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NED SCHMIDT:
The Case for $1,245 Gold
Ned Schmidt calls
himself a “financial engineer,” and explains that financial
engineering is the use of creative financial analysis and models for
making financial decisions. Employing value oriented investment
management with a world-wide scope, Ned uses methods both traditional
and unique to himself. He graduated from
Southern Illinois
University with a B.S. in Finance, and from the
University
of Georgia
with an M.A. in Business Administration. He has also done post
graduate study in business and economics.
As an analyst,
professional investment adviser, and consultant for nearly 30 years,
Ned Schmidt has advised individuals and investment and pension funds
worth hundreds of millions of dollars. Along the way he has also
taught college and graduate courses in institutional investment
management and investment research. Presently he writes and publishes
The Value View Gold Report,
a monthly newsletter, and at the end of this interview you will find a
special offer to Moneychanger subscribers
Ned’s new book,
$1,245 Gold: The Gold Super Cycle, recently captured my
attention. I found his work straightforward and unbiased. He kindly
made time on January 23, 2002
for this interview.
MONEYCHANGER Why in the
world do you believe gold is headed for $1,245?
SCHMIDT Actually, I think
it’s going higher, but I arrive at that number from several
different directions. Referring to some work that Ned Davis
did many, many years ago, we find that from bottom to top markets
average gaining about six times their starting value. The low on gold
was $252, so six times that would be $1,512. That’s within the
potential for a market move. The Dow went from under 1,000 to 11,000
– an eleven-fold increase. That size move in gold would put us well
above $2,700.
So in terms of market
movements from bottom to top, gold at $1,245 is not unreasonable. It
sounds like a lot to us, sitting here at $281, or down from higher
prices in the ‘70s or ‘80s.
MONEYCHANGER How do you
know this is the bottom? Markets may very well go up six to twelve
times once they bottom, but what makes this the bottom in gold?
SCHMIDT Gold investors are
still trying to convince themselves that $252 was the bottom. That
happened in July, 1999, well over 30 months ago. When a bottom
is 30 months old, it’s time to start accepting it as the bottom,
unless we have evidence to the contrary. It’s time to quit being
bearish on yourself.
MONEYCHANGER [laughing]
Right -- no question that the chart shows a series of higher lows, and
by definition that’s an uptrend.
SCHMIDT Other things also
make it look like a market bottom. You watch gold against the Dow
Jones Industrial Average. I watch the S&P 500 against gold.
MONEYCHANGER Yes, and I
was very interested in that. Do you know that you and I are just
about the only people in the world who watch the relation between
stocks and gold?
SCHMIDT I think so.
MONEYCHANGER I follow the
Dow in Gold Dollars, not ounces, because using gold
dollars gives me one uniform measure all the way back to May, 1986 –
at least one unchanging monetary measure, even if the Dow does
change. [A “dollar” of gold by statute weighs 0.048375 troy
ounces, about 1/20th ounce.] The Dow in Gold Dollars plainly shows
three rising peaks through the 20th century. Gold bottomed in July,
1999 and the Dow in Gold Dollars peaked and turned down in August,
1999. So far, it has proven utterly reliable.
SCHMIDT We’re looking at
the ratio of gold to financial assets. The last time that bottomed
and moved up, as it is doing now, was in 1969-1970. So the chart
conditions resemble those before the last move in gold.
Now add two other things.
First, most investors don’t believe it. The other day ABN-AMRO
announced its top global stock pick: Cisco. Now you and I may
not know what the top global stock pick for this year will be, but we
know it’s not Cisco. [Laughing]. Investors just don’t believe
gold.
The second thing is the
Pan Eurasian Islamic war. The Federal Reserve is monetizing that war
just as they monetized the oil pricing crisis back in the 1970s – that
also resulted from conflicts in the Middle East. They’re repeating the
same mistakes. Once again, the Federal Reserve will help us gold
bulls, just like the ‘70s.
MONEYCHANGER I just
finished reviewing the monetary statistics through the end of October,
and they’re incredible.
SCHMIDT Right!
MONEYCHANGER Between what
the public thinks of Greenspan as the great inflation fighter and his
actual performance there looms a great chasm. They think he’s Dr.
Greenspan, but actually he’s Inflation Hyde. He ranks as the
worst inflationist ever to chair the Federal Reserve Board of
Governors.
SCHMIDT He’s certainly the
most irresponsible chairman ever.
MONEYCHANGER That itself
will likely benefit the gold price.
In your report you write,
“Most analysis of the gold market focuses considerable effort on
tonnes of supply and tonnes of demand, which is fine as far as it
goes.” When I was writing Silver Bonanza I interviewed
Harry Browne. He made a point that has stuck with me ever since. The
real key in silver and gold, he said, is investment demand.
