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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.

4/27/2006: What's the meaning of $9 trillion in debt?


Greetings from American Gold Exchange. In this issue of Gold Market Commentary:

Metals surge, correct, and rebound
What's the meaning of $9 trillion in debt?
Current accounts and the teetering dollar
Inflation, oil, and commodities
Classic coin update

Metals surge, correct, and rebound

After rising to $570 an ounce in February and correcting down to $540, gold has been on a tear. In the past sixty days the spot price surged by an astonishing $100, closing above $635 an ounce yesterday, its highest close since 1979. Even more stunning has been the performance of silver. After hitting new highs in February at just under $10.00 an ounce, silver skyrocketed by 50% to almost $15.00 before profit-taking cooled the rally. Palladium and platinum have also enjoyed strong gains during this time frame, but not quite as sensational as gold and silver.

Just as remarkable is the time frame of these gains. Historically, the first quarter of the year is the weakest time for metals. Once Chinese New Year and the Indian festival season pass, international demand for physical gold generally subsides for a while and prices soften. But not this year. As 26-year market veterans, we haven't seen this kind of late-winter rise since the “mother of all bull markets,” the record-breaking run from 1976 to 1980, when gold reached its all-time high of $850 and silver peaked at $50 an ounce.

As we've reported over the last six months, during the summer of 2005 gold transitioned from a U.S. bull market driven primarily by U.S. dollar weakness, to a full blown international bull market. As much as gold has been gaining in dollars, it's been gaining even more in other currencies over the past eight months. Since September 2005, gold has gained by 40% in U.S. dollars, 52% in euros, 63% in yen, 57% in Swiss francs, 49% in Australian dollars, and 57% in British pounds.

Click here for 5-year gold charts in major world currencies.

Following gold, the other three precious metals have broken out of range-bound trading in all major world currencies, showing their strongest upside potential in a generation. Growing international support will give all the metals more resilience when short-term corrections come, as they have today. Last week was a good example: after experiencing sharp declines on profit-taking last Thursday, all four metals quickly rebounded to levels near or surpassing their cyclical highs. Pull-backs in all four precious metals should be considered as buying opportunities.

A variety of important influences are accumulating to create this bull market. Massive U.S. trade and budget deficits, higher oil prices, the rise of China and India as economic powerhouses, all are suddenly coming to bear on the market demand for commodities. On a geopolitical level, our deepening quagmire in Iraq, the terrible threat of Iran as a nuclear power, and the possibility of U.S. military intervention in Iran are creating a global hunger for financial safe havens. Add to this mix a U.S. president with the lowest approval ratings since Richard Nixon was driven from office in 1974, and you have a lot of ambient uncertainty about what's around the corner, politically and financially. Stock markets hate uncertainty but gold thrives on it.

Below are 3-year price charts for gold, silver, oil, and palladium. Each chart delineates annual lows (red support-line) and annual highs (green resistance-line) for each of the last three calendar years, with an underlying blue trend-line. The gold, silver and oil charts are remarkably similar, revealing a solid step-up pattern. In each of the last three years, prices have stepped consistently higher and trading ranges have expanded. And in the last eight months, prices have moved sharply higher in ways unseen since the late 1970s. Clearly, these charts are all extremely bullish, and suggest the possibility of sizeable gains continuing for the next several years.

The only difference in the 3-year palladium chart below is the fact that palladium made a price surge in early 2004, ahead of the other metals and oil. It corrected back down from mid-2004 through mid-2005 and then resumed its upward march.

Precious metals prices are hitting their highest levels in a generation, but the general public seems largely unaware. Reporting in the media is certainly becoming more frequent, and will increase as gold moves closer to its 1980 high of $850. But the causes of the bull market, especially the destructive consequences of our extraordinary national debt, seem to go either unreported or unnoticed. Sadly, most Americans today remain complacent as our future is mortgaged through an ever-expanding national debt.

What's the meaning of $9 trillion in debt?

The U.S. federal deficit widened to $85.5 billion in March, compared with $71.2 billion a year ago. Through the first six months of the fiscal year, the deficit totaled $303 billion, about $8 billion more than in the first six months of 2005. For the year, the White House expects a $423 billion deficit. The total national debt now exceeds a staggering $9 trillion.

The U.S. budget deficit has grown so huge it defies all logic or common sense. If the average taxpaying citizen understood the ramifications of this $9 trillion dollar debt, our nation might be more apt to hold our elected officials accountable for their incredible fiscal irresponsibility. USA Today recently published some figures that begin to bring the meaning of the debt home, which we're reprinting to illustrate the dimensions of this national emergency.

$9 trillion in debt equals:
—- More than the GDP of China, the world’s second richest nation.
—- More than the combined GDP of Japan and India, the next richest nations.
—- The equivalent of all monies invested in all U.S. mutual funds.
—- Four times the combined net worth of the nation’s 691 billionaires.
—- $30,000 for every man, woman and child in the United States.
—- $120,000 home mortgage for a family of four.

