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I advise buying gold

Richard Russell snippet
Dow Theory Letters
May 2, 2006

Extracted from the May 1, 2006 edition of Richard's Remarks

May 1, 2006 -- "How are we to pay for this future burden of healthcare and social security expenses? Aside from contractual legislative changes to both areas (which are surely just around the corner), the way a reserve currency nation gets out from under the burden of excessive liabilities is to inflate, devalue and tax." This is an excerpt from the current piece by Bill Gross on the PIMCO site. The Gross piece is a hair-curler and is a must-read for every one of my subscribers. Gross is managing director of the largest bond-management organization in the world.

Gross' final advice in this article is a shocker. Here it is -- "Need I say more than to sell U.S. assets and buy Asian ones denominated in their local currencies; or if necessary to hire a global asset manager with sufficient flexibility and proper foresight to thrive in an increasing difficult investment environment?"

Russell Comment -- Strange that Gross didn't mention gold (maybe it's too hot to handle for a bond guy). Note that Gross is not talking about an overnight situation or an overnight solution for investors -- he's talking about a situation that may take years to play out. The idea of selling US assets and buying Asian assets denominated in local Asian currencies is so foreign to US investors that I don't know if US investors are even capable of mentally taking in Gross's advice.

In the past I've said the same thing but in a different language. I've said that over time the US standard of living must fall, and the Asian standard of living must rise. We're seeing that now but it's hidden in a subtle way. The value of the US dollar is falling, gas prices are rising, taxes in the US are rising (mostly local taxes so far), and the price of housing and food is rising along with energy. This means the Americans will have LESS money to spend on other items that they want, meaning in turn that the standard of living in the US is just beginning to decline.

For those who are reluctant to buy Asian securities, I advise buying gold. The yellow metal is the only totally international currency, wanted by citizens and governments the world over. Since gold has been rising against all paper currencies, it's only a matter of time before an increasing number of knowledgeable people move to swap their central bank created fiat paper for real money. The march to gold is only beginning.

Because it's so important, I want to go over what I call the Bernanke "conundrum" (use of the word, conundrum, courtesy of Alan Greenspan).

Bernanke in his speech in front of Congress last week implied that the May 10 boost in short rates (even assuming that one occurs) may be the end of the line for rate boosts. But he added that further action will be "data-dependent." In other words, Bernanke wants to see what happens in the economy before raising rates again.

But problem -- gold has been surging. Gold has been up $77 over the last thirty days. Gold has not been rising for no reason. Gold has not been surging because of Iran, gold has not been surging because of out-of-control speculators. Gold has been rising in reaction to the Fed's policy of all-out creation of liquidity, which is the very definition of inflation.

Bernanke can ignore rising gold for just so long. After a while, ignoring rising gold become a matter of denial, a matter of refusing to acknowledge what gold is saying. Everybody knows what gold is saying. It can be expressed in one word -- INFLATION.

Normally, surging gold and rising inflation would call for the Fed to keep boosting rates. But here's the conundrum, the real problem. If Bernanke continues to push up rates, he's going to put the brakes on the housing market. If the housing market topples over, if home prices start coming down, US consumers will probably cut back on their wild spending. Consumer spending constitutes 70 percent of the GDP of the nation.

This means that it would be very dangerous, almost intolerable, for the Fed to continue its policy of raising rates. In other words, even if gold was to advance to 700, 750, 800, the Fed would hesitate to raise rates, which would perhaps topple both housing and the US economy. From the Fed's standpoint, the US could survive all-out inflation, but not all-out deflation.

The daily chart of GLD below is instructive. We see the correction/consolidation of February-March. Then the breakout to the low-60s area. Then a little pennant pattern, which usually marks the halfway level of the climb. And Friday (green) the upside breakout of the pennant. Sure gold is overbought. But this is a powerful bull market. Let's see what happens.

The P&F chart below gives us a dramatic portrait of gold action of the last few years. It's been consolidation and upside breakout -- repeated over and over again. The latest upside breakout gives us a "count" or target of 870 for gold. In powerful bull markets, upside P&F "counts" will often work out.

May 1, 2006
Richard Russell
website: Dow Theory Letters
email: Dow Theory Letters

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