ContraryInvestor.com has a piece on gold:
Among The Fields Of Gold
You Can Tell The Sun In Its Jealous Sky That We Walked In Fields Of Gold...As you might imagine, we've had a number of readers suggest we get off of our rear ends and address gold. Especially after the rather violent downside volatility of late. We'll be the first to state unequivocally that we are nowhere near as versed in the day to day fundamentals of gold and gold stocks as are many of the gold pundits you will find all over the net. From our humble perspective, gold as an investment has been and continues to be about insurance. Some might call it financial catastrophe insurance. Admittedly our gut is telling us that some form of insurance, per se, may be more a need today than at any time in decades. And a real need that may be less perceived as such by the general investment population than has also been the case in decades. Very briefly, here are a few comments.
Hit The Bench...In a lot of circles gold has been described as "real money". As you know, throughout virtually all of mankind's non-strictly barter related economic history, gold has indeed held a seat at the acceptable as currency table. But the fact that gold has been used as a medium of exchange, as opposed to almost anything else being used as that medium, is derived from it's intrinsic qualities. It is of relatively fixed supply over any short period of time. It takes some real effort to produce very little additional amounts of physical supply. And it's portable. For ourselves, we believe the importance of gold then and now, so to speak, is as a benchmark. Whether overtly or not, really as a benchmark against man's own proclivity for excess. IF there is to be a huge bull market in gold ahead, we feel it will largely result from some need on the part of financial markets, global economies and the global society as a whole for a benchmark against which to measure the value of paper and real "things". In the current world, our real worry is the paper end of the equation.
In the modern financial and economic era of postwar history, during which the linkage between a valuation benchmark such as gold and paper currencies has been severed entirely, the global financial market has been relatively extremely adept at self correction. As countries have developed financial or economic imbalances, the global capital markets have cast the final vote in terms of currency adjustments. When many an Asian economy was overburdened by leverage or imbalanced, if you will, in 1997, global capital movement provided a swift and sure identification of the problem and ultimate remedy. But we suggest that the global community now finds itself at a bit of a different crossroads today in terms of potential imbalance reconciliation. Not only is the US economy the largest singular economy on the planet, with the next nearest economy about half our size, but the currency of this largest of economies has become the likewise largest de facto global financial reserve "holding" of the moment. Three short decades ago, we were at least still pretending as a global financial system to have a benchmark against which the value of currencies would be measured. No longer. Now the value of paper is simply measured against that of other pieces of paper.
The ballgame has also changed in that the country whose currency has become the de facto reserve "value", or benchmark, on the planet is also the world's largest debtor nation. A nation dependent on importing the bulk of global savings at any point in time to finance its ongoing consumption needs. A nation running trade and current account deficit balances never witnessed before in postwar history. Just how do the global capital markets financially discipline the 800 pound gorilla when the economies that represent that same global capital may be dependent on that gorilla for their export markets? Exports they are, of course, financing. How do the global capital markets financially discipline the financial 800 pound gorilla when global central banks own the 800 pound gorilla's home currency as a major part of their financial reserves? At this point, if global capital enforces discipline, is it to their larger detriment near term?
In the current world, we need to ask ourselves just how far what are really global imbalances can be stretched until global capital ultimately seeks a benchmark of some sort that is an alternative to paper? A benchmark other than a financial asset whose backing is only perceptual. Of course in advance, the answer is unknowable. In the meantime financial imbalances grow by the day, the month and the year. In terms of gold, maybe we can be comforted by the fact that the price of benchmark insurance has really stayed inexpensive as these apparent imbalances have mushroomed. As you know, the price of gold today is what it was 10 and 20+ years ago. Compare that to the absolute level of trade imbalances, and government, corporate and household leverage 10 and 20+ years ago. In that light, the financial insurance that is gold appears to be a bargain. The same insurance premium today in terms of price to cover systemic financial risks much greater than those found in prior decades.
