Robin Hood,
First of all, it is my pleasure to put Blake's article up.
Two, you can get a two week trial in the cafe for free, and from our feedback,it is worth the $99. If I might say so, this is new to me. I am used to signing up clients for $8,000- mind you that is institutions- but call a spade a spade. That is a fact and it is the same information. To me $99 is a pretty small price to pay to get a decent scoop.
I will be all over this Black Hawk in my commentary soon. Blake loves these guys.
All the best,
Bill
By Blake Joyner September 17, 1998
The Death of Pax Americana and Globalism
and the Great Crash of '98
"Gold has worked down from Alexander's time...
When something holds good for two thousand years,
I do not believe it can be so because of prejudice
or mistaken theory.'
Bernard Baruch
Take a picture. Remember these days. Save a few Wall Street Journals or Barron's. Because years from now, your children or grandchildren will ask you about the days when it all ended, when Pax Americana and Globalism topticked, when the greatest crash of our lifetime wiped out hundreds of millions of investors around the world, and tens of millions of Americans. When the unrivaled hegemony of Anglo-Saxon capitalism and culture lost its supremacy around the world. When white trash from Arkansas disgraced the Presidency, and only a minority bothered to care. When America's great humiliation began.
Although Wall Street and Washington are loathe to admit it, we are in the midst of what will come to be known in coming years as the "Great Crash of 98". For many Americans it will be the financial epiphany of their lives. They will remember these days as our grandfathers remembered the Crash of 1929 and our fathers the great bear market of the 1970's. The world as we know it is about to be turned upside down.
These are strong words, I do not speak them lightly, or without much trepidation of being labeled a crank. But the evidence is so overwhelming, the ramifications so profound, and the potential solution I offer, so time tested, that the risks of outspokenness must be taken. After all, in the "Illiad" Cassandra was ridiculed for being a "gloom and doomer", but was unfortunately proven right in the end. I hope it does me more good than it did her!
Although we will call it the Great Crash of 98 in the years to come, the reality is that it started last year when the Thai Baht crashed. Soon the rest of Asia followed, in what Marc Faber (one of the very few who predicted it) called the greatest and fastest decimation of wealth in history. Asia is not in a recession, it is in a Depression with a capital D. A scenario very similar to the 30's seems to be playing itself out in Asia, and that scenario is spreading to the rest of the world.
With the collapse of Asia came the crash in commodity prices, with the CRB setting 20 year lows. The commodity crash meant the spreading of the financial virus to commodity-producing countries around the world. The economic devastation spread to the farm belt in the U.S., where the crisis is the worst in 20 years. Russia collapsed largely because of falling commodity prices. Venezuela and the rest of South America are on the brink of financial panic stemming largely from collapsing commodity prices. Commodity based Canada and Mexico face severe downturns. Amazingly, there are many who cheer this decline of commodity prices because they think it means lower inflation and interest rates. Another example of the old saying of "be careful what you wish for, you may just get it".
Throughout 1998, this financial AIDS has been spreading through the U.S. stock market. Many of the Russell 2000 stocks are in severe bear markets, but until August the 1998 version of the Nifty Fifty had obscured it. The Russian panic shattered that illusion, with bank stocks losing an estimated $500 billion in market capitalization over the last month. This is just the beginning.
Conventional wisdom is predicting a short bear market, like we had in 1987, clean out the excesses, then, it's onwards and upwards. They're wrong, this downturn is going to be like the 30's or the 70's, very painful and drawn-out.
Enough of the prelude. The purpose of this piece is to explain some of the enormous financial and political changes coming, and how gold and gold shares may help protect investors from the crisis that is upon us.
There have been two great equity bear markets this century; the first started in 1929 and lasted through the early 30's, and the 1973-74 bear market which really lasted throughout the 70's if one factors in the inflation rate. The 30's bear market was a deflationary collapse, while the 70's market was caused by the early stages of double digit inflation. During both of these bear markets, when fortunes disappeared and fear reigned, gold and gold shares soared. History is about to repeat, 1998 is the beginning of the third great equity bear market of this century, and gold and gold shares have just begun their third great bull market.
Gold, and the companies that mine it, are like volcanoes. Most of the time they are dormant, boring, and a waste of time and capital. During the fat years of prosperity, gold is at best considered a quaint anachronism, jewelry for the nouv au riche; at worst, it is ridiculed, and its owners subject to derision. Gold is the flip side of the equity market. When equities are good, gold is bad. When equities are bad, gold is strong. Equities have been great investments for approximately 80 years this century, and a horrible investment for 20 years.
Gold has been a poor investment for 80 years and an exceptional investment for 20 years. If historic trends prevail, gold and gold shares should be very good investments for five or ten years.
