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GOLD -- How High?

Well, as expected, the Fed cut rates again today and Gold took off while the dollar fell.

Bernanke cut rates on December 11th, followed it up with a emergency cut last week, and then a new one today. Holy cow! Sure seems like someone is running scared, as cuts are becomming quite a common occurrence. I even believe we may see another emergency cut before March 18th. Stay tuned...

So, with all the recent rate cuts, what's happening w/regard to our economy and what are the expected consequences for gold?

Let me try to keep this simple and find a good starting point:

If you've been keeping an eye on the Gold and Silver Market over the last couple of years, you're probably well aware of the fact that precious metals (PM) are exploding in price, but (like many) maybe you don't really understand the PM market, or recognize the reasons why we're seeing the rapid price increases.

Well, in an attempt to help you understand what is transpiring, I'll provide a few of the reasons for the price explosion below:

  • The US Housing bubble has finally burst and is expected to get much worse

  • Our financial/banking system offloaded too much toxic paper (mortgage backed securities and derivatives of such) to foreigners/investors who have been burned badly & are not happy about it.

  • Banking system write-downs have been massive thus far and it is expected to get worse.

  • Credit markets are locked up and mortgage lending standards have tightened dramatically; the negative consequences are expected to cross over to auto loans, credit cards, etc later this year

  • Fed Chairman Bernanke and the PPT team (led by Treasury Secretary Paulson -- previously CEO of Goldman Sachs and a Treasury "Plant") have panicked and have sacrificed the dollar in an attempt to bail out our financial/banking systems -- Lowering rates 125 b.p. in just 8 days, at a time when the dollar is at its weakest point in history, should be proof enough of their priorities/loyalties.

  • Deflation is on the horizon and therefore the Fed will make every attempt to INFLATE (print more money and inject it into the system -- continuing to devalue our currency)

  • Foreign dollar holders are working to diversify their holdings -- among other things, in different currencies, commodities, energy & gold

  • 43 of the world's largest stock indexes, from around the globe, have officially entered "Bear" Territory in early 2008

  • There is wide-scale pressure afloat to price oil in currencies other than the depreciating US Dollar.

  • OPEC nations are seriously discussing the need to de-peg their currencies from the dollar, as inflation internal to their domestic economies has been raging out of control

  • Investors are fleeing volatile markets and are seeking security in gold

Now, I'm not saying that we won't encounter a volatile ride w/gold, as we will most likely experience wide swings in the future--some up and some down (maybe even a down-swing back into the low $800's in the not so distant future), but overall I believe the mid-to-long term trend is Up, Up, Up!

Ok, if the long-term trend is up, just how high can the gold price go?

Well, based on the 1980 high of ~ $850, today's > $920 price is a new "nominal" dollar denominated high, but if you were to adjust for government published inflation figures, gold would need to be > $2,200oz to equate to the $850oz, 1980 price.

Additionally, as I've told you before, our governments published inflation stats have been understated for many years, and if the true rate of inflation were to be used in the calculation process (using the same metrics from the early 80's - metrics that have changed dramatically since -- to severely understate inflation), Gold would need to be priced ~ $5,000oz to equate the $850 purchasing power of 1980.

Looked at another way: Gold was $35 oz back in 1971 and soared to ~ $850 in 1980 ($850/35=24.2) -- so it increased in price by a factor of 24. Now, if we were to select the bottom of the last Gold bear market in 2001 and multiply $250oz by the same factor of 24, the potential upside target of $6,000oz is not unrealistic -- if the same stag-flationary environment were to return (which many predict will happen).

With all that now said, I believe the fundamentals of today's economy are much worse than those in the 70's, as back in the day we were a net exporting country, had a strong manufacturing base, had a positive national savings rate, and very little debt. Today foreigners are holding > $4.4 Trillion of our dollars, we have a $9+ Trillion dollar debt load, are running extensive trade deficits ever year, and have > $60 Trillion in un-funded future obligations.

Bottom line: I feel this Gold bull market is still in its early stages. When gold finally breaks the $1,200 mark, common investors will most likely wake up and the gold market will be flooded with new dollars. Eventually, the gold market will become a bubble itself and when that happens, it may be time to cash out.

Hold on to your hat because it's going to be a very interesting and wild ride...

Regards

 

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