I Don't Get No Respect...We've seen the total market cap of the gold related equities estimated at $90 billion, depending on the hour of the day, of course. As you know, so many smaller companies are micro cap in nature. Even large cap big daddy Newmont's market value is $10 billion. That's peanuts in the institutional world we spoke of on Tuesday. Gold, at least as represented by gold stocks, has no institutional constituency of size. The entirety of Newmont might be a decent portfolio position split up among maybe five large equity mutual funds. We have to be aware that at least for now, gold stocks are among the smaller traders' province. And that includes the loyal and absolutely long term focused modern day hedge crowd.
Even if a large cap equity fund manager is absolutely a believer in what gold represents, do you really think that individual can include it in size in his or her fund? There's a structural impediment at this point for the institutions borne of the law of large numbers. And that's probably not going to change any time soon. If large institutions decided to allocate to gold in even a moderate manner, we'd be squeezing a fat man through the eye of a needle. Almost by definition, the big institutions could not meaningfully participate in a possible significant bull market in gold. They'd drive prices to the moon just trying to get adequate exposure.
The History Of The World As We Know It...Well, maybe you're just going to have to settle for the history of capitalism in the US for now. From our vantage point, the history of our domestically practiced form of capitalism can at least in part be characterized by inflation. As we see it, it's one of the truisms that has remained a constant throughout our entire financial history as a country. A cyclical constant, mind you. In postwar history, the last few decades have witnessed an inflation in financial assets and the currency for the first time during which this currency has been completely untethered from the gravitational pull of a constant or a benchmark in terms of relative valuation. It truly is a new era in modern financial and economic times. Bernanke's "printing press" would simply be a pipe dream had we remained on the currency bench(mark) of the pre-early 1970's period.
Although we simply cannot even guess at the timing of potential or ultimate benchmark reconciliation as previously described, we may in fact be accelerating toward it. As you know, global perceptions of the US economy and government infrastructure are what really underpins the dollar at the moment. And the role of that government is absolutely destined to change in the years ahead. If we look at the domestic economy as a singular balance sheet, to keep prices stable to rising over time, some segment or multiple segments of that economy must be levering up with some sense of longer term consistency. Levering ultimately being a demand or driver for an increase in the money supply (the academic definition of inflation itself). During the 1990's, perhaps it was possible for the government to pull back on the throttle of leverage expansion and not harm the general level of system wide prices in the domestic economy as the consumer and corporate sectors were levering up with relative abandon. And in many cases, levering to consume assets that were not long lived. But now the shoe is on the other foot. As we have shown you in prior discussions, the corporate sector is in the clear and distinct process of delevering. We can see no other way around the fact that the consumer will also have a turn at bat when it comes to balance sheet reconciliation. Depending on the real economy near term, maybe sooner rather than later. Following the total domestic balance sheet analogy, that leaves it up to the government to continue levering to offset the delevering need in the corporate and consumer sectors. Otherwise, deflation may be a real and present danger.
Trying to tie this back to gold, we'd suggest that the delevering of the consumer and corporate sectors is in many ways independent of the dollar directly. Corporate blowups affect equity and bond investors. Consumer blowups affect the creditors of households. Alternatively, a perceived government debt problem would theoretically directly affect the dollar vis-à-vis the potential global movement of capital. You remember, a dollar that has become a global financial benchmark in modern times. The government is already well on the way to levering anew. The implicit costs of the current economic "soft spot" (increased transfer payments + lowered tax receipts) plus the costs of the war have given it one heck of a head start on the debt accumulation game.
