All-ahead Full for Gold

By Scott Silva

Editor,  The Gold Speculator

5-23-11

Gold is riding high now and its price will move higher as more economic data confirms the US economy will remain sluggish for the foreseeable future. Gold regained the $1500/oz level since dropping from its all-time high of $1577.40 on May 2^nd.  The week-long sell-off in gold early this month was modest compared to price drops of other commodities. But gold did not experience the parabolic rise of silver, oil, wheat and some other commodities over the last six months.  Instead, gold has seen a steady rise in price, a long bull move dating back to January 2001.

What is propelling gold higher?  A big part of the answer is government intervention in the financial markets and the stubbornness of monetarists who cling to the false notion that as “Masters of the Universe”, they indeed can control economies at the local, national and global levels. Like the forlorn bond trader Sherman McCoy in Tom Wolf’s Bonfire of the Vanities,  Ben Bernanke is coming to realize his “sure thing” is in a reality a colossal cropper.

The economy is not responding to any form of stimulus—not the $835 Billion stimulus package; not near-zero Fed fund rates; not Quantitative Easing 1; not Quantitative Easing 2. By every measure, Washington economic policymakers have failed.

Some say that the emergency actions of the Fed and US Treasury averted a steep depression in 2009. We will never know for sure. What we know from history is free markets recover more quickly from depressions than economies that are “managed” by central planners.  The depression of 1920 lasted only two years because President Harding’s hands off monetary policy allowed for natural recovery. The Great Depression lasted eleven years, largely because of FDR’s stimulus spending programs and Fed’s mismanagement of the money supply.

In the current case, bank bailouts and the subsequent easy money policies have created some terrible unintended consequences. Excess liquidity in the system has caused a rapid rise in commodity prices, which is causing inflation at the producer and consumer levels. The US Dollar is losing value compared to other currencies and is losing purchasing power. Demand is weak so, despite low interest rates, businesses are not expanding and unemployment is high.

The numbers tell the story: GDP growth 1.8%; Unemployment 9.0%; Core Inflation 2.1% (actual inflation 6-10%);  2011 Deficit $1.6 Trillion; US Debt $14.3 Trillion.

Something has to change. At his press conference last month, Chairman Bernanke announced he is ending Quantitative Easing 2 on schedule at the end of June. This would be quite a change. But the gold market has said no to the Chairman’s pronouncement. Gold has climbed in price, signaling there will be something like QE3 in late June. At the least, QE3 (sotto voce) will be continued Fed buying and expansion of its balance sheet through reinvestment of proceeds from maturing issues.  A more formal QE3 may also be in the offing.

But here’s the rub. Chairman Ben, like Homer’s Odysseus, attempting to navigate the Strait of Messina, must avoid Scylla to port and Charybdis to starboard.  Continued easing will accelerate inflation, devalue the Dollar and inhibit business growth (low capital costs favor consolidation rather than organic growth).  Any reduction of Fed assets will raise interest rates and slow whatever recovery is underway, which might cause a double-dip recession. Tightening will also impact interest rates on US Debt. All are bad outcomes for the economy.

The Chairman is facing dissent to continued easy money policy by members of the Fed. Last week, Thomas Hoenig, long-serving president of the Federal Reserve Bank of Kansas City, publically challenged the accommodative policies that the central bank has pursued since 2009. While many of the Fed’s Board of Governors and members of the Federal Open Market Committee view near-zero interest rates and massive infusions of cash into the economy as the best path to economic recovery, Hoenig believes the policies are “…sowing the seeds of the next financial crisis. When you put this much money into the economy, it's got to deploy. Some of it is deployed into commodity assets. You're going to have volatility in that environment, and we are seeing volatility.”

“The inflation of the 1980s started in the mid-'60s. It is a slow process along the way, but if you leave policy easy, then inflation will eventually catch hold.

