Gold Reaches One Month Low

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Good news everyone. Gold has reached a one-month low. In fact, February gold futures on Comex fell the most in six weeks. They tumbled four percent on the day, down US$34.

This is very good news. It means you will have a chance to buy gold at lower prices before it goes up higher later this year. Much higher, in fact, according to the 2009 forecast made by Diggers and Drillers editor Al Robinson. Look for Al’s special gold forecast issue later today in your in box.

Not everyone agrees that gold is going higher, mind you. “The deflationary scenario is still incredibly intact, even though the government has thrown trillions of dollars at it,” one Leonard Kaplan told Bloomberg. Kaplan is the president of Prospector Asset Management in Evanston, Illinois. “Gold has a long ways to go down,” he added.

Daloob. Seriously daloob. Daloob is a word that means whatever you’d like.

But what does it mean to say that the deflationary scenario is “incredibly” intact? Does this mean that the scenario is “not credible?” Or does it mean the scenario explains and predicts what’s ahead? The statement is incredibly opaque.

Either way, the deflationary scenario that Kaplan refers to is worth a few lines. The scenario is one where commodity and stock prices fall as the credit depression gets its hands around the neck of the economy and squeezes. Under that scenario, gold would fall. And under that scenario, the cost of paying off debts would rise massively as cash gained value. Old debts would become economy-killing burdens for households, businesses, and, dare we say it, governments too.

In fact, the real economic consequences from this kind deflation are so destructive that we would bet our left big toe that the Federal Reserve is going to do everything in its power (and perhaps some things not in its power) to prevent it. It’s not a risky bet. The Fed is firmly moving down the path to monetary weirdness. We are well and truly down the rabbit hole in 2009.

In the meantime, falling commodities prices are telling you that the forecast for the economy in 2009 is not good. Gold, oil, metals, and grains all moved down yesterday while the U.S. dollar moved up. It will be worth watching if commodity shares follow commodity prices down. Commodity shares, as we know all too well, were decimated in 2008.

But based on some analysis from our old friend Dr. Marc Faber in his latest Gloom, Boom, Doom report, commodities as an asset class are about the only stocks actually in a similar position to where stocks found themselves in 1987. That is, while the entire market was savaged last year, commodities may be the only sector worth taking a punt on in 2009, based on Dr. Faber’s analysis of previous bull and bear cycles in various asset classes.

What cycles? Faber says that the length of the cycle immediately preceding a correction or crash has a lot to do with what you can expect next. “If an up-cycle was brief,” he writes, “the down-cycle is also likely to be brief. If the up-cycle lasted a very long time and was accompanied by huge excesses, the downturn from the peak of such a cycle is likely to be lengthy-as was the case for gold after 1980, and for the Nikkei and the Japanese economy post-1990. Similarly, if a down-cycle lasted a long time (20-30 years), the up-cycle is also likely to last for an extended period of time.”

The bull market in commodities began in 1999 and was preceded by an infamous 20-year bear market. Equities, on the other hand, enjoyed an 18-year bull market from 1982 to 2000, but have been in a bear market since then (with a robust, credit-induced bear market rally from 2003 to 2007).

By that logic, the down-cycle in equities should be a lot longer because the up-cycle preceding it lasted so long. On the other hand, the down-cycle in commodities should be shorter because it was preceded by a much shorter up-cycle and a very long down-cycle. Stocks down. Commodities up. Got it?

But is it right? The reasoning makes sense, especially if you compare it with the historic numbers Dr. Faber presents (which we will not replicate here for the sake of space). But there is a simple objection that must be dealt with. What if the commodities cycle is itself a function of an even larger cycle, namely the credit cycle?

If you argue that the bull market in credit began in 1973 and a world of floating exchange rates and competitive currency devaluations (or 1913 when the Federal Reserve was founded, or 1694 if we want to go all the way back to the Bank of England again), then the direction of asset prices would be dictated by whether credit was in an up-cycle or down-cycle.

