Gold Is Going to Gain

As I mentioned last week, I expect the market to find a temporary bottom at some point this year and to stage a significant rally. However, I expect that this rally will prove to be a bear trap, as the market will then fall far more to find its true bottom a couple of years from now.

I don’t base this prediction on any sort of economic theory, but rather on history. Prior to the Federal Reserve Act of 1913, economic contractions were short and violent affairs. The Panic of 1907, for instance, was over and done with in a single year. The panic spelled the end of the Knickerbocker Trust Corporation, and many small regional banks failed and wiped out their depositors. This kind of “liquidation” of struggling companies was viewed as a necessary evil back then. No one likes liquidation, but it does its work quickly.

Things are different these days. John Maynard Keynes came along and theorized that all economic downturns were caused by “insufficient demand.” He argued that politicians needed to juice the economy with easy money to get consumers spending again. The fact that Keynes’s theory is nothing more than math piled on top of a foundation that’s part conjecture, and part shaky definitions, did not stop it from becoming popular. Similarly, the fact that Keynes’s prescription of juicing the economy with easy money does not seem to actually prevent recession — but, rather, prolong it, until it becomes far larger and more devastating — has not caused it to since fall from grace. Politicians get elected on promises to give money to their supporters and Keynes’s theory makes it their primary mission to do so.

This is why Keynesianism never goes out of style. After the advent of Keynesian theory and the empowering of central banks to create as much theory as deemed necessary, the character of economic downturns changed. Instead of being short and violent affairs that occurred with appreciable frequency, they became rare events that dragged on year-after-year. Since the true bottom for the stock market is only found at the end of the crisis, every rally that occurs before then is merely for suckers, and will ultimately take buy-and-hold investors down even further.

Since this crisis is still rather early in historical terms, I’ve been expecting for the market to find a false bottom and begin to rally. Despite the fact that I’m a market bear, the single-mindedness of this downturn has surprised me. Every week or two, the Dow seems to find a new low and I think to myself that the market will probably start to rally; then comes next week and the Dow is trading still lower. So many down weeks in a row have built up a powerful (albeit temporary) upside on the stock market. People seem to be waiting for any sign of good news to get back into the market, and that’s exactly what we saw yesterday.

Citigroup’s (C) CEO sent a letter to shareholders saying that the company seemed to be earning a profit for its first 2 months in operation in 2009. It wasn’t an official profit, and, given that Citigroup’s losses have been on a series of asset value write down rather than traditional losses, that hardly seemed to signal that the worst was over. The market rallied anyway. The Dow Jones raced up 5.8% and the NASDAQ was up a scorching 7.1%. In a market hungry for good news, this letter to shareholders was enough to set things into motion. Similarly, gold broke below $900 an ounce as investors figured that they wouldn’t need to hold it anymore, now that the worst was over.

Obviously, it's far too early to tell whether this bottom is going to last, but gold presents an attractive opportunity. The Dow could find a new low in the next few weeks and send those same investors back into the yellow metal, or the economy could start to improve which would quickly bring inflationary fears roaring back. The central banks of the world have been injecting new money into the world’s monetary system at an unprecedented rate in an effort to use inflation to mitigate the losses on the balance sheets of the world’s banking system. Investors have been comfortable holding these currencies, despite these inflationary policies, because they figure that the “velocity” of money (i.e. how many times it changes hands in a year) slows down in a recession. Since monetarist theory says that you only see price inflation when you see an increase in the amount of money multiplied by its yearly velocity (with no corresponding increase in the supply of goods), price inflation will become a very real concern if people figure that the recession is ending.

In either case, gold is going to gain.

I believe that this crisis is going to be another stagflationary scenario similar to the 1970s; central bankers will ease rates and print money to stave off a market decline, which will then stoke inflationary fears as the market stages any recovery in nominal terms. This will prompt central bankers to start contracting the money supply, which would then send the market back down. The 70’s saw the true end of the crisis when short-term interest rates where raised to 20+% and held there for a couple of years, which also allowed the forces of liquidation to do their dirty work, and the crisis ended. I believe this crisis is going to play out in a similar way, except I don’t feel the ending will be the same. The United States has far too much debt to flirt with high interest rates this time around.