Gold and gold shares are only worth owning during times of financial distress like the 30's and 70's. Investors only want gold badly when every thing else is going to hell, and then they want it very badly. It's a metaphysical thing, comparable to an alcoholic in the depths of his despair finding the Lord. Ask someone who has lost all his money if he has prayed or not, chances are he has. People will flock to gold during time of distress because they always have. As per the introductory Baruch quote listed above, it's instinctive and it's got a track record. Nobody but a few cranks love gold, but investor masses will flock to it because they are terrified of everything else. For the last 15 years the world has been very accommodating to capital. A world increasingly unfriendly to capital is a world friendly to gold.
One by one, the investment alternatives to gold are falling like dominoes.
l.The Derivative Market
Gold has been considered insurance for centuries. When Wall Street started creating derivatives to insure investors against all conceivable risks, the need for gold was diminished. Gold was seen as an anachronism; paper ruled. The startling collapse of bank and brokerage shares cannot be attributed to a few billion dollars in Russian losses alone; the market could be smelling systemic derivative problems. As in Asia and South America, this is likely to become a self-fulfilling prophecy. Credit contraction driving prices down, falling prices force additional cutbacks in lending: a vicious circle. This is the deflationary nightmare that Japan has gone through for nine years, bankers are afraid to lend, people are afraid to borrow. Expect a dramatic tightening of lending standards to hedge funds and other derivative businesses. Derivatives are based on confidence and trust, and increasingly, trust and confidence will disappear. Bull markets in gold are predicated on fear and a lack of trust. Why? Because only gold cannot default.
2.The Dollar
The dollar has been taking market share away from gold as the world's premier reserve currency for decades. Years ago, America thought it would be wise to have a dollar standard instead of gold standards for emerging market.countries. Our rationale for this was simple: during times of huge budget deficits, the dollar standard provided a source of cheap lending to the U.S. government. The climatic blowoff of this phenomenon can be seen in the widely publicized dumping of gold by central banks over the last year. The strength of the dollar resulted from a number of factors; Pax Americana military, cultural, and financial clout. The dollar's power and influence will never again reach its current stature in our lifetime.
With the exception of Western Europe, the vast majority of the world's economy is based on a de facto dollar standard. Alan Greenspan is widely thought to be not merely the head of the Fed, but the world's central banker. As the emerging market's are finding out, this is an illusion. There is an inherent conflict between these two roles for Greenspan. He had to choose which was his priority, the world economy or the American economy. America the Empire or America the Republic? If the world's economy was the priority, he should have eased dramatically. Instead, he has allowed an inverted yield curve. He sacrificed the Asians, South Americans, and every one else dumb enough to believe him, to make sure that some working stiff at Walmart wouldn't get a 5% raise.
His sacrifice of hundreds of millions of people on the altar of American inflation fears is comparable to the hubris and arrogance shown by the last great world power: Great Britain toward its vassal states. Remember Churchill sending the Aussies to certain death at Gailipolli? After all they're just colonials. Rather than lower interest rates and the dollar to help the emerging markets, Greenspan, Rubin, and the IMF are demanding double digit interest rates from countries in a depression. Such remedies are the recipe for wars, not economic growth. Emerging markets should have known that when push came to shove, they were just economic cannon fodder for the U.S. Remember De Gaulle's reason for pulling out of NATO and building up France's nuclear and conventional power, he didn't think America could be relied upon to sacrifice its own interests for those of its allies. Adapting this nationalist train of thought to currencies, DeGaulle became a major gold bug. "Any workable and acceptable international monetary system must not bear the stamp or control of any country in particular. Truly, it is hard to imagine any other standard other than gold." Nationalism and Regionalism will replace Globalism and Pax Americana. Globalism was bullish for equities. Nationalism is bullish for gold.
One of the inevitable results of this breakdown of trust between the U.S. and its vassal states on a dollar standard will be a rise in nationalism and xenophobia. Malaysia's Prime Minister blames Jews and speculators for his crisis, and implements currency controls. Russia's collapse costs its reforming Prime Minister his job, he's replaced by a former KGB agent who despises us, and wants to return to state control of the economy. Nature abhors a vacuum, the demise of Pax Americana and Globalism could bring chaos with it.
Of the emerging markets, India has survived the deflationary deluge with the least damage. It is no coincidence that India has been the least receptive to Pax Americana and Globalism. Their government made statements last week saying how foolish it was to rely upon the dollar as the sole conduit of world trade. They set off nuclear tests a few months ago because they know that the U.S. would sacrifice them to please the Chinese. They are the coming model for the emerging markets around the world. They are also big gold bugs.
