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Jim Willie
CB The following large pools of capital will each be diverted into the precious metals asset groups. The promise of greater returns will be strengthened by economic conditions, monetary stress, desperate reactive government policy, and international chaos. A volcano will build, with the USDollar providing the power. Each major road will feed large amounts of money into the gold market. Some up-to-date background precedes discussion of each supplying road. Motives will be covered for each source to seek out gold. Many are the roads. Many are the motives. Together they will build a volcano under gold, merging the roads and lifting its price with awesome power. SOURCES OF MONEY FLOWING INTO GOLD & SILVER:
Since December of 2002, gold has broken out, making major headlines around the world. The gold market has seen a significant breakout above the $330 price, even as silver appears poised to break above the $4.90 resistance level any week now. Numerous powerful factors are all at work, all pushing the gold price up from far ranging disparate and global sources, collectively impossible to control. These factors are detailed at length in my November article (see ref#1). Since that time the sources have become more clearly defined, while the actual forces have become more intense. As time lapses, the market dynamics are fast emerging with deep clarity whereby very large money flow sources are being directed toward gold. The roads are being paved with more official sanction, if not respectability, even as they widen. Although many experts and pundits proclaim with strained resignation that the new gold rush owes its roots to the declining USDollar, they often fail to explain the reasons behind the dollar decline itself, or offer few explanations. A dollar crisis is building, since no protection feedback mechanisms exist or operate at this moment. The overvalued dollar is correcting in value, even as its supply is accelerating. The monetary mechanism is being impeded by Fed intervention (prevent rising longterm rates) and the industrial mechanism has long been absent (offshore mfg in Asia and Mexico). No defense stands to protect the dollar, whose declines will set off a vicious circle. In the past few weeks, pathetically shallow and self-serving reasoning by the press & media attributes gold's rise to the Iraqi tension. How expedient! In my kept book, Saddam Hussein and Iraq rank somewhere around 6th or 7th on a long list of market forces behind gold. If the Iraqi conflict is resolved, sure, we might see a sudden $15-25 drop in the price of gold. But that drop will be overcome in the following weeks, then long forgotten. The pundits will be left scratching their heads. Over the next 18 months, I expect them to scratch their heads numerous times. Eventually they will watch gold in awe. A burgeoning trade gap, a dangerously escalating federal deficit, and pre-empted negative real interest rates are of greater importance, easily eclipsing the more public spectacle of Middle East tensions. This much goes without question to any serious student of gold and the dollar. As Stephen Roach points out, the US current account deficit was $40B in the month of November. We are on pace with a trade gap approaching 6% of the US GDP. Now the service sector is experiencing rising imports, a new development. Bulging deficits of this magnitude should next lead directly to big concessions in USTBond, US equity, and USDollar valuations. Certainly an immediate lack of confidence in American leadership within international circles has chipped away at the dollar. Worse still, isolation of the United States could jeopardize the required capital flows that keep our economy operating (in the red) at almost $3B per day. Shallow attribution of dollar woes to Iraqi tensions is akin to observing a man suffering from acromegaly, and calling him ugly since he has recently begun to show evidence of acne. (The condition is based upon excessive secretion of human growth hormone, see Frankenstein Effect or The Hulk). The US economy has been the object of decades of excessive secretion and absorption of financial growth hormones, and now suffers from severe imbalances and distortions, a grotesque form of "financial acromegaly." The gold rush has more dominant roots in the progressive failure of the post-bubble US financial asset markets, the debt-suffocated economy, and the faulty monetary system founded upon a debt-backed reserve currency. The gold rush finds its origin in a dangerously overvalued USDollar, coupled with discouraging fundamentals and extreme imbalances in the USA Inc "stock share." Consider basic theory of the firm. We have a national stock share with a hemorrhage of rising losses (trade gap), guidance of growing future losses (budgeted federal deficits), dividend below zero (negative shorterm real interest rates), uncontrolled new share issuance dilution (expanding money supply), a labor force suffering from fatigue (household debt), slumping product demand (excess capacity), large foreign ownership (hostile share holders), fraudulent financial books (raided Social Security Trust Fund, no Gold Reserve disclosure), and deceptive reporting (economic aggregates). Conditions are perfect for severe devaluation. If this were a company's stock, it would be in single digits facing a painful debt downgrade. This article addresses from a higher level, without a flood of data, what the major roads are that now deliver surviving capital toward gold during a frightening time when monetary system fractures are emerging and capital is tragically being set ablaze. Roadways are now delivering money into the gold sector, like magma flows through breaks in the earth's mantle. More roads will be built soon, even as existing roads are widened so as to cope with larger capital flows. The gold market is an imminent volcano, and as such requires two principal ingredients: avenues and forces. Fractures in the earth's mantle create avenues for hot molten magma to seek out and flow up to the surface. The forces originate from the intense heat and pressure beneath the mantle, lodged and released. Likewise, several fractures have been witnessed in financial markets, beginning with the March 2000 stock bust. The unfortunate, hopeful, yet gullible and illiterate masses regard the stock bust as the end of the calamity, but it was only the initial signal. The Enron debacle was the second signal, spreading into a credit calamity that crippled the utility industry. Has anyone properly interpreted the dire warnings issued now by the DJ Utility index? None except Richard Russell! The unheeded admonition comes as clearly written graffiti on the walls of subways and buildings alike - "a debt collapse is in progress." Dow Theory requires the utility index to respond to monetary stimulus. Instead, debt collapse is leading to internal monetary deflation forces, while China echoes with external price deflation forces. The most recent signal is the December breakout of gold, largely overlooked in the press & media. It signals not so much international tensions, but for a