G.I.C.
A Weekly Outlook and Analysis of the
Global Investment Climate
28 January 2002

This means old economy to analysts at the Financial Post, Financial Times, Barron's, and CNBC of course, to name only the few we've come across recently. I'm certain you've seen the same label applied to this market in almost every newspaper that deals with the subject of finance.

At least it involves some kind of logic, even if suspect. This way we can say that anything that goes up a lot is the New Economy, and anything that goes down a lot and for several years is part of the Old Economy.

Aside from the fallacy of arbitrarily labeling assets as if they were going to be thrown into a catalogue, nothing else they usually say makes much, if any, sense.

In one comment, it was said that although gold shares rose strongly last year, since they've got such a long way to go to recoup the past five year's worth of losses, you might as well toss any buying ideas out of the window. There is a reason they went down you see, for they're part of the old economy.

You can get advice like this from most newspapers today. It may cost more than the Goldenbar Report (nudge, nudge), in many ways, but at least you'd be thinking what everybody else is, and you'd be looking in the rear view mirror like everybody else. Heck, you'd fit right in.

However, the truth is that just five years ago, gold shares were making new highs in a primary bull market, despite just a steady gold price.

Are we going to assume that anything that has been going down since 1997 then is part of the Old World? What happened after this period of time that transformed the entire monetary world, and freed it from the shackles of history? Sure technological advance to an extent may have accelerated, but nothing was invented to replace the traditional role of money, unless the market suddenly chooses Semiconductor Chips as its sovereign medium of exchange.

If anything, the rapid advance in information technology is helping more investors understand the complex nature of money, which is why gold and gold shares may in fact now be turning around.

I am willing to bet that after five, or perhaps more, bad years in the broad stock market, just before stock prices turn higher, most of the world will hate stocks. Reporters will be pointing at the downtrend and reporting that the world is going to end, just like they did in 1990 when they sulked about high valuations in the stock market (and after the stock market crash of 1987) not recognizing that earnings had troughed and that some right steps were being made in Corporate America to bring them back.

I remember Citigroup's balance sheet, and it was ugly, so everybody hated the stock. They hated all the bank stocks.

The stock rallied fifteen fold over the next ten years. FIFTEEN-FOLD. And it all started with a bad balance sheet. Today they hate Newmont's balance sheet. Every analyst on the street tells you that they think Newmont's balance sheet after its merger will look terrible. Yet at the very height of the 1996 bull market (in gold shares), I bet Newmont's balance sheet looked good.

So many analysts use the rear view mirror, and spend their time selling yesterday's news that markets hold nothing but opportunity for those who know where to look. Of course, analysts aren't the only ones to blame. The salesmen (brokers) too spend an inordinate amount of time packaging and selling yesterday's stories.

The Fashionable Fed
Lest we forget that the 1997 destabilization in gold prices caught many investors off guard recall that many of those investors missed some of the most spectacular gains in the New Economy DELUSION. So their nightmare was multiplied. The loathing, however, spells opportunity.

Maybe things have always been this way, and the Internet has brought about an age of enlightenment, after an initial euphoria.

Either way, things being what they may, there is no better opportunity in the market then when prices are supported, or depressed, by an irrational label. People buy stocks because they are branded "New Economy," and they sell them if they are branded "Old Economy."

What they are forgetting is that business is not about fashion it's about value.

Yet it's not is it? Everything does seem to be about fashion today, in particular, what is fashionable to say or not say, in the broadcasting business at least if not in larger circles of power. It certainly is not fashionable for Mr. Greenspan to provide us with anything less than a positive outlook. As for President Bush, he's only allowed to promise to get those dirty rotten scoundrels, and maybe he's allowed to ask for a pretzel or two, if he doesn't choke on the first one.

It's certainly not fashionable to suppose that the 1929 stock market crash arose out of the Fed's prior bubble-economics doctrine, but it is fashionable to say that it came about because of its' unwillingness to lower interest rates, or because the Fed raised the interest rate in the first place.

Anyhow, that's where we see opportunity. Where something is or is not fashionable, so to speak, yet is not born out by fundamentals.

Such opportunity today exists almost everywhere. In fact, it could be argued that the Fed is the great defender of it, fashion that is. And who better to lead the world in fashion than an ex-jazz player?

Yet owing just to the fact that the fashionable Mr. Greenspan is at the center of the global financial stadium, the biggest opportunity of all lies right underneath all of us.

For Alan Greenspan, it is said, is America's gold standard. The same man who wrote that money comes into being as the commodity (anything can be a commodity) that is most preferred, is now Chairing the largest central banking regime in history to tell the market what it prefers.

Yes the science of economics has long established now that the market chooses what is money, and that money came into being through a very systematic process of elimination and specific human preference. These theories are better documented than any other theories concerning the process by which something becomes money, or how money came into existence.

It has also been established that while markets choose money, governments decree by law what is currency. And it has been established by history that all governments will debase that currency, which is one reason why gold has such a long history of sovereignty in the monetary order.

Now Mr. Greenspan comes along and changes all of that in just ten years? Suddenly we are supposed to believe that the business of gold's supremacy is finished? Recall, it was little more than 20 years ago that the dollar underwent its last devaluation against gold. This has been going on forever, and ever.