This inflation we're seeing is in everything now. It's not just in gas. Companies are telling me, ‘We're seeing 20 percent price increases in our inputs and passing along 10 percent or more.’ We're starting to see the psychology of inflation slowly change.”

If it were up to Hoenig, the Fed would cut the easy money era short, right now. He is not alone. Narayana Kocherlakota, president of the Minneapolis Fed, has voiced concern that excess bank reserves may create much higher inflation than we are seeing now. Today, Fed banks are holding $1.6 Trillion in excess reserves. Kocherlakota advocates selling $15 billion-25 billion of MBS a month, which would restore Fed balance sheet assets to more traditional levels in five years instead of the 30 it would take for the bonds to mature.

Maybe the Fed and others in Washington will come to realize that the best course of action for the Fed is to take their hands of the wheel and feet off the pedals. They’re not connected anyway. Only free markets determine what is to be.

Time will tell. In the meantime, gold is telling us that prudent investors are hedging their bets that the US economy will turn up sharply anytime soon.

Investors from around the world benefit from timely market analysis on gold and silver and portfolio recommendations contained in The Gold Speculator investment newsletter, which is based on the principles of free markets, private property, sound money and Austrian School economics.

The question for you to consider is how are you going to protect yourself from the vagaries of the fiat money and growing inflation?  We publish The Gold Speculator to help people make better decisions about their money. Our Model Conservative Portfolio gained 66.7% in 2010, and 55% for 1Q2011. Subscribe at our web site www.thegoldspeculatorllc.com  with credit card or PayPal ($300/yr) or by sending your check for $290 ($10 cash discount) The Gold Speculator, 614 Nashua St. #142 Milford, NH 03055

One word: Gold.

By Scott Silva

Editor,  The Gold Speculator

5-16-11

“I want to say one word to you, Benjamin.  Just one word: Gold.” If Mr. McGuire had given that advice to Benjamin Braddock (a.k.a The Graduate) in 1967, Benjamin might be much better off today. Instead, his advice to the young man was “Plastics.”

In 1967, the average price for gold was $34.95/oz. Of course, gold prices were not allowed to float in the US until 1971, but if young Benjamin had invested $4,000 in gold instead of that little red Alfa Romeo Duetto Spider convertible, he would have made a small fortune by now, roughly 42 times his money.  A pristine ’67 Alfa Romeo spider is selling for $15,000 or so today.

Why has gold increased so in value? One word: Inflation.  The purchasing power of the US Dollar has decreased steadily since 1967. It would take $6.47 today to buy the same item that sold for $1.00 forty-four years ago, a 647% increase in price. Benjamin’s college tuition alone would cost over $212,000 today. Certainly, there have been periods in US history when prices did not rise each year. In the last century, average annual prices fell in 1921, 1927, 1928, 1930-1933, 1938 and 1939. In 2009, average annual prices declined 0.4%, but since then prices have increased each year. According the Bureau of Labor Statistics, the US inflation rate is 2.1%, but this number is understated. Fuel prices are up more 27% from last year. Food prices are up by double digits year-over-year.  Import prices are up 11% from last year. Producer prices are up, too. Housing prices remain depressed, but overall, prices for almost all other goods and services are higher now than a year ago, and the year before that.

Some say that high commodity prices cause inflation. Others attribute higher inflation to corporate greed. With gasoline prices at $4.00/gal or more, the lynch mobs are out for Big Oil CEO’s. At a Congressional hearing last week, a senator remarked that “unchecked corporate greed has given them $30 Billion in profits last quarter”.  But the US oil refiners are accounting for the higher cost of imported oil, which has been at $98-114/bbl for the last five months. Today US consumers are still paying $4.00/gal to fill their tanks. And they are likely to buy gas at $5.00 or more before demand decreases due to price.

