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A Different Time #2

HEADLINE from 2011:

Montreal: City politicians, titans of finance and some of the best names in Montreal gathered today for the final trade at the world famous, global internet site known for trading Gold. They were there to witness the last trade to be executed, the final one for the liquidation of the U.S. Gold supply. Acting under orders from the IMF, the U.S. Gold hoard had been sold to pay off external dollar liabilities. When asked what now, Big "Buddy" Bullion, the retiring head trader, replied, "Some of us have got together to buy Guatemala. Told it will make a great golf course. Dollar gone, what fun can trading Gold be?"

In the last article was discussed how this era seems to be a different one for Gold. Readers not familiar with that article should review it in the archives of one of your favorite web sites. This writing is intended as a follow on to that one. Before proceeding, thanks for all the e-mails sent. We may not have gotten to respond to each but all were read.

Each investment era is different, as most well know. What worked two years ago today would sometimes seem to be the only thing not trading up in the last week. Every dog has a rabbit except the one you hunted with last time. That the constantly evolving investment scene is one of the greatest frustrations or greatest sources of wisdom is something each investor must determine.

That all said, some themes are timeless. Value investing seems to work over almost any sufficiently long measurement cycles. Growth stock investing has never been successful except for short periods at the end of market cycles. No reputable, and refereed, study of the stock market, or markets, has found contrary to these statements.

That reality is one of the three reasons that Gold investors should continue to look forward to a profitable future. Fair value for Gold is about US$525 today. What that means is since today Gold's price is below that value, it is under valued. In U.S. dollars, as well as Canadian, Gold is worth more. Using consistent methodology suggests a long-term value in today's dollars in excess of $1,200.

Yes, the numbers do seem to be going up. Four years ago when writing "$1,235 GOLD," our first major report on Gold, most people were worried about getting above US$300. Now though it seems a continuous flow of forecasts, each greater than the last, is required of writers. US$5,000 seems to be the top guestimate now, but surely that will be beaten by some prognosticator. Ever wonder where those numbers come from? Don't ask.

The second reason for interest in Gold is the fundamentals. Central banks, the Federal Reserve in the U.S., can be relied on to make Gold more valuable. Central banks just cannot avoid "fine tuning" the economy to avoid the economic repercussions of "external shocks." Someone at the central bank always has a good reason to clip a little metal off the coins.

Arguing about the existence of a Housing/Mortgage Bubble is probably not productive. The Fed says no bubble, and some of us say yes there is. Some of us said that a stock market bubble existed a few years ago. The Fed said one could not tell from looking at it. Time will tell, as they say. A housing bubble bursting will not be something well hidden.

Given the success of the Federal Reserve in the stock market, one must have to go with the bubble school of thought. With somewhere between 50% and 70% of new condominium sales in Florida being done by speculators, reality may be different from the predictions of the Fed's econometric models. Do you want to be holding U.S., or Canadian, dollars or stocks when the U.S. housing bubble bursts? Would you rather be holding some of that "non-productive" Gold or Silver? Which do you prefer, being uninsured or insured, somewhat, against the possibility, however slim, of the Federal Reserve being wrong?

Many believe that the Gold market may have been manipulated in previous years. Perhaps they are right, cause little doubt exists that governments try to manipulate the economy. In the U.S. that means multiple deficits, a fiscal deficit and a trade deficit. Both of these exist to hype the economy so that the manipulators, politicians, can retain their jobs. We have witnessed stock market manipulation, housing mortgage manipulation, currency manipulation and media manipulation. Every time these efforts have failed, so that if Gold is being manipulated that effort will fail. Ultimately, markets have more power than any government employee.

One of the manifestations of that economic manipulation, euphemistically called policy, is the tremendous amount of money owed by the United States to foreign investors. The first graph, from our previous article, portrays the magnitude of that debt. The solid line is the value of the U.S. government debt owned by foreign investors. That line uses the left axis, and the data comes from the reports of the U.S. Treasury. The triangles are the monthly average price of U.S.$Gold. The strong correlation between the two is readily apparent.

As we noted in our discussion of that graph, the magnitude of the U.S. debt to the world seems to be pulling Gold along with it. The market is reflecting in Gold's dollar price the excessive amount of U.S. debt being dumped on foreign investors. Many have been waiting for foreign investors to indicate that enough of this paper is owned, and to cease buying. The markets seem though to be ahead of the rationalities and the analysis.

The reasons for this close association should be understood. Markets reflect the collective wisdom of all participants. Prices already reflect the information that is readily available. The markets for dollars and Gold already know the financial calamity that is possible, so prices already discount part of the problem through devaluation of the dollar.

When we wrote the last article we suggested that data like in the first graph could be used to determine if an opportunity exists in the Gold market. In the second graph and third graphs we have taken such data and used it to identify strategic times to enter the Gold market. One of those times seems to be at hand.