If one of the major current global financial benchmarks (the dollar) becomes perceived as being tarnished, just where does global capital run? Over the last year we've already been given a little preview of this. One temporary hiding place has been the Euro. There have been a few folks clearly taking cover in the Yen relative to the dollar. But ultimately these alternative financial benchmarks may not prove suitable hiding places for purely fundamental economic reasons specific to the respective countries. So far, global capital has sought out other financial benchmarks to at least partially replace the world's most prolific financial benchmark it is beginning to question. If these other financial benchmarks prove less than adequate to assuage what is basically capital fear, will other historic non-financial benchmarks be considered? Although it may take today's masters of the universe cracking open history books to find it, gold is patiently waiting backstage. The government that backs the world's largest reserve currency must lever ahead to offset the delevering of its corporate and consumer sectors. As this financial leverage increases, it will be quite telling to watch the price of insurance that is gold. Will global capital eventually tire of chasing alternative financial benchmarks to the dollar and decide to benchmark against physical commodities in some manner? At least over the very long run, that's been part of the cyclical history of this medium of exchange we call money, regardless of what form it takes at any point in time.
The Motion Of Emotion...Again, in our puny little brains, we see gold as currently a very emotional proposition as an investment. Some of the largest and most vocal proponents of gold investing in recent years are convinced that a grand scheme of manipulation has befallen the global metals markets. We cannot dispute the claim with facts and can only offer that it has become a perceptually emotional crusade for some of these folks. Some proponents of the barbarous relic rant and rave that the world as we know it is about to come to an end, therefore gold is the only savior. To be honest, if they're correct, we'll gladly trade our gold to the first takers who offer us a sustainable supply of water, food, shelter, fuel, and ammo. You may be aware that just recently Jim Sinclair (top dog at Tan Range Exploration and quite vocal gold cheerleader) absolutely refused to ever post again at Jim Puplava's FinancialSense website. Sinclair also demanded that Puplava remove all prior Sinclair missives regarding gold from the Puplava site. Why? Puplava committed the cardinal sin of interviewing Bob Prechter on his weekly radio show. (As you may be aware, Prechter is calling for a deflationary collapse and projects gold into the low $200's.) If that is not an emotional human response centered around gold, then what is?
You can also see the emotion that swept this country during the gold rush periods, both in Alaska and California. Richard Russell often refers to the old saying that "there is no fever like gold fever". For those of you who own gold shares in today's market, certainly you have a taste for the emotion in prices over the last few years, let alone the last few months. Although this may sound like a cop out statement, we personally need to approach gold from the most unemotional position possible. For us, the bottom line is that gold is insurance against significant current global financial imbalances and ultimately the possible potential need for global capital to benchmark against something other than another financial asset. Longer term, it's not about breakouts, the 50 day moving average, relative strength or head and shoulders reversals.
Lastly, we'd suggest that in terms of emotion, the broader mass of public investors have just barely seen their pulse rate rise regarding gold over the last few years. Although many a technician and ardent metals follower can see what certainly may be the beginnings of a longer term bull being born here, public investors only know that gold hit the major headlines almost exactly at the most recent price peak and, according to this same media, the price of the metal is now down sharply due to the "war going well". (Long term, the war has about zero to do with gold.) Want to know how the public really feel? Have a look at the following chart. Please be aware that these are quarter end numbers. A ton of intra-quarter squiggles and wiggles are missing:
As you may know, China recently opened gold sales to their populace. Australia listed a security that represents physical gold on their exchange. Here in the US, the Fidelity numbers tell the story of how individual investors feel about gold, or more correctly about gold shares. At the moment, most folks are still much more concerned with trying to pick the next big bottom in the techs.
East Of Eden...As the physical nature of the real global economy shifts ahead, will the use of gold as a standard or benchmark become any more meaningful than it is today? Of course, today being not very meaningful at all. Specifically as we watch the changing nature of foreign direct investment (FDI), it is clear that areas providing low cost labor are currently recipients of the lions share of global FDI. China certainly being the model example. As countries such as China, India and those in Eastern Europe develop economically over time, will gold ultimately play a meaningful role in the benchmarking process of their specific country sponsored financial assets? Especially in terms of currencies? For now, our educated answer is "who knows?". At the moment, the Chinese renminbi is "benchmarked" against the US dollar. No big surprise. But it seems pretty darn clear that the current Chinese leadership is intent on ultimately becoming a global economic force of substance. As they ultimately decouple their currency from the dollar, would a gold backing or partial gold backing enhance the legitimacy of the Chinese currency from the perspective of global capital attractiveness? It sure wouldn't hurt, now would it? The issue of the role of gold in developing economies ahead remains open to question, but the one thing of which we are sure these countries are well aware is that they will not have the luxury of a "printing press". At least not if they want to establish any type of legitimacy. And of course it would be nothing short of historically ironic within the context of the economic evolution of the globe that just as developed country currencies have abandoned the benchmark of gold, the emerging currencies adopt it.