The demise of the dollar as the world's reserve currency is a long term phenomenon. Of critical importance in the short term is the disappearance of dollar strength in a flight to quality scenario. Despite the Russian collapse, the tremors in South America, and the cut in Japanese rates, the dollar has dropped sharply in the last few weeks. The decline in the dollar has corresponded with a rise in gold. This is largely due to the foreign perception of the scandal in Washington. They rightly fear that this potential impeachment will sap the attention and willpower of the U.S. during the greatest economic crisis in 70 years. Could foreigners be seeing Clinton's potential impeachment as America's version of the Dreyfus trial? A trial that puts the very soul of America in the docket? A trial that transfixes America while in Soros's phrase, "global capitalism comes apart at the seams". No wonder they're selling the dollar! Gold will be the beneficiary of these dollar woes.
3.Treasury Bills
One of the raps against gold during periods of optimism is that it doesn't pay interest compared to other supposedly risk free investments. If this is a deflationary environment like the 30's, TBill rates will drop like a rock. Japan is the leading indicator of this trend. The lower T Bill rates drop, the more attractive non-interest paying gold becomes. Contrary to popular belief, deflation is bullish for gold. With the desperate reflation attempts we expect worldwide, the opportunity cost of owning gold is going to fall dramatically.
4.Equities
So far the only panic on Wall Street has been by the professionals, while retail investors are praised by the media for thinking long term. I think that time will show that in 1998 "he who panicked first, panicked best". We have just seen the third great bull market in equities this century, the prior two being the 20's and the 60's. Every equity bubble must be followed by a bust. The previous two were. Why should this bull market be any different? Low interest rates and inflation will not save the stock market. Ask the Japanese. America's economy is not an island, as the bulls would have you believe. The worldwide deflation and loss of wealth caused by the drop in the markets will combine to tank corporate earnings. The bubble will turn to rubble. By the time this bear market runs its course, retail investors will have the same contempt for equities that their ancestors did in the 30's and 70's.
5.Alan Greenspan
Financial markets revolve around faith, confidence, and trust. More than any other single man Alan Greenspan is the leader of the New Era, even if he denies it. Faith in Greenspan gave Americans the confidence to take their ill-fated flyer on Clinton. Greenspan's hubris allowed him to encourage the replacement of gold by the dollar, when he knew that America would never sacrifice its parochial interests for those of the world. Time will show that Greenspan was a god with clay feet. Instead of raising rates a couple of years ago to head off the looming stock market bubble, he jawboned. Now instead of lowering rates to stave off a looming financial panic he allows an inverted yield curve. If he were a stock I'd short him. In his younger days, as a follower of Ayn Rand, he promoted gold as the ultimate currency. In the 60's, he laughed at those who thought they could predict the economic future better than gold. Thirty years later, like an aging King Lear, he discounts gold, and thinks that his number crunchers at the Fed can fine tune the world. His ignoring of the reasons for, and the ramifications of the collapse of commodity prices has brought us to the brink of the abyss. His rapid decline in stature, along with Clinton's, will mean a massive loss of confidence in America just when the world needs her most. He and Clinton could be the Herbert Hoover and the Andrew Mellon of this generation.
6.The Yen
I doubt that the yen will be a very attractive alternative to a crashing dollar. 1/4% interest rates, bad demographics, and the lack of courage to solve their banking crisis will combine to discourage foreign investors from moving capital to Japan. The Japanese have lost their nerve, their animal spirits. That's what depressions do to you, they grind you down relentlessly, day after day after day. Eventually the Japanese government will print money like wallpaper to try and jump start the economy. As the largest savers in the world, the Japanese investors are a huge source of potential demand for gold. Once they lose faith in the U.S. government, as they have lost faith in their own government, they should become big gold bugs.
7.The Deutschmark
Will investors flock to the traditionally hard money mark knowing that the willpower to keep it strong will soon be diluted by the needs of the soft currency Italians, Spaniards, and Irish? Will the world's investors seek out a country with a 1960's economy, that lies next to Russia, a nuclear disaster waiting to happen?
On the other hand, the deflationary tidal wave engulfing the world economy probably means the end of EMU for the same reasons that the dollar block is breaking up. The EMU is one those ideas that sound good during a "New Era" boom. I doubt it will survive the deflationary tidal wave heading for Europe. The resulting chaos from a breakup of EMU would be immensely bullish for gold and for the mark.
