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VOLATILITY IS BACK!
But is the long bear market over?
Watching
stocks, gold, and silver, the cross currents, whipsaws, and apparent
contradictions could confuse anybody. I wanted to bring everything
together into one article to try to make some sense out of it. Maybe
that way we can get some inkling of where things are headed. -- FS
CONSPIRACY? WHAT
CONSPIRACY?
Over the last four years a
very rare situation has ruled the gold market: the gold carry
trade.
Bullion banks have made
gold loans available at a one-percent interest rates or less.
These bullion banks don’t own the gold themselves, they only act as
middlemen. They borrow gold from some central bank, loan it to a
mining company, and the mining company sells it forward.
The big money hedge funds
caught on, and began to exploit gold for a “carry trade” just as they
had exploited the Yen. They borrow gold at very low rates (as they
borrowed Yen in Japan at less than 1%), sell it, and invest the
proceeds in stocks, Treasury bonds, or whatever.
Success always begets
excess. As long as the price of gold
didn’t – or couldn’t -- rise, it was free money – just back
up the truck. Would you like for your bank to loan you money at
one- percent interest? Could you have made any money in the last two
or three years with loans like that? (For more about the alleged
conspiracy to hold down gold’s price, see “Conspiracy in the gold
market?” on my website, <http:www.the-moneychanger.com>.
Only one thing could prick
the gold carry trade bubble: a flash rise in the price of gold.
OUT OF THE BLUE
Late on Sunday, September
26, 1999 fifteen European central banks startled the world by
announcing that for the next five years, they would limit their gold
sales to 2,000 tons (400 tonnes per year). The agreement contained
even more meat. The banks also imposed a moratorium on gold
lending. The flood of central bank gold that had kept the gold
market floating on supply suddenly dried clean up. This unexpected
news stunned the gold market, and set off a rally that reached for
$340. The gloomy cloud of central bank sales and lending which for
so long had threatened the gold price suddenly lifted.
TUG OF WAR
Since then we have
witnessed a tug of war between two powerful forces – the colluders
and the market.. We believe that the market will ultimately
win, and that means much higher gold prices.
Time is working against
the conspirators. The gold carry trade bubble stimulated a frenzy of
gold borrowing that has left an estimated 10,000-ton short
position overhanging the market. That’s over four times the total
average production from all the world’s mines in the last decade!
Meanwhile world gold
demand is rising. Not only jewellery demand but also
investment demand rose last year. On February 17 the World Gold
Council announced that in 1999 gold demand rose by more than a fifth
to a new record. Demand rose 566.2 tonnes to 3,278.4 tonnes, 21%
above 1998. Investment demand increased 7% year to year, thanks in
part to a beginning recovery in Asia.)
Don’t forget – investment
demand is the “swing component” of total demand. It appears from
nowhere and dramatically changes gold’s supply-demand dynamics – and
the price.
In 1980 gold hit $850 and
silver hit $52. The secret to that explosion in silver price lay in
the preceding price suppression.
For years governments had
been suppressing gold’s price to an unrealistic $35 an ounce and
silver to $1.29 – while they inflated their paper currencies
sky-high. When investment demand finally blew the lid off late in
1979, the sky was the limit for gold and silver.
CONSPIRACY IS NOT ENOUGH
Suppressing a price only
guarantees one thing. When the price eventually breaks free, the
pendulum will swing far, far past equilibrium. From $35 an ounce when
the game started, gold rose 2,428% by 1980. From $1.29 an
ounce, silver rose 4,031%. Today, when the colluders lose
control of the price, gold will snap up again (taking silver with it,
by the way).
[SUSAN: INDENT THIS
PARAGRAPH] But conspiracy suspicions alone – even from a market
that smells as much like mackerel as gold does today – are not
enough reason to make an investment. Prudence requires other forceful
reasons.
OTHER GROUNDS
Outside
the gold market, two other important forces are working
to push gold up. First, the trend is shifting from paper assets to
hard assets. Second, the stock market has blown up to the most
colossal – and fragile -- bubble in American history.
COMMODITIES REBOUND
Not point by point and day
by day, but as a general trend, commodities tend to rise together.
After nearly two decades (19 years) of falling, commodity markets
appear to have turned around. Without doubt politics drives some of
these markets (oil, platinum, palladium) as much as economics. Still
these uptrends may point to returning inflation and an
all-determining shift of money and investment attention from paper
assets to hard assets.
From a double bottom in
January and July last year, the Commodity Research Bureau (CRB) index
has risen about 15% (from 185 to about 215 today);
Base metals are up
strongly;
Oil has tripled in
the past year;
Platinum saw $573 in
February (up from opening 2000 at $433), and
Palladium shot up over
$816.80 in February, up from $438.10 when 2000 began.
Why are only gold and
silver lagging? It just doesn’t make sense. We have
never seen anything like this. Platinum and palladium roar through
bull markets while gold and silver flat-line. That’s another witness
that implies collusion to suppress the price. It also offers us an
advance warning that they’ll probably rise.
