Short, Medium, Long Term Gold

Chris Laird
www.PrudentSquirrel.com
Sep 7, 2006

At this time in gold, where prices are vacillating up and down, people look for some direction on things. With that thought in mind, I decided to write this piece on short, mid, and long term gold macro market drivers. We then, can get an idea of what to look for in the coming months ­ in terms of financial news developments and what they will do to gold.

I want to point out that, with these various time horizon scenarios, what I am attempting to do is provide what you should look for in the financial news. Many of these scenarios are dependent on this or that happening and are not intended as predictions per se. Then, I give a macro economic view as to what the various possibilities could do to gold.

I generally look at three timelines. The short term is the next 2 to 3 months. Midterm is 6 months. Long term is over one year.

Mid Term Gold

The best look would be to start with the mid term economic trends, then apply some analysis to gold.

In the Mid term, we will have a significantly weakening US economy, first and foremost. This will be largely driven by a rapidly falling US housing bubble.

However, as one counter example, I read recently that commodities will initially hold some support because of all the commercial real estate in the pipeline that will still have to be completed. There is also relatively strong manufacturing demand 'in the pipeline' world wide. These two 'in the pipeline' forces will provide some cushion to commodities prices, but will not override the mid term trend of a weakening US consumer and economy.

The extent of the US housing bubble is unprecedented. That means that, when US economic growth falters because of the collapsing housing bubble, the normal commodity downturn in recessions will be very pronounced. But this takes some time to materialize. This is why I stated in recent public articles that I foresee large drops in commodity prices, possibly as soon as January 2007, but not later than June or July 2007.

Of course there are more factors in a mid term view. But this synopsis provides what I feel are the most important issues.

A large drop in commodity prices, combined with slowly deteriorating financial markets will not be bullish for gold. However, if there is a stock market panic, or other financial panic, commodities will drop but gold will be bullish because of flight to safety. So, as I said, one will have to see how the onset of a US recession occurs, and then determine if the ensuing market drops are either orderly-slow, or panicky.

Another counter example I see often is that Europe and China-India are strong enough to withstand a severe US recession. This argument has the idea that Europe has large trade surpluses with the US, and China is involved in ASEAN, the Asian economic development regime. The problem I see with this counter example is precisely that these economies are super dependent on US imports. Most of their high buck and mass low buck exports depend on US demand. In fact, when Japan suffered real estate market crashes and stock crashes in the early '90s, they made a very concerted and successful attempt to export their way out of deflation to --- you guessed it-to the US.

This idea that the world is ready now to overcome a serious US recession does not take into account that the US consumerism model, that we are totally addicted to, started all the way back into the industrial revolution in the US with Henry Ford. Buying on credit was his brain child... In other words, there are deep seated trends in the world economy that are totally locked into a US consumer model... The effects a severe US recession would have on the world economy is very structural, not some generic economic issue.

Of course, there will come a time when China, Japan, the EU and India will all trade predominately amongst themselves, and get their consumers to take over the role of the US, but I expect the world is one great depression away from this happening...

There will be more of this analysis in the Prudent Squirrel weekly gold/economic newsletter.

Long Term Gold

The long term gold prospects are easier to derive. Clearly, the US, EU, and Japan have massive credit bubbles in all financial and real estate markets. All of these economies also have problems with government fiscal deficits, and very liberal monetary policies of loose money and expansion of the money supply. It is estimated that these countries are running money creation at about 8.5% in the past years. Since these economies are only growing at about 3% or less, that means they are inflating the money supply buy about 5.5%.

Interestingly, I have seen various estimates of inflation in the US, and Japan and the EU. There are two views on what that rate is. One is the usual government statistics that show CPI and Core inflation running at 2 to 3% roughly. In Japan it is a lower rate, as they continually battle deflationary forces... something I am not going to go into here.

The other view on inflation is that in the US real inflation is on the order of 8.5%. That view holds that the US is deliberately underestimating inflation. The US and Japan are both becoming notorious for playing games with their economic statistics... as we all know.

Now, it is interesting that, if we take the roughly 8.5% monetary growth, and subtract inflation at about 3%, that would leave us with 5.5% of excess money that finds its way into financial and real estate markets in these regions, the US, the EU, and Japan. If the financial and real estate bubbles don't take this money, then gold will skyrocket.

The point is that gold will reflect this increase in fiat money at the rate of 5.5% at least. This is a world-wide phenomenon, so gold will rise in all currencies in the long term. We will not be seeing a repeat of a 20 year period of gold doldrums after it ran up to 870 in the early 1980's.

Now, much of this money is finding its way into financial markets and real estate bubbles.
This ends up soaking up many inflationary forces of this fiat creation. The trouble is, as soon as financial markets start to show significant liquidations, that money will no longer be soaked up by credit bubbles. The major credit bubbles are the housing markets world wide, to include commercial real estate, and stock markets, also there is a manufacturing bubble in China. In China there is a very serious problem there with industrial overcapacity. Everybody and his brother wanted and want's to invest in a Chinese factory. The trouble is that these are now eating each others profit margins up. Also, the commodity markets are infected with speculation money, to include gold, all based on the last gangbusters 5 years of overspending by the US, over building and investing in US and world housing bubbles, and industrial overcapacity in China.

