all comments referring to Monday were intended to mean Tuesday;
changes have all been made>
There was lots of second-guessing
going on this past week as gold shares dove faster than Al Gore's
latest popularity polls. The volatility is likely to continue. But
the bears' vindication isn't.
The louder the gold bubble crowd
is, the more confident we grow that this bull market is still young.
I won't waste your time with arguing whether there is or is not
a gold bubble, since we dismissed it as fodder for the developing
bull market just last week.
Don't Hold That Punch!
However, we would contend that analysts calling it so fall into
one of either two categories, assuming they've been around long
enough for at least one:
- Those who missed calling the
tech bubble for what it was, and/or
- Those that missed buying the bottom
Of course it's important to know
their record, particularly if they claim to be some sort of authority
on the subject of bubbles, a theory we can apply to only paper by
the way if we want to avoid sounding, well, ironic. We
don't define a bubble by how fast stocks go up or down, but by how
far they are from reality, if you will. And it is important to think
outside the box if the goal is to determine reality.
At any rate, sharp wild corrections
will naturally follow sharp wild rallies. How
far could a stock, which has tripled, correct and then continue
on in a bull market rendering an otherwise scary correction in
the moment irrelevant, with hindsight?
I don't know. Some would say up to
two thirds of a move might be retraced in cases such as this, applying
some variation of Fibonacci analysis. Some would say that the correction
should at least tap the 200-day moving average.
We don't forecast corrections, though
we do assess them and try to warn our clients if their likelihood
increases. We try to predict bull and bear markets, or trends. As
far as our outlook is concerned, moreover, we're not so sure this
correction will be all that long, particularly since it has been
so fast, and since our near term outlook for the dollar and gold
prices is still as bearish as our long term outlook.
I think this kind of volatility is
only going to grow. The action in Tuesday's session was bullish
for gold shares, and could portend the end of the swoon that began
last week. All of the major gold indexes registered a familiar one
day reversal; one of the kinds of behaviors that has been extremely
reliable in signaling the end to many corrections as well as the
end to many rallies, particularly in the short term. Tuesday's behavior
was classic. Most of the shares whose charts we read all saw a spike
in volume after a gap down on the open; share prices tapped support
just under the last highest low in the intermediate sequence and,
if experience serves correct in my interpretation, suggests this
move just defined the low end of a trendline. Almost every gold
share we monitor carved the same signature on the chart. Follow
through will be important, more so to short term traders, but the
conviction of Tuesday's rally even as the Dow continued to unravel
is already a good sign, from the bullish viewpoint.
On May 31st we wrote to our clients
(in Subjective Values) that gold shares were fully valued
in the short term, specifically at $330 gold, yet undervalued in
the long term relative to our outlook for gold prices. We used Newmont
as our case study and calculated that at $300 gold, the shares are
worth $28 if priced at their average multiple of cashflow over the
past five years, but at a conservative 8 times (operating) cashflow
they are worth only half of today's market price, or about $15 per
share. At $400 that range grows from $25 to $46; at $500 gold we
calculate Newmont's shares could be worth from $38 based on eight
times cash to $71 per share based on 14.6 times cash - its five
report is available to subscribers. See our
Page for details).
Thus, if you're bullish on gold,
and can't decide if it is better to sell or hold your gold stocks,
the questions to ask are: how long will it take for the price
of gold to get to the $400 - $500 range to reflect better value
for my shares? And, in such circumstances, what is the more valuable
currency to hoard: a gold share or the dollar?
Should gold prices break through
$339 they'll have completed a near perfect five year double bottom.
Our confidence is high that 1999 was the bottom in this market for
some time, perhaps ever. I know that sounds bold, but it's
During late 2000, after a one-year
decline in price from a post Washington Agreement buying spike,
the same analysts calling this market a bubble today saw gold going
to $180. The reason we argued, at the time, they were going to be
wrong was that the conduits that helped sustain the monetary
boom had been impaired. Whether the Fed targets asset prices
or not, the fact remains while asset prices go up, the dollar carries
an investment premium that enables a check on the prices of goods
and services, and in turn buffers value of the currency. To the
extent they try and influence this premium we could say they control,
export, hide, or sustain the inflation.