Yet, today's journalists, reporters, and analysts are convinced that the Greenspan Fed is not like any of the other governments in history. Nor is it like the 1920's Fed, since this time it is lowering interest rates as far as they will seem to go. Certainly, there has never been another era where citizens trusted all the financial solutions offered to them by the same government that was busy siphoning their wealth.

Let me tell you something. None of these people understand that productivity can't be computed in the manner it is by the Fed, or generally (the Fed has entire research reports that tell us how to use their information even to value the stock market), nor is it possible they understand any of the computational "problems" in economics & finance.

But they're smart enough to label something new, and something old, and they are certainly smart enough to understand computational "solutions." After all, solutions to various problems are made available to all of us everyday.

What is the Proper Rate of Interest?
The main economic problem, to which Mr. Greenspan implies he is the answer, is the proper rate of interest to charge the economy with. This isn't an easy subject to deal with, and it certainly isn't as easy to eyeball as they make it out to be on finance-TV (to borrow a term from B.W.). But it is exactly the subject to deal with if we want to understand why gold prices are destined for higher ground.

I think it is important for many reasons to understand that the difference between a market set interest rate and a man-made interest rate is like the difference between a labor market with interventions and a labor market without. Or a commodity that has price controls on it compared with when it doesn't. There is no theory about it.

It's a matter of science. Today's economics is not science. Moreover, it is unsound because it rejects the simple idea that Jean Baptiste Say introduced to us in Economics 101.

According to the author of "Say's Law and Supply Side Economics," which may be found at: http://friesian.com, "Why Say's Law is correct is evident from one simple consideration: if inventory doesn't sell, then prices will be cut until it does."

In a report last year, we wrote on Say's Law and tried to apply it to dollar policy with I think some success. The bottom line is that in a liquid free market there can never be a shortage or surplus of that commodity. This applies to labor too.

However, there are other factors with labor. For one, it is often fighting the monetary debasement brought about by the Federal Reserve System's errors. I mean, in a system (we really can't call it capitalism) that exploits wealth transfer by means of monetary debasement, it is difficult to keep labor out of the party. At any rate, it makes it difficult to apply free market doctrine to labor without its consensus, and it's impossible to get that if labor is smart enough to figure out what's really going on.

The same can be said of other markets. Oil for instance. Consumers of Oil complain that cartels like OPEC hike up their prices, so they feel justified in letting their own government put price controls on it, or otherwise target the price under the guise of economic "policy." But, truth be told, they are also eager to consume the cheap oil.

So eager, in fact, that they're blind to the other interests in their government, which are in the habit of targeting certain commodity prices, directly or indirectly, from the Treasury to the Fed, to the President's special committee on financial markets. Why would anyone in his or her right mind complain about the low price of energy?

Moreover, they are far too eager to realize that cartels like OPEC exist to combat the debasement of the currency it receives for its oil. There are two sides, and both are wrong to intervene in the market, but because one exists, so does the other have to. Not surprisingly, shortages and surpluses result sooner or later. Shortages will occur when one group has been successful at keeping the oil price too low for too long, and surpluses when the reverse is true. Look, we were all paranoid about an oil crisis in 2000, less than two years after the price of oil hit $11 a barrel (guess what direction most reporters were saying oil would go after that - remember, we didn't need oil in the new economy… that was the line).

The same is true of the relationship between money, interest, and credit. Left to its own devices, the market rate of interest should equal what is called the consumer's time preference rate. This simply, is the rate at which a person is persuaded not to buy today, but rather, to save for tomorrow. The proper balance between the rate of savings and the rate of consumption is thus determined by the market interest rate.

By pushing down on the interest rate, however, the Federal Reserve creates an incentive to consume. Rapidly declining savings rates through the past decade ought to serve as evidence that the proper balance has been upended. But there is more. There is always more… credit that is. As much as lenders are willing and as much as consumers are able, is how much credit there is available.

This is true in the corporate world too, for they are also consumers in the end. But, still, there is more. Each dollar borrowed magically turns into money for some other party. Well, almost each one. The ones that do turn up in the money supply data.

When too much Credit turns into too much Money
This is where we find inflation. In fact, the rate of change in this data is closer to the true definition of inflation than any price index offered by the government. The only definition of inflation that can be applied consistently is that which applies to the rate of change in the quantity of money over and above that which is in demand.

The only way to observe that in a free market is by changes in prices. And our job as analysts is to monitor all prices, not just the ones the government says we can.

Surely asset price inflation is different, in terms of immediate consequences, because it affects the purchasing power of an increasingly abundant currency, so long as they (asset prices) can rise at a fast enough clip to attract foreign capital. Even without a rising foreign exchange value, asset price expansions can increase purchasing power.

This is good if the expansion in value is real, but it is not good if it is superficial, and otherwise induced by inflation. But, to look at growth in the money stock combined with growth in asset values, and not make a connection is simply inane. It's even more absurd to accept the solution offered by the Fed that the rise in stock prices is due to their measure of productivity, and therefore real. That's like reading a report from Philip Morris detailing how smoking is not addictive.

Hello, money makes the world go 'round, and it takes money to make stock prices go up. Productivity will not do it alone. More and more money is needed to make stock indexes move higher and higher, pulling up with them more and more stock issues.

