AGE Gold Commentary is our regular report analyzing trends in precious metals and rare coins. We monitor domestic and international markets and extrapolate from our 30 years in metals to place current events into a hard asset perspective. View archives.
3/27/2003: Why gold is destined for $375 and higher
Why gold is destined for $375 and higher
Greetings from American Gold Exchange!
In this issue of Gold Market Update:
It’s the Economy!
Budget Deficits, Trade Deficits
Falling Dollar, Falling Stocks
Consumer Debt, Consumer Confidence
Gold is currently trading at the $330 level. After its recent run up to $390, followed by a sharp fall back to the $330 level, some investors are asking whether gold remains a safe haven during our present time of turmoil. In this update, we will explain why the answer to this question is an emphatic, YES!
In fact, we believe gold should be priced at a minimum of $375, and has the potential to rise substantially above $400 per ounce into the $500+ per ounce range in the next 24 to 48 months. Here are the reasons.
It’s the Economy!
The U.S. economy is weak, confused and staggering about for direction (and maybe a gallon of strong coffee.) Despite the lowest interest rates in 40 years, it continues to languish with no fundamental rebound on the horizon.
Of course, the war in Iraq did little to create our present economic malaise. The end of the war, however much we might wish it, simply cannot restore the U.S. to economic health.
One of the strongest factors underlying the incredible U.S. economic expansion of the late 1990s was the fact that, for the first time in a generation, the United States Government was generating budget surpluses. Our government was taking in more money than it was spending, a change that inspired worldwide confidence in U.S. fiscal policy. With this confidence came massive investment (corporate, personal, and foreign) in our economy, our currency, and our markets.
Sadly, our hard-won and highly publicized budget surpluses have now turned once again into huge deficits. February’s $96.3 billion U.S. budget shortfall is the largest for a single month on record, at least since the data were first tracked beginning in the 1960s. So far this fiscal year, the government is $193.9 billion in the hole, about $127 billion more than in the same period a year ago.
This stunning reversal of fortune is directly linked to the continued weakness of economy and stock markets, the sinking U.S. dollar, and rising unemployment. Analysts for Republican-controlled House Budget Committee are estimating that fiscal 2003 shortfalls could soar to $400 billion. What is more, these deficits projection do not include the cost of the war in Iraq or President Bush’s tax cut agenda, which the Senate has just pared down from $670 to a mere $350 billion.
And these new deficits, it appears, are just the beginning. Mitch Daniels, the top budget man in the Bush administration, conceded in January that America has “returned to an era of deficits in the nation’s public finances.”
Only two years ago, as The Economist recently reported, Mr. Daniels was touting a projected ten-year budget surplus of more than $5 trillion as proof that America could easily afford a big tax cut. Now he expects deficits of between $200 billion and $300 billion (2-3% of GDP) over the next couple of years and spills of red ink “for the foreseeable future.”
Just as our government is running up huge budget deficits, our nation as a whole continues to sink deeper and deeper into huge trade deficits. The U.S. consumes far more than it produces, imports far more than it exports, and we subsidize the difference with a monstrous debt.
In 2002, our Current Account Deficit – the difference between our imports and exports of goods and services — climbed to almost $500 billion. In other words, we imported half a trillion dollars more in goods and services than we exported last year, sending $500 billion in greenbacks to foreign soil. That’s about a billion and a half dollars a day!
So far this year, although the final numbers aren’t yet in, most economists think the current account deficit has swelled to $136.8 billion in the first quarter, according to a recent Reuters poll. At this rate, the full-year gap will exceed last years, making it the largest since the Commerce Department started keeping records in 1960.
Why worry about these deficits? To begin with, they're a sign that the U.S. has been living far beyond its means, and plans to continue doing so, which is never a good idea. In addition, in the short term, deficits could suffocate an economy that’s already gasping for breath. Many economists believe that higher deficits cause higher long-term interest rates by increasing competition for savings. Higher rates, in turn, would sharply curtail mortgage refinancing and home equity loans, thereby cooling the housing industry, which has been virtually the only warm spot in the economy.
But the long-term implications are worse. Normally, modest budget and trade deficits aren't too much of a threat, economists believe, as long as investors in other countries are willing to finance our spending spree by pouring their greenbacks back into the U.S. economy in the form of investments. This is precisely what happened in the 1990s, when foreign investors couldn’t get enough of U.S. technology stocks, Treasury bonds, and other U.S. assets, all of which must be purchased with U.S. dollars. Demand for dollars led to a stunning run-up in both the value of the dollar and of the U.S. stock markets, a story we all know too well.
But now, faced with huge budget and trade deficits, foreign investors are correctly questioning whether we’ll be able to pay our debts, and are looking askance at the U.S. economy as a bad risk. No wonder the U.S. stock market, despite its recent “war bump,” and the value of the U.S. dollar have plummeted.
Since the ‘90s bubble burst, and even before the Bush administration announced its return to budget deficits, demand for U.S. assets has been in sharp decline. As a result, the dollar has already lost 17% of its value against other currencies in the last year, leading many economists to worry that, in order to keep money flowing into the U.S., asset prices might have to fall further, and the dollar must be even cheaper.
"The dollar has been depreciating, and that leads investors to expect it will continue to depreciate," said Sung Won Sohn, chief economist at Wells Fargo & Co., last week. "That may discourage foreign investors, including foreign central banks, from buying dollars or dollar-denominated assets."