It’s pretty safe to say that credit appears to be in a down-cycle, starting in August of 2007. What’s more, it was preceded by a massive “up-cycle” in which the supply of money and credit grew globally. That “up-cycle” drove up all assets in all countries simultaneously. We will find out this year if another “up-cycle” can be artificially by Obama and Bernanke.

But if we are now in the “down-cycle” for credit-the Credit Depression-then how can commodities possibly outperform equities and rally while stocks fall?

Well, the only possible way for commodities to go up in price during a credit depression when global economic activity shrinks…is if we experience massive, central-bank backed money printing and the inflation that ensues. Not that this is an outcome we find desirable. But it’s clear as day from the Fed’s actions and words that it will produce inflation at any cost to prevent being crushed by debt and deflation. For all its real wealth destruction, the Fed appears to prefer hyperinflation to credit depression.

And don’t worry that the Fed is out of interest rate bullets in its pursuit of reinflating the credit bubble. There are other weapons. It will mail checks directly to people or buy assets directly on stock markets. You can expect the debt-to-GDP ratio in the United States to approach and exceed 100% before Obama’s first term is over. You can also expect to see more direct government asset purchases and intervention in markets.

How can we be so sure that we’re on the verge of a brave new world of government-managed markets and economies? It’s simple. Central banks and national governments the world over face an existential crisis-the loss of public confidence in paper money. Action must be taken to restore confidence or real economic activity (lending, borrowing, spending, and investing) will grind to a halt.

Perversely, the monetary authorities will destroy public confidence completely through massive inflation. It will also unleash a great deal of social and political disorder. But the authorities appear to prefer this chaotic result (which they can then police and manage with new rules) to another Great Depression characterised by too little money and price deflation. The excesses of the credit bubble will not be liquidated. Instead, they will be perpetuated and subsidised. The resulting economic and social disorder will be met with more State activity in your personal and economic life.

All of this is a long way of explaining why the current lull in the gold price is a great buying opportunity. You know the tactics and strategy of the central bankers. And you have a pretty good idea that any rally in the stock market is a fake out rally, not sustainable based on the economic forecast OR previous cycles (where markets are coming off 20-years of rising prices). What you don’t know is if gold prices are going to fall further before eventually heading higher.

To find the answer to that, you can consult 1974. At that time, stock markets looked oversold and gold had begun to move and was on the verge of a correction. “If someone really felt that the similarities between the 1974 low and the current market conditions are overwhelming,” Dr. Faber adds, “he should consider purchasing gold and oil rather than U.S. equities (and also shorting U.S. bonds)…Gold corrected between the end of 1974 and the summer of 1976 by 40%, while the stock market surged. But from its August 1976 low, the gold price increased eight-fold.”

“If we are really in an environment such as we were in at the 1974 lows (and I have serious reservations about this assumption), then we should expect some further weakness in gold prices when equities rebound. Such weakness would then provide an excellent buying opportunity.”

“However, keep in mind that even if you bought gold at its 1974 high at US$196 per ounce, by 1980 you would still have quadrupled your money, which was far better than the return the stock market provided. So even if you endorse the view that we are in a similar situation as in 1974, I would be reluctant to stay out of the gold market entirely in the hope of buying it at lower prices.”

“Another reason why gold may not sell off as much as it did between 1974 and 1976 is that governments’ interventions with monetary and fiscal measures around the world are unprecedented. ..Therefore, based on my time/cycle analysis above, commodities and commodity-related shares would also seem to be in a far more favourable position to resume their up-trend than broad U.S. equity indices, which (a sharp rebound aside) are unlikely to enter a sustained longer-term bull market.”

If Faber is right, what will it mean for Australia’s broad equity indices? Well, you’d expect them to go higher as commodity prices react to the increase in global money supply. It certainly seems like most of the deleveraging is done in commodity stocks, meaning it would take something monstrous for mining shares to retest the 2003 lows.

