19 Reasons Gold Has Probably Bottomed
Posted on Thursday, August 13, 1998 at 09:44 AM
by James Turk
Freemarket Gold & Money Report
Investing requires taking action based on a calculation of
probabilities, not certainties. And right now the probabilities
suggest that the bottom for gold has already been reached.
By implication, we can conclude that a new bull market in Gold
is beginning right now. Hard to believe? Well, yes, frankly, it is
hard to believe, but that is already reason number one.
(1) Bullish Consensus. Bull markets end when most everyone is
bullish. Bear markets end when most everyone is bearish. We
have now had very low bullish consensus readings four times
over the past year 18% on July 7th with Gold at $318.10, 18%
on December 4th at $286.50, 16% on January 12th at $278.30,
and 19% on June 15th at $284.60. Any reading in the teens is
unusual for Gold, and in the past has generally marked the
beginning of a new bull market. Four in-the-teens readings over
one year are unprecedented. This extreme level of bearishness
signals that a turn is at hand.
(2) M3 Growth. M3 continues to grow at an alarming rate. The
annual rate was 11.1% in the week ending June 15th, another
13-year high. The Dollar is being debased, which inevitably
results in reduced purchasing power brought about by inflation
and/or a collapsing Dollar foreign exchange rate, which is bullish
for Gold.
(3) Treasury Intervention. For the first time during the Clinton
administration, the Federal Reserve, acting for the Department of
Treasury, intervened in the foreign exchange markets to sell
Dollars. In this case, it sold Dollars to buy Yen. Treasury
Secretary Rubin has been adamant in his defense of a strong
dollar, stating that a strong Dollar is in the best interests of the
United States. He, of course, is correct. But now things have
changed. At this time, it is still uncertain why Mr. Rubin took this
action, but rumor has it that he was over-ruled by the President.
By this line of thinking, Clinton wanted his trip to China to go
smoothly, so he placated the Chinese by buying Yen, thereby
taking pressure off the Chinese to devalue their currency in an
attempt to remain competitive with the Japanese. In other words,
political considerations ruled over sound monetary practice, never
a good sign for any flat national currency. This action will cause
money to flow away from the Dollar, and Gold along with the
Swiss Franc and possibly the Deutschemark will be the natural
beneficiaries of the demise of Mr. Rubin's strong Dollar policy.
(4) Japan. The Japanese economy and banking system are on
the verge of collapse. Importantly, the price of Gold continues to
rise in terms of Yen, and is now probing over-head resistance at
Y42,000 per ounce. A rising Gold price acts much like a
barometer, signaling bad weather ahead. The rising Yen price of
Gold will further frighten Japanese bank depositors about the
state of the Yen and the insolvent nature of the Japanese banking
system, so they will act to further withdraw funds from the
banks. Bank runs and/or bank 'holidays' have to be considered a
real possibility, and given the interlocking nature of the world's
banking system, problems in Japan will have worldwide
ramifications, all of which will be bullish for Gold.
(5) Asia. The comments above regarding Japan apply to most of
Asia. Even though the banking systems of Hong Kong, China,
Thailand, Indonesia, etc., are not as important to the global
banking system as are the Japanese banks, failures and bank runs
in these countries will have worldwide ramifications, and bullish
implications for the Gold price.
(6) Derivatives. While on the subject of Asia, bank derivative
exposure should be mentioned. For example, the $20 billion
bail-out of the Indonesian economy and its momentary and
banking system has been delayed. The reason is that derivative
exposure not heretofore known has increased the potential need
for funds to at least $30 billion, though at this stage, no one really
knows the total loss. And as the Indonesian economy continues
to slide into an abyss and as the Rupiah sinks along with it, these
losses continue to grow. The derivatives losses in the other Asian
countries are also mounting rapidly, particularly in Japan and
Hong Kong. These losses will add to the growing fear about the
insolvent nature of many Asian banks, which will cause
depositors to take money out of the banks and convert it into
safer vehicleslike Gold.
(7) Currency Depreciation. Many currencies around the world
are collapsing. There are different reasons for the collapse, but
they have a common thread. These currencies are all flat
currency and therefore rely upon only one basic propconfidence.
And right now confidence in these currencies is collapsing, from
the Baht to the Rupiah to the Yen to the South African Rand. For
example, the Rand has depreciated by nearly 20% over just the
past few weeks. Investors learned a few years ago from the
Mexican Peso that once a currency begins to depreciate, it tends
to fall 'off a cliff', like the Rand is doing now. And investors also
know that Gold appreciates in local currency terms as the
currency collapses, making a flow of money from all of these
countries into Gold inevitable. By the way, the Peso and most
Latin American currencies are near or at near record lows, so
more currency bad news can be expected immediately ahead.
(8) Currency Instability. After a period of relative calm,
exchange rates are again becoming more volatile. Rapid moves of
several percentage points within days or even hours are once
again occurring. This instability is not good because it causes an
increase in awareness of the fragility of most monetary systems,
which, in turn, causes fear to rise. This fear causes people to act,
and they typically do so by reducing uncertainty as much as
possible. They sell currencies and buy Gold.
(9) Fear Index. The Fear Index of the US Dollar is at 1.37%, a
record low. Never before has confidence in the Dollar been this
high. Given all of the developing economic, financial and
monetary problems throughout the world and, in particular, also
given the demise of Mr. Rubin's strong Dollar policy, it seems
safe to conclude that the present extremely high level of
confidence is unsustainable. Fear will soon be rising, along with a
rising Gold price, particularly as the stock market falls.