These arguments miss the point about the cause of inflation. Higher commodity prices and corporate greed are not the causes of inflation.  Contrary to popular opinion, inflation is not about price increases for goods and services. Inflation is about increases in money supply. The general increase in prices comes only by the increase in money stock. The inflation we are seeing now at every level is in fact due to increases in money supply. This is the case now, and it has been the case for every period of inflation in history.

Aristotle defined the four properties of “good” money. Money must be durable, portable, divisible and have intrinsic value.  Aristotle’s definition has stood the test of time. For more than 2,000 years sound money has been proven to be a good medium of exchange as well as a store of value. The only time gold money lost its intrinsic value is when governments debased coins used by the general public (reduced the gold content in a coin by substituting industrial metal at the same weight), while hording pure gold coins for themselves.

Fiat money has never been good money because it lacks intrinsic value.  Governments debase fiat money by printing more of it. Increasing the money stock chases good money out in the same way Copernicus described in his 1519 treatise  Monetae cudendae ratio: "bad (debased) coinage drives good (un-debased) coinage out of circulation.”  This concept has become known as Gresham’s Law. These days, the Fed seems intent on codifying Gresham’s Law. Since 2008 it has printed $2.7 Trillion of the paper stuff to support various fiscal stimulus packages and bank and industry bailouts. More paper money chasing fewer goods and services causes prices to climb. Inflation is a tax on every consumer who buys with paper money.

An example of inflation brought on by the printing of fiat money occurred in the US Civil War era. During the war, both the federal and the confederate governments issued paper currency to finance war expenditures.  The federal government issued $450 million “Greenbacks.” Inflation soared. Northern currency fluctuated in value, and at its lowest point, it took 2.59 inflated Greenbacks equaled $1 in gold. The Confederate paper currency lost much more purchasing power; $60-$70 equaled a gold dollar.

At the end of the war, President Johnson authorized the Treasury to repay Federal war bonds with gold. This reduced the outstanding Greenbacks by 20 percent which propped up the value of Greenback dollars and drove down the Greenback price of goods. In the election of 1868, the Democratic presidential candidate Horatio Seymour repudiated the “Ohio Idea,” which proposed that war debts be repaid with Greenbacks rather than gold.  Predominantly western Democrats who first offered the fiat money financing idea became known as “Inflationists.” Seymour lost the presidential election to Ulysses S. Grant 214 to 80. Inflationist policies financed other wars including WWI, Vietnam, Iraq, Afghanistan and now Libya (WWII and Korea were paid for primarily by tax increases).  

Gold money leads to lower price inflation.  Studies show that price inflation is lower under gold standard monetary regimes than in fiat money regimes.  The classical gold standard prevailed in all the developed economies in the period from 1880 to 1914. Then, authorities maintained the value of national currency in terms of a fixed weight of gold, or the mint price. During this period, the mint price was set at $20.67 per ounce of gold. Under the gold standard, the purchasing power of gold tends to equal the long-run cost of production.

We can see from the chart, from 1880-1913 inflation averaged about 3 percent annually in Australia and Finland, about 2 percent annually in the Netherlands, and slightly less in the United States. For the other nine countries, the average inflation rate was between plus and minus 1 percent for the period. Average inflation over 33 years of these 13 countries on the gold standard ranged from –0.6 to 3.0 percent.

Today’s economies use fiat money and employ muscular monetary policy such as inflation targeting.  Since the collapse of Bretton Woods, central banks have attempted to maintain low inflation and relative price stability.  Clearly, these policies are failing. As the chart shows, the average inflation rate was much higher in the modern period (again for 33 years, from 1968 to 2001).

So what can the individual do today to protect his wealth against rising inflation?  He can buy and own gold. Gold has maintained its intrinsic store of value against the ravages of inflation and debasement of fiat currencies for decades. Today’s economic environment is characterized by unprecedented expansion of the money supply, which ensures prices will continue to rise for the foreseeable future.

The real price of everything…is the toil and trouble of acquiring it. The

same real price is always of the same value; but on account of the variations

in the value of gold and silver, the same nominal price is sometimes of very

different values.