STOCKS & BONDS
I can hardly find words to
describe the present stock market. It’s like watching a basketball
game in slow motion – you’ve seen the basketball shoot up into the
air; now you’re just waiting for it to come back down.
While it is possible that narrow averages may
yet see higher peaks, how can they sustain such high levels without
the broader market participating?
·
On the New York Stock Exchange, 78% of the listed issues
are trading below their 200-day moving averages – that’s right, over
three-fourths of the stocks are in a bear market.
·
Of All NASDAQ stocks, 51% were off 40% in 1999.
·
Out of NASDAQ’s 4,845 stocks, 65 stocks (1.37%)
generated almost all its gains last year.
·
Market breadth has also turned bearish. The
advance/decline line has been heading down since it peaked in April
1998 (not 1999, but 1998).
Dow Theory already
says the market has turned.
·
The Transports failed to confirm the January new high in
the Industrials.
·
When the Industrials average broke 10,000, it posted a
new low (since October), confirming the downtrend in the
Transports.
·
Don’t underestimate the psychological punch of breaking
through 10,000. It damages confidence just when stocks need it most.
Does it make any sense to buy Dow or S&P 500
stocks when they pay a measly 1.35% dividend? Why would anybody
prefer those equities over much safer treasury bonds that pay
5%? An investment that yields only 1.35% will take 55.4 years to pay
itself off! Who’s going to wait that long to get his money back?
Nobody. Stock buyers are all
gambling that the price of their stock will rise. Only old
fossils still care about dividends.
WHEN THE BUBBLE BURSTS
By just about any measure, the stock market
is a bubble, like the gold market in early ‘80. People don’t
expect stocks to repay their investment through dividends, they expect
them to pay off through price increases in share value. Once that
gambler’s confidence breaks, a massive investor purging will begin.
It won’t stop until all the excesses have been flushed out of the
market. As the old market proverb says,
“In a bear market, money returns to its
rightful owner.”
Merely to return to normal
historical valuation, the Dow Jones Industrial average would have to
drop to 2500 –3000. Today’s airy heights overvalue stocks about 75%.
NOT EVEN THE EXPERTS
BELIEVE
When the bear takes hold
of a market, it will give back 50 to 95% of its bull market high. I
won’t even bother to calculate the Dow’s price reduced 95% from
its 11,722.98 high. After an 18-year bull run in stocks, you probably
couldn’t picture it anyway. It would sound absurd. (That’s why
people ride losing investments so stubbornly to the bottom. They made
money with them once, so they can’t believe the trend has
changed.)
The inevitable collapse
after a bubble always sounds absurd -- before it
happens. Not even the experts are immune to bubble fever. Let them
speak for themselves:
·
“The
poorhouse is vanishing from among us. Given a chance to go forward
with the policies of the last 8 years, we shall soon… be in sight of
the day when poverty will be banished from this nation. ” --
Republican presidential candidate Herbert Hoover, 1928
·
“The
election of Hoover … should result in continued prosperity for 1929.”
– Roger W. Babson, American financial statistician,
9/17/1928
·
“The market
is following natural laws of economics and there is no reason why both
prosperity and the market should not continue for years at this high
level or even higher.” – Thomas C. Shotwell, “Wall Street
Analysis,” 1929 World Almanac
·
Stocks have
reached what looks like a permanently high plateau. – Irving
Fisher, Yale Economics Professor,
10/17/1929
In August 1929, the Dow
hit an all time high at 381.17. On October 24, 1929 the panic
struck. Five days later, on 10/29/29, the Dow posted 230.07, a 39%
drop. Even after that terrible warning, the experts still refused to
believe that their casino had closed forever:
·
“I
see no cause for alarm.” -- J.J. Bernet, Chesapeake & Ohio Railway
president,
10/25/1929
·
“There
will be no repetition of the break of yesterday … I have no fear of
another comparable decline.” – Arthur W. Loasby, Equitable Trust
Co. president,
10/25/1929
·
“This is the
time to buy stocks. This is the time to recall the words of the late
J.P. Morgan that any man who is bearish on the
United States will
go broke. Within a few days there is likely to be a bear panic rather
than a bull panic. Many of the low prices as a result of this
hysterical selling are not likely to be reached again in many years.”
-- R.W. McNeel, McNeel Financial Service,
10/30/1929
·
“The end of
the decline of the Stock Market will . . . probably not be long, only
a few days at most.” -- Irving Fisher,
10/14/1929
·
“FINANCIAL
STORM DEFINITELY PASSED.” -- Bernard Baruch, American financier
and presidential economic advisor, in a cablegram to Winston
Churchill,
10/15/1929.
At the bear market low
in July 1932, the Dow reached 41.22, a staggering 89% loss of value.
But those who practised
“buy & hold” survived and prospered, right? Sorry, those who
bought and hold lost and kept on losing for more than a
quarter of a century. After the October 1929 crash the Dow took
twenty-five years and one month to reach its nominal 1929 level.
Meantime inflation had wreaked havoc on the dollar. Adjusted for
inflation, the Dow didn’t recover 1929 levels until sometime in the
1960s.