That’s what makes them move. I think that’s your point here.
SCHMIDT Exactly. We are
asking about investors’ attitude and the gold price. How does a
market function? Focussing on these obvious supply and demand
components just really isn’t very useful a lot of times, because
investors carry things to extremes in both directions. We are looking
at this change that will take place in investors’ minds.
In that vein, this morning
it occurred to me that gold can’t keep hiding its performance. After
long enough, it will show up on investors’ radar screens. Look
at the Wall Street Journal’s recent year end numbers for
the mutual fund categories. Forty-two are listed, all the way from
large cap stocks to government bonds. For the year ending 12/31/01,
gold oriented funds were the best performing category. So the cat is
out of the bag. Even for the last three years -- and this hasn’t been
a great three years -- gold funds have beaten a third of all other
funds. Performance can’t be hidden, and investors and advisors will
start observing and be drawn to it. Since they own so little gold to
begin with, they won’t have to buy much to keep ball rolling.
MONEYCHANGER And there’s
so little to own, only about 1,200,000 ounces in the Comex warehouses,
worth today about $336 million. The gold market is tiny,
compared to stocks, bonds, or even currency markets that trade a
trillion dollars a day. Very little money running into gold has a
very large impact.
SCHMIDT A very good
point. In addition, liquidity has been shrinking in the gold market
for several years. Many companies have dropped out of trading gold --
Credit Swiss, for example. Since that market has become more and more
illiquid, new buying will cause a more dramatic price impact.
MONEYCHANGER The point is,
investment demand really drives the gold market. I appreciated
another insightful statement in your report. “The increase in the
value of gold we expect in US dollars is due to the depreciation of
the US dollar. Remember that the issue of today is not
inflation/deflation, as we traditionally think about those subjects.
The real issue is the future value of the US dollar.”
SCHMIDT That’s true.
That’s the heart of the matter. As we look around at other
currencies, they have not posted a very good record the last ten
years. Now people have hidden in the dollar and ignored its problems,
partly because they have blind faith in Alan Greenspan. Still,
eventually economics works. It may take longer or go further than
we expect, as the Nasdaq did, but the dollar’s fundamentals cannot be
avoided permanently.
MONEYCHANGER Then in the
face of poor dollar fundamentals, we have a bubble in the dollar?
SCHMIDT You’re right. I
hadn’t thought about it that way. We have a dollar bubble.
MONEYCHANGER Which US
dollar fundamentals have deteriorated?
SCHMIDT The dollar has a
gigantic current account deficit. To finance that, the US must
borrow from the world over a billion dollars a day, every working day
in the world. That happens only because people have confidence in
us. However, that’s like borrowing on your credit card: sooner or
later the credit card gets full. Any day that confidence dampens, the
dollar can have serious problems.
What will make the dollar
have a problem? It looked like it had peaked this past summer, but
when Greenspan tried to re-ignite the stock market, that re-ignited
interest in the dollar. However, the high dollar is crushing US
manufacturing. When the reality hits the world that we are not
going to have a V-recovery, that in fact our economy is going to make
another down leg, that will rattle the confidence in the dollar.
Today there is an alternative to the dollar, the Euro. People are
ignoring not only gold, but also the Euro. The dollar is living on
borrowed time. It’s Greenspan’s dollar bubble, and bubbles always
pop. This one will pop, too.
MONEYCHANGER However, both
the Euro and the Yen are closely tied to the dollar. There’s an old
saying: If you owe the bank ten thousand dollars, they own
you; if you owe the bank ten million dollars, you own them.
Somewhat the same situation exists between the US dollar and the
Euro. The Europeans hold huge US dollar reserves. They can’t help
that because the dollar serves as the world’s reserve currency.
Let’s say the Europeans decide to smack the dollar down so that
everyone will switch into Euros. They would shoot themselves in the
foot, at least two ways. First, they are depreciating the US dollar
reserves standing behind their own currency. Second, raising the
value of their own currency makes their exports more expensive, and
frankly, they’ve got a lot bigger troubles economically than the US
does.
SCHMIDT Let’s separate
those two. First, no, they’re not going to drive the dollar
price down all in a day. That will happen gradually, with
incidents like the Chinese deciding to match their reserve holdings to
trade flows. Up to this point the Chinese kept almost all their
reserves in dollars, but recently they’ve announced a course change.
China itself is the second largest holder of foreign currency
reserves, and if you throw in Hong Kong, they’re probably the
largest. What you will see is that at the margin – and that’s
what drives things – there will be a shift into Euros. The Europeans
will use some very clever devices, too. The US did away with the $500
and $1,000 bills, so that drug dealers wouldn’t use them. The
Europeans are smarter than that. They issued a 500 Euro note, which
will become the preferred currency for illicit trades.