                                                                                         Adam Smith (1776)

Investors from around the world benefit from timely market analysis on gold and silver and portfolio recommendations contained in The Gold Speculator investment newsletter, which is based on the principles of free markets, private property, sound money and Austrian School economics.

The question for you to consider is how are you going to protect yourself from the vagaries of the fiat money and growing inflation?  We publish The Gold Speculator to help people make better decisions about their money. Our Model Conservative Portfolio gained 66.7% in 2010, and 55% for 1Q2011. Subscribe at our web site www.thegoldspeculatorllc.com  with credit card or PayPal ($300/yr) or by sending your check for $290 ($10 cash discount) The Gold Speculator, 614 Nashua St. #142 Milford, NH 03055

TIME FOR EQUITIES, OR NOT

By Scott Silva

Editor,  The Gold Speculator

5-9-11

The recent sell-off in commodities, particularly gold and silver, has caused some investors to consider investing in the broader stock markets. The stock markets have lagged gold and silver the last few years, but earnings are improving and many believe equities are ready to take off. Is this the case? Will the equity markets outperform precious metals over the next six months?

To answer this question, we first must understand the factors that drive the equities and commodities markets. We then can make rational judgments on allocating investment assets.

The largest US equity markets include the NYSE and the NASDAQ, on which over 5,000 issues representing $17.4 Trillion are traded each day. The most frequently used stock market indices are the Dow Jones Industrial Average (DJIA), the Standard & Poor 500, and the NASDAQ Composite.

Earnings are the single most important metric for a company. Equity prices move as a function of future earnings expectations. The key measure is Price/Earnings, or PE ratio. The DJIA is currently trading at 14.4 times earnings;  S&P 500 at 16.84; and the NASDAQ at 12.62. These are all lower than PE’s seen a year ago.

Gold and silver do not have PE ratios. The price reflects the value the buyer is prepared to pay for the metal. That value is typically a premium over the value of paper currency.  Therefore,   precious metals are considered to be stores of value.

Future earnings for equities are driven by many factors including top-line revenue, operating costs and overhead. As large part of operating cost and overhead is personnel cost.  In recessions, most companies cut back on personnel and slow production in an effort to save costs. Today, US unemployment remains high, 16% by one government measure (U-6).

Part of operating costs is the cost of money, or interest cost. Low interest rates usually encourage capital expenditure, but since the financial meltdown in 2009, banks have slowed lending, reducing CAPEX for many companies despite very low interest rates. Today, the banks are holding $1.4 Trillion in excess reserves.

Wall Street stock analysts predict earnings for a traded issue using sophisticated financial and market analysis. An important input is company guidance, the company’s own projections for the next quarter or year. But the cat-and-mouse game between Wall Street analysts and company officials can create self fulfilling prophesies that lead to market “surprises”.  The company may understate guidance in an effort to lower Wall Street consensus estimates. Printing numbers that “beat” the street usually propels the stock price up.

So what is the outlook for stocks compared to gold and silver?

We see from the chart for the DJIA, there have been two significant technical breakouts since the financial meltdown of 2009. The first was a breakout of the head-and-shoulder pattern on July 20, 2009. This was a run from 9,000 to 11,258 on April 26. 2010, a 25% gain. The second breakout occurred November 29, 2010 at 11,092. That move continued up to 12,876 the high last week, a 16 % hike. The next resistance levels are 13,000, then 13,790 and 14,119.

What could slow gains in the DJIA? Many think inflation is already eating into earnings, and seen more earnings erosion coming. Higher global commodity prices are affecting source prices. Now, higher labor costs are pushing up manufacturing costs in China. High fuel prices continue to hinder the global recovery. Slowing demand is also a factor. US GDP growth slowed to 1.8% for 1Q11, down from 3.2% for the previous quarter. World GDP for 2011 is forecast to slow to 4.4% average down from 4.9% average in 2010.