Inflation is not prices. It isn't
a change in prices. It is a "process" that results in too much
money first, and debasement second. The way in which it accomplishes
this is more varied than Marx's imagination. But it always is
a process that affects (usually dislocates) individual valuation
judgments within an economy. Interfering with the mechanism of
prices, which Adam Smith called the invisible hand, is only part
of the story, and only the beginning of it at that.
The rest of the story lies in what
happens to the economy's capital structure, and then to its currency
once the investors propping up its value realize how long it will
take to heel the resultant dislocated structure. In other words,
how long before real profits come back (Ed Bugos).
Flash From The Past
When the tech bubble first popped, we realized right away that the
US current account deficit was in danger of halting the dollar's
ascent. The gruesome fate of the stock market suddenly made the
current account deficit seem unsustainable. But many analysts at
the time still largely questioned our objection to a deficit that
had been sustained for as long as their careers probably spanned.
By late 2001 it was apparent to most
of Wall Street that interest rates were going to stay sticky despite
the fall in commodity & asset values, and the government's deteriorating
books weren't going to help matters there. Even if rates could lower,
and they did in the short end, this we argued would only further
dislocate the economy's structure. We argued that stock prices would
not benefit, and that profits weren't likely to come back until
the economy was allowed to heal itself laissez faire like.
In the meantime, the bear market
on Wall Street meant that analysts had to start thinking differently
about where earnings would come from now that stock prices weren't
going up every day, and companies couldn't report windfall investment
gains as well as other shams without getting caught.
A few months ago we wrote about the
crumbling pillars of dollar policy, another conduit that has enabled
a check on prices (or control of the inflation), though this one
is deliberated to certain ends. In this case we've sensed a division
in the team that has traditionally run economic policy, specifically,
the US President, Chairman of the Fed, and Secretary Treasury. Clinton's
complicity in this union was an important element supporting the
US strong dollar policy. But equally, Bush's apparent disloyalty
to this team in mismanaging the nation's fiscal ledger, and proposing
his new not so free trade doctrine, are factors that undermined
it, and consequently may have impaired the Fed's ability to manage
America's former "freer" trade position
was a bullish factor for the dollar (or dollar denominated assets
to be precise) to the rest of the world, and helped its standing
as an international reserve currency. That's because Greenspan knows
there is a market that determines what is money, and I
believe this is why the EU understands the importance of freer trade
The point of the brief historical
recap is that we've argued for an inflation breakdown (breakout
to most people) ever since 2000, and nothing has happened in the
past week to change that outlook, so we won't be getting bearish
on gold anytime soon.
In fact, the markets have moved closer
to this inevitability, even as we write. The dollar is three points
from reversing a primary bull market, and gold prices are $18 from
beginning a new one. Wall Street's bear market is still decisively
on. Since most investors continue to remain bearish on gold's longer
term prospects, and bullish on the broad market, of course the noise
from that camp will be louder during each correction in gold shares,
and rally on Wall Street.
And although gold shares did trade
a little ahead of themselves, who are we to say if they will stay
ahead of themselves or not. I know I'm not smart enough to guess
how smart everyone else is. But we do think that if
gold prices complete the five year double bottom we see developing
on the chart, technically they are likely to aim for $425.
I'm a technician because it works
when my brain doesn't. But if you're not, it ought not to matter
because the fundamentals seem even more bullish than that tepid
Valuation Is A Process
...just like inflation is. It takes a market to determine value
and the market may change its mind tomorrow about the value of something.
In our kind of monetary system, most any determination of value
will depend on how the inflation alters our valuation judgments
tomorrow, relative to the recent past.
If for instance, the major stock
market averages recover into the summer, one could say that the
inflation is working to help bulls revalue the dollar. If the foreign
owners of wealth in the US decide to invest their liquid proceeds
in either real estate or directly into long term fixed projects,
as opposed to repatriating them, one might be able to say that the
inflation has been worked to underpin the dollar.
