LIES, STATISTICS AND... ER, GOLD
by John Mauldin
Now for the question on everyone lips: what lies in the future for the yellow metal, that barbarous relic?
First, let me say... I am no gold bull. Indeed, I have been bearish to neutral on gold for over a decade. However, a number of economic trends are causing me to re-think my position. I believe the case I lay out is one you will not have read from the usual gold bug suspects.
Buried in reports that the economy grew in the 4th quarter of least year was this astounding number. The GDP price deflator, a gauge of inflation tied to the report, fell at a 0.3% annual rate in the fourth quarter. That's the biggest decrease since the first quarter of 1952 and followed a 2.2% pace of increase in the previous three months.
Holy predictor of deflation, Batman! We are on the verge of watching inflation slip below 1% within a few months. That is not an environment in which the Fed is going to feel the need to put on the brakes and raise rates.
Wait... I can hear what you're thinking. "You are telling us on one hand that deflation is coming but now you may be turning bullish on gold? Isn't it inflation that is supposed to be good for gold prices?" Inflation is one factor, but as we will see, there is another.
My long term disinterest in gold stems from the fact that every time gold gets around $300, some central banker threatens, or actually does start, to sell gold. As an investor, I am not interested in investing in something that has an artificial "ceiling" to it.
However, the roof might be cracking, so maybe we can see a little ray of opportunity. I have reviewed a lot of gold studies. Many of them breathlessly predict gold going to $1,254 or some nonsense; or they can confidently suggest their numbers show a fair value for gold far above where it is today, and we only need to buy gold (presumably from them) and wait for the market to agree with their view.
These reports are full of charts and graphs showing the relationship of gold to everything but the kitchen sink. Invariably, they are all bullish relationships. If gold comes back to "trend," on this relationship, it will be at an all-time high.
Most of these relationships are non-existent, in my opinion. The relationship of gold to the S&P 500 or oil or whatever may be interesting, but it has absolutely no bearing on the price of gold. None. Zero.
I am reminded of the observation that there is a statistical correlation between the length of skirts and the rise in the Dow. If there was such a correlation, then Argentina would be the world's most valuable stock market.
The reason, we are told, that gold has not gone to its fair price, are those nasty central bankers. It is a conspiracy, and we need to put a stop to it.
In my opinion, there is no conspiracy. Central bankers in most countries simply do not like gold. To them, it is an asset from the Dark Ages, one which does not pay interest. In the case of some of the central banks, they need the cash.
To them, gold is not money. Even a firm which has its roots in the gold movement has recently abandoned the fervor of its founder. Nowhere is this more starkly illustrated than in the year-end letter from Blanchard and Company. Blanchard was started decades ago by Jim Blanchard, and was one of the premier gold bullion dealers. Jim was a good friend and business associate, and I miss him as he is now walking streets of gold rather than selling them.
But, as was noted here in The Daily Reckoning, Jim's old company wrote the following: "Effective as of January 1, 2002, Blanchard and Company is changing its business practices and policies in order to limit its exposure to falling gold prices, and recommends to its clients that they do the same. As of that date Blanchard will not maintain inventories of gold bullion or gold bullion products, nor will it market gold to, or solicit gold sales to, Blanchard clients.
"Gold is no longer a hedge against inflation, devaluation of the dollar or falling stock prices," continues the mailing from Jim's old company. "It is no longer a store of value. The very idea of gold's intrinsic value - value that is not dependent upon the actions or promises of any government - is publicly questioned by senior central bankers, and by the heads of major financial institutions."
I believe they and the central bankers are wrong. And clearly the market does as well, or gold would fall dramatically. Gold is the scale upon which the actions of central bankers are weighed. It is a neutral currency, an arbiter of the value of all other currencies.
If you lived in Japan, you would not be talking about gold conspiracies. You would have simply watched gold recently rise 50% in your currency. No wonder mama-sans are buying gold in large amounts. When the leaders of a country clearly declare their intention to devalue their currency, it is time to head for the hills.
Where can you go if you are Japanese and you don't want to lose buying power? Large investors flee into dollars or some other store of value. Smaller investors flee to gold.
