HEADLINE from 8 Sep 2004:
Hurricane Frances should be a good lesson for people, and perhaps one that investors might remember. Nothing created by mere human beings can accurately predict a storm, change its direction, or mitigate its wrath. Forgetting those lessons should only be done with ready acceptance of the associated risks. Nature is stronger than mankind, and does what it does without consideration of human efforts.
In our human world, global financial and goods markets exist. In the United States the Federal Reserve is run by individuals that believe they are smarter and faster than global markets. Their actions, they believe, can forecast accurately, contain, and control world financial markets. They may learn that "Mother Nature" is more powerful, but only after the damage is done.
Across the sea, the Euro is building mass. Behind it will soon be a bigger economy with more people than the United States. Their current account surplus will need to be invested. The day when Euro denominated individuals cease humbling themselves to the U.S. dollar is on the calendar, though we may not know that date. Europe's cash will ultimately be an important influence on the denomination of international financial assets in the years to come. The dollar will no longer be dominant, but have a shared roll. This coming monetary tidal wave will wash away dollar holders in a not unprecedented manner. (Weather and water metaphors just come out this week.)
The gurus on Bay and Wall Street talk about the vitality of U.S. growth and the absolute importance of the U.S. economy and financial markets to the world. They contend that the U.S. economy and the dollar will remain supreme. A hundred years ago, they would have made the same argument for the British economy and the pound. They have forgotten that "Mother Nature" dictates whether or not the electricity is on, not computer models in their offices or at the Federal Reserve.
Canadian politicians and pseudo flag wavers, and in Mexico, dither over the idea of a North American currency union. Recent strength in the Canadian dollar has relieved the pressure on these myopic monetarists. A symbiotic relationship requires that the primary host remain healthy. When the U.S. economy pays the price for the Federal Reserve's bubble approach to managing the economy, the Canadian situation will not look so good.
Canadian investors should ask themselves an important question. When the Euro is worth US$3.00, what will the Canadian dollar be worth in Euros? Focus on the true matters, not the market noise.
Before talking about fundamentals let us turn to one of the better rules of technical analysis. A problem with using computers is one no longer becomes intimate with the data. In the days when we plotted on paper, the analysts developed an awareness of the data in a special way. Each point had to be put on the chart by hand. Relationships, and especially the way they developed, just seemed more real. An analyst came to meaningful understand what was happening.
That fairly reliable rule dealt with attaching the next sheet of graph paper. When the analyst got to the edge of the graph paper, another had to be taped to it. The direction in which one affixed the next sheet of graph paper was a fairly reliable indicator of the future trend, or direction, of a market. May sound simplistic, but a wet thumb does tell one from which direction the wind is coming just as well as expensive meteorological equipment.
In the First Graph we are approaching perhaps the need to attach another sheet of graph paper. That chart covers the last fifteen years of monthly US$ Gold. Should we see the need to attach the "next page" at the top, a fairly strong indication of the future direction of Gold will be given. Besides, "breaking out" to the upside on a fifteen-year chart would seem to convince even the most skeptical of observers.
Patience, though, seems reasonable. Many may be anxious that Gold has retreated from the high, and seems to be without a trend. Breaking out into new territory is not easily done. With no overhead resistance evident in this fifteen-year history of trading, moving into that higher territory is likely. Immediate gratification does not happen in markets. Have a little patience, your reward for moving out of paper assets and into Gold is on the horizon.
Recent market weakness is in part due to the U.S. dollar performing better. Of course too, many market participants trade under the delusion that they can predict the future for the U.S. economy, the European economy and the price of oil. The second graph shows the cumulative change in the official holdings of U.S. government debt since the middle of May, and each bar represents a weekly plot. Since mid-May, foreign central banks have purchased almost a hundred billion dollars of U.S. debt.
That is a massive ticket, almost one quarter of the U.S. government annual deficit. Little wonder the dollar has had a little strength. If one does not own Gold, a bet is being made that these purchases by foreign investors will continue indefinitely. That wager is like assuming that the storm will never come ashore in your direction.