monetary crisis with the USDollar at the epicenter. First stocks, then credit, now currency in the prescribed order for the Perfect Storm. This will build into a volcano, with the dollar decline building the massive pressure and force necessary for the volcano to erupt. A giant cantilever pump is under construction, with the dollar downward pressure lifting gold up. For every 1% drop in the USDollar, we have seen a 2% rise in the gold price. The dollar's decline will lead to the death of the USDollar as we know it, and will provide liftoff for gold, which will take on a life of its own before 2005. After China revalues their yuan currency upward, we in the United States will see inflation, perhaps hyper-inflation!!! I defy you to identify a single cycle where our Federal Reserve failed to overshoot. Can anyone remember their delusional plan for a Soft Landing with a Fed tightening in 2000??? Next is the likely slow-motion attrition in the Treasury markets, as Bonds and Notes wear down after bottoming in yield, which will cause fallout in the housing sector. Following the credit market, and very much related to it, is the upcoming gradual separation of real estate from the hard asset class. Real estate is but a "hard asset impostor" destined for a debt downgrade. Its property values are derived much more from the mortgage finance industry, than from hard asset commodity considerations. This final fracture will be clearly the most painful, as the economic consequences are vast. The volcano is building in pressure. What say to forces? The forces will be capital seeking preservation, survival, even growth opportunities. They will join with the USDollar decline cantilever. Mammoth hydraulic power coming from the Federal Reserve itself will finally pump new money into a desperate system with utter futility. While fighting deflation, the unintended consequence of limitless creation of new fiat dollars will be a sustained power amplitude. Think of it as the USGovt kicking in the "turbocharger" to the dollar plunge, from adding to an oversupply already. The new money will find the path of least resistance and highest prospect for gain - COMMODITIES. The chief financial commodities are gold & silver. The chief commercial commodities are oil & gas. Where debts do not obstruct investment, money will seek out and be directed like a magnet. The Kondratieff Winter scoffs at central bankers with little or no reverence. This winter has succeeded in scraping off much superficial paper machier (gold cartel short positions) which fails to effectively cover the rushing magma flows. The exposed and liquidated debts only heighten the sense of urgency for capital to seek true safety. Up to now, that safe haven has been found in the risky and temporary shelters of Treasuries and Real Estate. K-Winter shows no mercy (see ref#2). It will next deal with these final debt classes, releasing capital in large streams. K-Winter will spare no form of debt from a severe challenge in test. We will know that the mission is completed when the transportation sector has been delivered financial death blows. Note the supercycle pattern every 60-70 years, one human lifetime. Unlike railroads in 1870, automobiles and radio in 1930, this transportation culling exercise had warm-up sessions with the internet, wireless, fiberoptic, and telephone in 2001 and 2002. The main event will next deal with automobiles and airlines. Fully one quarter of all airlines are now in bankruptcy. I expect all US car makers to either go through bankruptcy or become nationalized. Foreign acquisition is out of the question, given their debt and pension obligations. The economic fallout has huge implications to the stability of capital, and thus directs more money toward gold as recession grips and more debt is threatened. Whether this volcano endures for a lengthy life spewing steady lava flows, or ultimately explodes with gusts of noxious financial gases followed by lava flow bursts, remains to be seen. Given the complete reluctance for the markets to permit capitulation, my vote is for steady enduring lava flows for month after unresolved month. Its climax could well occur immediately before or after the unanticipated resurrection of the gold-backed USDollar, the motivation for which is expertly outlined by Jim Sinclair (see ref#3). A crisis would precipitate such action, but either way this historic action would herald a global rush into the precious metals since the governments would announce their competition for the scarce resource known to enforce financial stability and responsibility - GOLD. Economists have been fast asleep in forecasting the languishing recovery, the failure of the stock market, the default and liquidation of widespread debt, and the emergence of precious metals from over a decade of slumber. They helped build the system, and now might be blind to its faults. Beholden to the only system they have ever known, they advanced their incompetence with more creative shabby analysis, further compromising their integrity, going so far as to distort the reporting process itself. I have little respect for this entire profession, and offer considerable detail and reasoning for my position (see ref#4). Brokerage analysts are even more biased, departing from objectivity in grandiose ostentatious style, offering no apology for their harlotry trade. Together, economists and brokerage analysts have sold their souls, having behaved like blatant whores to the equity and credit industry for decades. Their corners of honesty are few. The public has begun to wizen to their ways. Unfortunately, scientists have rats to test their theories. Economists have none. We the public, the consumers and investors, we are their rats. If the system they devised is faulty in its foundations, we may not see changes until that system faces the gradual slide toward collapse that is difficult to rectify. I believe we are close to that point, as debt levels now suffocate every single component of our economy. Compounding the problem, politics now infect and subvert almost every aspect of our society, from newspapers to TV channels to school systems to security systems to corporations to nonprofit organizations to sports franchises, and of course the government. Only a predictably stable stream of initial and secondary public stock offerings from mining firms will magically transform Wall Street thinking toward the bright future potential in precious metals. We think they wear gray pinstripe suits. When these men sporting hot red miniskirts are offered million dollar contracts in Board Rooms as opposed to $100 bills on street corners, their thought patterns will predictably turn positive. But that day is several months away. Newmont's upcoming secondary issuance will offer some indication toward Wall Street's receptivity to change in thought. The investment banking business has recently become as inactive as the bankruptcy business has been brisk. In a land where truth is purchased or hired, both economists and brokerage opinions will be swayed by the prospect of nascent revenue streams against the present backdrop of a severe drought. Their evolving