The Gold Share Strategies
Like John Wayne and the cavalry riding to the rescue of embattled settlers in the westerns, this financial AIDS has arrived just in time to save many gold shares from the abyss. The across-the- board (with the exception of silver) collapse in commodity prices has brought gold shares to their knees. Most blue chip gold shares dropped 70% from their 1996 highs, while the second and third tier companies are down 90-95% from their bull market highs. Until three weeks ago, most of the tertiary gold shares were priced for bankruptcy. If we are right about gold breaking out, small gold shares offer the risk to reward opportunity of a lifetime. At the risk of seeming outrageous, I would not be surprised to see gold shares rise 15-20 times if gold hits $500 an ounce in the next couple of years.
If tertiary gold shares offer extraordinary reward potential right now, they also carry a large amount of risk. If we are wrong about the timing of the gold bull market some of these companies could disappear. Additional risk comes from the danger of dilution caused by equity raisings at low share prices by desperate companies.
Institutional investors desiring greater liquidity and higher quality companies should stick with the largest 10 gold miners. Their upside leverage is probably 30-50% of the juniors, but with substantially less risk. One additional caveat; if possible, stick with companies with as little exposure to the gold derivative market as possible. If I am right about the earthquakes coming in the derivative market, the gold and gold share market could also be adversely affected. These potential convulsions would be very bullish for gold, but could be bearish for gold miners with large forward sales.
Now a few words about central bank sales of gold, and their effects on the gold price. As I show on the accompanying chart, we are at the third so called New Era this century. Each bull market carries with it an aura of invincibility that "this time it's different". That in this era, we are smart enough and technologically advanced enough to conquer the business cycle and all those other maladies of an earlier inferior age. Each New Era brings with it an antipathy towards gold as being backward and inefficient. The inevitable, bifter hangover from each of these New Eras brings a renewed faith in the raison d'etre for gold.
During the first New Era in the 20's, John Maynard Keynes called gold a "barbarous relic". Five years later gold was vindicated. As the accompanying shows, gold shares saved a lot of people from the ravages of the Crash of 1929 and the Great Depression. In the second New Era during the late 60's, LBJ and Nixon though that America had repudiated mathematics and could have a Guns and Butter fiscal policy, financed by a syncopathic Fed. Eventually Nixon eliminated the last link to gold saying "We're all Keynesians now". This hubris was shown to be folly in the next few years when gold prices soared. Now even the supposedly prudent and trend resistant central bankers have bought the bear case on gold.
Over the last five years, a new facet in the latest New Era war on gold has arisen; commission hungry brokers. Bullion dealers, primarily based in London, have waged an intellectual war on the raison detre for gold. They have informed central bankers that gold does not pay interest. Duh! So they have convinced many bankers to sell their gold or lend their gold to the bankers, who in turn lend it to someone else who sells it. Thus, the birth of a huge derivative market in gold.
The bullion bankers are in many ways comparable to urban real estate brokers in the 60's, who developed sales strategies called "blockbusting" in their never ending search for commissions. These real estate brokers would move a black family into a block which had previously been exclusively white, then they began a whispering campaign informing worried white homeowners that soon the neighborhood would be black, with its concomitant rising crime and failing home values. If successful, blockbusting resulted in mass white flight, which meant major commissions for the brokers.
The blockbusting game in the gold market is being played for big stakes. Central banks own hundreds of billions of dollars of gold, enough to make any broker's mouth salivate. The brokers will do anything they can to discredit gold, they must create a "beggar thy neighbor" fear in the minds of weak thinking central bankers. "Sell now, before another bank does and drives the price down further."
As the number of credible investment alternatives to gold contracts, the bear case against gold in the eyes of central bankers will shrink as well. Eventually, all it will take is a few large buy tickets from someone like Soros or an Asian central bank and gold prices will breakout like the gold shares have done in the last few weeks. The handwriting seems to be on the wall.
In all due honesty, I hope I am wrong about the forecasts made in this piece. As all professional investors know, investing is a matter of probabilities and risk/reward ratios. Of qualitative as well as quantitative analysis. Right now, I place the odds of the scenario described in this paper at 40% or higher, a year ago I put that number at 5%. Maybe history will not repeat itself. Maybe this time it is different, and Americans will dodge the deflationary bullet, but I wouldn't bet that way without a healthy dose of investment insurance. I strongly recommend that you consider gold shares as that insurance, they've stood the test of time. I would be happy to discuss practical ways of creating that insurance for you. If my fears turn out to be unfounded, and Goldilocks returns, the commodities should be ready for a good rally. I want to stress that the risk/reward on the long side of gold and gold shares may be the best of our lifetime.
Dow Jones Industrials/Gold
TSE Gold & Silver Index
DJIA vs Homestake Mining
Blake Joyner specializes in gold and silver mining shares for high net worth individuals and institutions for First Albany Corporation in Chicago. He can be reached at 888 879 7730 or 312 879 7738.
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