This whole mess of financial and industrial excess, financial in the West, and industrial in China, is going to unravel very badly. The onset of a severe US recession or depression will be seen as the cause. Gold will ultimately benefit greatly because the entire world will then have to try and inflate out of a developing deflation. Probably the first attempts to hold the whole rotten structure together will be vigorous defenses of the US dollar. This will be by foreign central banks working in tandem to keep the USD above certain levels, ala Japan in 2004. But, ultimately the USD will be doomed as the Central banks ultimately realize their world reflation will fail. Then gold will skyrocket.

When the credit bubbles stop showing returns, gold will attempt to immediately reflect the excess money creation that was formerly going into the credit bubbles (real estate is a credit bubble too). This will be very gold bullish.

Also, the ending of the massive world credit bubbles will cause financial deterioration in those economies and that will cause government fiscal deficits to increase greatly. That is going to be very gold bullish.

Furthermore, as financial markets start to show big stress, the central banks and plunge protection teams are going to spend a gigantic sum of money trying to support them.
Previous economic collapses have not had the present battery of coordinated central banks and programs such as plunge protection teams to manage their crashes. We now are in a situation where, the next time we have major stock drops, these CB's and PPT's are going to pull out all stops to try and stop a stock panic. I do not give them very good chances, unless they are willing to monetize about half the total value of their respective stock markets, and I think they will relent and not do that.

OF course, if they did attempt to monetize to that degree, then the world could switch within a month from a deflationary onset to depression to an inflationary onset to depression. Of course, gold will find any major monetization of financial markets extremely bullish. In this case, gold could easily rocket to $2000 once a consensus was reached by financial markets that such monetization of falling stock markets was under way. That consensus would only take about one month of that kind of activity to convince investors that that was indeed the decision the 'powers that be' made. Again, gold would recognize this and shoot up rapidly. I give this kind of scenario a better than 50/50 chance.

In addition to the risk of monetizing collapsing stock markets, gold would find major flight to safety buying at all levels. The only ones who may defer in this case might be central banks, because they would have already decided to pull all stops to support financial and stock markets, and if the CBs bought gold bullion in this situation, that would be counterproductive to their strategy.

Of course, there would be a concerted attempt to conceal major monetization of stock markets by central banks. That would delay the gold markets' determination that that was indeed happening. But, ultimately, the facts would come out.

I believe that the possible discontinuation of the COT report suggests this CB monetization plan is already under serious consideration. Also, there is a new US policy of financial secrecy where public companies will be permitted to hide their true financial condition at the whim of the Director of Homeland Security. This was recently done in a Presidential Executive order.

We are in for some strange times on the next stock market panics, when they ensue.
I have written for some time about the very very serious problem of lost financial transparency. I call this the 'Black Box phenomenon' that has become the US and Japanese -economic and financial and banking systems, and now even stock markets -with the latest moves by the DHS, and the strange stuff about possibly canceling the COT report. These are only two of the latest manifestations of black boxes being put around our financial world where we have our money invested. Other black boxes are the manipulation of economic statistics. This kind of stuff makes our financial world very opaque, and lack of transparency only prevents people from taking defensive action, but does not prevent actual market collapses.

In short, with black boxes, you put your money in, but cannot see what happens after, and only get a 'return' or a stock loss as output, mainly as surprises because the real financial goings-on have been adroitly hidden. This is one major reason why I am so down on financial markets today.

To bring this all into perspective as to long term gold, I view gold as the most secure way to protect ones wealth, given the fact that there are horrendous financial fundamentals in the world, the emergence of huge credit bubbles that are on the verge of collapsing, and the collapse of the housing bubble that is going to take all the other bubbles down with it.

Again, there is a whole lot more to this long term picture, but this is a quick synopsis. Further detail will be included in the PS newsletter as time progresses.

Short Term Gold

While I have made a number of successful short term gold predictions recently, I have to say the short term is a dicey thing to try and divine.

First, we have the seasonal jewelry and holiday demand beginning again. Also we have the return of much of the investing community from summer holidays. Also we have hedge funds with scads of hot money seeking returns in a world where any reliable returns are few and far between. Then we have the trillions of dollars in retirement and mutual funds seeking returns. All of this means that we will see reemerging volatility in gold, stock markets, and commodities.

The only question is, which way will the volatility lean? At present, I suspect they will begin to lean down on most all markets. The reason markets are somewhat horizontal now is because there is no clear world wide trend to boom or bust. Asia is booming, but the US is about to enter a deep recession. I suspect in the next several months, markets will turn south in anticipation of a US recession beginning around January 2007.

Gold short term will find strength in flight to safety- if there are serious market crashes this fall/winter. However, there will be a counter trend for gold in that commodities will tank hard if stock markets crash this year, and that will be gold suppressive. At this point, I am reluctant to say which force will win out in gold, other than to say that, absent a big stock crash, if the US were to slowly fall into a deep recession, dropping commodities will pull gold down some from here. If the US or other major economies were to have fast stock crashes, gold will rocket up from flight to safety.

More of this analysis will come in the Prudent Squirrel Newsletter. The PrudentSquirrel Newsletter is a weekly gold and economic commentary by Chris Laird. The latest issue is a special report on precious metals in serious recessions. Stop by and have a look.

Chris Laird
Editor in Chief
website: www.PrudentSquirrel.com
email: editor@PrudentSquirrel.com

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