It's true that productivity engenders greater profitability. But if that is the case today, why are profits falling at such a fast rate? I mean so fast that even while stock indexes declined by 12% last year in the US, valuations measured by the PE ratio on the S&P 500 continued to rise by almost 50%, to 40 times earnings.

PE Ratio is in Red (right axis)

In fact, for all the hoopla in the stock market during the nineties, earnings could not keep up in the first place. And now we're finding out about charges and other things that are reducing current and future earnings.

At any rate, prices of things continue to go up. Some at a faster clip, and some at a slower rate, and others are declining. Credit continues to expand, and rising national default rates ought to prove that there may be too much bad credit issued. But instead we are told that deflation is the cause of the rising incidence of default, and equally, the source of the pressure on corporate profits.

To be sure, people who aren't using the word (deflation) scientifically tell us this. In fact, all too often they attach their own meanings to the word.

However, recall that at the appropriate rate of interest whatever that is, there should be some sort of balance between consumption and savings. An imbalance will cause distortions in the structure of capital, which are likely to produce lower profits, in due course. And if there is an imbalance it is usually because there is intervention by the government. Either the rate of interest is too high, or it is too low. If there is too much bad credit, then that must mean the interest rate is too low.

How do we know if there is too much bad credit? Rising default rates suggest it, and falling profits suggest it. How do we know if there is too much money? Rising prices will suggest it, whether we are talking about the prices of commodities, services, or assets.

Again, a market interest rate should poise the interests of savings and consumption so that the factors of production within society are arranged in an order maximizing everybody's welfare. If imbalances occur between consumption and savings, it is because the interest rate is too low, or too high.

We are not writing this to prove that theory, for that has been done. It's just unknown by most of Wall Street.

So because too much credit produces rising default rates, and because an improper allocation of the factors of production seems to be leading to poorer profits as well as a rise in the ranks of the unemployed, is no reason to suspect deflation. The cause of these problems is easily the agency that allowed for too much money and credit in the first place.

In fact, analysts can look far and wide and write eloquent essays on why deflation is coming, from the mysterious forces of a Draconian winter to an explanation as to why it is resulting in a rising foreign exchange value of the dollar, but they will not actually find it. At least not in terms of any of the fiat currency systems on earth, they won't.

There has not been deflation since Roosevelt confiscated everybody's gold, period.

The subject of gold & money is neither an old economy nor a new economy subject. Neither is the subject any more a matter of that than is fashion, or politics.

It is, on the contrary, a matter of economics, and in particular, capitalism. It is our protection, as is OPEC the Mid East oil industry's protection, from monetary and in particular, government chicanery. In order for Capitalism to really flourish, all of the markets need to be free from intervention, and certainly control.

But what so many analysts, reporters, and anchormen cannot seem to do is find it fashionable to criticize the government and other interventionists. Instead, they find deflation symptoms, and "solutions" provided by whomever, as convenient enough to criticize the government not for intrusion, but for not intervening enough. Everyone requires more rate cuts because market discipline is no longer fashionable.

Now, all that has happened is that valuations have soared, and profits continue to shrink, as we keep saying. The direct result of the Fed's intervention over the last year has been to further distort the structure of capital, and promote malinvestment, perhaps worsening the ultimate trough that profitability sinks into.

But where is the deflation? How can equity averages trade at a PE ratio of almost 30 times earnings if deflation is here? How can interest rates be going up if deflation is here? The breakdown in monetary systems does not result in deflation; it results in more inflation, and more, and more. Look around at the world today. It has been happening everywhere from Russia to Asia to Argentina to South Africa, and now in Canada.

ROI Important to Foreign Exchange Values
Trade rarely determines foreign exchange values. If it did the dollar would always go down. Actually, they are determined in the same way most markets are, by money flows.

We should know that America's chronic trade deficit, which Mr. Greenspan dubs as the consequence of its propensity to import, is offset by foreign investment flows. It is true that "some" of this is seen in the capital accounts, but clearly, we can explain the rising dollar better this way than by deflation.

While such catallactics can pressure certain domestic prices, that is not deflation. It is money, or capital, flowing into the US seeking a relatively higher rate of return.

Big difference, particularly when the higher yields are fueled by a policy that seeks to maximize consumption by artificially lowering certain interest rates. And particularly when the resultant inflation manifests in racing asset prices. This is what is causing the dollar to rise as we speak (write).

Have a look at the price to sales ratios of various global markets below in order to derive an answer to which one holds the highest set of expectations about the future course of its own profits.

Source: Bridge.com

The higher the ratio, the more of a premium investors place on each dollar, euro, or yen of revenues. Clearly, investors in the American market expect better returns on each sales dollar. This fact is implied in the relatively high US bond yield.

Treasury yields have been rising faster in the US than elsewhere, reflecting many things actually. This is only one. But so long as stocks and consumption are on the rise, this is the main implication of rising yields.

However, these aren't normal times, and we're hearing nothing but how much supply bond dealers have had to contend with. Thus, rising yields could also mean that too much credit is being issued, more than lenders have, or are willing to part with.

If this is the case, it really means that bond yields are up due to inflation. Perhaps it is possible that the lender's willingness has been compromised by his rising exposure to bad credit?

