Some Thoughts on Gold's Steep Correction
By Doug Casey
Jun 23, 2006
CASEY is the author of Crisis Investing, one of the few financial
books that made it on the New York Times Best-Seller list and
spent 26 weeks there, ranking #1. Due to his contrarian views,
Doug is a well-known and popular speaker at investment conferences.
He is also the editor and publisher of the International Speculator,
one of the world's oldest and most respected monthly newsletters
dedicated to gold and silver stocks poised to produce profits
of 100% or better in 12 months or less. Read on for his outlook
on Gold's Corrections or click
to learn more about the International Speculator.
Not surprisingly, gold's steep correction has generated some
concern for resource stock investors. So let's take a look at
the gold market.
I figure the metal "should" be worth something like
$1,000 an ounce now to be in a rough equilibrium with the value
of other things the dollar can buy. That's an arbitrary guess;
there's no exact method I know of to determine gold's real dollar
value. If the U.S. dollar were sound, there would be a fixed
amount of gold in the treasury for every dollar in circulation;
in the 19th century, a $20 note was a receipt for an ounce of
gold held on deposit, and a "dollar" was just a convenient
name for a 20th of an ounce of gold.
Today, of course, the relationship between the dollar and the
amount of gold the U.S. Government has to redeem it with is so
tenuous that it's completely academic. But, assuming that the
government were just to make good on dollars held by foreigners
- forget about Americans - how high a gold price might be needed?
First we need to know how many dollars are outside the U.S. Nobody
knows exactly. They constitute the reserves of most foreign central
banks and the de-facto currency of record in dozens of countries
for ordinary citizens. The amounts are almost beyond belief;
it's said that, in Moscow alone, there are more US$100 bills
circulating than in the entire U.S. Could $5 trillion be the
number? If so, and if there are the reported 261 million ounces
in the U.S. Treasury, the value of that gold comes to about $20,000
an ounce. Just to make good on the reported U.S. trade deficit
of $800 billion for the last year, we're talking $3,000 gold.
Forget about what the numbers would be if you added in the domestic
money supply, M-3. Especially since they don't even publish it
But the numbers, at this point, are academic. My basic view on
gold is unchanged. And the fact it had a 37% gain this year,
reaching a peak of $725 on May 12, or has given back 22% since
then is meaningless in the big scheme of things. As I've said
before, before this market is over, gold isn't just going through
the roof; it's going to the moon. And the market is by no means
over. It's just starting to wake up from a generation-long slumber.
Why did it heat up the way it did? Perhaps the attention of the
traders was drawn to gold by Bush's brinkmanship and buffoonery
over Iran. Perhaps it was people noticing that gold was a relative
laggard among the metals in this bull market. Perhaps the market
was paying more attention to the Russians and the Chinese, among
others, divesting dollars. There is solid evidence that dehedging
by the producers helped fuel the surprisingly strong rally, and
that that dehedging is now slowing.
Likely it was a confluence of these and other factors. Thousands
of hedge funds, most of which collect their 20% profits just
to follow the trend, piled in. As the herd took their positions
- especially when the short-term oriented traders had all bought
- momentum slowed, and it went into reverse.
Remember that most of these traders were toddlers the last time
gold got anyone's attention, back in the 1970s, and so they only
know what they've been taught - that gold is an anachronism,
a valueless relic. Consequently, they have almost no understanding
of gold's fundamentals.
Consider, for instance, a primary reason given for gold's big
correction is that higher interest rates will make gold a less
attractive asset. As if there is some hard and fast rule that
says gold can't move up when interest rates are rising. But that
ignores the clear historical precedence of the 1970s when interest
rates were surging at the same time as gold.
It's unwise to try picking tops and bottoms in the market. But,
the way I see it, gold has made its bottom as you read this.
The fundamentals haven't changed; there's only been a swing in
As for the gold stocks. We're still in the "Wall of Worry"
stage of the market. The larger public is not involved, and the
thin slice that is, is just moving with the price of the metal.
The downdraft has been aggravated by the weakness in the NY market.
Remember, gold stocks do best when both gold and stocks are rising
and worst when both are falling.
My guess is that now, after losing perhaps 25-30%, the big selling
is over. The stocks will drift through summer, and the game will
be on again come the fall. You should use this time to pick through
the wreckage and put in stink bids on the issues likely to lead
the market back.
Although the best indicator is to watch popular magazines,
with an eye to doing the opposite of what their covers scream,
there's still too little public interest in gold to merit their
attention. And it's too early in the market for your neighborhood
cocktail party chatter to tell you much. Best to use your own
psychology: when you feel bold and enthusiastic, sell. And when
you're fearful and depressed - like now - buy, or at least line
up your targets. Don't forget how much higher these stocks are
now than a year ago. And remember they're likely to be much higher
a year from now.
The best recent analogue remains the Internet market. Every time
those stocks sold off from about 1995 on, it just set the stage
for an even stronger resurgence. That's how this market will
play out as well.
Finally, a reminder that volatility is the norm, not the exception,
in gold and silver stocks. It's very important you only invest
in them to the level of being completely comfortable with a 50%
or even 90% loss. That's not just a passing platitude, but perhaps
the best bit of advice I can give you. Reading some of the emails
we've received these last few days, it's clear that some of you
probably got carried away and so are now panicking. That is never
the right frame of mind, under pretty much any circumstance,
but especially when it comes to investing.
As the gold and silver stocks come roaring back in a month or
so, do yourself a favor and scrape enough off the table to get
you back to the point where even steep losses are unconcerning.
Meanwhile, patience, steady nerves and a focus on loading up
on the best of the best at bargain prices will win the
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