Time span of U.S. debt accumulation:
—- 213 years for the first $3 trillion (1776 to1989)
—- 10 years for the second $3 trillion (1989 to 1997)
—- 5 years for the third $3 trillion (2000 to 2005)

Foreign U.S. debt holders:
—- In 1970 foreigners owned about 5% of our national debt
—- In 1980 foreigners owned about 17% of our national debt
—- In 1990 foreigners owned about 18% of our national debt
—- In 1995 foreigners owned about 22% of our national debt
—- In 2000 foreigners owned about 31% of our national debt
—- In 2005 foreigners owned about 45% of our national debt

U.S. debt held by foreign countries in 2005:
—- Japan — $687.3 billion
—- China — $252.2 billion
—- United Kingdom — $182.4 billion
—- Caribbean Banking Centers — $102.9 billion
—- Taiwan — $71.8 billion
—- Germany — $63.5 billion
—- Korea — $61.7 billion
—- Opec — $54.6 billion
—- Hong Kong — $48.1 billion
—- Canada — $47.8 billion

Here's a genuinely staggering fact: annual interest payments on the national debt cost $184 billion, making it the fifth-largest item on the U.S. budget, just behind Defense spending, Social Security, Medicare, and Medicaid!

Gold has returned to favor as an international currency in large part because it's not a debt. Gold has intrinsic value. Unlike paper currency, bonds, or equities, gold depends for its value on no one's liability; it carries no promise of repayment. Gold is permanent, not a piece of paper with an arbitrary value printed on it. You can’t make more gold by edict or printing press. In this era of instant global communication and digital wealth, it's ironic that the hard asset of the ancients is popular again. Why? Because you can depend on gold to be exactly what it's been for millennia, a stable store of value in an unstable world. And, of course, until the U.S. abandoned the gold standard in 1971, every dollar was backed by gold.

Current accounts and the teetering dollar

Like the national debt, the U.S. current-accounts deficit has grow so gargantuan that it's virtually inconceivable. So it's no surprise that this crucial measure of the gap between our imports and exports is largely ignored by the news media despite its truly devastating potential. In the fourth quarter this deficit quietly rose to a record $225 billion, or 7% of GDP. What's more, it's on track to hit an annual rate of $1 trillion before the end of this year, and could rise to 12% of GDP by the end of the decade, according to The Economist.

The problem, of course, is that Americans seem unable to reduce their compulsive appetite for inexpensive foreign goods. Like guppies, it appears, we will consume until we burst. According to Stephen Roach, chief economist at Morgan Stanley, imports now account for 37% of America's domestic purchases of goods, up from 20% in 1985. And as long as the economy continues to boom, the gap will grow wider.

One way to balance the books, the healthy way, is to reverse this trend and start exporting more than we import. But here's the rub: our deficit has grown so large that we must now double the growth of exports over imports just to stay even! The unhealthy alternative is for the dollar to lose value—lots of value—against the currencies of our creditor nations. Unfortunately, this alternative seems more likely every day.

Despite all the commotion about a strong economy, and despite years of rising interest rates, the dollar has been losing momentum. After rising for much of 2005 on the back of rate hikes, the greenback has lost around 3% against the yen and euro in the last six months, and slumped to a three-month low against the yen and seven-month low against the euro this week. And despite last year's rebound, the buck is still down by 28% against the euro and 13% against the yen since its peak in 2002. More dollar losses are imminent. Traders have become increasingly bearish on the dollar in recent weeks after the Federal Reserve indicated that the end of the interest rate tightening process was probably near, shifting market attention back to the record U.S. current-accounts deficit.

According to Kathy Lien, chief strategist at Forex Capital Markets, "the dollar will be pushed substantially lower a combination of the deficit, foreign banks reserve diversification away from the greenback, and a potential revaluation of the Chinese yuan" (see Dollar decline won't hit stocks—yet).

Decreases in the dollar are likely to have a negative impact on the U.S. stock markets, shifting foreign capital to stronger investments like gold. For example, the early part of this century saw U.S. dollar weakness to the end of 2004, a trend that coincided with the bear market in stocks that ended in March 2003. It is no coincidence that gold began its current bull market at the same time.

Consider Iceland. In recent years this tiny country ran up a current accounts deficit of 16% of GDP – much larger than the present U.S. deficit but not that far beyond the 12% predicted for the end of the decade. Last month Iceland's currency and stock market fell sharply, and its banks are struggling to roll over short-term debt. Iceland is an extreme example but hardy alone. New Zealand, Australia, Turkey, and Hungary have also seen their currencies drop precipitously in recent months. Like the U.S., all of these nations have economies with outsized current-accounts deficits driven, in part, by consumer spending booms financed by booms in asset value (like home equity) and credit.