Surely not restraining lenders is a lack of liquidity to lend out. In fact, the unbridled expansion in money supply is in all likelihood the real cause of the factors that have led to the failures of many business models, and businesses recently.

Thus, when stock markets implode the incorrect solution is to throw more oil into the fire. There is already enough oil, metaphorically (and actually as well perhaps). It is possible that the correct solution is less oil, but admit that I have no idea how to get there without getting burned (excuse the bad humor).

In any case, the main point is that by throwing more oil onto the fire, it will grow so that investors (having also been burned) will continue to shrink the dollar investment premium. This is more likely to result in a crack in the dollar than deflation, if history is any guide.

Dollar Devaluation is Inevitable

Source: Sharelynx.net

Source: Sharelynx.net

Never mind cumulative imbalances in the Balance of Payments accounts of America, the only experience in the Fed's history that came anywhere close to deflation was the experience the entire world is trying desperately not to repeat. That is the 1929 stock market crash and depression that arrived shortly thereafter.

The dollar was backed by gold at the time, and people were withdrawing whatever money they had on deposit at financial institutions they weren't comfortable with, for very good reason. Those institutions were part of the process that created too much credit, and in turn, compromised their deposits.

In the end the only way that the government could stop these bank runs was to make the greenback non-convertible into gold. FDR called a bank holiday, and it was now illegal to hoard gold. Then he devalued the dollar against gold. That means that prices of things were rising despite massive unemployment (note when the bottom arrived in Raw Materials prices in the chart above).

The same occurred in the seventies, with respect to prices and employment. Prices rose, and so did unemployment. Yeah, it's a depression when people can't afford to buy things, and when they're unemployed, regardless of what GDP says about the economy. There certainly was no deflation.

Sure, while there was a gold link, deflation was inevitable. But this meant only that any unnecessary credit was forced into corrective liquidation, as opposed to compounded. The monetary busts through all of history that seemed the worst were the ones following the most rapacious (unrestricted) expansions of money and/or credit.

Moreover, the gold link was compromised (ineffective) because it had to coexist with the Federal Reserve System, which only meant that the creation of credit could continue without retribution, or without the market discipline that could keep the system of money, and thereby the system of production, sound.

In fact, the Fed found that the gold link would result in bank runs regardless of its own existence, because the public would lose confidence in its bank's balance sheet, since the Fed existed so that banks could lend excess credit. The coexistence of the FRB and the gold link lasted only from 1913 to 1933, twenty years.

Since its creation, the FRB has believed that a free banking system supported by a lender of last resort is the natural evolution of a gold standard. But it isn't, because the gold standard that existed was not what we are talking about today. That gold standard was already a government decree (lawful money), not a product of the market. Ever since the day the government fixed the bimetallic ratio in the mid 1800's, money in the US was no longer a product of the market.

Naturally the evolution of the free banking system, as we know it, succeeded that gold link. But all that has been done by abandoning the link was to debase the currency.

They'd outlawed silver by 1873 and gold by 1934, as backing for the dollar. This was not the result of silver or gold being old economy ideas; on the contrary, it was the straight line result of a debasement in the coin of the realm. With a central bank, credit is now allowed to grow as long as lenders and borrowers want, in theory. The current system of money is not the natural evolution of a sound monetary system, on the contrary, it is blatant corruption financed with the public trust. The market that determines what money is, continues to exist.

Instead of bank runs, however, we get dollar devaluations now. If a gold backed currency were legal tender, we'd get bank runs, as depositors would withdraw their gold the moment they lost confidence in their banks. But today it is the banks, not us, which have a safety net: the Fed. That's our money people; it's our public trust that they use to support their bad investment policy with.

Of course, when I say we would always get bank runs, I mean only to the extent that the banking system is overly avaricious with the issue of notes in the first place.

Unfortunately, there is no other way for us to protect our monetary system than by exercising the right under the system of property, which allows us to own gold, or whatever asset or commodity we think is the most secure (can hold its value) and liquid (preferred by the market). By doing this we secure the system of production known as capitalism, but by allowing the expansion of money and credit to go on, is to sanction a transfer of wealth and surrender capitalism to a system of production that is based on government and producer sovereignty, rather than individual (or consumer) sovereignty.

At any rate, we've spent enough time in past articles debunking the deflation myth. From here on in we'll just have to see. The point I want to make is that deflation occurs as people hoard money balances. However, history again (never mind logic) has shown that when this happens it isn't the dollar that people perceive as money, it is gold.

So even while the New Economy falls apart right before their eyes, analysts continue to show their faith in the catalogue. Duh, this one is new economy, this one is old…

Unbeknownst to them, what they imply by tossing gold out with the old economy is that the people at the FRB offer a better money, one that we'll want to hoard when the banking system goes the way of Japan's.

Alas, Japan, but don't they have a deflation problem? Get off that already. No, they generally have a rising currency problem, as a consequence of less relative inflation, mainly. Defining deflation by movements in prices, which leads to many mistakes, Japan does have relative deflation.

Remember that if America has the propensity to import, Japan has the propensity to export. But it has done more than export goods; it has exported its capital, as has Canada, some European countries, and any nation that has a chronic trade surplus with America. That is the main reason that the foreign exchange value of the dollar ever rises, because most of the world is engaged in competitive devaluation against it. However, in Japan's case, rather than engage in competitive devaluations, they had targeted certain export industries for maximum productivity, and either exported their profits (savings) or allowed them to accumulate overseas. The result is a surplus not only in trade, but also investment income.