Stock prices have been pushed up by the Fed’s easy money policy. Near zero interest rates have kept margin rates low. When the Fed tightens, the stock market slips. We have seen rate hikes kill stock rallies before.  But tightening (or even just ending Quantitative Easing 2) is likely to impede the fragile recovery. So it is not clear that the Fed will indeed forsake its easy money policy in June as scheduled.

On the other hand, gold and silver have outperformed stocks for the last few years and are likely to outperform stocks for the next year or more. Despite last week’s pullback, today’s market action shows the precious metals are resilient and poised to reach new highs.

This is because the forces that favor the precious metals remain intact. Political unrest in northern Africa the Middle East threaten the major oil supplies.  The EU has failed to fix its sovereign debt crisis; more bailouts are required for Greece, Ireland and Portugal. Global inflation is on the rise. Oil is trading above $100/bbl. The US debt crisis will hit states and municipalities, and upset Federal budget negotiations. The US Dollar is likely to remain weak. Uncertainty will continue to be the norm.

Uncertainty will continue to propel the precious metals up. Gold is trading above $1500/oz and silver, hurt by massive increases in margin requirements and selling by large hedge funds last week is leading the precious metals rebound, up 6% today, reaching $37/oz or better as new buyers come in.  Technical analysis is pointing to $47/oz for silver in the next few months, a retest of the $50 resistance level. Gold is trending to $1600 over the same period.

To reach the 14,000, the 2008 high, PE’s would need to expand to 16.19 for the DJIA, representing a 12.4% gain today’s price for the index. At $47/oz, silver would have gained 27% from today’s price.

For my money, gold and silver are the better trades.

Investors from around the world benefit from timely market analysis on gold and silver and portfolio recommendations contained in The Gold Speculator investment newsletter, which is based on the principles of free markets, private property, sound money and Austrian School economics.

The question for you to consider is how are you going to protect yourself from the vagaries of the higher prices and economic uncertainty?  We publish The Gold Speculator to help people make better decisions about their money. Our Model Conservative Portfolio gained 66.7% in 2010, and 55% for 1Q2011. Subscribe at our web site www.thegoldspeculatorllc.com  with credit card or PayPal ($300/yr) or by sending your check for $290 ($10 cash discount) The Gold Speculator, 614 Nashua St. #142 Milford, NH 03055

BALANCING ACT

By Scott Silva

Editor,  The Gold Speculator

5-2-11

Ben Bernanke is on the tight rope, trying to balance between unemployment and inflation. This is a difficult balancing act; no one before him has successfully reached the twin mandated goals of price stability and full employment using monetary policy alone. But monetary policy is the only tool in the Fed’s tool bag. The Chairman is persistent, but he is on a fool’s mission. His easy money strategy has not created price stability nor reduced unemployment. To the contrary, Fed monetary policy has contributed to precisely the opposite result--growing inflation and high unemployment. And there are unintended consequences of the Fed’s prolonged accommodation, namely, the death of the Dollar and rise of the commodities bubble.

For gold bugs, the Fed’s single-minded easy money policy has been a godsend. Since the Fed began its ultra-low interest rate and Quantitative Easing policies in 2008, the Fed balance sheet increased by $2.1 Trillion and gold has doubled in price. Silver has quadrupled over the same period.

Many consider the price of gold to be the barometer for risk facing the economy. During good times, gold prices tend to lag stocks, bonds, real estate and other investment assets. Gold tends to outperform when there is uncertainty in global economies and dollar-denominated assets are in decline. The Fed’s easy money policies contributed to the real estate bubble, which ended in the financial crisis of 2008 and the drop in the Dollar. Gold led commodities out of the abyss of the financial meltdown.