The world’s monetary system is on the verge of collapse from over-expansion and right now, everybody is trying to re-inflate it. How this crisis is going to end is anybody’s guess, which is why I stick to being a gold investor. Gold has a tremendous upside in this environment, regardless of what happens next. Technicians are calling for gold to find a new support point around $850, but I’d encourage people to get in now. $900 an ounce is an extremely attractive buying opportunity.

Comments

[@TexasER:]

I'm even more harsh than Sakata. The difference between a speculator and an investor has nothing to do with your time horizon. Hours or years make no difference to me.

A speculator is someone who *speculates* that they will be able to sell an asset for a profit down the road. This is 95% of equity market participants.

An investor is someone who puts capital to work with the intention of driving future earnings and employing people. This is 95% of small businesses.

Nothing wrong with either, by the way.

On Mar 11 08:41 AM Sakata wrote:

> This is a misuse of the word "investor". People who react to the
> slightest change in market direction are speculators, not investors.

Mar 11 01:07 PM

[frank90291:]

One smart Lady !! IMHO


On Mar 11 09:35 AM Kelly Lieberman wrote:

> When one looks at the big picture -700 unemployed applying for a
> janitors job, 1,000's of Americans homeless and moving in with family
> or worse tent cities, millions of people out of work... you have
> to be realistic. The domino effect has just begun and it is racing
> around the entire globe.
> The world is not only on a precarious financial precipic, but we
> also have a myriad of security issues to worry about. Along with
> that, add in the usual natural disasters we can count on every year,
> and the growing discontent,frustration and fear in the world's population.
>
> Tell me, do you really think that the day to day ups and downs of
> the dow will make a difference in 99% of the world's population?
> Traders are making money whether the market goes up or down but the
> average guy in the street with no money and no job still doesn't
> have money to spend. Meanwhile, more jobs are lost every month,
> and the cycle continues. Unfortunately, this crisis is not over
> and we will continue to see fluctuations in the market. Have your
> stops in place...

Mar 11 02:18 PM

[GMiki1:]

Paul & Shark,

Gain can mean not losing all your money, having a roof over your head, and eating.

Mar 11 02:40 PM

[Conan the B...:]

Gmiki: preserving what you have left to live and the return of my money.

Mar 11 02:53 PM

[mr freddo:]

Mr. Poulter:

Thank you for a well written and thought provoking article. Many writers and prognosticators get stuck on what's to happen next. it is interesting to read your 3 year perspective. Bear Rally, Bear Trap, New lows in 2 years, inflation, higher interest rates, finally things resolve themselves in about 10 years. Yikes!

I agree with your comments on Keynesianism. If I am a congressman, facing election every two years, I want to show that I am getting some of the grab for my district. And Keynesianism makes it all sound like good management. On the other hand, there are the deregulators, another group that never seems to lack in campaign contributions.

How about Freddonomics? Under Freddonomics, the government is responsible for investing its sovereign wealth fund for a profit and to promote certain industries that are deemed to be indispensable to the defense of our way of life.

After many years, the sovereign wealth fund becomes so large and successful, that taxes are no longer required and each citizen receives a check of $10,000 per month.

It sounds crazy but I believe Jon Luc Picard talked about just such a period in human history. Why can't our government make a profit for the people? Why do we manage to a deficit? This idea that we can spend all that we want and then finance it is backasswards. We should cut expenditures, and look to making a profit on government services.

Okay we are talking about 50 years out now...

Mar 11 03:21 PM

[allan skye:]

excellant piece Preston.

Mar 11 04:27 PM

[Conan the B...:]

The Government made a promise to the People on Social Security, No Taxes on Social Security.

Promises by Presidents: Read my Lips, No increase in Taxes.
The same old Pork spending will not be allowed on my watch.

Bush, Obama both presidential promises, both broken.

Trust Governmental promises? Let them keep a few for a change.

Mar 11 04:35 PM

[AndrewBaker:]

Good article, and provoked a lot of different comment, with the majority agreeing that:

1) Keynesianism isn't a good answer but helps politicians buy or keep votes (they think), whilst prolonging the misery for those most affected.

