"You can never really know about these things," said a guest at our beach shack on Saturday night. Our friend runs an investment fund, mostly family money and mostly following a macro-economic analysis.
"There is clearly a bubble in liquidity. But when they are throwing a big party like this you don't like to miss it. We pulled out of Russia too early. We could have made a lot more money by sticking around a bit longer. Now, we're in Chinese stocks, oil, and tourism. And cash. We've increased our cash to 25%. We're definitely worried that this thing is going to come to an end. And when it does, those Chinese stocks will take a beating. But we don't invest for the short term. We're looking 10 years ahead. And what we see 10 years ahead is higher prices on Chinese shares, higher energy prices, and a real boom in tourism in many places.
"Have you seen what is going on in Costa Rica? The place is booming. People are paying huge amounts of money for resort properties. And the same thing is happening in Panama. A place like this would cost millions in California...and almost that much in Panama or Costa Rica. Here in Nicaragua it is still very early in the cycle. The same piece of property that you can buy here for $100,000 would cost your $400,000 or $500,000 in Costa Rica.
"But let's get back to the macro situation. We're 25% in cash, as I said. The trouble is, we're worried about cash too. We hold our cash in dollars, just like everyone else. It's the safest, surest currency around. And we presume that when the liquidity bubble pops, the price of financial assets will go down. Which means, that the value of the dollar - to an investor - must go up.
"But remember, it's all relative. If we lose some money in a credit meltdown, we won't be the only ones. And if we lose less than other investors, we're winners. Because we'll be in a better position to buy back some of those financial assets at distressed prices.
"The trouble with moving into cash, generally, is that you have to worry about the cash too. I mean, there's nothing sure about the dollar either. We could suffer a big loss from the dollar itself...against other currencies or against consumer prices. So we don't like to go too far into cash.
"You probably go into gold. We don't. Gold has been a terrible investment for most of our adult lives. Besides, we just don't know anything about it."
Our friend was right about gold. It was a terrible investment for most of our adult lives. But the thing about gold that makes it a terrible investment most of the time makes it an exceptionally good one occasionally. One of those occasions happened in the last five years of the 1970s. The price of gold rose from the low $40s to over $800. Gold was reacting...then over-reacting to the consumer price inflation of the '60s and '70s.
Now, gold is reacting again. But to what? There is very little consumer price inflation, and yet the yellow stuff has more than doubled in price since the beginning of the long war against terrorism. Last year, it rose nearly 20% against dollars. This year, you could have already made more from gold than you could have from an entire year's worth of return on Treasury bonds.
We guess that gold is reacting to the inflation of ASSET prices, not consumer prices. And we guess that the trend still has a ways to go. As we keep pointing out, the worldwide money supply has been going up about 10% per year for the last 10 years. That's about three times as fast as the supply of the goods and services the money is used to buy. So far, consumer prices haven't been much affected, because the money has gone into investments, not into the cost of goods produced. That is subject to change, of course. Consumer price inflation could increase - which would drive up the price of gold.
But there is another potential outcome...an asset price collapse. And if the price of stocks, bonds, property and Andy Warhol paintings goes down, what happens to gold?
We don't know. Gold may soar - as people seek shelter from collapsing asset prices. Or, it may wobble too...or even go down. But the price of gold is still low, compared to other financial assets. It has gone up...but not yet reached a frenzy. Even sophisticated investors, like our friends in Nicaragua, do not own it...yet. In a meltdown, typically the things that go down the most are the things that went up the most. Gold is still below its peak set 27 years ago...while almost everything else is setting records.
GoldMoney's James Turk echoes our sentiment, saying, "Because the future is unknowable and markets are therefore unpredictable, nobody knows, but I don't think gold will be stopped at $715. There is just too much buying power coming into the market to stop it. There are just too many reasons to buy gold, number one of which is the tremendous volume of new dollars being created by the Federal Reserve aimed at flooding the economy with 'liquidity'.
"All this so-called liquidity does is add to the mountain of debt and debase the purchasing power of the dollar with inflation. It's therefore no wonder that the CRB Continuing Index made a new all-time record high this past Friday, closing at 412.90, which is a 17.5% gain from one year ago.
"With the CRB at a new all-time record high, it seems to me that it won't be too long now before gold also reaches a new record high. So while gold may stop for a breather at $715, I expect this level to soon be exceeded."
Remember, it's all relative. Gold has performed well, but only in the last few years. Our guess is that it will perform spectacularly well when this liquidity bubble finally pops - and reaction turns to overreaction.
Bill Bonner
The Daily Reckoning Australia
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About the Author
Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
Comment by Navin Sinha on 27 February 2007:
I do not feel that gold is going to cross 715 USD per ounce in this rally sing it hasent yet given a 50%retracenent level.As weare aware that before a market goes for some historic rally then enerally it gives atleast 50%retracement.So i would at least expect gold to come once to 475 level once and then peoceed for 1000$ rally which may be expected to be seen in January 2009.AS per 2007 is concerned i feel that gold will proceed for new highs at the end of the year and the ultimate high that we can expect this year is 7% more than the previous years high.This is because as per my study i am expecting the other metal family like Copper,Zinc,Aluminium,Nickel,Tin,Silver all to fall terrifically in 2007.Henceforth if these happens then there are chances that gold will be underpressure since this will effect the asian markets too which is expected to fall as per the downfall of copper which will be effecting the construction and the production sectors.
Analysing the market with the help of gyan theory we can also see that the market has not yet given a 50%retracement and historically when the market went for this secondary rally then it first gave a retracement of 50% then proceeded for the historic high.The 50%retracement level is coming anyway below 475$.
Visiualising these factors i feel that in the long term gold is extremely bullish but for a buy entry one should wait till the end of 2007.
Comment by Roert Cassidy on 27 February 2007:
The laggard relative price of
gold is understandable.
The central banks are stuck with a multi trillion dollar horde of increasingly risky T-bond reserves . They slow the exchange value erosion by periodically "lending" gold to bullion banks - with instructions to DUMP - This clandestine practice has been effective -but will prove to be unsustainable !