Gold's Finest Hour: How to Buy Now

by Eric Roseman

The global economy continues to slow. Markets are dropping under the increasing weight of soaring inflation and a credit contraction. We're facing an outright bear market in financial assets and...

Gold is approaching its finest hour since January 1980.

From its all-time intraday high in April, spot gold prices have declined 8%. Even though gold has soared over the last few years, the spot price of gold is still 55% below its inflation-adjusted high since January 1980.

Gold Is Still Miles Away from Where It Should Be

Amazingly, gold remains miles off its inflation-adjusted high. Unlike many of the skyrocketing base metals this decade, gold prices are just $106 above its best levels in the last bull market in 1980. Over the same period, U.S. inflation as measured by the consumer price index or CPI has averaged 3.9% per annum.

There's Still Time to Buy!

From a technical perspective, spot gold prices remain well above their 50-day and 200-day moving averages. Spot prices should take-out the intraday high of $1,033 an ounce on the next up-crash cycle. This should occur during the summer or early fall.

Seasonal strength for gold has arrived early this year, typically starting in the fall. But as far as I'm concerned, the latest price action is bullish because the United States and other countries are starting to lose control of inflation. In June, U.S. CPI hit 5%, the the largest annualized gain since 1991.

Gold prices are heading much higher before this bull lays to rest. This marks the first time in history that every facet supporting the bull market is riding on steroids!

Global gold production is now declining since 2005 with South African and Australian output virtually stagnant in 2008. Net supplies are approaching deficit as production fails to meet rising demand.

We've seen a booming demand mainly from exchange traded funds and a dramatic asset allocation shift among investors. Retail investors are dumping dollars and other fiat paper money for the relative safety of gold.  

The Euro Is No Panacea Longer Term

In Europe, dollar-based investors have been dumping the buck in favor of the euro since 2002. But there's just one problem with this plan. Growing economic problems in the Eurozone will fracture the euro at some point.

More than any other region, I visit Europe several times per year and can tell you with absolute certainty the Continent is suffocating under the strong euro.

Though unimaginable to many dollar bears now, the euro is unlikely to remain strong over the next several years. Right now, weaker countries in the Eurozone are plunging into a hard recession - namely Ireland, Spain, Italy and possibly, France. That hurts the euro's overall strength. It's also possible that one or two Eurozone members might leave the single currency altogether as deflation threatens economic growth and stifles export competitiveness.

This scenario is growing more likely by the day. When that happens, gold prices will rally even higher as investors dump what's perceived to be the ultimate king of fiat currencies.

Even if the U.S. dollar does recover and posts a cyclical bear market rally, gold prices can still rise. This occurred in 2005 as spot gold prices climbed 18.3% while the dollar rallied 12.8% against the euro. There's no steadfast rule that gold must decline if the dollar strengthens, especially in a counter-cyclical bear market rally. Provided investor demand remains strong for gold and global interest rates remain historically low, gold prices can climb to new highs as the dollar strengthens.

It's Not the '70s All Over Again...It's Worse

Unlike the 1970s when the global economy suffered through stagflation, the late 2000s offers a completely different economic paradigm. This is not stagflation all over again - or not exactly.

For the first time in the post-WWII period, investors are struggling with "inverse stagflation" or deflation in housing, credit and financial assets (stocks and bonds) combined with soaring inflation in food and energy prices.

If this was truly an inflationary economic cycle, textbook economics would support rising home values. But this is certainly not the case considering the S&P Case-Shiller Home Price Index has plunged more than 15% over the last 12 months through April (latest data available).

This data is certainly not consistent with traditional inflation supporting housing values. In the 1970s, inflation-adjusted home prices increased, unlike in the post-2006 period.

The U.S. financial system is another source of deflation as banks struggle to recapitalize and purge their illiquid backlog of derivatives tied to housing and other opaque securities. Banks are now lending less - also a deflationary event. If less credit is flowing, then the economy can't grow.

The CPI Numbers Don't Tell It Like It Is

Of course, prices for just about everything are soaring over the last 12 months.