So the demand for Euros
won’t all appear on Day One, but it will grow. As we know, everybody
in England predicted a disaster with the switch to Euros on January 1,
but, sorry, no disasters. We missed that one. We just can’t
seem to have a good disaster.
On another point, I’m not
sure the trend in Europe’s problems is worse than our own. They have
done so many things to change their economic structure and now they
have introduced a common currency. All those changes now highlight
the problem with their laws and regulations. No longer can they blame
their troubles on trade barriers, lack of a common currency, or high
duties. The spotlight will be on problems with European laws and
regulations, and they will be changed.
People make another common
mistake about Europe. They point out that Europe is a diverse
community, as if that will hinder it. Well, let me tell you, the
United States is a diverse community. There’s a big difference
between Tennessee and San Diego.
MONEYCHANGER [Laughing]
You’d better believe it.
SCHMIDT They’re two
different worlds.
MONEYCHANGER With two
different languages!
SCHMIDT So I’m not sure
that our dire view of the European economy really describes things
accurately. The structural changes in Europe within the last four
years have been incredibly dramatic: no passports, no barriers to
movement or work -- giant shifts. Are they becoming more or
less competitive with the United States? I think more
competitive, so at the margin the Euro has some advantages over the
dollar.
The tail end of our growth
mania has held the dollar up. Maybe Enron will finally put an end to
the growth mania. I don’t know.
MONEYCHANGER Earlier you
remarked, “We can’t seem to have a good disaster.” The single most
amazing face of markets in the last two years has been their
astounding complacency. Argentina undergoes the largest default on
sovereign debt in world history, $207 billion (so far at least), and
nobody gets excited. In fact, it hardly hits the papers in the
United States. Enron, the seventh largest corporation in the
country, goes into bankruptcy, the largest corporate bankruptcy in the
history of the US, and nobody gets upset. Stocks don’t tank;
gold flatlines. Beyond that, everyone knows that Enron was a heavy
duty player in all kinds of derivatives, so there is no telling
what kind of skeletons are going to fall out of that closet.
SCHMIDT In part K-Mart is
a casualty of Enron. They used surety bonds for a lot of their
worker’s comp and liability insurance. Enron’s sinking almost
sank the surety bond market. Not only were they using it, but they
were involved in it as well. That was one reason K-mart had to throw
in the towel. The Enron bankruptcy is more important from things that
aren’t going to happen. My best example is that Williams
Companies cancelled a billion dollars in capital expenditures.
The Enron mess is not only pulling the plug on today, it’s pulling the
plug on tomorrow, too..
MONEYCHANGER But why do
markets remain so complacent? None of these events are hidden,
although their outcomes may not yet be fathomed. Many of the effects
of Enron’s bankruptcy, for example, can already be seen, yet the
markets toddle on as if nothing had ever happened. The Ted spread is
down around 20, for instance.
SCHMIDT The bullish
psychology built up during the Greenspan stock market bubble has not
yet dissipated.
MONEYCHANGER If that’s the
case, and the future disillusionment matches the present complacency,
then at some point will arrive a panic truly terrifying.
SCHMIDT Yes, and the
complacency has blind faith in rules that have no meaning, like “The
S&P has never dropped for three years in a row.” What does that
mean? That means nothing. [laughing] If we changed the
way the calendar year falls, there would have been.
MONEYCHANGER You said that
there will be no V-bottom in the economy. We know that
everyone’s hopes are now pasted on this much-foretold V-bottom.
SCHMIDT You know what
amazes me? As I listen to these people on CNBC, not one ever asks the
question, “How?” What mechanism links lowering interest rates
to raising economic activity? Nobody talks about that mechanism.
They’re recurring to past recessions caused by high interest
rates that killed housing, autos, etc. That’s not why we have
a recession right now. High interest rates were not the problem,
so they’re not the solution.
We’re in a recession
because an overvalued dollar has left one out of four US factories
sitting idle. We’re in a recession because the
technology-telecommunications bubble collapsed. As time passes people
will finally realise that the economists forgot to talk about the
mechanism that connects lower interest rates with higher economic
activity. Only automobiles and housing are up, and that’s because GM
is giving away cars. How long can we survive on an economy where GM
gives away automobiles?
MONEYCHANGER How will real
estate perform over the next ten years? One of the shibboleths of
American investing (in the same class with “The S&P has never seen
three down years in a row”) is that “real estate never goes down” or
“Since World War II, real estate has never dropped.” That’s not true
regionally, by any means. How do the next ten years look for real
estate, both commercial and residential?