Over the last two years, massive and continued Quantitative Easing (QE2) combined with economic weakness in the EU and political uncertainty in Africa and the Middle East has weakened the Dollar and pushed gold to record highs. But the weakening Dollar has also fueled inflation in every asset class except real estate, and the US unemployment rate remains above 8%. Clearly the Fed’s monetary actions have failed to achieve mandated goals.

I say it should not be the Fed’s mission to solve the unemployment problem in the United States.

As we have seen, near-zero interest rate policy does not create jobs, and Quantitative Easing does not create jobs.  Further, the premise that there is a balance between inflation and unemployment, as represented by the Phillips Curve is fundamentally flawed.

The Fed mandate emanates from the Keynesian notion that there is a trade-off relationship between inflation and unemployment, and that economic prosperity can be achieved by the proper balancing of the two variables.  But the stagflation of the 1970’s defeats the Phillips Curve. The current economic situation is proving the theory to be false once again.

Today, the Fed recognizes inflation to be 2.1%, but in fact inflation is closer to 10%. According to the US Labor Department, US unemployment is 8.8%, but actual unemployment (U-6 rate) is 16%.  Latest GDP growth has slowed to 1.8%, down from 3.1% in 4Q10. These numbers represent stagflation, the condition of simultaneous high inflation and high unemployment.  The Federal Reserve cannot set the magic interest rate that achieves a balance of tolerable inflation and unemployment.

As readers have seen on the pages before, the road to US prosperity is not through government intervention in the markets. On the contrary, it is the private sector that is the engine of growth. Government should help create the environment for private sector growth.  US private sector expansion has created more permanent jobs than any government stimulus program, including the 1930’s WPA programs.

The environment that is most conducive of economic growth is one of smaller, less intrusive government. Pro-growth economic policy is one of low corporate and individual tax rates, responsible fiscal policy (much lower government spending), lower government regulation and sound money.

History has shown that tax cuts, not tax increases have stimulated job growth and prosperity in the United States.  The “soak the rich” approach to tax policy is a myth. Government revenues actually increase when taxes are reduced. In the1920s, tax rates were slashed from over 70 percent to less than 25 percent. Revenues rose from $719 million in 1921 to $1164 million in 1928, an increase of more than 61 percent.

In the 1930s Hoover and Roosevelt pushed marginal tax rates to more than 90 percent. In the early 1960’s Kennedy cut tax rates to 70 percent which increased revenues to $94 billion in 1961 and $153 billion in 1968, an increase of 62 percent. When Reagan cut tax rates in the 1980’s, tax revenues climbed by 99.4 percent.  

In 2003 Bush cut the dividend and capital gains tax to 15 percent each. The U.S. economy added 8 million new jobs from 2003-2007.  From 2004 to 2007, federal tax revenues increased by $785 billion, the largest four-year increase in American history.

But tax cuts are not part of the current Washington plan forward. Instead, tax hikes are planned to help fund continued deficit spending. This will continue to pressure the Dollar and impede GDP growth. Industry will continue to bump along like Vonnegut’s Harrison Bergeron, weighted down with excessive regulation and class-leveling “fair” taxes, set by the Handicapper General.

There are better choices for investors seeking to maintain their wealth. Investors can choose to protect their wealth by owning gold and silver. Today’s pullback provides a good entry point. The bull market in gold and silver has a long way to run.

Investors from around the world benefit from timely market analysis on gold and silver and portfolio recommendations contained in The Gold Speculator investment newsletter, which is based on the principles of free markets, private property, sound money and Austrian School economics.

The question for you to consider is how are you going to protect yourself from the vagaries of the higher prices and economic uncertainty?  We publish The Gold Speculator to help people make better decisions about their money. Our Model Conservative Portfolio gained 66.7% in 2010, and 55% for 1Q2011. Subscribe at our web site www.thegoldspeculatorllc.com  with credit card or PayPal ($300/yr) or by sending your check for $290 ($10 cash discount) The Gold Speculator, 614 Nashua St. #142 Milford, NH 03055