opinions will converge toward the truth, but only with the passage of time and the sway of a payday. Precious metal miner stocks have enjoyed excellent gains relative to other sectors. Their performance has been noted clearly in annual reviews quietly promulgated in the usual end-of-year fashion. However, these stocks should very soon experience monumental gains, as evidenced by their extremely bullish chart patterns and large short interest. The Gold Cartel has moved their villainous game from the futures pits to the stock market in recent months, inviting a short squeeze in both arenas. Chart patterns show a realized Cup & Handle in the gold metal, and similar patterns soon to be realized in leading gold stocks and their indexes alike. John J Murphy provides thorough, professional technical chart analysis that the gold metal has broken out of its C&H pattern (see ref#5). Clive Maund reinforces the evidence with coverage of the unhedged HUI index and leading miner stock charts (see ref#6). Next to break out is the gold miner stock group, summarized by its index, in atypical reverse fashion whereby the metal leads. Gold does the heavy lifting, while silver grabs greater spoils. Gold wages the international battles, fights the skirmishes inside the currency and bond markets, and serves as the object of editorial opinion in the press & media. But stocks work the role of asset value anticipation and future expectation, offering rich leverage to metal price gains. The equity markets still harbor a modicum of distrust, if not the hint of impending trouble from the harsh hammer of the gold cartel. Little do they realize that the cartel is disintegrating in its partnerships, finding itself of the wrong side of the young new bull market in gold. It is now resigned to helplessly ratchet up their risk control programs with ever higher and more fruitless "lines in the sand." The image of a tightening neck noose comes to mind. With investment demand picking up, a short squeeze is written in stone. Gold has now begun to be viewed in a monetary role; silver may soon follow. Regular tests of COMEX gold supply deliveries by such mavericks as GoldCorp's CEO will naturally be followed by similar tests of silver supplies. An accident for both gold and silver is just waiting to happen. Short positions for gold and silver are at least two year's worth of production. Whereas 95% of all the gold ever mined still sits in vaults serving as financial ballast, silver is consumed by industry. Gold can be shuffled around in a grand shell game, concealing the imbalance. But silver's imbalances cannot be masked by such deceitful paper shenanigans, continuing the deception played upon the public. Silver is consumed in photography, electronics, batteries, superconductivity, engines, burn treatment, water filtration, and slaying werewolves. I expect silver default events first, despite its lackluster price action. Exploration firms can reap huge investment profits, even with unchanging precious metal prices. Mineral deposits on their mine properties can be confirmed and verified by geologists, only to see their projected market capitalization jump an order of magnitude higher. A lift in the gold or silver prices only amplifies the value of deposits and thus the shares of the mining firm. These explorers magnify value through their expertise in locating mine properties, analyzing geologic formations, learning from regional historical trends, and seizing on opportunities as they hammer out complex contracts. Many promising properties were neglected and abandoned in the last decade. Large production mining firms depend heavily on these dynamos who bring raw supply to the table, replacing their depleted reserves. These large caps pay dearly for the acquisitions. Canada is a ripe breeding ground for such companies who might be best described as modern alchemists, turning hillsides into gold & silver. Gains in their stock prices have been extraordinary since the latter months of 2001. This trend should continue. The Canadian Dollar will rise gradually, shored up by expanding mineral and resource industries, despite expert claims to the contrary. Hence, junior miner stocks will receive an added equity dividend. Many pundits such as Ned Schmidt proclaim a severe fall in the "looney" owing to their economy's tethering to its southern neighbor, sending it to 50 cents per US$. I believe he is loud wrong. Their natural resources are staggering in breadth and depth, covering oil & natural gas from the western provinces to the eastern maritimes, with gold, copper, industrial metal and structural metal deposits, even diamonds, scattered throughout the entire northwestern territories toward Alaska. In 2001 alone, US firms invested fully $23 billion in lands showing promise of mineral and resource ventures. Now those lands have begun to be exploited to bear results from active development. Quite the contrary, I expect the Canadian Dollar to rise toward 80 cents from its current 64-66 cents. In a real crisis, with rising energy and precious metals prices, the looney could challenge parity at 100. Sure, they will share some economic pain from their own debt-ridden economy, but flourishing commodity industries will offset to enlarge trade surpluses. Investment capital will be seeking the energy and metals equity market, adding to demand for our neighborly "other" dollar. Heck, at least one dollar must survive. A phenomenal leveraged silver/copper opportunity called Cardero Resource Corp. (CDU- TSE Venture) is in the making now among Canadian juniors. This emerging explorer is fast receiving attention and recognition. Ongoing surface work, including mapping, sampling, and processing massive quantities of ore are underway. Geochemical tests are proceeding from shallow drill sites near the La Providencia and Chingolo mineralized zones in Argentina. A deep hole drill program will follow within a few months. Calculations on the ultimate size of deposits will take some time, but are expected to be extremely high. Several of the leading junior mining editorial writers have begun to notice this company, including Robert Bishop, who has cited it in his monthly miner investment letter. Many other editors are starting to show interest. Its production costs are expected to be minimal, inferable from high percentage of copper concentrates. Small-scale mine extractions have been measured from 200 tons over a ten-year period. In all likelihood this stock must be revalued an order of magnitude higher, or else disrupt entire valuation comparisons among other pure silver plays such as SIL, PAAS, SSRI, CDE. All this is possible even with a flat silver price. This tiny giant and a few other Canadian juniors will be featured in the corollary to this article, which I expect to issue soon. The press & media declare Gold to be the true "counter-currency," as it has resurrected from a 20-year exile of neglect. Rick Santelli aptly describes it as such on his morning CNBC segments covering bonds, equities, and currencies. Gold, the financial commodity, is embraced by those who defiantly forego dollar-based financial securities, last decade's