In fact, in most countries of the world, gold is in a major bull market. Gold is up sharply in terms of Euros. The bulk of that rise is owed to the 20% decrease in the price of the euro, and the rest is due to the rise in gold in terms of dollars.
Gold has not risen in the US because the dollar has been rising faster, in terms of the rest of the world. When central bankers in Europe sell their gold, they are getting a lot of euros. The incentive is for them to sell, especially if they think the dollar is too strong and will come down over time. And especially if they do not want to own gold.
As the dollar comes down, so will the price of gold in terms of the euro. If you as a central banker do not want to own the metal, then it is better to sell high. That means now. As long as gold is high in terms of the euro, there will be pressure from central bankers selling.
For there to be a sustainable bull market in gold, there needs to be a break in the King Dollar. Period.
I have been arguing that the yen is on its way down. No sign of the dollar dropping there. But the yen could be part of the problem in another way.
Many observers worry about the Japanese repatriating their huge dollar investments in US stocks and bonds, causing the dollar to drop, as well as the stock and bond markets. That would cause gold to rise, maybe even sooner than I think. That is possible, but it is not my main concern. Mine is just the opposite.
With the Japanese government committed to a weak yen, it is likely they pursue "reform" so as to avoid increasing the price of the yen. It is just as possible that they inject capital into their banks in such amounts that not only do the banks not need to repatriate dollars and turn them into yen so as to shore up their balance sheets, but that they have excess yen to purchase dollars (and perhaps euros) to hedge against a dropping yen.
This, along with the rest of the world dealing with the huge deflationary pressures running rampant throughout Asia, could actually create a stronger dollar. Indeed, it could be a bubble. We all know what happens to bubbles.
What could be the catalyst for the break in the dollar? The current accounts or trade deficit. I know, I know - the bears have been pulling this one out of the closet every year or so, and like the boy who cried wolf, nothing has happened.
The world continues to buy our goods, stocks, bonds, businesses and real estate to finance our buying binge. It is now running almost $500 billion through the last quarter, according to Morgan Stanley.
They estimate that the trade deficit could be almost 6% of GDP in 2003, which would be 50% higher than ever seen. We would need almost $2 billion per day from foreign sources. This is unsustainable. Just as Amazon.com could not grow their stock to the sky by borrowing and spending far more than they make, the US will one day have to pay the piper. On balance, the US owes $2 trillion dollars to foreigners, net of our investments overseas. That number has been growing dramatically for the last few years.
At the projected 2003 rate, foreigners would own everything not nailed down in the US in a few decades, which clearly cannot happen. Something will have to give, and that something is either the dollar or a massive reversion in US dollar outflows. We will need to export more and buy less on a huge scale for this to happen.
But the dollar being strong makes international sales more difficult in the face of cheaper competition whose currencies are weak. And it makes cheap foreign goods more attractive to those of us with strong dollars. As long as foreigners keep selling us things so cheap, it is hard not to buy. Like I often tell the waitress, take this plate from me before I eat some more!
The question in your mind is, "How far will the dollar fall?" The answer is hard to gauge. There are a lot of variables. One of the biggest is the Japanese. Could we see the dollar rise against the yen and fall against much of the rest of the world? Yes, that is quite possible.
If we do not see a bubble, we could see the dollar drop as much as 20% or so against the euro and other strong currencies. For a lot of reasons, I rather doubt it goes much further, unless we have another major recession and Europe is in a growth cycle, which is hard to imagine now.
In one sense, 20% is not that much. But a 20% drop in the dollar could mean a rise of gold to the high $300's or maybe even a spike to $400.
When does this dollar correction happen? I seriously doubt it happens this year, without some unforeseen external event and probably not until we are well into 2003. But the gold market could begin to smell the drop and rise in anticipation. There is just no way to know.
But that is the reason gold will rise. Not some intrinsic hidden value of gold. Not some relationship with the S&P or oil or silver or whatever. It is that gold is basically a currency play. When the dollar drops, gold will rise in terms of dollars.
When that will happen is anybody's guess...
John Mauldin, for The Daily Reckoning
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