This is not to say that stocks are always a bad investment, any
more than gold and silver are always a good investment. You
have to stay tuned to the dominant trend, or as the Wall Street
proverb says, “The trend is your friend.” Most of all, you have to
watch and keep on watching for a change of trend, where the
really big profits are made.
THE TREND SHIFTS:
PAPER ASSETS vs. HARD ASSETS
I watch one trend indicator of my own very
closely: the Dow in Gold Dollars (DiG$). Every day I convert
the price of the Dow into gold dollars (about one-twentieth of
an ounce). That enables me to compare the price of the Dow from the
19th century right up to the today’s close, measuring with an
unchanging standard of value.
As long as that DiG$ graph rises – more and
more ounces of gold are needed to buy the Dow – then the trend favors
paper assets. However, when the graph turns down – when fewer and
fewer ounces of gold are needed to buy the Dow – then the trend has
turned in gold’s favor.
On August 25, 1999 the Dow in Gold
Dollars peaked at G$925.42.
Since then, the trend has been down.
Recently it completed a secondary and lower peak, confirming
that downtrend. Today it’s trading in the neighborhood of G$700.00,
down more than 25%. Would newspapers and the FNN talking heads be
howling if the Dow had dropped over 25% against the paper
dollar? You bet. When the Dow drops 25% against gold, do they
holler? Ne’er a word.
WHERE WILL THEY RUN?
If panic breaks out in the
stock market, where will investors run? Every panic is a race to
safety, and nothing is as safe as cash. Today, investors
will probably run first to United States treasury bonds or notes.
After all, their professors and politicians have taught them that
“gold is a barbarous relic.”
It is even possible that
at first a stock market crash might drive gold and silver
down. Since 1980 a floodtide of new financial products and
derivatives have appeared which are billed as “safe havens.”
But in truth, even the
mighty US bond market offers no safe haven. Today foreigners own
nearly 40% of US government debt. Foreign-owned money also sits in
the stock market. If foreigners pull money out of stocks, that could
drive the US dollar down. Those foreigners holding US bonds won’t
take that sitting down. They’ll sell bonds, stepping up pressure on
the dollar. As the Federal Reserve tries to defend the dollar with
higher interest rates and investors try to run into bonds, we could
see terrifying whipsaws in all financial instruments.
But in the end, all
paper assets are derivatives. Worth nothing in themselves, they
derive their value from some underlying obligation or
business. Unlike paper money, stocks, and bonds, gold and silver are
the only financial assets that are not at the same time somebody
else’s liability. They are valuable not because they pay interest or
a dividend, but because people want them for safety. Gold and silver
are the ultimate cash.
There’s more. Compared to
the global markets for currencies, US debt, or equities, the metals
markets are thin and tiny. Far less than one percent of US
retirement funds are invested in gold and silver. If only a little
bit of that scared money runs into precious metals, it will drive
prices up powerfully – overnight.
DRAWBACKS & UNCERTAINTIES
If making good investment
decisions were easy, every one of would be sitting on the Riviera,
soaking up the rays and puffing on Havanas. It’s hard every
day to peer through the dust and judge events rightly, especially at
critical market junctures when fundamental trends are shifting. You
always have to weigh the pros against the cons.
Technically today both the
Dow and the S&P 500 look sick. The S&P shows a triple top and strong
downtrend. The Dow has broken to a new low below 10,000. Nothing in
their daily, weekly, or monthly charts suggests anything but “Get
out.”
Gold and silver are more
uncertain. Gold remains in an uptrend as long as it holds above
$286. The daily chart is a nail-biter, but the weekly and monthly
charts plainly show that gold has strongly broken out of its four year
down trend.
Silver’s daily chart shows
yet another disappointing breakdown to $5.00, but the weekly chart
clears up the mystery. Silver is working out a long, rising
flat-topped triangle. Around $5.80 there are big and determined
sellers. However, every time silver bounces down off $5.80, it
doesn’t bounce quite so far. Around $5.00 there is an equally
determined set of buyers. At some point the sellers will run out of
$5.80 silver, and the race will start.
I’m no fortune teller, no
seer, and certainly no prophet. I just point out the facts and draw
my own conclusions. In the end you have to judge for yourself.
You make the decisions, so you have to live with the
consequences. But for my part, I think gold and silver are looking
forward to their best years in a long, long time.
Can you continue to ignore
the warnings and believe a “new era” of permanent prosperity has
arrived? Ask your grandfather.
-- F. Sanders
P.S. In physical gold,
wholesalers expected big liquidations of gold and silver that had been
bought for Y2K. Many Y2K buyers were investing in gold and silver for
the first time, without understanding exactly the rationale for owning
metals as a financial and monetary hedge. Once Y2K passed, they sold
coins in amounts large enough to drive down their premiums, but not
large enough to affect the world market.
That’s bad news for
sellers, but good news for buyers. All gold coins (including
fractionals) now cost less relative to the benchmark spot gold or
silver price. Once the market digests these Y2K liquidations, expect
premiums to rise again.
We do not recommend
that you sell gold or silver right now. However, if you absolutely
must sell, please let us help you. If you bought from us, you
probably qualify for a lower commission rate when you sell.
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