successful asset classes. The Wall Street Journal remains hidebound on the gold topic, as do Barrons, Investor Business Daily, and the New York Times. Not surprisingly, their advertisement sponsors have no loyalty to precious metals. The charming Santelli might be one of only two or three people on the CNBC staff (excluding guests) who have anything intelligent to say. Their Economics editor Steve Liesman shows signs of comprehension, citing gold not only as a currency alternative, but also as a beneficiary to worldwide currency supply expansion. Gold has begun to benefit from recognition as a currency, breaking ranks from mere commodities, and now is emerging from the shamed role of a demonetized metal. The golden bull has arrived, and will continue to trample paper-based asset groups until a mania fully blossoms, steering a full stampede. While on the subject of that fading cable channel beacon that ignores much relevant phenomena, leads cheers for bulls in the face of storm warnings, and drones hypnotically with its recycled ads, let me say this: A new gold bull market will benefit from formidable, unrestricted, and nearly limitless supply of capital which feeds demand. We are talking about a world-class asset traded on every continent, bought and sold around the clock. Govt intervention will resemble firemen showering lava streams with water hoses in futility. Their firetrucks will retreat in the face of approaching lava, much as risk control programs repeatedly raise their futile lines in the sand. Years of rising prices are in the works. Several sources have been supplying gold with capital in the past 18 months. Other sources will merge to send gold even higher. I intend to provide here a survey of the sources that will supply capital flows to the gold market. Also, the motives will be covered for these investors to abandon some or all of their positions, assuming a fresh stance and outlook toward bullion and the miners who produce it in gold & silver. I focus on money SOURCES and changing FORCES, much as a volcano requires avenues for molten magma lava to find routes to the surface, and powerful forces to push the matter to the surface. Fractures have occurred, and more fractures are coming. Investor motivation will be to sell traditional paper-based securities, and buy gold. Personal desire to preserve and build capital will combine with desperate government action to avert the Liquidity Trap from ensnaring us. The merging of forces will sustain this bull for years to come. The world precious metal sector has only an $80 billion market capitalization. Compare that paltry sum to a sample of individual leader stocks and their mktcaps: Microsoft $250B, General Electric $225B, Exxon/Mobil $225B, WalMart $210B, Pfizer $180B, Citigroup $170B, Intel $100B, and Dell $60B. The impact of large-scale capital (lava) flows into gold & silver stocks will not only overwhelm the current short interest, but will lead to price explosions with ease. A mere diversion from leading stocks now languishing would attract world attention. US
TREASURY DEBT SECURITIES: The USDollar decline will inflict damage next on the Treasury market, slowly sending longterm yields higher. If dollar-based Trez securities drop in value, the market will employ its natural pricing mechanism to attract buyers. Thus longterm rates will rise, which will surprise the Fed and Dept of Treasury to foil their monetization plans. In fact, that is the cost of such plans. Higher rates and a lower dollar constitute the market effect of such oversupply destruction heaped on the once almighty dollar at the expense of loyal foreign investors. Owners of Trez debt will flock into gold instruments. Recall that the Weimar Republic attempted the same tactic in the 1930 decade. Will we become Weimar Amerika? Eventually the Fed will be coerced to raise even shorterm rates. The Liquidity Trap in falling rates will pull the Fed toward no change, but the declining USDollar will force their hand as a crisis builds. If dollar-based assets are being abandoned, then be sure that foreigners holding approximately $3000 billion in Trez debt issuance will turn toward gold for real safe haven. The dollar will deliver losses to US-based securities. And let's not forget about the Americans who hold an even larger stake in US govt debt. They will increasingly seek out gold also, shunning the negative real rates on the short end, not wanting to assume the inflation risk on the long end (preferring gold). Flat performance in bonds assist gold demand, but faltering bonds power gold demand bigtime. CHINESE
AND RUSSIAN CENTRAL BANKS: Many critics are now urging a yuan upward valuation. They devote little thought to the consequences of having their demand granted. Some experts in the currency markets fully anticipate a higher valued yuan would immediately precipitate a USDollar decline acceleration. Asian currencies would all revalue to higher levels, with an eye set on competitive rank with respect to the Chinese currency. All Asian import prices would rise in lockstep when this occurs, setting off import price inflation within our shores, a rise in longterm USTBond yields, further crimping US economic growth in a world still overly dependent on US-centric growth. Gold would correspondingly accelerate upward during this dollar deterioration. In January of this year, the Russian Central Bank announced its plan to diversify out of dollar-based reserves into EuroBonds and Gold. Clearly, they are selling USTBonds in favor of the same type of assets chosen by China. US citizens are shifting from stocks to TBonds, even as foreigners are selling them. Little known to even the informed Western world investment community is that Russia ranks behind only Japan and Germany in their trade surplus with the USA, amounting to roughly $40B in the last year. Crude oil and heating oil imports have become staples to our economy from this nation rich in energy resources. Combine official Russian demand with the staggering black market in that country, and you have sizeable amounts of gold being purchased. Just this month, official Russian sources announced intentions to boost gold and foreign currency holdings to $55B by the end of this year, a rise of 17%. The movement toward bullion-linked bank reserves is very much underway. Numerous small Asian Central Banks are woefully overfunded with USTBonds and undersupplied with gold reserves. Their gold bank holdings are less than 5% of total reserves. These Asian banks also have a long way to go before appropriately supplied with gold. They are likely to follow the lead provided by China, their fearsome rival. ARAB