Monsters are real though, so we can’t completely discount the possibility that 2009 will be worse for resource shares than 2008. However, one needn’t be a raging bull on Aussie resource stocks to see that the case for gold looks good. It’s distressing that gold looks so good because the outlook for the economy is so bad. More on that tomorrow.

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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11 Comments on "Gold Reaches One Month Low"

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Pete
Guest

A very good read Dan, thank you very much

Nic
Guest

Dan, thanks for another good post on the golden topic.

As a small scale retail investor, how do we increase our exposure to Gold? As far as I’m aware of, the cheaper option would be to buy (1) Gold Companies (eg. ASX:LGL, etc. ), (2) Buy the Gold ETF (ASX:GOLD) or (3) CFD Contracts on Gold Futures (eg. CMC Markets)

What other methods would you recommend retail investors to use to acquire a position in Gold?

Many thanks and keep up the good work!

Greg Atkinson
Guest
Dan, since the ASX 200/All Ords are basically driven my miners and banks you can safely say the Australian stock market will be slave to world economic events. I suspect commodities have a little more pain to go through as the Chinese and others. make BHP and RIO pay for charging outrageous prices for iron ore etc. over the last few years. We will then go though the usual cycle where mining project are canceled (as they are now) and supply is cut back until demand picks up and mining companies scramble to build capacity again. As for gold, it… Read more »
Pete
Guest

Gold and oil are so much different Greg. Also I believe the proportion of gold use as materials/jewelry is quite low – i am pretty sure it is under 20%.

Thing is, gold is a fear resource – when people get scared of inflation or financial uncertainty, they go to gold. Fear is such a strong emotional force that it is doubtless that gold demand will increase if inflation or uncertainty are upon us.

Greg Atkinson
Guest

Pete…jewelry is actually the biggest consumer of gold, much bigger than investment. In 2008 around 2400 Tonnes for jewelery and around 650 Tonnes for investments..although some of the jewelry could be classed as an investment I guess. All the data is on the world gold council website.

Bron Suchecki
Guest

Nic, I would also suggest Perth Mint Gold (ASX:ZAUWBA) which has a lower management fee than GOLD (0.15% compared to 0.39%) and allows you to take delivery of physical if need be.

Unfortunately for Australian investors, the fall in the USD gold price has been matched somewhat by a fall in the AUD/USD, so the AUD gold price is holding above $1200. Now if it would only go below $1000.

Pete
Guest

Sorry Greg, I must have got it wrong about current supply. What I was thinking was more along the lines of total gold in existence – being that it can still be traded aswell.

Something like this:
http://www.fgmr.com/gold.htm

But I do stand corrected on above and will be interested to see what happens if jewelry demand shrinks.

I also found this article and the comments interesting:
http://seekingalpha.com/article/87383-the-case-for-gold-today

Cheers

Andrew
Guest

While gold continues to slide in US dollars, we holders here are thankful we possess at least some of the yellow stuff. In New Zealand dollar terms, gold is more expensive to buy now than at it’s high in March. I will always see gold as a protector of value first rather than an investment. I think this is holding true.

Pete
Guest

I did post a reply with an apology Greg, but it is awaiting moderation. I expect it to come through sometime late April

Greg Atkinson
Guest
Pete…No need for any apology. There is a lot of misunderstanding about gold just as there was (is) about what moves oil prices. I have been looking into gold prices now for a few weeks and every thing seems quite complicated. The latest demand data I have been able to find indicates that demand for jewelry is falling, I actually saw a comment that the demand in the U.S has collapsed. In addition gold prices are at historical highs against mining costs, i.e. the margins for gold miners are high. So to keep prices high we need the demand to… Read more »
Andy
Guest

Great analysis and some “golden” points presented. I like gold as an inflation hedge and a portfolio diversifcation play.

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