HEADLINE from 2011:
Occasionally one particular question arises. What could change the future financial environment in such a way as to prevent the Gold Super Cycle from unfolding? The easiest answer would be to dismiss the question by replying simply that nothing foreseeable could prevent the Gold Super Cycle from developing.
Such a response is not fair to the asker of the question.
Gold's, as we will review later, drivers are the heavy weights that have pushed, and are pushing, the dollar into a long term bear market. This situation is similar to what the British pound has been experiencing since the first shots of World War One. The first of those weights is the debt of the U.S. to foreign investors. Second, is the arrival of the Euro on the international financial scene. The Euro will sit on the dollar like the racoon on a dog in water, till the dog succumbs. That latter development we will discuss at a later time.
Some of us have been waiting for inflation to revive for such a long time that the odds of our sixth grade girlfriend calling now seem greater. Perhaps the real manipulation of this era is that of the construction of the inflation indices. Yet Gold has done particularly well since some of the central banks determined that shooting themselves in the foot was not a wise idea. That the CPI actually measures inflation will be accepted here if for no other reason than it is followed popularly. Most of us recognize that whatever it does measure, it is not inflation. And besides, the calculation of the CPI keeps economists off the streets where they might cause serious trouble.
The first graph, cleverly titled "First Graph," portrays the record of U.S.$ Gold and U.S. inflation for about the past eight years. A casual review of that picture would suggest that in the early period whatever forces were pushing down inflation were probably doing likewise to the price of Gold. Few would argue with that view.
In the latter part of the picture, a different set of circumstances exists. U.S. inflation, as measured by the CPI, continued to march downward. However, Gold spent most of that latter part of the graph rising in dollar price. Thus if one had been right on inflation in the early period, one would have been right on Gold. In the latter period if one had been right on inflation, one would have been wrong on Gold.
Most modern "Gold Bugs" have come to realize that the risk to the financial system is not current inflation but the boatloads of green, paper dollars being sent abroad to foreign producers. Those manufacturers have happily filled and returned those boats with cars, petroleum, DVD players and a host of things, all of which are far more desirable than green pieces of paper. A nice group of people those producers, though one must wonder about their financial acumen.
Sooner or later, apparently much later than most of us forecast, these foreign producers, investors and central banks will say that the cup is full. Foreign currency markets though have already started to make the price adjustment necessary to accommodate this financial imbalance. The U.S. dollar peaked more than two years ago, and has been falling in value since then. That Euro, which so many forecast as a certain disaster, has rallied strongly. Gold, a mirror reflection of the dollar's value, has risen in price.
So often market prices begin to reflect economic reality before major sellers step forth. Such is the reason that most investors find themselves selling after the market has topped. Many stock traders still today do not understand that the U.S. equity market peaked a long time ago. Realization that the market has already turned is often elusive. In short, smart money moves first. The smart money has been already moved, and is moving, out of the dollar. Central bankers are not smart money, as they have proved so often.
Before going too much further though, some final comments on inflation might be wise. The record of inflation, again as measured by the CPI, can be used to create some buy and sell signals. These signals have then been applied to the line for U.S.$ Gold in the second graph. Yes, your observation is correct. As is readily evident, these signals, in the more recent era, have been giving the wrong answer.
Inflation is not the source of a problem. Inflation is the manifestation of a problem. Inflation develops after a period of monetary excess. The focus on inflation as a driver for Gold, while so right for so long, has been less than optimal. The correct focus has been on the U.S. trade deficit, the ascendency of the Euro and foreign exchange markets discounting the future.
The dollar has topped, but yet the holders of U.S. debt paper continue to hold. Perhaps they are listening to their economic advisors. Central banks will certainly sell later rather than earlier. They are not the bell for which so many have been waiting to ring. The point is that the foreign exchange market has already turned against the dollar, and the central banks will be sellers long after the damage has mostly been done. Central bankers are not any smarter than traders of technology stocks, as the old saying goes about putting on one's pants.
As mentioned earlier, the focus on the fountain of debt into which the U.S. economy has evolved has been a correct shift for Gold Bugs. Remaining mired in the inflation school has not been productive. The same is true for the deflation school. That deflation school was correctly positioned after the collapse in Japan, but has since also been out of phase. In short, inflation in the U.S. will be a consequence of economic events rather than a creator of events. Though likely is that has always been the case.
In the third graph is a plot of the cumulative trade deficit of the U.S. and the US$ Gold price. Here we see the reverse of the situation observed with inflation. Following the trade situation would have led to the wrong conclusion on Gold in the early period. In the latter period a close relationship has developed between the spewing into the market of the vast amounts of dollars and the value of those dollars. The price of Gold is simply the mirror reflection of the dollar's value. A massive trade deficit does eventually push down the value of the currency and push up the price of Gold in that currency.
The fourth graph takes a look at the accumulation of those U.S. debts in the hands of foreign investors. As this is simply the collection of green paper from all those monthly trade deficits the pattern is similar to that which we have just looked. The massive size of this debt though cannot be dismissed as likely to be resolved by a "rosy" scenario, as so many hope. Debt bubbles are never resolved in a desirable manner.
The markets have already started the adjustment process. Depreciation of the dollar is already evident in the US$ price of Gold. Waiting for the foreign investors to sell has, as is evident in the graph, caused so many investors to be late to the Gold market. Dollar-based investors, those in particular in North America, should be accumulating Gold as an offensive investment during the early stages of this ongoing depreciation of the dollar. The issue remains not if to own Gold, but rather when to buy it.
That data in the last two graphs can give us some insights into the time to wisely buy Gold, on a strategic basis. Such information will have to await till another writing, or the August newsletter. A set of circumstance seems to be coming together to create another major opportunity in US$ Gold. The months ahead may offer one of those rare opportunities to move from paper stocks into Gold that should not be ignored.
Now, back to our original question. The Gold Super Cycle is built on the Dollar Debt Bubble now existing in the hands of foreign investors. As all bubbles have burst, how this Dollar Debt Bubble bursts is the only issue. Two choices exist, and neither is the rosy scenario. No bubble in financial history has ever had a rosy resolution.
Choice one is a massive devaluation of the dollar which shrinks both the trade deficit and the debt pile to manageable proportions. All devaluations have been associated with high inflation, high interest rates and massive recession, as in the case of Argentina. The U.S. voters do not seem likely to willingly accept any discomfort in their lives, especially if it might deny them SUVs or palatial homes.
The second choice is that the Federal Reserve creates a recession large enough to turn the trade deficit into a trade surplus. That surplus would be then used to pay off the foreign debts. The required size of this recession is so large as to be second only to the Great Depression. Not much chance of this choice being voluntarily chosen by the Federal Reserve. Therefore, until such time as an economic resolution of the U.S. Debt Bubble occurs, the dollar will go down and Gold will go up.
That Gold investors seem to be destined to participate in a Gold Super Cycle remains the reasonable expectation. Only the earthly manifestation of the Good Fairy would seem to stand in the way. Fortunately for Gold investors we have the Federal Reserve rather than a Good Fairy in charge of monetary affairs. Strategically, Gold should be in portfolios. The only remaining decisions are the times to buy Gold, a tactical matter. Just remember to buy on dips, and watch on days of enthusiasm. And on all days keep remembering the Gold Super Cycle now unfolding that will carry to well over US$1,200!.