In any case, when US led monetary booms turn bust, they almost always result in the devaluation of the US dollar against other currencies as their trading partner's surplus capital is withdrawn. Indeed, dollar policy in our view is all about maximizing the investment premium on the US dollar, relative to other currencies, in order to make it attractive enough to continue attracting net foreign capital flows.

Maximizing returns in this way is superficial, and unsustainable. And it is in this way that the gold debate is tied to the stock market debate. It is our contention, as well as other's, that equity valuations are indeed superficial. They are the consequence of a monetary boom (inflation) that is likely to end like all the others if not worse, for the dollar anyway. If we are correct, profits will continue to erode, and so will bank balance sheets. Stock market valuations must eventually collapse if this is true. The returns that seemed so high only a few years ago will look increasingly negative.

When that happens, the investment premium will shrink, and the incentive for the accumulation of dollar assets should decline. That hasn't happened yet. Recall that we do not measure this premium by the relative direction of stock prices, but by their relative valuation compared with other stock markets.

The steep yield curve and buoyant market valuations are the only plausible reason that explains why the dollar is still aloft, in our opinion.

When the system of inflation no longer supports this superficial system of valuation, and it all breaks down, deflation will not be the outcome. Dollar devaluation will.

Money Monopoly is by Decree Only
What does all of this have to do with gold? Plenty. Remember, global central banks have been selling their gold reserves over the past decade. They have been selling so much of the stuff that the market has become convinced the rest of their gold is also up for sale, as if it was a surplus overhanging the market.

Concurrently, the market has also become convinced that gold is from the old world, not something that is useful today because (and there is only one because) of the presumption that the dollar and Fed have replaced gold.

But neither gold nor the dollar nor central banking is new. Neither are the characteristics of this specific business cycle, new. They are old, each of them way more than 200 years old.

What also is not new is that while the government decrees lawful money, the market chooses real money. History has already shown that outlawing gold will not prevent any market's victory anymore than price controls will.

In fact, even while the IMF has outlawed gold as legal tender in most of the world, it is still preferred. Indeed, that is why it is outlawed.

Yet that hasn't dissuaded the Japanese savings community from buying it. Despite the decree, and all the noise of deflation, investment demand for gold is accelerating in Japan. From the November issue of the World Gold Council's Demand Trends:

Gold demand for jewellery and personal investment responded to global events in Q3, both before and after September 11. The slowdown in global economic activity during the period and the volatile gold price after September 11 caused jewellery demand to fall 10% from year-earlier levels to 649 tonnes. Meanwhile the increased global uncertainty following the terrorist attacks caused a rise in safe-haven buying of investment gold in a number of countries. This was particularly noticeable in countries such as Japan, Korea, Vietnam, Thailand and USA with lesser effects in a number of other countries. Together with the issue of the Deutsche Mark commemorative coin, this pushed investment demand to 106 tonnes, 17% higher than in Q3'00. Overall demand for Q3 was 755 tonnes, 7% below year-earlier levels bringing demand for the year to date to 2,356 tonnes, 2% below that for the first three quarters of 2000. Demand surged in Japan rising 37% on the back of a 91% increase in investment purchases.This trend to higher investment was already evident before September 11 but was reinforced by the global crisis. The weak economy resulted in a 7% fall in jewellery demand but this was tempered by a continuing shift towards yellow gold jewellery away from platinum - WGC; November 2001.

Last year, on the advice of Dr. Larry Parks the World Gold Council wrote to the IMF requesting that they reconsider their law. I haven't heard anything new yet, but can you imagine the opposition?

Greenspan might be out of a job, for one. Of course, we don't need to explain to you that we are not talking about societies with citizens exchanging gold ingots with each other. There is absolutely nothing wrong with paper or other technology substituting for gold and/or silver.

But Mr. Greenspan et al currently run a money monopoly. By depressing the rate of interest beyond what the market might determine, they have allowed the issue of an enormous amount of "lawful" money. So much so that a form of Gresham's law has been invoked.

That is, the money the government's decree has undervalued disappears from the market and the money which the decree has overvalued remains (von Mises).

If central bank selling of gold, or even just the decree, has not overvalued the dollar then why has gold disappeared from circulation? That's a whole essay in itself. The point we are trying to make here is that this money monopoly is run by decree, and it is in constant conflict with the market over what is, or isn't, money. It's not easy keeping a monopoly, just ask Bill Gates.

Furthermore, the monopoly has produced consequences that we argue will compromise the value of the dollar, not only in terms of other fiat (money substitute) currency, but also in terms of certain commodities, and particularly that one commodity, which continues to provide the best liquidity (most widely accepted) and holds its value through time.

It just happens to be the one commodity outlawed for use as legal tender, anywhere in the world.

Western Government's have been keen to outlaw gold ever since Marco Polo came back from his trip to Asia with the first sample of paper money the West had ever seen. Yet for one reason or another, they could never keep it outlawed from the market. Markets develop whether they like it or not. Just ask any Russian about that, or just look at the long-term gold chart again.