As discussed in our last article though, these accumulations build up. The value of this burden is rising to a level that is excessive. Too much supply will result in the value, or Gold price, of that debt being pushed down by the markets. That can be accomplished only by an increase in the dollar price of Gold. (Readers not familiar with previous article should read it for a complete understanding of this phenomenon.)
One of the old college jokes is about the difference between research and plagiarism. Plagiarism is taking material from another author. Research takes ideas from more than one source. For the fourth graph we are indebted to articles by Martin Wolf in The Financial Times. Martin is unique in that he is one of the few journalists that actually understands the subject about which he writes. He has a new book out on globalization which is recommended for those that want a fuller understanding of the matter.
Portrayed in third graph is the ratio of the value of U.S. imports to the value of exports. If the ratio is rising, the nation's level of imports is rising faster than it exports. Yes, that is the pesky trade deficit about which we worry. Note that in the early part of the graph the line moved in a lateral pattern. U.S. imports and exports were moving in conjunction with each other.
Then the ratio rose in the 1990s. The good time era of the Greenspan Stock Market Bubble prosperity created a taste for imported goods. That false prosperity caused imports to begin an era of a serious imbalance with exports. The ratio then turned flat far a while. After the stock market corrected for the Federal Reserve's hubris, a recession developed. The ability of the former rich to import fancy goods faltered. The Fed, apparently worried about the economies of the rest of the world, lowered rates. In the latter part of the graph the ratio is again rising, and foreign producers were saved. A Housing and Mortgage Bubble is financing again the importation of massive amounts of goods.
Make sure before going on that you understand two of the implications of this ratio. First is that U.S. consumption is above the country's productive capacity. Those excessive purchases are now financed by borrowing from foreign investors. Should the Federal Reserve be forced to finance them, that inflation all have been anticipating will occur.
Second, that imports are rising faster than exports means the U.S. dollar is over valued. That means that Gold is under valued. The U.S. dollar, during this period, has been able to buy too much Gold. This concept of the dollar over valued implying Gold undervalued is a concept more have come to recognize. As an investor, this concept if fundamental to your understanding.
Two other factors are also at work here. Space does not permit an extensive discussion. A structural problem has developed as bubble economics caused the dollar to be over valued. Production moved offshore to counter this disadvantage. A second matter is the importation of oil at higher prices. For you see, under the Fed's view of the world the U.S. does not need to drill for oil as technology and the internet will provide. This author is still waiting for gasoline to come out of the internet connection.
The fourth graph brings this concept together with the price of Gold. Shortly after the ratio passed upward through about 1.2 the price of Gold bottomed. Around the world, markets recognized the over valuation of the U.S. dollar, as indicated by a low price for Gold. The ratio's long-term rise is an indication that the U.S. dollar is still over priced, and that Gold is under priced. As we have been finding in our research, the only indicator not suggesting that the Gold Super Cycle is still well on track is the inflation numbers put out by the government. We all have our opinion on that matter so no comments are required.
A factor which should give Gold investors further encouragement is that despite the rise in the dollar price of Gold, the ratio has not been meaningfully reversed. High oil prices are certainly part of this condition. Competition in the future for resources around the world is not going to be materially reduced in the decade to come. Does anyone really believe China and India will consume fewer resources 3 or 5 or 8 or 10 years from now? What oil prices do in anyone week is nothing more than statistical noise.
Note also that this rising ratio has been dragging Gold out and upward to the recent fifteen year high. Fundamentals are driving the Gold price, and will drive it higher. Remember that this process is really the U.S. dollar being devalued. Do not let the analysts on Bay and Wall streets, most of which don't know a fundamental from a rubber duck, keep you from reducing your exposure to paper assets and adding to Gold and Silver holdings. When that financial advisor whips out those color charts on asset allocation, look for the Gold recommendation. If no Gold or Silver is included in a meaningful manner, and we do not mean some pitiful five percent or so, simply look them in the face and say, "That is nuts."(Obviously, this author would use another adjective.)
For whatever the true reason, our intermediate indicators for Gold, as shown in the last graph, and Silver seem to be moving toward buy signals. Short term measures gave buy signals on both last week. An important time to buy Gold and Silver may be approaching, and hopefully you are ready to do so. When Gold is trading for more than US$1,200, will you be sitting on profits or still reading brokerage reports on technology stocks?