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Currency Crisis Means Bull Market for Gold & Silver

Todd Stein & Steven McIntyre
The Texas Hedge Report
September 17, 2004
Courtesy of

The dollar's recent counter-trend rally may give investors an opportunity to buy gold and silver before another series of powerful rallies begin as the U.S. dollar comes under heavy pressure in the months to come. Nearly every major central bank is in a race to debase their currency against the dollar, yet they simply cannot do it fast enough as the dollar continues to fall over the last couple of years. The dollar collapse is made all the more amazing when one considers the U.S.'s soaring GDP and rapidly ascending asset prices of all financial assets. Perhaps the foreign exchange markets are finally starting to realize just how grave a problem the U.S.'s twin deficits and monumental debt load on both the consumer and corporate levels really are. And perhaps, the foreign exchange markets are realizing that it takes more and more financials stimulus just to keep the U.S. going. Tax cuts, record low rates, 0% financing, and severely relaxed lending standards have borrowed forward consumption in the U.S. and we will be paying for it the rest of this decade.

In the end all roads lead to inflation when you have central banks pandering to a democratic electorate whose approval they desperately seek. Those of you believing in the fantasy CPI our government produces with its CandyLand hedonic adjustments are in for a very rude awakening. Look all around and you will see that good and services of all sorts from food to energy to healthcare to commodities are soaring. Below is a graph of the Dow Jones Spot Commodities Index over the last 2 years. It clearly shows the ramp in virtually all commodity prices.

Still believe the government's fabricated CPI numbers?

When these rising costs will accurately be reflected in higher bonds yields is anyone's guess, but eventually the fundamentals will demand it. In a world where foreign currency gains will be limited by their governments' misguided motives and where TIPs are restrained by phony CPI numbers, the world's oldest currency will once again become its strongest. Gold has been a monetary unit for 2,000 years and is prone to booms and busts, as are most financial assets. Having suffered a 20-year bear market for much of the 80s and 90s as the U.S. stock market and dollar experienced one of the great bull markets in history, gold's time has again come.

Unfortunately, for U.S. investors the nearly two decade old bull market in stocks morphed into an out and out speculative bubble spawned largely by an incompetent Fed that continued to give a drunken investing public more and more fuel to drive stock prices and the dollar (among other things) to absurd levels.

The return to rationality in stock prices suffered a setback in 2003, but the currency markets continued to inflict pain upon U.S. holders. The dollar index declined 13% in 2002, and 15% in 2003. Gold on the other hand was up 25% in 2002 and 19% in 2003. Thus far in 2004 both the dollar index and gold are roughly flat.

To invest in gold is to express concern about the future purchasing power of the dollar and other currencies. It is also an expression of general concern on the bubble-like asset prices in stocks, bonds, and real estate. As recently as 2001, most market participants were proclaiming gold to be a useless relic of no value. The tide has begun to shift a bit as holders of dollar denominated assets have begun to take a liking to the monetary store of value that gold offers. While central banks can and will sell portions of their gold hoards as prices go up, we can almost always count on them to do the wrong thing. The same can be said for most of the public who holds gold and might be inclined to monetize it should prices rise. The fact remains that unlike fiat currencies; gold cannot simply be created out of thin air. It is a finite resource whose cash costs number somewhere around $200-$220 an ounce and whose all-in cost with depletion and depreciation numbers closer $250-$275 an ounce. Like natural gas and a few other commodities, the large exploration leaders like Newmont and Anglo have seen so many of the best gold deposits picked over and mined that even with rising prices there is little hope to materially increase production in the near term. Quite simply it takes time to find, permit, design, and build a mine, which is quite a contrast to Federal Reserve Governor Ben Bernanke's printing press.

There are currently 7.5 trillion dollars in mutual funds. A return to an investment climate where gold is viewed as a necessary diversification asset would put a strong bid into gold stocks and bullion. An additional move of 1% of mutual fund assets into gold is a $75 billion bid for the gold industry and if one could imagine potentially 5% of mutual fund assets finding there way to gold that would place a $200-250 billion additional bid into the industry. Considering that the entire market cap of the industry is only a couple hundred billion, a return to diversification in gold could push the prices much higher.

One other big positive for the gold sector is the likelihood of at least one and possibly two gold exchange traded funds (ETFs) entering the scene. Those who have tried to buy physical bullion, particularly on an individual level, know of the hassle of trying to find a gold dealer or coin shop and then enduring the high frictional costs of buying the metal from the usually "interesting" characters running the shop. A gold ETF would be a tremendous way of providing liquidity and depth into the gold market on a whole new level and should lead to a great increase in both institutional and individual demand for the "yellow dog" as it has been affectionately termed for the sustained bear market its holders have endured.

Gold has entered a secular bull market where it will grind upwards over weeks, months, and years but, periodically its holders will have to endure incredibly sharp breaks in the prices as the weak holders are shaken out before the price can resume its upward trend. Many have asked just how high we think gold can go and we really don't have an exact answer to that, but we do know that until the stock market and dollar bubbles have been thoroughly erased that the run in gold isn't over.

Depending upon the level of work that an investor wishes to put into the gold sector, we would recommend the large unhedged gold miners. For those willing to commit even more time, a basket of small cap junior miners will likely generate the best returns. The gold ETFs should also be seriously considered once they begin trading. Gold futures may be an option professional investors choose. Keep in mind that options on gold futures, particularly long dated ones, have very little liquidity.

Finally, for those who commit the time to know the gold story we feel confident that it would also be worthwhile to learn the silver story. Silver is unique in that it has both industrial and monetary aspects that drive the price. If we are right on gold then it will be the investment demand that will propel silver to heights that most never thought was possible. Quite simply silver's fundamentals are far better than gold's and gold's are pretty darn good. We have been long gold and silver since the late 90's and plan on continuing to be so until the financial bubbles in this country are popped.

September 17, 2004
Todd Stein & Steven McIntyre
Texas Hedge Report

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Todd Stein & Steven McIntyre are internationally known analysts and editors of The Texas Hedge Report, a market newsletter that highlights under and overvalued securities in the equity, bond, currency, and commodity markets.
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