The value of national monies is the issue of this era. Gold's price rise indicates investors around the world are turning away from existing artificial national monies.

The issue for the U.S. is not the growth rate of GDP, but rather whether or not a set of economic conditions have been put in place that will ultimately result in the global repudiation of the U.S. dollar as a reserve currency. On the more immediate horizon is the Euro, unhampered by an unmanageable current account deficit, which will rise in value relative to the U.S. dollar far higher than any expect. Further out will rise the Chinese renminbi, carried higher by real economic progress. The issue for the U.S. is the secular decline in the importance of the dollar.

Gold is regaining a leading role as a monetary store of faith as the Federal Reserve has demonstrated both an unwillingness and an inability to properly manage the U.S. economy. The world is shifting from the fiction of paper money to the reality of Gold. Government money is in general being divested. Given the U.S. Mortgage Debt Bubble and the Global Liquidity Bubble, $1300 Gold and a $3 Euro are likely. The CNBC daily reports will be simple, "The U.S. dollar bought even less today than it did yesterday. Canadian dollar did not trade today on foreign exchange markets."

$Gold trading at cycle highs carries a far greater message than many commentators realize. The dollar price of Gold gives us the Gold price of a dollar, and likewise for any other national money. Simply take one(1) and divide by the dollar price of Gold. That calculation, the price of the dollar in terms of Gold, for the past 24+ years is plotted in the First Graph. The U.S. dollar is trading at a 24+ year low. That is reality, not conjecture. All the discussion of illusionary productivity gains, the internet wonder, Miscrosoft, Google, or any of the other fantasies of the Street does not erase the fact that the U.S. dollar has now traded at the lowest level in more than two decades. That is moneyization. The world is moving out of dollars. Gold trading at a cycle high is an indication of the global nature of the move out of government monies and into real money.

What this Business Week writer and so many other misguided individuals in the popular business media are missing are the developments shown by the relationship plotted in the First and Second Graphs. In the Second Graph is plotted the ratio of $Gold to the S&P 500 at year end. While 2005 is not yet in the history book, relative values are likely to change little in the next few days. As many of us know, this ratio turned up in 2000 and gave a major long-term buy signal in 2001. A rising ratio means $Gold is performing better than paper equities. Similar set of events occurred in the 1970's, signaling the beginning of the last bull market cycle in Gold. One would think that a picture is something a journalist could understand, but they have to make an effort to find the picture or talk to someone other than the "paper peddlers" on Wall Street and at mutual funds.

This analysis provides the basis for two important activities, value estimates and trend confirmation. If we use the average value of the ratio plotted in the Second Graph, estimated values for $Gold and the S&P 500 can be created. If the average ratio and today's value for the S&P 500 are used, $Gold should be at US$1,533, or 204% above the current level. If today's value for $Gold is used, the S&P 500 should be at 417, down 67% from the current level. Reality will be somewhere in between. However the message is clear, buy $Gold and sell U.S. paper stocks.

The Third Graph portrays only the most recent experience. The circles are the ratios plotted in the previous graph. Note the long-term buy signal that was given when the ratio rose above the moving average at the end of 2001, when $Gold was less than $300. Second, the ratio has risen to a new cycle high. This action is a technical signal that confirms the uptrend. When the price of an asset, $Gold in this case, moves to an absolute high we want the relative measure to confirm that move. The ratio of $Gold to the S&P 500 is confirming the uptrend in $Gold's absolute price. Third, the ratio rising in 2005 means that Gold has again outperformed paper assets.

$Gold investors, capitalizing on these trends, have an important ally in their pursuit of profits. The Federal Reserve, by mismanaging monetary policy for nearly two decades, has created $500 Gold. Fortunately for $Gold investors, President Bush is making an equally inept appointment, Ben Bernanke, to serve as the next Chairman of the Federal Reserve System. Dollar denominated investors that have moved to Gold and those foreign investors that have shifted assets out of dollar investments will be well served by the new chairman.

Bernanke's baggage includes both his Delusion and his Illusion as well as his fear of the last Depression. The Delusion contends that the U.S. current account deficit is not the consequence of bad monetary policy. Rather, that deficit is the fault of other countries not also pursuing a consumption binge. If consumers in foreign countries would also spend more than their income as is the case in the U.S., the U.S. deficit could be filled. In short, two economic wrongs would combine to make one economic right.

The Bernanke Illusion is that if monetary policy was managed based on a measure of inflation an economy in equilibrium would be the consequence. Unfortunately, the measures of inflation created by the U.S. government border on the nonsensical. No private company would be permitted to issue such misleading statistics. That aside, this concept of inflation targeting looks fine on a two dimensional classroom blackboard. The real world is not a chalkboard. Monetary policy based on this "inflation rule" is the equivalent of driving your car with a speedometer measuring in bushels rather than miles per hour. $Gold investors will be rewarded with profits by investing in real money, not by following chalk dust illusions.

Monetary policy, based on the Chairman's desire to please political forces and the Street, has been generally unwise. That, however, has been how U.S. monetary policy has been determined for two decades. Continuing that approach, the Federal Reserve recently announced the intended suspension of the data release on a broad measure of the U.S. money supply, M-3. The European Central Bank(ECB) takes a different view of the matter, and recently raised rates as a consequence of money supply growth.

"The ECB is fretting because broad money[M-3] is growing at an annual rate of 8.5 per cent , compared with the 4.5 per cent reference level it thinks is consistent with medium term price stability. . . . But the ECB's devotion to monetary analysis puts it in a league of its own among central banks across the world."(Atkins & Giles,2005,p.17)

The differences in these approaches is worth noting. The ECB thinks "printing" too much money is a policy error on the part of the central bank. Excessive money creation would likely will lead to price increases and a reduction in the purchasing power of the Euro. Then we have the Federal Reserve which does not believe that even reporting complete money supply data is a worthwhile effort. The ECB pays attention to how many Euros exist in the world. The Federal Reserve sets policy based on using interest rates, easy money, to hype one part of the economy or another. In the future, monetary policy will be based on the chalkboard theories of a new chairman. Little doubt exist that with these different approaches that the U.S. dollar is set for further depreciation.

Our Fourth Graph considers the recent action in $Gold. Policy mistakes, of years past and yet to come, and a structural trade deficit mean that the long-term bear market for the U.S. dollar continues without interference. Well-positioned investors will benefit from policy ineptness at the Federal Reserve as far as one can see into the future. Investors denominated in U.S. dollars need to move in a timely fashion into Gold. Waiting till $Gold is trading well above $1,300 will be too late. As shown in the Fourth Graph, $Gold has been moving toward another important buy signal. This week's rally will likely be followed by a down leg into that signal. Dollar denominated investors need be prepared.

Canadian investors have a strong imperative for investing in Gold. First, the future for the Canadian dollar is inextricably linked to the fate of the U.S. dollar. North America is a single economic boat. We are all in it together. When a boat sinks, the whole boat sinks. Second, the rally of recent years in the value of the Canadian dollar versus the U.S. dollar creates a rare opportunity for especially timely purchases of Gold. Do not let the paper money illusion keep you from making wise long-term investments. As the Fifth Graph portrays, CN$Gold may also, after this week's rally, work itself into another important buy point.


Atkins, R. & Giles, C.(2005,November 29). Trichet's test: In raising rates he must weigh the risk to tentative recovery. Financial Times,p.17.

Weber, J.(2005, December 26). Hedging against inflation. Business Week, p.123.


Ned W. Schmidt, CFA,CEBS

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December 28, 2005