The government's official CPI numbers don't tell the whole story. Consumers are paying much more for goods and services today compared to last year. In fact, some consumers are paying more than double for items like gasoline and certain foods. Yet, the official CPI is just 5% over the last five months through June.

The bull market in gold is still sitting pretty. Investors, policymakers and consumers are scrambling to decipher how to stop rising inflation. Meanwhile central banks in some industrialized countries can't aggressively hike lending rates because deflation has already gripped housing and bank credit. It's an awfully delicate macroeconomic landscape.

Inflation and deflation now co-exist for the first time since 2001. I'm not sure which economic evil will win this war. But one thing is for sure. If given a choice, the Federal Reserve and other central banks would much rather allow inflation to grow than deflation or an environment of accelerating falling prices.

This, in fact, has been the sad history of all paper money. Over the next 12-24 months, I suspect the Fed and its international counterparts will aggressively print credit because deflation is seriously threatening the global economy. They don't have a choice. Millions of consumers are witnessing a purge in asset values. Inflation is the lesser evil and central banks recognize this.

So...gold anyone?

Disclosure: None.

Comments

[yuman:]

This puzzles me a great deal and I beg for some explanation. There seem to be arguments for gold everywhere and every economic and financial factor has been used by gold bulls. I don't remember seeing a gold bear article. Inflation is said to be good for gold. But I don't see proof presented for that, or a correlation between CPI and gold price. I am afraid that during deflation, we will hear that deflation boosts gold prices and will even be shown charts proving that point. Weak dollar, strong euro of necessity, is said to be good for gold. Now in the current article, we hear:
"gold prices will rally even higher as investors dump what's perceived to be the ultimate king of fiat currencies (euro)." This is odd since it means that strong dollar boosts gold. I also heard that credit crises, which is deflationary, boosts gold. It's also quite convincing that prosperity boosts gold. Any factor, in either the positive or the negative direction, boosts gold. If I believe what I read about gold, any change boosts gold, so does stability. Are the gold bulls nuts?

2008 Jul 20 01:52 PM

[drooyrich:]

yuman, I share your doubts - we are in the winter cycle according to Kondratieff were the credit boom = debt boom has been fenomenal - now, this theory well documented which has with precision forecasted financials boom and bust is now predicting deflation - frankly, I cannot see how we will get deflation since the other tsunami is much bigger i.e. peak oil - with oil becoming more and mote expensive, this will have an inflationary impact on food, energy, metals, etc. I think the deflation will be on housing, stocks, bonds - so, according the the classical Kondratieff theory, gold will outperform during the housing/stock/bond deflation and should do even better since we will have inflation on food/energy/raw materials - the target price ?? Ok, if we calculate how much monetary mass has been increased during the Autumn period (1980-2000) gold price should rise to 32.000 dollars just to match this increase - I know this sounds crazy but these are the facts - will it ? I would be happy for just 6000-10.000 dollars - best luck to you - protect yourself, your family because what is to come will not be pretty at all !

2008 Jul 20 02:07 PM

[Gigem77:]

During periods of economic growth, gold acts primarily as a commodity. Most of the gold used is for jewelry. The bull market for stocks that ran from 1982 until 2000 was a bear market for gold. Volcker raised interest rates until he squashed inflation and that took gold from 850 down to 250 by the end of the cycle.

Since 2001 gold has outperformed stocks and bonds. So has oil and for that matter corn and sugar. The world added over a billion people since 1982. China and India grew large middle classes with increasing purchasing power.

During periods of economic problems, gold acts also as a currency. Investment demand sends the price soaring. We've only seen the beginning of investment demand for commodities, including gold.

There won't be deflation. Nobody is on the gold standard and fiat currencies will be inflated to monetize all debts eventually. Stimulous checks, bailouts, whatever it takes.... the dollar will be weakened and "stuff" will continue to outperform.

Kondratief was a Russian working for the Kremlin long before Bretton Woods or the Basle Accords. His work is very out of date. Inflation is here and gold is giving a very clear signal.