2) Gold (and silver, let's not forget) are real wealth that politicans and financiers can't mess up, so in bad times we should hold our share of it.

I agree with both, and am heartened that the majority of the small sample here at any rate share these consensus views. There's hope for us yet!

Mar 11 04:52 PM

[Paul H. M.:]

So the author wants us to return to a system in which I would lose my deposits every ten years.

If wealth is measure by quality of life and the luxury of a low-stress existence, we have far greater wealth under our current system.

While I agree that government can get out of hand at times, what we have now if obviously far better than what we had when we did things the libertarian way.

I'm 30 years old, and never lost my deposits once. If I lived under system that this author wanted, I would have lost all my cash or gold that I ever deposited, three times over.

While it hurts to lose 20% of my net worth in this current recession. I'm still fairing much better (and so are the rest of you) than I would under the non-Keysesian system.

Mar 11 06:32 PM

[5142152-337:]

I have been converted! There was a time I would take CLH to task for his silly rants. No more. I really ENCOURAGE him to continue to do so. Why? Because his rants will enlighten the readers how narrow, shallow, and really uninformed are the gold haters.

Buy PHYSICAL gold and silver now!

Mar 11 08:04 PM

[Tim in HK:]

"Buy PHYSICAL gold and silver now", to which I would add "if you can". In Hong Kong at least, physical gold shortages are not some figment of some conspiracy theorists's fevered bloggings, they are a fact. Supply is drying up all over the place. Anecdotally even the Bank of China (traditionally the biggest supplier) was cleaned out (all branches) the other day by a certain Russian gentleman standing in front of me in line with a Zero Halliburton briefcase and a lot of cash. "Try next week" was all they would say. And forget about getting silver in quantity. It is simply not available. This for an industrial metal whose demand has supposedly dropped off a cliff because of the synchronized worldwide depression? Talk about conspiracy theories.

Mar 11 09:04 PM

[Conan the B...:]

Tim: Silver production has dropped off a cliff. Silver is a byproduct of many of the different types of Basic Metal mines being shut around the world.

A shortage will develop in Silver.

Mar 11 10:23 PM

[Hmm?!:]

What is with some people?

No Country in the history of the world has ever taxed, borrowed or government spent their way to prosperity!

And I do not see that happening now.


On Mar 11 06:32 PM Paul H. M. wrote:

> So the author wants us to return to a system in which I would lose
> my deposits every ten years.
>
> If wealth is measure by quality of life and the luxury of a low-stress
> existence, we have far greater wealth under our current system.<br/>
>
> While I agree that government can get out of hand at times, what
> we have now if obviously far better than what we had when we did
> things the libertarian way.
>
> I'm 30 years old, and never lost my deposits once. If I lived under
> system that this author wanted, I would have lost all my cash or
> gold that I ever deposited, three times over.
>
> While it hurts to lose 20% of my net worth in this current recession.
> I'm still fairing much better (and so are the rest of you) than I
> would under the non-Keysesian system.

Mar 12 12:34 AM

[Maxe Paul:]

i like the part where you say "Things are different these days", as in this time it's different! Thats what they always say, and they are always wrong!

Mar 12 01:50 AM

[Conan the B...:]

Maxe: lets reverse it, When has the Present mix of a Worldwide Crisis with Worldwide Government Intervention, with Gold near a $1,000 and $4 Trillion sitting in Money Market funds, Ever happened before?

When has the US economy been so lopsided toward consumer spending with such a Great Loss of Wealth but with Low interest rates and expectations of same continuing, Ever occured at the Same time as the above.

When have there been so many disparate Countries affecting each other?

Circumstances are the same for some aspects but not in the Aggregate.

Since the present situation has Never Occurred in the Past, It is different this time. IMO

Mar 12 09:06 AM

[Wayne Found...:]

People, the Ultimate Resource

If we look long-term, the value of the world's basket of resources increases or decreases as a whole. Oil, gold, land, food, timber, minerals, etc will at times diverge to head in opposite directions, but ultimately they all trend in the same direction. Generally that direction has tended to be up. But there are extended downturns in the chart of world history, called depressions, and the value of all goes down during such times.