Any number of scenarios could evolve
to save the dollar before it cracks 108, which is the level that
would confirm our analysis. But the conduits, or tools, which have
made life so easy for policymakers in sustaining the inflation &
purchasing power of the dollar over the past decade, are now
working against them.
When I meet with old mining gray
hairs at the soup kitchen they tell me that it's not over; that
the government can sustain the value of the dollar relative to gold
in particular. In my opinion they've underestimated the market.
Their eyes may be on the "crisis" ball that bounces around
unpredictably, save to the privileged few puppet masters.
I believe the bull market in gold
is part of a healing process that will end once the vast majority
of investors understand why gold is money. I see the market
rejecting the government's models for the economy throughout that
The Sky is Falling... It's a Bubble
The process of revaluing gold is still young. We haven't even seen
the point of recognition.
Instead we hear warnings from the
professional investment community about the danger of gold bubbles
who sound like Chicken Littles running around telling us the sky
is falling just when the sun is rising.
Their timing is impeccable, though
it is the same thing they've been saying all along. It's just more
perceptible this week because gold shares are down nearly 20% by
the average index (before Tuesday's close).
The technical resistance points that
controlled the 5 year bear market in gold shares were blown away
last month, particularly those pertaining to the shares of producers
that aren't hedged.
Obviously, if gold prices are still
in a primary bear market and the dollar is still defined by a primary
bull market sequence, gold equities probably got ahead of themselves
by jumping into a new bull market with both feet. In our view that
was just the first punch. The question in determining the value
of a gold share is not what will happen with India, or Iraq,
or North Korea, it is what will happen to the dollar, and thus gold
For in the end, a gold company's
profits are determined largely by the price of gold.
Consumer demand for Jewelry can fall
all it wants. Bearish analysts say that India is an important consumer
of gold and that the higher gold prices go, the less gold will be
bought in India. I would argue that while Jewelry demand has been
an important component underlying gold demand in the nineties, investment
demand is likely to replace it in the new decade, even within India
at some point, but especially around the globe.
If we weren't counting on investment
demand to make a secular recovery in the gold business, there is
no way on earth we'd be so bullish on gold prices.
However, to the extent that new enthusiastic
shareholders of gold mining companies haven't factored the rising
risk premium that all stocks are increasingly having to contend
with, into gold shares, this sector can fall along with a major
stock market collapse at first, depending on its nature (severity),
and depending also on how gold prices and the dollar react to it.
Tuesday's bullish foot prints in gold shares on a reeling Dow is
reason for optimism.
If the market factored in a $330
gold price a few weeks ago for most gold shares, it is factoring
less today. But at that point where Wall Street's demise cracks
the dollar's primary support at 108 (for the dollar index), and
gold prices bust through $339, it is likely that gold shares will
be undervalued, even in the short term.
The case for $180 gold will appear
as it does in every correction we've had so far but it is going
to require new highs in the value of the dollar against other currencies,
as well as relative to the commodities that have been made scarce
by the policies supporting the dollar over the past several years.
But there is little indication, technically, that the plausibility
of a recovery in the dollar's primary bull trend is anything other
than... maybe we get a bounce off support before it hurls towards
Deflation is a pipe dream. I mean
that scientifically. Some prices will fall. But anything worth more
than the currency it is denominated in is likely to rise in value
relative to it, as a result of the atypical protracted bust side
of the prior 20 year long monetary boom, and the nature of our monetary
system. This is particularly true to the extent that a market still
determines what is money.
And it is true so long as the Fed
exists. In fact, it has been true as long as the Fed has existed.
And it is why the gold business is a growth story.
So why would we sell our modest 30%
allocation in gold shares because of a little bit of volatility?
We would if they became overvalued
relative to our outlook. But since we expect gold prices to make
it through $339 and head towards $425, sooner than most think, we
feel they aren't.
If we are wrong about our targets
for gold prices and the deflationists get their $180 gold then gold
equities are indeed overvalued today. Being wrong about that obviously
means we disagree with that outlook. Still, while this correction
could grow deeper for gold shares, it would require either a crash
in the Dow, or a significant recovery in the dollar's value... an
outcome that recent action on Wall Street appears increasingly likely