It was easy for the U.S. to finance its $800 billion current-accounts deficit in an era of easy money. And the dollar is still supported by large purchases of dollar-related reserves from China and the Middle East. But how long can this support go on? For the first time in years, central banks in America, Japan, and Europe are tightening their monetary policies and draining liquidity from the financial system, which will surely result in a flight from risk among global investors.

Tightening international credit will contribute a much-needed shift in exchange rates. The IMF has recently stepped up the pressure for far-reaching shifts in exchange rates, declaring that the dollar will have to depreciate “significantly” over the medium term if global economic imbalances are to be resolved in an orderly fashion. The statement came in the IMF’s twice-yearly World Economic Outlook, published earlier this month, which highlighted global imbalances as the biggest threat to what was otherwise an “unusually favorable” economic environment. (See IMF calls for dollar depreciation.)

During his recent visit to Washington, China's President, Hu Jintao, got an earful about the artificially low value of the Chinese yuan. At least among some politicians, the cheap yuan has been singled out as the bete noir behind American deficit woes, as if our negative national savings rate has played no part. But as The Economist recently noted, the yuan is actually far from cheap when observed over a longer term. Between 1994 and 2001, its real trade-weighted value (adjusted for inflation) gained 30%. And during the East Asian currency crisis China did not devalue its currency, although most of its neighbors did. What's more, the IMF has found little evidence that the yuan is much undervalued; estimates by several investment banks say 10-15% is probably all, rather that the 15-40% common cited by yuan-bashers. So what does it mean? Just this: we can't expect a rising yuan to fix our current-accounts problem, or to save the dollar from a substantial and perhaps very painful correction.

Inflation, oil, and commodities

Right after Janet Yellen, president of the San Francisco Federal Reserve Bank, voiced her concern that continued rate hikes might "overshoot the mark" of inflation, what happens? The March inflation report comes in showing U.S. core inflation rising at the fastest pace in a year, rekindling expectations that the Federal Reserve might have to raise rates a few more times. In addition, a separate measure of core inflation that does not exclude food and energy costs showed prices rising at the fastest rate in twelve years. The increases in both the consumer price index and in core prices were above Wall Street expectations.

"This was not a good report, especially if you are a member of the FOMC," said Joel Naroff, president of Naroff Economic Advisers. (See March's core inflation highest in a year.)

Indeed, inflation is here and it's not going away any time soon, especially with oil reaching $75 a barrel last week, an all-time high. With escalating worldwide demand for energy and all commodities, especially in emerging markets like China and India, the cost of just about everything is likely to keep on rising. Add in the deteriorating situation in Iran and Iraq, and the price of oil has the potential to reach truly stagger heights.

One way to get a handle on inflation is simply to watch the gold price, which tends to rise during inflationary periods. In the last eight months the yellow metal has surged more than 40%. While rising gold prices don’t necessarily translate into higher consumer prices in the way that higher oil prices do, they are a sure sign that commodity prices are on the rise.

"Gold is like the canary in the coal mine — a warning signal that inflationary or deflationary pressures are building," said Brian Wesbury, chief economist for First Trust Advisors. "Commodity prices and gold clearly suggest that monetary policy remains accommodative." (See Are gold prices signaling inflation?)

With the world awash in cheap money and geopolitical uncertainty, commodity prices are likely to continue their remarkable climb. Oil could easily reach $80 to $100 per barrel in the next twelve months, especially if Iran tensions flare up, and precious metals are on the march to additional multi-decade highs. For the past year we've been citing a target gold price of $680 to $750. They way things are going, that range is likely to be far too conservative!

Classic coin update

Prices for classic U.S. gold coins have been lagging behind the escalating gold and silver markets, and the big increases are yet to come. When bullion rises so far and fast, classic coins tend to lag for a period, creating excellent buying opportunities for attentive investors. In the last few days we've begun to see the tipping point: demand for classic coins is now completely overrunning dealer inventories, which are at the lowest point in many years. With more cash than coins, dealers are now aggressively competing with each other to restock. Clearly, prices can really surge in this situation, and we expect demand to increase even more in the months ahead. Classic U.S. coin prices are likely to continue to rise in coming months even if the gold price falls back under $600 per ounce, which seems unlikely today.

A few sectors of the U.S. gold coin market remain undervalued relative to gold bullion. Unfortunately, there are not enough coins to go around. So, rather than tip off the whole market to the best values by publishing the information here, we're taking the unusual step of asking you call an AGE account manager at 1-800-613-9323. We'll be happy to discuss our recommendations, and to provide the best values for your particular portfolio needs.

In the mean time, please review our nice current inventory of classic U.S. gold coins.

That's it for now. As always, thanks for your time.

Best regards,

Dana Samuelson, President and Owner
Dr. Bill Musgrave, Vice President


Metal Ask      Change
Gold $1,798.01           $-9.42
Silver $18.98           $-0.16
Platinum $851.12           $-10.27
Palladium $2,047.68           $-0.35
In US Dollars