Without those foreign investment dollars flowing back into our economy, the only real option for offsetting our debt is to radically increase the money supply. With interest rates at 40 year lows, money (in U.S. dollars) is already cheap. Nonetheless, because of our desperate debt and falling stock prices, the Fed has all but pledged to make dollars superabundant, in effect reducing their purchasing power on purpose and opening the door to inflation.
In November, Ben Bernanke, a Federal Reserve Board governor, said as much, remarking that using a device called “a printing press,” the government “can produce as many dollars as it wishes at essentially no cost.” A month later Alan Greenspan echoed this comment, declaring that the Fed could easily suppress long-term bond yields with free-flowing dollars, just as it did during the wartime years between 1942 and 1951.
Cheap dollars raise the specter of inflation, declining asset values, and reduced purchasing power. Of course, cheap dollars also promise higher gold prices. Gold has appreciated in the last year in almost direct proportion to the dollar’s decline. Priced in dollars, gold becomes cheaper and more attractive to foreign buyers when the dollar loses value.
Stocks, meanwhile, remain historically expensive, despite a market correction that recently passed its third birthday. The stocks in the Standard & Poor's 500 are trading at a price equal to about 30 times their earnings per share over the last year. At the end of the 1990-91 recession, that multiple was 18.
No less an authority than Warren Buffet agrees. In Berkshire Hathaway’s recent report to shareholders, Buffet declares US stocks to be over-valued and counsels away from stock investments at present.
If U.S. governmental and national debt look like a flood, U.S. consumer debt looks like a roiling sea, a fact that causes any quick economic recovery to drift further and further out of reach.
Consumer debt has more than doubled in the past decade. Americans now owe about $1.7 trillion in credit card and other debts—an amount roughly equal to the gross national product of England and Russia combined. Even if we cease all credit card spending today, it would still take decades— and trillions of dollars in interest payments—to wipe out our present debt.
As a result, Americans are now going bankrupt in staggering numbers. As The Street reported recently, more than 3 million bankruptcies were declared in 2001 and 2002, and experts are expecting 2003 to break more records. Foreclosures last year accounted for four out of every 1,000 homes, a level unseen in the 30 years. And seriously delinquent loans, those well past due and on their way to foreclosure, now account for 5% of all loans—levels unseen since the last recession.
The combination of falling stock prices, cheaper dollars, higher unemployment, and record levels of debt spell big trouble for consumer spending, which fuels two-thirds of the nation's GDP and so far has propped up the economy. No wonder consumer confidence fell in February to its lowest point in more than a decade.
In the 1990s, consumer spending was fueled by growing wages, a secure job environment, and huge gains in both real estate and the stock market. All of these stimuli are long gone.
Since mid-2000, consumer spending has been driven primarily by record low interest rates, which have resulted in a deluge of home equity loans and mortgage refinancing, which in turn freed up a lot cash in Americans’ ever-tightening budgets. But signs are becoming clear that this lifesaver of a real estate market, too, is beginning to sink. The number of new housing projects builders broke ground on in February plunged by 11 percent, the sharpest decline in nearly a decade. And mortgage rates are now creeping higher, which should further slow the housing market.
The U.S. economy is still months — perhaps years — away from wringing out the excesses created by the boom of the late-‘90s. Athletes and armchair quarterbacks are familiar with the cliché, “no pain, no gain.” Describing the present economic reality, most economists would say the reverse: “No gain, no pain.” History shows that almost every major economic boom is followed by an economic bust of nearly the same proportions. The most obvious (and perhaps most relevant) example, of course, is the Roaring Twenties, which gave way to the Great Depression. Although we’re unlikely to feel that level of economic hardship and paralysis again, we’ll nonetheless feel for a while to come the pain of those easy gains from the Roaring Nineties.
Budget deficits and record trade deficits. Overvalued dollars and overvalued stocks, both falling. Record personal debt and plummeting consumer confidence. Add comatose job market and it’s clear: there are no easy or quick solutions to the economic problems that we face today.
But gold, indebted to none of these problems, most assuredly remains a safe haven.
For the economic reasons discussed above, based on economic fundamentals alone, we believe gold should return to between $375 and $500, just like it was in 1980s, when our economic problems were far milder.
No market moves in a straight line, up or down. Between 1998 and 2001, gold routinely traded in the $270 to $290 range, with three short-lived spikes up to $330. Although the basal gold price today is $330, we’ve just witnessed a spike up to $390. We believe the gold market has already told us where it’s heading.
Today the world is so focused on the war in Iraq that almost everything else is overlooked. Most investors seem to be trading the news and not the numbers these days. Once that conflict is resolved, attention will quickly turn again to the dismal U.S. economy and its poor underlying fundamentals. Gold will rise to the level where it is fairly valued relative to the falling dollar, falling stocks, and overall economic weakness. We fully expect to see gold at $375 and above, with the potential to push over $500.
We feel today like we did in the summer of 1999, when gold was $255, and again in August 2002, when gold was $300. Both times we issued STRONG BUY signals, and gold quickly surged in price from these bottoms. Today, we’re not certain that gold has bottomed yet; it could possibly drift another $10 lower over the next couple of weeks. However, we do believe gold is now undervalued by 10% to 30%, or more.
Of course, timing this market to perfection is impossible in the current geopolitical environment. While gold might have a $10 to $15 downside potential today, the upside is $100 or more. It’s only a matter of time – and perhaps not much of that – before the market agrees. We’ve advocated buying the dips for the last 18 months, and the current pull back to $330 is offering an excellent buying opportunity. Continue to accumulate and build your core position while the gold price remains undervalued.
As always, thanks for your time!
Owner, American Gold Exchange
AGE Gold Commentary
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