PETRO-DOLLARS: As US Military Forces wield their power and turn it on Iraq or any other Arab nation, expect some severe financial reprisals from the Islamic world. Saddam Hussein might be a pariah in their eyes, but he is their brother in the pan-Arab world. Islamics have around $60M per day in oil revenues, which can be diverted from US markets. I believe the Saudis and other Gulf sheikdoms are quietly amassing hefty quantities of gold. In time, they might engage in outright financial terrorism in an attempt to weaken the dollar and our Trez markets. Such is the risk when hostile foreign entities own our federal debt in significant magnitude. We became their servants, and they our masters. For instance, we now defend Saudi Arabia, and overlook Osama Ben Laden's refuge within their border near Yemen. Foreign entities own 45% of our $6400 billion federal debt, a bulging sum of $2900 billion. The embryonic Islamic Dinar holds legitimate promise for becoming a valid gold-backed currency, used in a limited but important role to settle up bilateral trade imbalances within the Islamic world. So far the Malaysian Dinar offers the first true working example when launched this June. The Islamic Dirhim might serve the same role but with silver. Gold in significant quantities will have to be stored in order to execute on this plan, properly reinforcing the commercial trades with hard asset exchange. GOLD
MINERS: Not to be left out are the accomplices to the gold miners, who may not escape with any less harm than their overly hedged miner clients. I mention the private gold bullion bankers, who pushed and sold to excess these dangerous forward contracts. Many are so opaque and exotic that the miner firms themselves are unaware of their actual risk as the price of gold rises. See the story of Ashanti Gold in 1999 for details, where consultants and accountants were hired to analyze the company's risk exposure. Diversion of funds from legitimate operations further limits the ability for mining ventures to bring gold production to market. Most contract buybacks cost more than the original sum taken in. They deprive productive operations, and better yet, they add to gold demand. The gold market shows strong evidence of being an inelastic market. Demand rises with a rising price. And a rising gold price has a detrimental effect on supply, just the opposite of what one would expect! FEDERAL
RESERVE MONETIZATION: Imagine you are a very large private holder of Trez securities. You see the Fed gratuitously pumping phony money into Treasuries, with a clear motive to prop up their values and prevent a natural rise in the TENS yield. You are a savvy fellow. You diversify into other asset groups including gold. Imagine you are a large Fanny Mae investor. Same story, where you see the Fed propping up your investment. You diversify into other groups. The siphon witnessed now for the benefit of the Chinese will be repeated for US asset holders on the domestic front. The entire monetization effort is artificial, distorts the equilibrium, and cannot be viewed as permanent. Assorted securities subsidized by our government's desperate actions will diversify and seek a safer safe haven. At first it has been Treasurys. The next safer haven is to be gold. Acceleration in the USDollar supply only exacerbates an already oversupply in the currency. Fed monetization broadcasts a dangerous message to foreigners who hold large sums of our debt in the form of USTBonds: "your investment will be written down!" It is not a coincidence that the dollar went below parity on its trade-weighted index within weeks of Bernanke's speech on "limitless" printing of dollars to avert deflation. Foreigners took notice. It is also no coincidence that gold broke above its "line in the sand" at #330 during the same time. Dollarized securities are being converted to gold. The USDollar decline has entered a treacherous phase for our nation's foreign creditors. EURO
BONDS: So why has the euro risen? I have written about the expected rise in the euro since the spring of 2002, in the face of naysayers who beat their chests and boast of US supremacy in capitalism. The answer is not simple. Dollar supply continues to rise, and dollar demand is on the wane. Supply of USDollars is high, growing, and out of control, while demand must remain exorbitant in order to keep our economy in equilibrium. Foreigners are becoming frightened. They are seeking alternatives and finding them in Europe, a fully established and mature financial system. Europe also has a much longer tradition with the Arab world. However, the answer lies in both the supply-demand equilibrium and the monetary birth-death process. Our entire economy has abused credit extension to the extreme, which has invited capital destruction. Cross currents now pit rising money supply against the deflationary force of this capital burning. Dangerous eddies now swirl, adding risk to both analysis and investment. Investment capital is finding greater temporary safety in Europe. USDollar fundamentals are terrible for balance of payments and federal budgets, getting worse, and probably nearing crisis proportions. The first alternative to the USTBond has been the EuroBond, given the bias toward both govt bonds and Western financial markets. We have seen this in unmistakable fashion. Arab petro-dollars have been diverted from US market recycling, in defiance of our War of Terrorism, adding to the migration. In fact, Arab diversion of capital toward Europe could be the dominant factor "at the margin." Money will remain invested in EuroBonds until the gap between the Federal Reserve sponsored rates and European Central Bank sponsored rates closes. A 2.0% differential is currently at work, attracting hot money to Europe. Their longterm rates are virtually identical to ours. Each economy faces similar current threats with price deflation on the finished product side. But with a rising euro, Europe has no complementary threats with commodity price inflation. They import commodities to the same extent that we do, but pressures on supply costs are offset by a rising euro. Most commodities are priced in dollars. Their energy costs are more stable than in the United States, except possibly for natural gas, which will be a worldwide problem soon. We share food cost consequences from harsh weather -- drought in the US last summer, floods in Europe. The European Central Bank is exhibiting sheer stupidity in keeping shorterm rates high. Chairman Win Duisenberg is suffering from severe delusion and ineptitude. He and the his ECB governors fear an overheated economy, incredibly. German mfg and the eurozone economy are in the process of stalling badly. Germany is now seeing large declines in its export business from currency shifts. In time, EuroBond shorterm rates will drop to close the gap, removing the attraction of the interest rate differential. Our economies have many similarities, with the exception that the European Union has far less internal debt within its community of nations. Their consensus deflationary risk is somewhat less from burned capital resulting in monetary deflation, and somewhat less from the shared product overcapacity effect. Their corporate earnings are troublesome, but I believe they are not in as much jeopardy as ours. Two events could keep our rate gap wide. The US Economy might fall into the Liquidity Trap, with low rates begetting still lower rates. A USDollar crisis might unfold, triggered by an vicious circle decline in our currency. Longterm rates held low through direct Fed monetization of the 10-yr Trez Note probably ensures it. Each event is a real possibility, and