SCHMIDT Actually there are
three kinds of real estate, agricultural, commercial, and
residential. I’m very bullish on agricultural land for the next ten
years. For the average investor the problem with real estate is that
it’s not liquid or divisible. I can’t sell ten square feet of my lot
to pay the grocery bill. Commercial is very scary because you have to
look to the tenant. That’s what people in California are finding out
as real estate in Silicon Valley is being hammered.
Residential is scary,
too. That may be the one thing we are all ignoring. What’s propping
up residential real estate? Low interest rates, people can sell their
house in the northeast and move, and refinancing. Those are
conditions brought about by these abnormally low interest rates.
Residential has another problem: baby boomers are growing older,
unfortunately. I’m in that group, and I’m looking for a smaller
house. I don’t need four bedrooms any more. So the outlook for
residential real estate in several areas is not very good.
If real estate looks
shaky, how does the individual investor get exposed to real assets?
Gold may be one of the best mechanism for that, because it has
great liquidity and divisibility.
MONEYCHANGER As opposed to
real estate.
SCHMIDT Yes, but in my
view raw land with some productive value is wise, too. I believe that
very strongly.
MONEYCHANGER Because it
can produce a return?
SCHMIDT Because it can
produce a return.
MONEYCHANGER What is the
most likely trigger to set off a panic?
SCHMIDT It’s something we
don’t know about yet. Big events that are well broadcast, like the
millennium, don’t normally have the impact. It’s something we don’t
know about yet, and not a big event. Looking back, big problems have
been caused by rather small events. World War I was caused by
one mad Serbian with a gun. The present war on terrorism was caused
by one mad Saudi Arabian. The trigger is usually some small event
that we only recognise the day after.
But you cannot buy
hurricane insurance when they’re forecasting a hurricane.
MONEYCHANGER [laughing]
Then if you intend to protect yourself, you have to act now.
SCHMIDT Right. When the
TV weather report announces a tornado coming down on Tennessee, you
can’t call up the insurance man for tornado insurance.
MONEYCHANGER What does
that mean today? There’s no point in telling people to sell Nasdaq
stocks now, because they’ve already missed the boat on that. They’re
down 65 – 90%, and they’re not coming back. One of my most
frustrating jobs is trying to convince people that stocks are not
going to come back. They still want to hold onto them, in the forlorn
hope that some day they’ll recover, but they never will.
SCHMIDT I know. People
will sit there and do nothing. This hope that it will recover is –
maybe we’re afraid to accept the reality of it.
The Nasdaq, as you know,
has been particularly weak here, a lot weaker than people expected. I
checked on currency in circulation. You remember back when the Y2K
concern arose that people were drawing massive amounts of currency out
of the banks. The Federal Reserve had to supply that liquidity, and
that gave us Nasdaq 5,000. When they took the liquidity out, that
broke the Nasdaq. At Christmas we had the highest rate of increase of
currency in circulation since Y2K, and the Fed was forced to provide
great amounts of reserves to support that. Shortly after the
beginning of the year currency in circulation reversed itself,
evidence that the Fed has been draining liquidity out of the system,
and they will continue to do that. That means, I think, that Nasdaq
has broken and will drop to test those lows. I think we’ve had a
major crack here in the Nasdaq.
MONEYCHANGER If you look
at the history of hot markets, the last area to flourish is what they
used to call the “cats and dogs,” i.e., the stocks nobody in
his right mind would buy. Nasdaq was indeed all the cats and dogs,
and a couple of ostriches and emus in there, too. It’s reasonable to
expect that market to give up 90 to 95% of its peak value.
SCHMIDT I agree with you.
MONEYCHANGER Would you sum
up your argument for $1,245 gold?
SCHMIDT For the first time
in 30 years, we’re at the right place and the right time for gold.
Investors enjoy few times in their lives where they can examine the
world rationally and say, “Yes, we are at one of those junctures where
the investment continuum shifts to gold, silver, and real assets, just
like 1970. So you need to follow the shift and place your bets on
those new vehicles, and remember that investors always carry things to
extremes. They will carry it higher than we expect, just as they
carried it lower.
MONEYCHANGER What about
your fundamental arguments for higher gold? What else besides the end
of the stock market bubble and the length of the gold bear market?
SCHMIDT The popping of the
Dollar Bubble.
MONEYCHANGER Thank you,
Ned, very much for your time.
Ned’s monthly
newsletter, The Value View Gold Report, regularly costs $99 a
year, and his soon to be released 152 page book, $1,245 Gold: The
Gold Supercycle, will sell for $55.
I asked Ned to make a
special offer to Moneychanger subscribers. Here it is: You
can order both a year of The Value View Gold Report and
$1,245 Gold, a $154 value, for only $99 – plus a new
gold option strategy recommendation. Call Sue Rutsen at (800)
345-7026 or (312) 341-7494, and make sure to tell her you are a
Moneychanger subscriber..
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