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.
3/20/2007: Hard times for easy money
Greetings from American Gold Exchange. In this issue of Gold Market Commentary:
Hard times for easy money
U.S. family income, debt, and savings
Subprime mortgage meltdown
Global M3 and yen carry trade
Recommended classic U.S. coins
On the heels of last month's update, when gold and silver were quietly rising to their second highest prices in a generation, markets across the globe experienced risk-averse pull-backs. In this update we explain how the precious metals sector has fared during this contraction and what its ramifications are for the future.
Normally we begin our updates with the gold chart. This time, however, we’ll begin with the latest silver chart because it paints the most vivid picture of overall trading patterns for precious metals since last May's highs and the ensuing period of consolidation, which is now moving toward its conclusion.
The one-year silver chart above reveals how volatile the silver price has been over the last 12 months. Since the May 2006 top and June 2006 bottom, silver has been stair-stepping higher, setting higher highs and higher lows. Each rally has been followed by a sharp profit-taking sell-off. Despite this 'two steps forward, one large step back' trading pattern, the silver trend line is clearly headed higher as the blue parallel lines on the chart indicate. In fact, these trend lines for the highs and the lows are in almost perfect alignment.
This chart is extremely strong and suggests further gains, and perhaps very big gains, are in store for silver in the coming months and years. The 50-day moving average remains within the high and low trend lines and is now higher than it was when silver spiked to almost $15 an ounce last year. The 200-day moving average continues to be a major support line that silver has seldom fallen below.
Using these averages as our guide, it’s obvious that when silver falls below its 50-day moving average, it is good buy; and when it falls under its 200-day moving average, it’s a great buy. We’ve advised on numerous occasions to buy the dips, and we're in good one with silver at the moment. As the parallel blue trend lines, the 50-day, and 200-day moving averages all show, despite the latest steep decline, silver remains in a very strong upwardly moving trading pattern. The red resistance line across the top of the chart shows just how close silver came to breaking above its May 2006 peak, before the risk aversion profit taking decline of the last several weeks occurred.
Once silver breaks above the May 2006 peak, it will have nothing but blue sky above on the chart, and is likely to move substantially higher in price, like it did in the September 2005 through May 2006 rally, when it exploded from under $8 to almost $15 an ounce. We are currently setting our sights on the $18 to $22 range as silver's next upside consolidation target.
If you would like to look back at precious metals prices pricing prior to the September 2005 through May 2006 rally to gain a better perspective on just how far the precious metals came before the recent consolidation period, please see the precious metals charts in our July 2006 update.
Just like the current silver chart, this gold chart is very strong and demonstrates a progressive stair-step pattern of two steps forward, one step back. The blue trend lines continue to remain decidedly bullish, despite the sometimes sharp profit-taking sell-offs. In the silver chart, our low blue trend line is clearly defined all the way back to the June 2006 bottom. In the gold chart, we do not see this pattern emerge until the October 2006, when the metal bottomed at $566.70. Since then, gold’s upward trend line has become much clearer, with the most recent highs and lows in almost perfectly parallel alignment.
Like silver, gold remains within its blue trend lines. It is below its 50-day moving average while remaining well above its 200-day moving average, so we think it's a good buy today.
From the start of this bull market in 2002 through May 2006, gold was leading silver. Market activity since last summer suggests, however, that silver will lead gold in the coming months. But both charts show real strength despite last month's sell-offs. We currently have our sights set on $750 to $850 as the next consolidation range for gold. Buy the dips!
The latest one-year palladium chart reveals a very steady five-month uptrend, with the blue parallel trend lines almost perfectly matching the 50-day moving average. Palladium continues to remain decidedly above its 200-day moving average, which is just now beginning to turn up slightly.
Like gold and silver, this is a strong chart and suggests further gains for palladium are coming. We have not inserted a red May 2006 top line on this chart, like we did with gold and silver, because the more appropriate resistance line would be at the $360 to $365. This is the range where palladium hit resistance on four previous instances without moving higher. We believe palladium will trade in the $340 to $365 price range for the time being. If it moves over $365, look for a run to $400 and perhaps a real test of last May's high of $402. Continue adding to your palladium position on any weakness.
Platinum, the most volatile precious metal of late, may finally be settling into a clearer trend, like silver, gold and palladium have already done. The latest one-year chart shows a steady uptrend beginning in December 2006. Platinum appears to be settling into a trading range of $1,190 to $1,260 per ounce, just above the intersection of its 50-day moving average and 200-day moving average, and below the red upside-resistance level at $1,260. Upside resistance for platinum appears to be very strong between $1,260 and $1,322, suggesting that it needs to consolidate longer before testing the May 2006 high.
While platinum is now entering into a solid uptrend after a much longer period of volatility the other precious metals, it will most likely face stronger upside resistance at its May 2006 top than the others, too. That said, because of its greater overall volatility, once platinum breaches this top of $1,322 it will most likely run strongly higher. Nonetheless, because its extreme volatility and high relative price, we continue to focus on the safer yet still very profitable silver, gold, and palladium markets.