In fact, we would argue that the dollar could not survive if gold was made illegal to own, outright. And we could also argue that is the reason the government does not make it illegal to own gold today. Perhaps they have figured out that it is better to let the dollar devalue gradually than suddenly. Though the stubborn strategy of the Treasury in recent years in guiding a mock strong dollar policy may prove that market induced devaluations, sudden or gradual, are not even considered acceptable. For those that will read this comment and go on with their merry lives because they assume that alone means the dollar will go up forever, I am surprised they got this far in the article.

Central Bankers will Buy Back Every Ounce

Nonsense! That is absurd. Central banks have no use for gold, and they're selling it in increasing quantities at every chance they get. After all, the dollar has been rising against gold, in value, over the past twenty years. They'd be happy to sell it all.

Remember dollar policy - the superficial maximizing of returns through inflation, and the fast-forwarding of Gresham's Law? Inflation is a hidden tax because it taxes through the debasement of currency, eventually.

By themselves, these facts have little to do with gold, except to the extent that when the debasement becomes visible and perceived, gold will be increasingly preferred. And the more gold central banks sell at low prices, the more demand they will beget (recall Say's Law), and the less valuable will become their own currency.

US Geological Survey / World Gold Council

This is just a fact of life. To all of those analysts who really believe that the world's central banking cartels are not really interested in owning gold, we wish them well and trust they will continue buying dollars as long as the Fed exists. Note the gap between demand and supply above, charted as one series, below:

US Geological Survey / World Gold Council

Now if there is one piece of evidence that proves a market has been "intervened" with, and that stands out like a sore thumb, it is the chart above. That's all we really need.

The World Gold Council's estimates for demand reveal that demand for gold in 2000 outpaced production by more than 30%. The fact that central banks made up the difference is inconsequential. This year's figures aren't in yet, but perhaps part of the improving tone in the market suggests they will be hot.

What is important is that the more gold sold too cheaply, the more consumers and investors will desire to own it. So central banks may indeed be stoking demand by selling their gold too low, if not with their poor fiat policies. And if they truly do believe that they don't need any of their gold, all that will happen is that they will continue to sell it, and stoke even more demand, until one day the rising price and their empty vaults turns them into buyers, or outright failures.

While producers haven't been able to keep up with the demand, banks have. And if bankers sell their gold (or gold they don't have) in the derivatives market, they turn around and offer to buy the producer's forward gold at a liquid contango, thereby spreading risk and finding a new (vested) partner in crime, with the incentive.

The consequence of policy like this is an overvalued dollar. Thus banks have been all too happy to sell their gold reserves; to fetch more of these overvalued dollars.

However, since the biggest competitor for gold is the dollar, while the dollar remains overvalued, gold appears plentiful. Its scarcity will become apparent only when the dollar begins to lose its value, or perhaps sooner. Perhaps the swoon in currencies such as the Canadian dollar, Euro, the Yen, and Argentine Peso will spur investment demand for gold, as is the case in Japan at the moment.

That said if and when the dollar begins to lose value (early this year I suspect) there will be many problems of scarcity to contend with that haven't even been considered yet. In fact, if you've come far enough to understand why Greenspan cannot replace gold with anything at the Fed, and that gold is the (decreed) dollar's free market competition then it isn't a big leap to grasp how the declines in currencies such as the South African Rand, Canadian Dollar, and Aussie dollar conveniently bring more gold supply to the market.

It has gotten to the point where the Australian gold industry is handicapped because its producers have been selling forward so much of their future production for rising dollars, and for liquid contangos (under the assumption that gold prices will stay weak).

South Africa and Australia are two of the worlds top three gold producers, together contributing 30% to global gold production. The United States, which is second, has a 13% market share, approximately.

US Geological Survey

However, note in the chart above, when the dollar trends down the world becomes more dependent on production in the US, and vice versa, when the dollar trends up, market share rises outside of America. This is under the notion that a rising value in the domestic currency reduces the incentive to produce gold, so production rates are stoked by a falling currency, and they are restricted by a rising currency. These differences may have been marginal in the past.

However, hampered with big hedge books now and a potential turn down in the US dollar, what will happen to production in South Africa, Australia, and Canada, if those currencies rise in relation to the devaluing dollar?

A rise in the currencies of gold producing nations is likely to dissuade production just as the rise in gold prices is likely to discourage forward selling. Worse, if producers have already forward sold a lot of their in ground gold, cheaply.

And it could be even worse (for gold supply) if the entire North American exploration infrastructure is disabled. It is you know. The mining exchanges on the Canadian west coast are gone. The cost of exploration must be born by the industry now, and we all know how slow that is to start up. Maybe the Nasdaq will pick up the slack.

At any rate, it is possible that a reversal of the dollar could herald a problem of scarcity like nothing we have ever seen. Nothing that even could be compared with in the oil business.

As a consequence of both dollar (investment) policy and the willingness of nations to enter into persistent competitive devaluations against it then, banks and producers have sold way too much of their gold, unless they are right in the end - that Alan Greenspan has created the ultimate money, which is liquid, holds its value, and that everyone will always prefer. Or heck, if they don't, he'll change it so they do.