would keep money flowing steadily from the US to Europe. When returns stagnate on EuroBonds, investors will look elsewhere. I believe the euro is a rest stop, a temporary sanctuary for capital. Credit markets remain the primary sanctuary for capital fleeing the equity markets. Our economy may remain weaker for a period of time. So hot money will continue to seek out the higher rates offered by EuroBonds. Europe is likely to lose some of its appeal as terrorism is shipped to that continent. Britain offers direct support for US efforts; other European leaders offer tacit support. Regardless, a euro currency overshoot will invite a correction before long. Political pressure from the US Leadership will also jawbone European rates closer to ours, softening the threat to the dollar. Fading prospects for wide differentials and still lower rates will eventually leave investors seeking alternatives. I believe they will turn to gold. The path will lead from the USTBonds to EuroBonds, and then ultimately to gold. The Arabs will assist in this two-step process, probably even lead the way. JAPANESE
SAVINGS: Many of its people are totally fed up with the revolving door of coalition leaders, their indecision, and the same old same old senseless federal projects. They are deeply frightened by a federal debt amounting to 140% of their GDP. Their competitive future among other Asian exporters is darkening. China is taking markets away from Japan, offering much cheaper labor, while Japanese firms rush to invest in industrial capacity within the mainland Chinese economy. Threats abound for the Land of the Rising Sun. So bad is the monetary situation, that lenders are now offering slightly negative rates of interest! I kid you not. Plenty of motive exists for continuing to sock away money into gold, as this former beacon in Asia declines in wealth, power, stature, and influence. Although fading into oblivion, Japanese citizens are chock full of hard cash, which they have shown willingness to chase a traditional favorite in gold. PENSION
FUNDS (MANAGED AND UNMANAGED): Privately managed IRA, 401k, and Keogh funds have suffered mightily. Together, managed and unmanaged pensions total $8 trillion. Personal inexperience has led to tragic losses; individuals know next to nothing about bonds. I have had dozens of conversations with friends, acquaintances, associates, and ordinary people in the last few years. I have not found a single person who either is aware of bonds or has invested in bonds, except a good friend from my DEC computer days. He is a smart puppy hunkered down in Rhode Island doing consulting work. To make matters worse, fund offerings are pitiful. You can select among largecap stock funds or growth & smallcap stock funds or a nondescript bond fund. And of course a money market fund. Precious metal mutual funds do exist, but they are not usually offered to private pension fund investors. Some day we will see Toqueville Gold Fund offered, but not yet. HEDGE
FUNDS: REAL
ESTATE: Vast distortions are now being skewed in both the housing and car sectors. Benefitting from structured sources of finance, new house construction and new car production have each distorted the delicate supply & demand equilibrium for their respective industries. Their financing arms buttress sales, but at a huge risk to their entire industries. I refer both to Govt Sponsored Entities (e.g. Fanny Mae) and to publicly traded home builders (e.g. Lennar). Supply of existing houses and used cars has risen to dangerous levels. Unsold residential properties now flood major markets nationwide, in stark contrast to easily financed and quickly sold new homes. Used car inventories are absolutely overflowing. Zero down, zero percent, and hefty cashback deals enable continued new car sales. Car dealers bear the risk for used cars, a depreciating asset which most banks avoid and deny easy credit terms. Such is the nature of distortions created by Structured Finance. Its resolution will be certainly painful and disruptive. Financial Socialism has now implicitly decreed that American home ownership should be institutionally subsidized. Instead, the movement has left households and the financial industry even more vulnerable to cyclical downturns. The Federal Reserve will continue to support the housing industry, which serves as the bedrock for private citizen wealth accumulation. Homeowners have unwisely leveraged to the hilt with minimal or nil down payments, raided their home equity, and put their nesteggs at risk. All to maintain the consumption patterns gone overboard. In fact, the principal residence now operates as a shaky foundation for the household's own structured finance, which we euphemistically label "bill consolidation." BUT, default on your single big bill, and you lose your home !!! Home equity now finances Mastercards, student loans, vacations, as well as general consumer spending. The Fed can monetize mortgage-backed securities, even subsidize Fanny Mae and the other GSE's. But for how long? Richard Russell put it well last autumn. "Low rates kept home values up in the year 2002. Job losses will undercut home values in the year 2003." Since WW2 every economic recession has centered on the housing sector and car industry. I believe the 2001 recession was not the main act, but a preview of the real deal coming this year. The upcoming recession is written in stone, to be led by the struggling profitless automobile industry hellbent on easy terms amidst severe overcapacity and the strangle of union labor contracts. Their fall will be compounded by real estate, but only when either the jobless rate rises more than a little, or the mortgage rates rise more than a little. The process will receive an early push from the city, town, municipality, and state fiscal distress. Already the reaction has begun with increases in property taxes. California is the early focal point for these gale-force winds hitting residential property. All in time, as the economy will shed more jobs and the dollar hazard will force longterm rates higher, a certain disruption to the finance arms. When it happens, a torrent of money will exit real estate speculation, will capitalize on the retired nestegg wealth, will swing from owner to renter, and will squeeze out of equity lines of credit. It will find gold in a big way, especially when news spreads about recent leveraged buyers sitting on negative home equity. In fact, I expect negative home equity to crop up as a major story in 2004, in search of a national solution. MORTGAGE-BACKED