In the second graph is plotted the amount of U.S. government held by foreign investors, but denominated in Gold. Each month the amount of U.S. government debt held by foreigners is divided by the U.S. dollar price of Gold. That data is plotted using a solid line and the left axis. The triangles are the monthly price of U.S.$Gold.

As is apparent, in terms of Gold the value of U.S. debt is at an extreme, similar to during the late 1990s. The value of U.S. debt in terms of Gold is too high. The Gold price of U.S. debt is too high again. This means that the dollar price of Gold is too low. In the last sixteen years, the Gold price of foreign held U.S. debt has only been this high one, shortly before Gold bottomed and started the run to over US$400.

Make sure the relationship being viewed here is understood. The left-hand scale is the value of all the U.S. government debt held by foreigners in terms of Gold ounces. In terms of Gold, that U.S. debt is being over valued. To correct this situation either the debt goes down or the number of ounces of Gold it commands must go down. The only way the latter can occur is by the dollar price of Gold rising.

Apparently the market does not like the Gold value of foreign held U.S. debt to exceed 4.5 billion ounces. Those points in the price of Gold are indicated by rectangles with diagonals. You can find one just before the bottom in 1999. The second occurred recently. We should note also that some indicators may give only buy or sell signals. This measure gives only conditional "buy" signals, and as such is suitable for strategic moves not trading. Such indicators suggest that the preconditions are in place for a move, not the moment the move will start.

Why are these levels important? The answer to that question we will never know. Markets determine their own price levels based on supply and demand. Too much supply causes prices to decline. The market has before decided that at this level, or Gold value, the debt is over priced. The supply of debt is excessive. To correct this over supply the price of debt, in Gold, must come down. That happens by each ounce of Gold being worth more dollars so that when the value of the debt is divided by the price of Gold that ratio goes down. This process reduces the value of the dollar. Each dollar buys less Gold.

What we know is that at this level the market has simply said that the value of the dollar and the amount of dollars held by foreign investors are out of equilibrium. In the 1990s the disequilibrium was caused by too low a dollar price of Gold. This year the disequilibrium is due to too many dollars being held relative to the price of Gold. Harmony in the market can only be reestablished by a higher dollar value for Gold.

In the third graph we look at this situation in another way. Here the Gold value of the monthly U.S. trade deficit is plotted using a solid line, and the left axis. Each month the U.S. trade deficit is divided by the dollar price of Gold and plotted. The triangles are the monthly price of Gold in U.S. dollars. Think of what is being plotted here as a flow of dollars. In the previous graph the concept being observed was a stock, or balance, concept.

Apparently the markets do not like a flow of dollars that exceeds the equivalent of 120 million ounces of Gold. Those times when that level has been breached are marked with rectangles with diagonal lines. When the flow exceeds that level, the market feels a compulsion to devalue the dollar. This devaluation takes the shape of a higher dollar price of Gold.

As can be observed in the graph this situation has only occurred about three times in the last sixteen years. The 2002 experience we are counting as one. In the first two of those the price of Gold went on to move higher. Recently the Gold value of the U.S. trade deficit exceeded the critical level, as shown in the graph. On this measure too we are seeing signs that the dollar is over valued and Gold in U.S. dollars is under valued. If one has missed the last two opportunities perhaps now is the time to start making your strategic shift to Gold from paper assets.

Before moving on a word about the indicators at which we have looked. Remember that these type of indicators are strategic in nature. They do not give you the day and the hour to buy. What they tell you is that in general conditions are favorable for a strategic shift to Gold.

In both of these measures, one a stock of dollars and one a flow of dollars, the relationships suggest that either the dollar price of Gold is going up or the mountain of U.S. debt held by foreigners is going to go down. By not owning Gold an investor is saying that the mass of U.S. debt is simply going to quietly go away. If that is the case, one should buy Google. If on the other hand, one believes that the correct message is that the dollar price of Gold is the side of the equation that will adjust, then a strategic shift from dollar denominated paper assets to Gold is appropriate.

After making a strategic decision to shift to Gold one must start making tactical decisions. When to buy becomes the question. Generally one should look for days when the traders and peddlers are looking elsewhere. These days come and go, but generally exhibit some selling pressure on price. Buying on weakness is the key, not on days when every mouse-clicking, hedge fund manager feels a compulsion to buy Gold. Our work, as shown in the final graph, suggests that price conditions for implementing tactical purchases may soon again appear.

To what else is our attention turning? Is the Patriot Act the economic equivalent of Smoot-Hawley of 1930? Given that financial globalization is what trade was to the 20th century, that possibility exists. When will the Canadian dollar cease to exist as an independent currency? Nothing is forever. What about the Australian and New Zealand currencies? When do they go the way of the winds? A lot of things to think about around the world. And all of them are single bricks in the road to the Gold Super Cycle.

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