I suspect that the market is catching on. And just because everyone else disagrees, still, is the biggest reason to be bullish, in this case (as opposed to a blind contrarian call). This is not simply a case of, "geez, the market is so low I have to be bullish." We leave that for the New Economy's techno-mavens on the Nasdaq.

Governments (in this kind of economic system - Inflationism) can only hold back the price of this metal as long as they can produce a positive return on the dollar, and so long as they can sustain expectations that financial assets will outperform the bulk of the commodity complex, over the long term.

The FRB can sustain this for some time by maximizing consumption at the expense of savings under the mandate of a full employment doctrine so long as problems that will ultimately surface such as declining profits can be postponed. This is happening now; the declining profits part. Remember, too much credit creates too much bad credit.

Recall, too much money has distorted the structure of capital, thus the factors of production, which leads to all sorts of economic problems.

The result of monetary policy in 2001 therefore was a worsening of this condition. And it is likely to continue worsening until the corrective forces of the market are able to heal the economy. This can't be accomplished by "short cuts" through interventionism, or apathy for the market, which can only worsen the condition by further shifting the factors of production away from producing the correct order of capital.

To believe otherwise, that interventionists can arrange the proper order of capital, is just not born out in the historical record.

However, be that as it may, gold and gold shares have been trading well, indicating perhaps that some corrective forces may already be on their way.

Propaganda notwithstanding, there is little sign of real recovery, and markets may be realizing that when the Fed is forced to reverse interest rates, it'll be like a tail wind for the invisible hand.

It's Different This Time
Normally, gold prices and gold stocks rise in front of a stock market accident. They didn't this time. Furthermore, last year's move up off of 15 year lows, while better than most, wasn't spectacular. But what happens "normally" when the stock market falls? It usually takes this sector down with it. Possibly, this time around, investors have learned (markets train us you see) not to jump in before a crash.

Some investors could be thinking that since the gold market hasn't turned up yet, the bull market in most stocks is still on, and that gold shares are going to move up now, along with the Dow's last leg, I presume. I think that is precisely wrong, because their expectations could cause them to panic if the Dow turns down "prematurely."

The same expectations in prior years were reversed due to this mistake. I think we have to expect the worse, in this case a stock market crash. However, the evidence that I can report to you (as an observer of the market action in all of these stocks) is that it is an increasingly exciting phenomenon to watch gold shares rise on the days when broader market averages look particularly vulnerable.

Perhaps also holding back gold bulls this time around is that the Reg Howe versus B.I.S. action seems to be hanging over the market because of the uncertainty about what Mr. Ashcroft hasn't said yet. But that can be bullish. I'd hate to see a rally get caught because the case is thrown out of court.

Still, what I am increasingly perceiving is a persistently more bullish tone in the gold market where stock prices are getting away from investors waiting for just one more dip, or new low in gold prices. If accurate, it's a terrific sign because the market is full of skeptics.

Source: Bridge.com

Although the inexperienced might find widespread skepticism reason enough to stay out of the gold market, we know better. We know, for instance, that if it goes up and up and up, most people will eventually become bullish. The skeptics will become fodder for the bull market.

What I'm getting at is that if the market can grind its way up without any support at all, from the mainstream, then what will it do when people really turn bullish?

Every turn down in gold shares this year scared investors away. To me this is a sign that it is still early. But it is more than that, the timing is improving - the turndowns continue to reverse faster and from higher ground than we expect, and the gains look particularly impressive on days that the broad market sells off ominously.

Still, while fundamentals for gold have been improving for several years, its prices, and those of the producers' equities, have been lagging those developments.

Another key difference between this cycle and others is that in the eighties and the seventies the dollar had turned down before the stock market fell.

This hasn't happened yet, and in all likelihood it hasn't happened yet because of how far the FOMC has gone to support reckless stock market valuations with the interest rate lever, and how far the Treasury has gone to ensure the valuations aren't eroded by break away nominal prices. But because of how far they have gone this time, when it does happen, meaning when the dollar and stock market do fall, it might be much harder to stop the decline than in prior bust sequences through the 19th century.

Raising interest rates while profits and stock prices are falling could pose a political problem for the boys at the FRB. Their only hope is that profitability on Wall Street, at least, comes back before they have to reckon with rapidly falling share prices.

Will profits come back?
If we are supposed to believe that by adding more money and credit to an economy already suffering from too much of it, and moreover, if we are to believe that by engaging the government in larger spending programs, America will become more profitable, then we are truly in a New Economy.

The simple fact that so many people do believe just that is scary all by itself. Indeed it is about as scary as the belief that by fueling consumption, the central bank can reinvigorate the capital spending incentive. Such perceptions are not scientific in the slightest bit.

Earnings are still coming in, but so far they've been nothing short of dismal. Beneath every headline number, which already tends to represent a fall in profits, or sales, or both, there is more bad news. But because analysts spent the past year reducing forecasts, when the headline arrives it still matches or beats expectations (if they've been beating it's been marginal for the most part).

Expectations for a recovery in profits are imbedded in signals coming from leading indicators that are themselves influenced by expectations (stock averages as well as surveys play big roles in many leading indicators). I suppose, though, if participants are under the impression that confidence alone can run an economy, my questioning of these models is moot, at least until they are proven wrong.