(10) Stock Market Top. The stock market is looking very
toppy. It is already a high risk market because of the extreme
level of overvaluation, so if its momentum (which is the only
thing it has going for it) now also starts to fade, then look out
below! Falling stocks will increase the level of fear, which will, in
turn, increase the flow of money into Gold.
(11) Formation of the ECB. The European Central Bank has
been formed, and we will soon learn what its reserve policy will
be. We already know that Gold will have a role to play, which is
not too surprising, given Gold's historical role and unique
advantage as money. Besides, many central banks are increasing
their Gold hoard, like the Russians, who have just announced a
10 tonne increase so far this year to 525 tonnes. And, as the
Bank of France said recently in its annual report: "Neither the
U.S. Federal Reserve, nor the German Bundesbank, nor the
Bank of Italy, nor, of course, the Bank of France, plan to sell the
precious metal." Consequently, the fear of European dishoarding
will be lessened, and along with this decline, people will
increasingly move some of their wealth into Gold.
(12) Interest Rates. Key interest rates around the world are out
of line. Dollar rates are too low. Yen interest rates are way too
low. Gold's interest rate has been way too high. Interest rates are
a reflection of risk, and there are basically two types of riskcredit
risk and price risk. Gold's interest rate is well above normal
historical levels, and should drop as the credit risk of national
currencies becomes more apparent as bank failures (in Japan and
elsewhere) once again become a front-page topic. Gold's interest
rate will drop as its price increases, thereby bringing a greater
availability of bullion supply into the market. The relationship of
various interest rates will return to normal levels, which means
the Gold price is destined to rise.
(13) Technical Considerations. There are many positive
technical factors, but I'll group them into one reason. These
include the high short position in the precious metals at the
moment, the extreme oversold level that has been reached, the
length and magnitude of the decline, and that both Gold and
Silver have recently held important support. These factors are
bullish.
(14) US Trade Deficit. The US trade deficit is ballooning.
Record deficitsprobably over $300 billion per annumlie just
around the corner. These deficits will weaken the Dollar, which
probably already peaked against the European currencies in
August 1997. A weak Dollar will increase the demand for Gold,
and higher Gold prices will be the result.
(15) Foreign & Domestic Debt. As noted above, the United
States is flooding the world with Dollars by importing countless
foreign made products and exporting Dollar denominated IOU's.
The United States is the world's largest debtor country as a
result. That is not a good position to be in. Debts eventually have
to be repaid, the ability to repay these debts has to be questioned.
This skepticism about the level of debts only increases when one
recognizes that it takes ever more debt to be created in the United
States to get an incrementally smaller growth in economic activity
as measured by GDP.
(16) Gold Production. The output of newly mined Gold is
expected to remain stagnant, instead of growing as previously
forecast. Long-time readers of these reports know that I do not
put a lot of weight on production reports. For example, with
85,000 tonnes of monetary Gold in aboveground stocks that is
perfectly substitutable for newly mined Gold, does it really matter
much whether or not the miners produce 200 tonnes a year less
than expected? In reality, it matters very little. however, the new
forecasts of slower production are of some importance for one
reason. Declining or even stagnant production gets a lot of
publicity, and because it is perceived to be bullish, this news
should positively effect investor sentiment about Gold.
(17) Commodity Prices. For most of this year, commodity
prices have been under pressure. Crude oil slid because a drop in
Asian demand led to over-production. Base metal prices were
also hurt by a drop in Asian demand. Foodstuffs were hit by a
stronger US Dollar and also by ideal growing conditions so far,
particularly in the US. However, the good news for lower
commodity prices is behind us. Commodity prices will begin
rising from here, which will have a bullish impact on precious
metal prices.
(18) Credit Risk. In a period of rising confidence, credit risk is
rarely questioned, let alone doubted. However, it is an undeniable
fact that not all IOU's are repaid. Inevitably, some loans go bad,
and some promises to pay are not fulfilled. Historically investor
and consumer confidence rises and falls along with such factors
as economic output, stock prices, etc. When confidence falls, the
public increasingly turns to Gold because it is the only money that
is no one else's liability, and is therefore immune to credit risk.
Credit risk has been ignored, even forgotten, since the early
1990's. That disinterest is about to change. Problems in the banks
in Asia, and soon thereafter, problems in US banks being affected
by the collapse in Asia, will cause the public to once again look
more closely at credit risk. When they do, they will recognize that
the level of confidence today in the banking system is ill-founded,
so they will respond by shifting money out of currencies into
Gold.
(19) Great Value. Very rarely does a bell ring when it comes to
investing. But a loud bell did ring early this year when Warren
Buffett, the doyen of value investors, announced that he had
acquired 130 million ounces of Silver. It was a wake-up call that
Silver in particular, and the precious metals in general,
represented great value. As a consequence, Warren Buffett in
effect announced to the world that the previous metals should be
looked at by anyone wanting to acquire an undervalued asset,
which is the basic strategy that made him so successful as an
investor. Years from now it will probably be clear that Mr.
Buffett had picked the bottom of the market to accumulate his
precious metal position.
To conclude, it is well known that bull markets end in exhaustion,
i.e., all buying has been spent. Bear markets end in capitulation,
i.e., the last weak hand has sold. Regarding Gold and Silver, we
have seen unprecedented capitulation, as well as unprecedented
bearishness.
Things, however, do change eventually, and it now looks like the
time has finally come for a change in the precious metals. The
many reasons for change are there; the extreme level of
undervaluation is also there. These factors provide a potent mix.
The result could turn out to be an explosive rally in Gold and
silver in the last half of the year.
A rally in the previous metals? An unexpected conclusion? Yes,
but bear markets end when least expected.
Source: Freemarket Gold & Money Report, P.O. Box 5002,
North Conway, NH 03860. |