The Doctor And Patience Relationship...Gold has been a relatively key component of the economic history of mankind for many centuries. It's really only been in the last three decades that the grand financial experiment of replacing a physical valuation benchmark with an open ended financial benchmark (the dollar) has taken place. Modern day experience with completely fiat based currencies is still in its infancy. As you know, history is replete with cyclical examples of the need for economies and financial systems to benchmark at various points in time. Especially during times of elevated financial stress. Historically the ultimate and most consistent benchmark has been gold. For ourselves, there is only one way to approach gold right here. It's with patience and the understanding that gold as an investment is insurance against the ability of the current global economy and financial system to correct what are very significant imbalances without some type of financial disruption. The disruption specifically being currency related. That's the bet. Certainly folks can choose to trade around the volatility in gold and gold shares. (In the broader sense, isn't the greater financial market of the moment really largely centered around trading more than anything else? Of course it is.) If a significant bull in commodities, including gold, lies ahead, it plays out over time. Patience and then more patience is required. Easy to say and very tough to do in a world geared toward immediate gratification. Would any rational person in 1990 have guessed just how the NASDAQ was to end the decade? Probably not. So to do we have no idea just how important gold becomes to the global economy over time. Again, although it's never knowable in advance, the historically recent decade acceleration in the proliferation of paper promises throughout the global economy cannot continue indefinitely without a crises in benchmark valuation confidence at some point. The multi-century financial and economic history of man is pretty darn clear on the subject. The questions of course being, when do benchmark paradigms shift and to what benchmark does the global financial system seek out next?
Although we strongly suggest you take a longer term view of the potential future meaning of gold to the global financial system, we will fill the ChartRoom this weekend with various pictures of gold. As you may know, the $325 number for gold is relatively significant in terms of near term technical action of the group. In the meantime, we'll leave you with this:
Over The Hill And Through The Woods?...You may remember that last week we suggested it would be important to watch market reactions to upcoming economic stats and corporate earnings announcements. Based on market action this week, investors are surely looking over the hill in terms of the ISM and jobless claims numbers. On Tuesday we briefly discussed the manufacturing ISM reading. As a follow-up to a bad manufacturing based ISM report, today's services oriented non-manufacturing ISM reading was simply terrible. As you can see below, the headline business activity reading was the worst since the post 9/11 reading. The March monthly change was the fourth worst monthly drop in the history of this survey.
Again, maybe this will all "go away" once the Iraqi conflict is over, but if not, then a double dip recession is right around the corner.
In addition to the service sector ISM reading, jobless claims data today soared to the highest number in almost a year. Although there can certainly be revisions here, the jobless claims data reflects the anecdotes regarding weak labor markets seen in almost every economic stat of the past three weeks. Do you buy the fact that claims are breaking out to the upside?
We'd dismiss it for now as a one week reading had this not been foreshadowed by too many recent corroborative data points. We'll just have to see what tomorrow's employment reading brings. In terms of the financial markets, it's as if these at least eye opening economic statistics didn't even hit the tape this week. Are investors simply too busy counting the miles to Baghdad? Had they already emotionally written off what was a relatively high potential for discouraging near term economic news? Are they just looking well beyond the conclusion to the current Iraqi conflict? As has been the case in recent weeks, despite the severity of real economy factual data, the invisible hand of the market has shown little tolerance for downside action in equities. |