Nonetheless global stock averages are inarguably overbought, by many measures. Investors were anticipating signs of recovery to show up in the fourth quarter reports. But all they're getting is the same old Wall Street hoopla about how earnings are down because of this or that, but they've met or beat deflated expectations (the only place you'll find deflation is in their egos).

Still, while they may be meeting or beating most headline forecasts, expectations are much higher. If investor expectations were only equal to the lowered forecasts, stock valuations would be much lower.

Expectations are indeed high, the stock market is indeed overbought, and valuations are certainly not sustainable. All of these could be considered as compliments of the Federal Reserve's monetary policies.

So what's the Fed going to do this week? Who really cares? It's moot, because even if it reduces interest rates, all that will happen is that valuations are buoyed a little bit longer, while earnings continue to fall apart. And that's the good news. The bad is that prices of important commodities begin to rise, as they've been threatening to.

What's worse is that it might not work. In fact, probably will not work. Confidence is waning, and before the fourth quarter reporting period is out, my guess is that it will be eroding. And if it doesn't work, look out below.

There are enough smart people out there to know to take any rate cut as a selling opportunity now. They've been trained by the bear market to do just that.

If I were a gambling man I'd guess there will be another rate cut, based on the observation that expectations for a rate cut are being played down. The FOMC has the element of surprise in its corner this way. If they don't make a move, my guess is that will pull the hope carpet out from underneath investor's feet.

Should they move to raise interest rates, with the declining trend in earnings, lofty dollar, and extended valuations, the Fed risks blame for a stock market crash.

However, as crazy as it may sound, from a strategic point of view, that could work to their advantage for two reasons: they could keep their central role in the scheme of things because people would believe that if it was possible for the institution to bring the stock market down, it is possible for it to lead it up. Second, they would fire up the populist criticism that it should have provided more money, or lower interest rates, thereby setting up the next cycle, if you will.

It's crazy because the political and socioeconomic result is not predictable. However, that hasn't stopped them before, and further, it may be their only option - to at least lead the yield markets higher. But it's more than crazy, it would take big courage, or if not courage, desperation.

Conclusion
We've reached a critical stage where it is increasingly clear that there is no amount of money that can reverse a bear market (in equities). I think investors are beginning to realize that, and that is indeed what the gold market is all about today.

If we consider a meltdown in implied and expected real return (expectations) for the dollar as the catalyst that will put the gold market into orbit, we can estimate several sources of investment demand that will grow and fuel a bull market, including central banks that choose to buy back their gold with too many dollars, individual investors exchanging their dollars for gold (or gold stocks), producers busy reversing their hedges, and the hundreds of mutual funds seeking to hedge their portfolios (rather than outright liquidate them) with a stable asset.

Furthermore, a breakdown in the dollar would probably create a break away in most prices of goods that pundits refer to as inflation. We have already discussed how the (superficial) strong dollar policy of the Treasury has contributed to shortages becoming increasingly apparent in many of the commodity markets.

Finally, forget about the lease rate when trying to understand supply in the gold market. I cannot understand the significance analysts place on lease rates, despite the fact that most arrangements are made over longer periods than the short term leases most widely reported (usually one year or less), and notwithstanding the fact that the WGC has already said that ninety percent of leasing liquidity has dried up, since the signing of the Washington Agreement in 1999.

The main thing that can be concluded by looking at supply and demand trends is that the price of gold is probably way lower than the free market would put it.

Combined with the extremely low exploration incentive over the past decade, as well as other supply issues, and add to that a potential down turn in the foreign exchange value of the dollar as the American investment premium (dollar policy) deteriorates, gold prices are set to light up the sky. I do not mean it sarcastically that when we see bullish gold market commentary by a Bloomberg, or CNBC analyst, it will be time to consider selling.

And at this point, even if we're wrong about all the other commodities, as well as the foreign exchange rate of the dollar, unless we are wrong about stocks and the overall economic outlook then gold should still outperform the dollar. For the only way that the foreign exchange value of the US dollar can appreciate, in our view, is if trading partners allow further competitive devaluations in their currencies.

But nations cannot live on trade alone. Rapid investment outflows are undesirable, as are rapidly rising prices, stoked through currency debasement. Every Argentina is a reminder of that. And every Argentina is increasingly creating new investment demand for gold.

If policies like this continue to be pursued in Canada or Europe, particularly as the value of assets decline or don't keep up with increases in nominal prices, and as well, while the investment premium on US dollars shrinks, investment demand for gold is sure to grow.

Dow Industrials	XAU Gold Mining Index

Note the rhythm in both markets above. There has been no real bounce in the Dow, other than just that, a bounce. The tempo of this trend should come through - lower lows and lower highs. What could possible happen to reverse this rhythm now? What could happen to get the Dow to rally to 11000? Nothing, in our view.

The Dow is headed for 7000, or lower. It may bounce then, but my guess is that gold and gold shares will be a lot higher by then, and the reasons for them to be higher will become increasingly clear to the skeptics loathing the opportunity today.

Good luck,
Edmond J. Bugos

The GoldenBar Global Investment Climate is not a registered advisory service and does not give investment advice. Our comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. While we believe our statements to be true, they always depend on the reliability of our own credible sources. Of course, we recommend that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and barring that, we encourage you toconfirm the facts on your own before making important investment commitments.