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Why I Am a Gold Bug



-- Posted Tuesday, 27 May 2008 | Digg This ArticleDigg It! | Source: GoldSeek.com

by Howard S. Katz

 

          The establishment argues that gold does not pay interest and therefore is an inferior investment to stocks, real estate or bonds, which do pay interest.  Why then should anyone be a gold bug?

 

          We know that the establishment argument has been wrong for the past 7 years.  Gold has put on a dramatic rise, over 4-fold from low to high, while the average mutual fund has barely squeezed out a gain.  Furthermore, if we go back in history, then from 1970 to 1980 gold multiplied in value by a factor of 25 times in nominal terms and 12½ if we correct for the depreciation of the currency.  From 1966 to 1982, the DJI dropped 22% in nominal terms, but correcting for the depreciation of the currency this was a drop of 74%.

 

          Now it is true that the establishment did well in the 1980s and ‘90s.  So they can argue that, if you stick with stocks for the really, really long pull, then you will come out ahead.  But this argument is not as nice in practice as it is in theory.

 

  • First, if you took the establishment’s advice and bought “good, sound stocks for the long pull” in February 1966, then you had to wait until 1995 to get back even in real terms, and today you have a miniscule average annual profit.  That is really the long pull.
  • Second, it is a fact that the establishment lost heart and did not follow its own advice.  They were full of confidence about stocks in 1966, but they were full of gloom in 1982.  Indeed, they erected a very pessimistic gentleman, nicknamed Dr. Doom, into their favorite guru, and he kept scaring them away from stocks.  So they themselves failed to practice what they preached.

 

          The true solution to the question of where to put your money lies with the theory of the commodity pendulum.  I discovered the commodity pendulum in 1995, and it has been nicely vindicated by the financial markets since that time.

 

          Remember, the original gold bugs (Jim Dines, Harry Browne, etc.) of the 1960s were enthusiastic about gold because the U.S. Government had been suppressing its price for something on the order of 20 years.  The Government fixed the price of gold in 1935 at $35/oz.  At that time, this was too high, and the U.S. Treasury experienced a large inflow of gold.  But there was an enormous rise in prices over the 1940s.  General prices more than doubled.  The $35 gold price became too low in real terms, and the Treasury began to experience a gold outflow.  In 1968, the Treasury threw in the towel, and gold began a 12 year rise.

 

          But this was a special case.  There were no price controls on gold in the ‘80s and ‘90s.  True, several central banks would sell gold from time to time.  This did have an effect, but it was nothing like a flat ceiling.

 

          I started to become uncomfortable with my bullish gold position in 1979, and I turned bearish on gold after the giant one-day reversal of Jan. 21, 1980.  Many of the gold bugs of that day were upset with me.  They were just getting revved up.  I was a party pooper.

 

          During the 1980s and 1990s the price of gold and many other commodities were driven down to extremely low levels.  This was due to Greenspan’s policy of extremely low interest rates.  When credit is easy, the banks are free with credit, and commodity producers are able to get their bank loans and expand production.  This expanded production creates more supply and depresses the price.

 

          This is why Greenspan was able to get away with his expansions of money and credit.  The money that he created would normally cause prices to rise.  But the short term effect of declining commodity prices undercut the rise in consumer prices.  Greenspan was called a miracle man.

 

  • Establishment Economist: “Mr. Katz.  You warned Greenspan not to jump off the building without a parachute.”
  • Katz: “Yes, he’s crazy.  He will kill himself.”
  • Establishment Economist: “But he’s doing it.  He’s down to the 18th floor and going strong.  He’s a miracle man.”

 

          Well, commodities were more undervalued in 1999-2001 than they were in 1971.  They have started their move to the upside.  As commodities move up, consumer goods move up more and more rapidly.  For example, looking at the producer price index, 12 month increase for April 2008, we have:

 

  • crude goods             +34.1%
  • intermediate goods    +10.4%
  • finished goods            +6.4%

 

Crude goods are those very close to the commodity stage.  Intermediate goods are inbetween.  And finished goods are those very close to the consumer stage.  (Source Bureau of Labor Statistics web site, www.bls.gov)  It is very clear that price increases are originating with commodities, moving into crude goods, then to intermediate goods, then to finished goods and finally to consumer goods (whose 12 month increase for April ’08 was 3.9%).

 

          In short, the source of what our establishment friends call inflation is not the cost of labor pushing up prices.  Indeed, wages are lagging the increase even in consumer prices.  The source of “inflation” is the rise in commodity prices.  That is, the money which Greenspan printed in the 1990s is now coming home to roost.  The only error in my analogy is that Greenspan himself will not be smashed on the pavement; he has handed off the reins to Bernanke in the nick of time.

 

          The 10 year commodity upswing of the 1970s was preceded by a (much milder) easing of money and credit from 1963 to 1971.  But the current commodity pendulum was preceded by a 20+ year easing of money and credit.  It therefore has the power to go twice as long.  If we date it from 2001, then we can be looking for the ultimate commodity top around 2021.  So I plan to be a gold bug until approximately that date.

 

          Hopefully during these intervening 13 years the establishment will do some rethinking of its economic premises.  When you have been wrong for 75 years running, it ought to make you wake up.  Europe has already adopted a strong position against “inflation.”  (Hurray for Jean-Claude Trichet.)  This is why the euro is $1.57.  Do we have to wait until Europe is richer than America before these people wake up?

 

          If we do, then those who put their money in gold will be way ahead of the pack and will be in a position to reshape the new generation.

 

          The above is the type of thinking that goes into the One-handed Economist.  This is my fortnightly newsletter, available for $300 per year, which makes predictions on the financial markets.  I never say, “On the one hand this but on the other hand that.”  Being the one-handed economist for whom Harry Truman was looking, I call it the way I see it.  And right or wrong you know what my prediction was.  Also of interest is my web site, www.thegoldbug.net, which applies economic truths to political and social problems of the day.  No charge.  (For directions to subscribe to OHE (and an amusing economic poem) visit www.thegoldbug.net.)

 

          In the May 30 issue, I will be discussing the blow off of May 21.  Was this a spike top in crude oil?  What are the effects on gold?  What about the gravestone doji in the HUI?  And what is the One-handed Economist advising now?

 

# # #


-- Posted Tuesday, 27 May 2008 | Digg This Article | Source: GoldSeek.com




 



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