Monday, December 14, 2009

Gold: Is the dream run over?

The fall in Gold prices (from US$ 1225 to $ 1115 levels) over the last few days, has got a lot of people worried that maybe, Gold was a bubble and that its dream run is now over. With that in mind, I wanted to take a few minutes today to map out my thoughts and readings on this subject.

So where is Gold going from here?

This actually is a very tricky subject to analyze because there is such a confluence of factors. Indeed, even if we go from what history shows us, we get mixed messages.

For starters, Gold has outperformed every asset class on the planet for the last 10 years. The last bull market in Gold lasted roughly ten years, running from 1970 to 1980. So strictly looking at Gold from a timing perspective (with no eye to fundamentals, inflation forecasts, etc.) this current Bull market is looking a little like close to ending by 2010.

In contrast, from a gains perspective, Gold looks like it’s just getting started. During the last bull market in gold, the precious metal rose 2,329% from a low of $35 in 1970 to a high of $850 in 1980. From mid-1971 to December 1974, gold rose 471%. It then fell 50% from December ’74 to August ’76. After that, it began its next leg up, exploding 750% higher from August ’76 to January 1980.

In its current bull market (2000 to today) Gold has followed a similar pattern albeit at a much slower pace. The precious metal took nearly twice as long to complete its first leg up (2000-2007) rallying 300+% ($250 to $1,032).

Then, just like during the last Gold bull market, the precious metal staged an 18-month correction (Feb 2007-September 2009) though this time around it only fell 30% rather than the full 50% retracement in the ‘70s. Gold then erupted into its second major leg up a few months ago, tearing through the $1,000 price point and soaring to over $1,200+.

Here’s a chart detailing the two decades:

GOLD Bull market of ‘70s Current Bull Market

First leg up 1971-74 (471%) 2001-07 (312%)

Correction 1974-76 (-50%) 2007-09 (-30%)

Second leg up 1976-80 (750%) 2009-? (?%)

If Gold were to follow the historic trends of its last Bull Market, one could argue, from a gains perspective, that the precious metal has only just begun its second leg higher. And if history is any guide, this leg will be the big one (last time around Gold rallied 750% which would forecast a move to $7000 per ounce in today’s Dollars).

Thus, history is showing us two very different points of view. In terms of timing, this current Gold bull market is looking pretty old (if history serves as a guide it will end in 2011). However, from a historic gains perspective, Gold’s bull market is still very much in its infancy.

Another way of looking at the price of Gold is simply as a reference point for fiat currencies. If your currency is strengthening (e.g. AUD), gold prices quoted in your home currency will decline. If, on the other hand, your currency is weakening (e.g. USD), gold prices quoted in your home currency will rise. Much of gold's move in USD terms is due to the depreciation of the USD. So in real terms, gold hasn't actually appreciated as much as it seems till now. Several experts have claimed that Gold would hit the US$ 2300 mark by 2011, which is the inflation-adjusted price of Gold in 1980.

In his book “Sub Prime Resolved” Anil Selarka reasons, based on evidence and official figures compiled from the Fed & the US Treasury that, “United States has lost almost 78% of its gold through covert lending practices to certain banks, investment banks and hedge funds to depress the gold prices with intent to control the inflation numbers to help them justify lower interest rates”. An excerpt from his book follows:

“The FED and Treasury appear to have been concealing lending of gold to hedge funds by camouflaging transactions through various central banks. When those Central Banks lend to these hedge funds to short the gold, they appear to claim the gold from Fed and Treasury who earmark the gold in its balance sheets. In other words, the earmarked gold shown in Fed / Treasury balance sheets is in fact owned by foreign Central Bankers and is no longer owned by the United States. If the shorted gold does not return to Fed / Treasury, they will be obliged to show it as “sale” one day. That day of reckoning will come when the Foreign Central Banks start demanding the gold physically.

According to my own research almost 6100 tons of gold earmarked in the Fed/Treasury balance sheets are non-returnable. The hedge funds who shorted it at prices $260 to $360 can not buy back at today’s prices. If they can not return, their deposits will be at the most forfeited. In other words, the Fed/Treasury will be forced to recognize the forced sale of gold @ $260 to $360 or more, but not more than $430 at the most. That is, Americans have lost their most valuable and prized asset – Gold – due to fraud perpetrated by the Fed/Treasury officials. It happened without their knowledge because the Fed/Treasury balance sheets were never audited. The office of OCC (Office of Controller of Currency) conducts only physical verification of the gold, not the true ownership. This is why Ron Paul, Senator, introduced a bill to audit the books of Fed. That is not enough. The gold is handled mainly by US treasury – Fed merely manages the operational part.”

Building on the theory, he goes on to justify a price target of US$ 6400 per oz. for gold!

Taking a closer look at US history, the 70's bull market in gold seems to have been a result of a currency crisis that resulted from President Richard Nixon dropping the gold standard – an act which many refer to as “unconstitutional”. The ensuing increase in gold prices was a result of the excessive printing of the fiat currency (namely the US$) that had taken place prior to dropping the gold standard (while US citizens were prohibited from trading their dollars for real money i.e. Gold). Once it was legalized again, there was a decade long rush for the exits. This was also reflected in the inflation rate. Volcker put an end to the currency crisis by raising interest rates above the inflation rate.

That bought the US ten years of prosperity, which were then followed by ten years of excess under Greenspan, which resulted in the currency crisis that the US is facing now. The difference between 1980s and today is that now the US has a huge debt to deal with, which will prevent it from raising interest rates. Once the monetary inflation that has already taken place starts hitting prices, look out! There won't be a way to stop it. The dollar is on the verge of death, and the only way that individual investors are going to be able to avoid the knockout blow is to get into gold, silver, or some other tangible asset or commodity.

Happy investing!

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