2008 Jul 20 07:46 PM

[starkoski:]

I agree with your article tooooootally and silver will do even better then gold. Much better and buy food commodities too!!! See you in real money heven on earth!!!!!!!!!!!!

2008 Jul 20 08:52 PM

[DavyJ:]

Yes, I'm puzzled to yuman.

If gold is an inflation hedge and it is currently below it inflation adjusted high, doesn't that mean that gold is not a good inflation hedge?

Something I've always wondered about.

2008 Jul 20 10:43 PM

[Nate C:]

I agree with DavyJ. I keep hearing from the gold bugs (my grandgather included) that gold is an inflation hedge and should be traaing around $2000. My question : why is gold not currently trading at $2000 if it really is an inflation hedge.

If you want a real inflation hedge buy timber. Historically it has provided returns 4-6% higher than inflation. Sure beats gold's record.

2008 Jul 21 01:21 AM

[Lazer Wolfe:]

Gold & Silver are money and have been for thousands of years, plain and simple. In order for the present fiat system to function the supression of monetary metals is necessary and has been well documented, see (GATA) for more info.
Real money keeps government spending in check therefore cannot be allowed by the fed and banksters.
Fiat ( monopoly money) has always destroyed any society or empire over time, and the U.S. is no exception. Research, educate yourself and the problem becomes obvious, the result however few want to hear or admit.

2008 Jul 21 03:09 AM

[Maximus:]

This is much needed article and this issue needs to be addressed more by economists and analysts as it is the key issues for investors at the moment.

I agree that central banks the world over will inflate away the debt-finance spending binge in developed economies. It is too expedient for politicians to inflate economies and economists seem to agree that deflation is worse than inflation.

This is good for gold. Even though one cannot consume gold as critics point out, the yellow metal as historically served as a store of value.

I also believe that the euro is not sustainable and this is good for gold since it means that there is not alternative reserve currency. For example, I live in Spain and believe the country is heading toward a protracted recession that includes deflating asset prices (housing, stocks) and an inflationary consumer prices given rising energy and food prices. The country will be akin to Argentina of the late 1990s: too much spending by the public sector crowding out the private sector, and with a currency tied to a then stronger dollar that dampened export-led growth. Without a depreciating currency, Spain simply will not be able to keep the economic chugging (even if in reality it is only running in place) and I wouldn't be suprised to see a return to 20+ unemployment in the next few years.

I also believe however that the world economy is heading for a long recession and a period of deflation, especially in the aging US and Europe, since peak oil and energy inflation will eventually destroy demand and slow down growth.

I don't think that gold is necessarily an attractive asset in a deflationary environment and would prefer to own zero coupon bonds as well as real estate or land (assuming this is not Armageddon, then all bets are off).

The more I think about it, the less pessimistic I become. The US has survived periods of rampant inflation as during the civil war and the 1970s oil shocks and periods of deflation and high unemployment as during the great depression. On the political side, it defeated both fascism and ultimately communism albeit at a great loss of human life.

The challenges of the future are no different and the US can overcome them as well. There is no reason US-based energy companies cannot lead the transition to the US of alternative energies in the face of peak oil. There is no reason that Silicon Valley cannot continue to be at the forefront of new information technologies. There is no reason, American automobile manufactures cannot make attractive, efficient vehicles that consumers want to buy (they do so in all other parts of the world except North America).

At the moment I am not long the dollar but once the current dust settles I will be because I believe the American political system offers and will continue to offer the best environment for motivated economic agents.

I recently wondered why Warren Buffett traveled to Germany, Spain, and Italy of all places to look for new investments. What happened to Asia? I suspect that he is believes demonstrated democratic states are more friendly to long term investors and maybe yet dubious as to China's commitment to human and property rights.

2008 Jul 21 07:11 AM

[CLH:]

Maximus---Your comment is very good and I agree. Gold appears to be making a double top. I see little inflation. Higher prices in food and oil is not inflation. Inflation is too much money chasing too few goods. I dont see too much money. Ask any wage earner. There also is no shortage of oil or food. Most important the dollar is no longer dropping. As the market bottoms, the dollar will strengthen.