We might be able to guess where one resource is going by looking at another. Many try to predict gold by looking at oil, or silver by looking at gold. Will a recent decrease in value of oil, grain, lumber and other basic materials bode poorly for the value of gold? What about the value of the world's ultimate resource, people? Does rising unemployment, corporate pay cuts and rising cynicism, terrorism, a boom in gladiator-style cage fighting, mean the value of people is now trending down? And will that reduced value of people drag down the value of other resources? Even gold. I think so.

Since the dawn of civilization, pharos and kings have sought to increases and protect their resource base. Land, timber, minerals, but most of all -HUMANS. Resource control, over the course of history, has been primarily a way to manage and control the people. People to do the work of the empire, to fight the wars, and pay homage to a nationalist agenda.

The Soviet Union did not allow its people to leave, they had to defect at great risk. Cuba similarly attempts to hold its people. Pharo, chased after the Israelites to maintain his base of workers, soldiers and skilled craftsmen. It is a drama as old as time. And to me it shows that people are the ultimate resource in the eyes of those who truly control the world. When the value of people goes down, it is a leading indicator that the value of all resources will go down. We can only hide in a room full of gold for so long.

Mar 12 10:15 AM

[Brad Harper:]

Not so much...

On Mar 11 06:32 PM Paul H. M. wrote:

> So the author wants us to return to a system in which I would lose
> my deposits every ten years.

As opposed to the one where *everyone* loses their deposits every 30 years?

> If wealth is measure by quality of life and the luxury of a low-stress
> existence, we have far greater wealth under our current system.<br/>

You mean despite of our current "system"...? The amount of wealth that our Keynesian nightmare has destroyed, along with the corresponding prosperity, is immeasurable.

> While I agree that government can get out of hand at times, what
> we have now if obviously far better than what we had when we did
> things the libertarian way.

Exactly when and what are you referring to?

The only men who fear an objective system based on absolute economic justice are those who'll eagerly condone starving the whole world save a few able bodies and minds to mooch off of.

Mar 12 12:55 PM

[Yamaka:]

Yes, there is easy money in the system: most Central Banks have lowered the short term money rate because of the deep recession. Once the recovery is on the way - most probably by mid 2010 - the Central Banks will hike the cost of money, which will keep the inflation at check. If this happens, then where is the future for the yellow metal? I believe it will languish around U$800-1000. All this Gold Talk is from Speculators! Not genuine Investors.

Mar 12 10:15 PM

[ageczi:]

Anybody trading in gold is nothing short of a speculator. Gold has become obsolete the moment economic activity was measured in monetary units. Gold, much like a Federal Reserve Note today, represented one's widely recognizable contribution (or value) to economic activity therefore has no more intrinsic value than any central bank note when demand for it as a commodity is removed. If people actually understood this simple concept and stopped equating it to monetary security and viewed it for what it really is (a commodity), the premium sitting on top of its value would evaporate overnight. It would behave like the price of oil has in the past several months. Faith in gold did not prevent mercantilist policies of the 17th century from contributing to high levels of inflation in Spain, and it will protect against inflation in the 21st century only so long as people fail to understand its true significance. I suppose you can always bank on ignorant people being ignorant, therefore bank on gold.

As far as Keynesian economics is concerned, there is no need to look further than the rudimentary circular flow diagram of economic activity to figure out its potential impact on restoring confidence and growth. However, the implementation choices made in Washington will certainly affect its effectiveness, which is where we can debate until the cows come home.

Mar 13 03:33 AM

[Conan the B...:]

Or, If Gold has reached Investible Status because it is being portrayed as an "Island of Stability" during unstable times, then Gold will not be Viewed as an Inflation hedge alone.

Do you actually believe what we are going through currently will be forgotten within 2-5-10 years? It will be remembered like the Great Depression was 75 years ago.

I maintain that Gold as an Investment class, will be recommended for every Porfolio eventually. More will heed the recommendation than not.

Gold is an Investment. It is also Insurance against various scenarios including, but not limited to, Inflation.

IMHO

Mar 13 01:03 PM