SECURITIES: Residential real estate values can come down without doing harm to these securities. However, most factors that weigh down property values also do harm to mortgage-backed securities (MBS). They suffer from refinances when rates fall, depriving owners of their expected originally projected returns. When defaults and delinquencies occur, MBS securities lose value, since returns are cut off or interrupted. When rates rise, they lose value just like any bond instrument. Many investors do not understand the risks involved, and simply chase any security with a "bond" label in this deflationary environment. I believe we have seen the lows for mortgage rates. The still overvalued USDollar threatens the entire bond market now. Currency risk joins the risks of default and delinquency to put a floor on rates. When losses come, and they will, a very large pool of capital will be released. The far greater risk is the unwinding of the Structured Finance Pyramid, which is larger than any tech stock bubble. We have both an archipelago of household pyramids at the micro level, and a monstrous inverted pyramid for the entire mortgage finance industry, each dangerous evidence of Structured Finance gone amok. Mortgage bond holders will see the lion's share of their money returned upon their sale. The same might not be said about FNM stockholders. Together they supply lenders the funds for home loans, on the opposite side of the table from heavily leveraged home buyers. They will realize many capital gains, unless they invested when rates were at the bottom. Either way, a tremendous amount of money might soon regard their present residence in MBS bonds and FNM shares as highly unsafe, at high risk. The risks may mount higher than many imagine if Fanny Mae has an accident, as I expect it will. She is chartered as a GSE, but many believe the federal guarantee of experienced losses to be unlimited. It is not; rather, the limit is widely reported to be a mere $20 billion. Before this credit bubble is popped, FNM losses could possibly top $1 trillion, inevitably at taxpayers' expense. The risks run much deeper than just some minor losses to individual investors, unaware of MBS risk. An entire derivative monster exists to support and balance the Structured Finance Pyramid. A jump in mortgage rates of 75-100 basis points could distribute shock waves to the pyramid, with unknown consequences. As the story of gold is told, money invested here will find it wants to participate. The Fanny Mae stock price will be a good leading indicator for the breakdown of Structured Finance itself, as smart money departs this credit market niche. We are talking about roughly $7 trillion in mortgages nationally, of which the majority have been securitized as asset-backed bonds in a truly mindless fashion. CORPORATE
BONDS: Interest rate swaps are precisely where current risks lie in the private credit market. When the Fed began its belated and reckless cutting of interest rates in January 2001, swaps came back in vogue. (In my opinion, this abrupt policy reversal was a direct admission of failed monetary policy and chronic abuse of debt extensions in the last decade.) General Electric brought the issue to attention, but Bill Gross of PIMCO openly discussed the heightened risks. It seems countless corporations employed swaps to take advantage of lower shorterm rates, thereby offloading their longterm higher rate obligations. Nothing comes without risk though. If and when shorterm Trez yields are driven back up, either by virtue of an economic recovery or by ill-fated pressures from the currency markets, corporations will then be caught in a vise. Their earnings will feel the great impact of sharply higher borrowing costs, a backfire in their swap strategy. This $6 trillion non-guaranteed credit market represents a truly colossal pool of capital, equal in magnitude to our US Treasurys. Two scenarios each benefit gold. If (when, I expect) things begin to turn sour from USDollar pressures, rates will rise across the curve in defense of the dollar. Investors will seek other safe havens such as gold in a pressure cooker environment. If (unlikely, I expect) the economy responds to fiscal and monetary stimulus, rates will rise across the curve from credit demand. Investors will seek out gold as an inflation hedge, protecting themselves from the risk known to massive monetary expansion. Since January 2000, the MZM money supply has increased over 45% in a desperate nightmarish attempt to save our economy, our monetary system, and our way of life. So far, traction has not been evident. The Liquidity Trap is at work. I do not expect sustained traction for a few more years. Until then, money will leak from the massive corporate sector and find gold. S&P
STOCKS: The economy is not responding to over two years of monetary stimulation. Next we will witness more desperate attempts at fiscal stimulation. I doubt that will succeed either, except temporarily. Debt levels are absolutely suffocating; business capacity is largely idle; product supplies are too much in excess; worker incomes are increasingly insecure; pricing power is nonexistent; and China continues to undercut on price as it captures market share worldwide. Oh well, the end of the road of the Keynesian Monetarist Economic model will do that. Sooner or later, stock investors will give up on this dead-end game. Disgusting earnings reports that feature fraudulent or deceptive profit-loss statements and debt-ridden balance sheets will dissuade investors on an ever-increasing basis. Precious metals mining stocks will soon find broad appeal, as gold & silver metal prices continue their march north. This will enable a massive short squeeze on the cartel, which has dabbled their short game during the last few months in precious metal mining stocks. In time, the precious metal stock group will realize sizeable momentum. Capital will repeatedly attempt its typical cyclical return from bonds back home to stocks. We have now seen numerous such attempts. In time, patience wears thin. Precious metal stocks will grant more reliable share price gains, while mainstream stocks (whether techs or "old economy") will continue to meander or whipsaw, neither course encouraging investors. Stock investors will increasingly turn to mining stocks, since they will make money. Right now, the metals lead the PM stock indexes. This aberration will change after education of stock investors. The teacher is losses and stagnant returns. The entire pool of money invested in US Stocks will gradually discover gold in the equity market. NEW
UNITED STATES GOLD-BACKED DOLLAR: The crisis will center on the USDollar decline, which I believe will enter a slow-motion freefall. As the Fed enforces a ceiling on longterm interest rates, forestalling damage to corporate balance sheets and homeowners, they will dismantle the very mechanism to limit the extent of the dollar decline. Naïve observers again do not anticipate such an outcome. They make faulty assumptions on foreign willingness to stand pat and absorb continued and growing losses. They will not. Making matters worse, rising rates together with a falling dollar can deal a double loss to foreigners. High dollar valuation and low foreign labor costs have dispatched manufacturing capacity abroad for a wide range of sectors. Mfg operations have actively shipped to Asia, and assembly plants to Mexico, where labor and plant cost offer big cost advantages. When the market process shifts the strong dollar policy into reverse, all hell breaks loose. The internal mechanisms are absent on the monetary side, with a rate ceiling. They are also absent on the economic side; the apparatus has been exported for 20 years. The United States has neither the monetary