great letter tonight on Richard Russell's web site
dowtheoryletters.com
Dear Mr. Russell:
I have been a fan of yours ever since you started your newsletter. My career started January, 1955 as a stock broker. As the years passed, I have been a managing director, portfolio manager of two mutual funds I started in the early 80's, monetary strategist, partner, and part of owner a significant brokerage firm. Now, I just do what you do, take care of my accounts and family money. I was one of Wall Street's "gold bugs" between 1965 and 1980. Having been successful at that I convinced my firm to start the two mutual funds I ran. One was a hybrid(the first of its type) investing in a variable combination of precious metal assets and U.S. guaranteed securities.
The other was an income fund. As you might guess, when in 1986-87 I did nothing in those funds but buy long maturity treasury securities, my peers decided interest rates would rise, not fall, because they were all so sure inflation would become a big problem again. Therefore, I was fired from the bond side job of managing those funds. Then the firm was sold to another major financial house, and I straddled the fence between them, running the gold side of the hybrid fund. When I believed gold would go even lower, and down-weighted precious metal assets sharply, I was laid off from that job too(retirement they called it). In any event, I went from being an inflation and gold hawk in the 60's and 70's, to a deflation and long t bond hawk in the 80's, 90's and now into 2003.
I addressed this the way I did, because if you have not seen Lacy Hunt's report, I suggest you avail yourself of it. His analysis is exactly the same as mine, we are into a deflationary era, which you also seem to believe. Aside from that, I wanted to discuss the question of what the US dollar will do.
My own analysis is as follows. The dollar is held by all central banks around the world. It is the reserve currency for their own financial systems not held in dollars, but mostly US Treasuries. If central banks sell dollars it shrinks their own national money supply. They cannot do this under current conditions of weak economic activity around the world. Furthermore, if our economy declines, as I forecast, into a deflationary period, as the US is the importer of last resort for the rest of the world, I believe all the other economies probably would be hurt more than ours. Therefore, when we enter a synchronized deflationary period around the world, I see the dollar as getting stronger against other currencies, not weaker. There may be periods such as now when shorter term cyclical influences bring the dollar down to some degree. But as long as we are heading toward a deflation I think the long term trend is toward a stronger dollar. In fact, as the dollar is measured by the "dollar index", this measure maybe faulty because there are many currencies, particularly in Latin American against which the dollar is rising.
Having said that, I think the long t bond goes to 4% or less in yield, which means there is still a potential appreciation factor in the bond of somewhere around 20%, assuming yields fall within a few years. History shows that in general there is no correlation between what a currency does and long term interest rates. On the other hand, if the world economy gets so terribly bad that all central banks are forced to resort to accelerated debt monetization(such as Japan), to keep the financial system lubricated, therein lies the seeds of the great new bull market in gold, even if the dollar is stronger against other currencies. I believe what we are looking at is a very very long term move toward the destruction of the federal reserve system and its system of debt monetization for the more debt that is piled up in a deregulated financial(floating rates) system, the worse the economies will be. Simply look at Japan for a clue to that. It has been monetizing and running larger and larger deficits, and it is not working despite extraordinarily low interest rates. The management of money supply growth by the federal reserve system cannot work over the long run. Better to take away the power of the central bankers, and just increase the money supply at a constant 2.5% as suggested by Milton Friedman.
It may or may not be that gold has embarked on a new gold bull trend. It is too early to tell for certain, as we have not yet had the deflationary recession I foresee. When we have that then we will see how gold will behave. We may find that gold simply got so low and supply demand factors went positive for it, and that the rally started because of that and sustained by other geopolitical and market player beliefs. Be that as it may, the next gold price correction, and note that shares have been doing that, might be a good time for investors to put about 5% of their assets in the gold market through mining shares, precious metal share indexes such as the xau, or the individual stocks. On the other hand, as you, I have counseled all my clients to remain in the highest grad fixed income securities such as Treasuries, GNMA's GNMA cmo's, aaa tax exempts, a preferreds, and a corporates, with relatively long average maturities(durations). This has allowed us to get our cake and eat it too, sustaining a higher average income flow, some tax relief, and some appreciation(in the long treasuries and t zeros).
To close, I am so pleased that you continue to discuss the truth about trends in finance and other matters affecting the American public. Your discussion of the eras I went through, the second world and Korean wars, tug at me greatly. You are right. The American public has lost its focus. I think only hard times will bring back the disciplines we used to have as a people. I hope and pray that our system of government and rule of law will survive the difficult period ahead of us. And, given our ages, I ponder how much of this change we will get too see, although I think we will be around long enough to see at least part of the hard part.
Respectfully
August F. Arace |