2008 Jul 21 08:32 AM

[andyn:]

Be careful with Gold. It might go up over $1000...but it also comes down fast. This is because unlike other commodities, gold keeps accumulating in the system, so supply technically is not a problem. For an anecdotal example, I know few Indian friends of mine who finally started selling their jewelery when gold spiked last time and Indians have been accumulating gold for the past 2000 years!!!! I would buy GLD but have puts alongwith it.

2008 Jul 21 08:57 AM

[xsuddensam:]

Will we come to our senses only when we see money printed on one side? That's what happened in Germany. They couldn't print the stuff fast enough.

We are printing money 24/7. It never stops because we have no way to solve our financial problems other than to throw money at them.

Because our economic growth model is based on credit rather than sound financial principles, it is eventually going to fail. It's so simple, it is mind boggling that reasonable people can't see it for what it is. It's time to pay the piper.

Gold. If you own it, keep it. If you don't, get some. And by all means, take possession of it. Don't accept a piece of paper saying that they will hold it for you (ETFs). Don't trust anyone with your gold.

2008 Jul 21 08:57 AM

[Kelly Liebe...:]

xsuddensam-
I agree with you. I don't need charts, statistics etc.. to know that I can't fix my family's financial problems by photocopying $100 dollar bills, so what makes our treasury think it can fix the economy with the same game?
Wake up everybody! If your printed money is not tied to VALUE it is just Paper!!!
We live in a credit card society, so people think that as long as they have this plastic card it will continue to be accepted as payment for goods...
Well, did anyone watch the news last night? Because the credit card companies are now looking at what you are purchasing and if they determine that you are making purchases on rent, utilitity bills etc they are deciding to raise your rates and cut off your limit..
This is the next step in the collapse of the lower and middle class....and as that happens panic sets in and gold and silver go up.
The choice is yours..

2008 Jul 21 11:10 AM

[Engineer:]

Andyn, yes gold accumulates, but people accumulate too. An important indicator is the amount of gold available per capita, which is probably now less than one ounce per person.

2008 Jul 21 11:17 AM

[jetsby10:]

Davy, gold is marching it's way back to that high. Does it get there? Who knows? Does it eclipse it? Maybe. Point is, gold is up 300% this decade. That's a pretty good hedge if you ask me.

2008 Jul 21 01:04 PM

[fran:]

i hear told--an ounce of gold has been sufficient to purchase a suit of clothing and footwear since ages BC thru today. i don't know much about inflation/deflation, but if what "i hear told" is correct, what's all the discussion? am i hearing wrong?

2008 Jul 21 07:59 PM

[goldilocks:]

xsuddensam, I agree with you right along with Kelly ! Would like to take your advice & aquire some gold - I live in the caribbean & am not certain what to do...how to get it delivered, where to store it... banks are safe from hurricanes (I assume), but is a box at a failed bank a safe place for gold ?

2008 Jul 21 08:27 PM

[xsuddensam:]

Goldilocks:

Google "gold" and check out Monex, Kitco and others. Like anything else, compare prices, commissions, shipping and insurance. Typically, the more you buy the more you can negotiate commissions and certain costs.

Safe deposit boxes in reputable banks work well in the U.S. You are signing a service contract and paying a fee to the bank to safely store you possessions. You are NOT making a deposit so the bank has no right to use your gold as if you had made a cash deposit in your checking or savings account.

Of course, the old time tested method of digging a hole and burying it can work just fine. Just make sure no one will stumble upon it by chance; it's probably a good idea to have several locations.

Some companies will store your gold on account. Be sure to ask if your gold will be allocated to you personally with bar weights, serial numbers, etc. I wouldn't recommend un-allocated or "pooled" storage because your metal could be moved around with others just like deposits in a bank.

Personally, I don't want anyone, including ETFs, holding my gold.

Happy prospecting!

2008 Jul 22 07:06 AM

[goldilocks:]

xsuddensam, many thanks for your advice !

2008 Jul 22 07:38 AM