nor the economic mechanisms necessary to effectively stem the upcoming uncontrollable USDollar Decline. We have witnessed evidence in a trade gap that continues to yawn wider. Only a gold monetary role will halt the decline. Sinclair expertly articulates a gold-backed dollar, a new dollar, which would (will) enjoy the support of a partial cover clause. Alan Greenspan himself has spoken in less than his usually cryptic style on the possible return of gold to a monetary role. As Jim Turk reports, each ounce of gold in the US Reserve matches up with over $32,000 of US money supply ($8500 billion versus 260 moz gold.) If a 5% cover clause were enacted, the USGovt purchases would find balance near $1600 per ounce of gold. Furthermore, official govt sources would be required to continue purchasing gold in order to keep pace with additions to the money supply expansion. A new $400 billion in annual monetary expansion would necessitate the purchase of $20 billion in new gold reserves, which amounts to more than 50 million oz. While this revolutionary step would certainly send the gold price to new heights, it would issue a much stronger signal. We would immediately see rampant competition for scarce gold resources, sending the price above the eventual point of equilibrium. Pressures on the relatively tiny annual gold supply would be utterly overwhelmed. The gold price would far surpass estimates of equilibrium, then settle back. Given the history of gold tied in ratio to silver, I expect both precious metals to soar in value. Silver was once valued at a 16:1 ratio with gold in the Bimetallic Standard. The current ratio of 78:1 heaps disrespect on this unique metal with astounding technological properties. Convergence in time toward the historical 16:1 ratio will surely come about. Other major currencies would (will) not necessarily follow suit to create a gold-backed euro or yen. Deeply troubled and endangered currencies would be forced to react in this extreme manner. Other nations such as China will choose instead to back their currency with gold, when positioned advantageously. One can see that only the best and worst positioned nations will back their currency with hard asset reserves!!! Private investors worldwide would enter into competition with the USGovt for that gold. The price of gold would enter the stratosphere. Again, naïve observers actually claim that gold would stabilize in price, since the USGovt would need it to stabilize. What utter shallow baseless nonsense drivel! I expect gold will rise 10-fold, just like in the 1970 decade, when govt intervention failed to curb the market reaction to widespread currency debasement. Investors worldwide would force official govt buyers to pay up. Once more they overlook the dynamics of change. The USGovt would purchase massive amounts first to stabilize the dollar. It would continue buying every single year as monetary expansion continues its longstanding patterned model. The end result would be a magnificent transformation of the gold (and also silver) market, announcing sustained and regular gold demand, reversing 30 years of the official policy to put gold under foot. The USGovt might talk about legally capping the gold price, but we are talking about world markets, where US Law cannot apply. The impact on Asian Central Banks replenished with gold would change the face of the geopolitical and economic structures. Gold would (will) stabilize only after the abuse of the currency ceases, only if stability is achieved, and not until it is achieved. Until the dollar currency stabilizes, one should expect gold to rise. If the Fed printing press can issue new dollars in limitless fashion, as Bernanke boasted, then gold also has corresponding limitless upside potential. Newton's Third Law of Motion dictates it - "within an equilibrium, every action invokes an equal and opposite reaction." Transition from old fiat dollar to new convertible dollar will be replete with risks and accidents and jolts from airpockets, probably with high levels of resentment and distrust. This is the world reserve currency, the monetary standard, standing in denomination of 75% of world banks reserve assets. NEW
ARGENTINA SILVER-BACKED PESO: Argentina will likely resurrect itself from ruins, serve as a laboratory reconstruction model, and potentially lead the world by example with a new silver-convertible peso currency. I withheld this prediction from the January article. I give my call at least a 50-50 chance of happening. China has at least two years before it will carry out the same revolutionary step, but with gold convertibility for the yuan instead. If either nation undertakes this bold action before the United States, then pressure for creating a gold-backed USDollar will be unstoppable. Argentina has colossal silver deposits in numerous locations across a sizable land mass. Their government is perfectly positioned to be a major purchaser of its local silver deposits to rebuild an embryonic new currency. Restoration of its banking system and economy would follow. I believe social and political forces will rule the day that dawns on a silver-backed peso. Mexico and Bolivia could follow the lead taken by brave bold leaders from Buenos Aires. A select few Canadian junior mining firms are perfectly positioned right now, owning substantial Argentine silver mine deposits. Their development will be encouraged by local leaders, would aid the creation of jobs, building real wealth throughout the land. Identification of promising mining firms will be addressed in the corollary to follow in the near future. Cardero Resource Corp leads the pack. REFERENCES: 1. Jim Willie CB: "25 Reasons Why Gold Will Rise" (Nov 12, 2002) 2. Jim Puplava interview of Ian Gordon: "The Kondratieff Winter" (July 2002) 3. Jim Sinclair: "Gold to be Remonitized!" (Jan 24, 2003) and "Gold's Role Redefined" (Feb 1, 2003) 4. Jim Willie CB: "A Statistician's Indictment of Economists" (Dec 2, 2002) 5. John Murphy: "Gold Bull Market is Based on More than Iraq" (Jan 27, 2003) 6. Clive Maund: "Gold, the HUI and XAU" (Jan 13, 2003) 7. Jim Willie CB: "Predictions for the 2003 Year - Bear Claws" (Jan 27, 2003) 8. Jim Puplava interview of Doug Noland: "Structured Finance & The Bifurcated Financial System" (Jan 25, 2003) ### Jim Willie
CB Jim Willie CB is a pseudonym used since 1998 on Silicon Investor. Jim works as a statistical analyst for a private consulting firm engaged in consumer packaged goods marketing research. He holds a Ph.D. in Statistics. His career has stretched over 22 years, involving work at Digital Equipment Corp in manufacturing consulting and marketing research, and work at Staples in retail forecasting analysis. Visit his free fledgling website to read other articles and material, as well as to enjoy light-hearted satire, under the name: "www.GoldenJackass.com." Many links appear for significant articles written by other authors. Future works are planned, including a mock interview of Sir Alan Greenspasm, director of the reactive inflationary pendulum. 321gold Inc
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The Gold Volcano:
Chinese and Russian Central Banks 