The one-year oil chart above shows oil falling in sympathy with other world markets since the late February sell-off began. Oil is now testing the low side of its recent $57 to $64 trading range and could experience normal seasonal springtime weakness between the end of winter heating demand and the beginning of the summer driving season in the northern hemisphere. OPEC is attempting to control and support the oil price through production cutbacks, but this effort may prove ineffective in the short run. We expect to see oil fall below $57 in the coming weeks but hold above $52 as it settles into somewhat lower trading range for the time being.
While a softer oil price over the next several months may not influence precious metals much, a weakening U.S. dollar is likely to send them much higher. This past week the U.S. dollar index has been falling sharply. Sudden worries about U.S. equities and the housing market are adding to fundamental problems like massive debt, growing inflation, and exploding money supply, which have been ongoing for years. Like the metals charts, the dollar index chart has the 50-day moving average leading the 200-day moving average, but this time the averages point decidedly downward instead of upward. The dollar has dropped precipitously in the last week, and now seems poised to test its December 2006 low of 82.47 on the index chart.
As we’ve stated in numerous updates, if the dollar falls below 80 on the U.S. dollar index, it would signal extreme weakness that could send the currency into free fall, perhaps losing as much as 20%. This kind of dollar crash would create an explosive opportunity for precious metals. We will be watching the U.S. dollar very closely over the coming weeks and update you as developments warrant.
Hard times for easy money
At its simplest level, the dismal prospects for the dollar (and the shining prospects for gold) may be summed up by the phrase, too much of a good thing. There are simply too many dollars flooding the world. U.S. money supply (M3) has exploded after years of accommodative Fed policies, and the result has been astronomical household debt, a crashing housing market (which is only beginning to reveal its full impact), and burgeoning inflation that will be difficult to control regardless of Fed vigilance. All of these consequences spell bad news for the dollar and good news for gold.
But the problems of easy money don't end with the excessive supply of dollars. A rising sea of liquidity in most nations is inflating asset prices, encouraging risky investments, and creating scenarios like last month's 'Shanghai Surprise,' in which a 9% drop in the Shanghai stock market triggered an asset sell-off around the world. All of this excess cash has been slopping around world markets seeking after high returns and quick profits, much in hedge funds and other huge institutional investment vehicles. Valuations have been pumped to the bursting point by so much easy cash that virtually any perturbation (like a quarter-point increase in the cost of the yen) brings the whole system to its knees, as we saw last month in the Shanghai stock market and yen carry trade.
We've been saying for quite a while that the explosion of the U.S. money supply is reaching epidemic proportions that are likely to have a devastating long-term effect on the economy. According to many experts, the U.S. is already plagued by inflation far greater than the reported CPI and PPI numbers suggest, precisely because of the money supply. The inflation rate of the dollar as measured by M3 is actually about 10%, far higher than the CPI rate of 3.3% for 2006. Inflation, as we've said before, is simply a reduction in purchasing power, which is a reflection of the amount of money available to spend.
So despite all the noise about the Fed's vigilance against inflation, the government is sewing the seeds of huge inflation problems down the road by running the dollar printing presses overtime. As David Ricardo, one of the founding fathers of modern economic theory said in 1817, "experience shows that neither a state nor a bank ever had the unrestricted power of issuing paper money without abusing that power." Truer words were never spoken.
The unsettling prospects for inflation and M3 are underscored by Michael Hodges in his superb Grandfather Economic Report series, which we highly recommend to all of our readers. We discussed this information in a recent update but it bears repeating in the context of the current subprime mortgage meltdown and the recent global market corrections.
As you can see in the chart above, the purchasing power of the dollar has eroded profoundly over the last 50 years, and in almost perfect symmetry with the unprecedented explosion of the U.S. money supply. Since 1950, according to the data analyzed by Hodges, the dollar has lost 88% of its purchasing power while the money supply has increased by 3,000%.
The issue is not money and credit in themselves, but money and credit that are created out of thin air. The accommodative policies of the Fed have combined with our fractional reserve banking to create an excessive money supply, with nothing to back it up but guarantees. Because of the inflation it encourages, both in prices and asset values, an excessive money supply sets in motion a speculative exchange of 'nothing for something,' which ultimately undermines the creation of real wealth.
The current subprime crisis, which we discuss in detail below, is a perfect example of this 'nothing for something' conundrum. Rather than real wealth creation, these mortgages, and the easy money policies that make them possible, provide the illusion of wealth based upon the unrealistic promise of supercharged asset growth, itself fueled by yet more easy money and easier credit. But when this growth stalls out, as it has in the housing market, borrowers find themselves worse off than they began, unable meet their payments or keep their homes.
In general, financial markets are the first to benefit from an expanding money supply. As the prices of financial assets swell, in order to maintain growth momentum, the money supply must grow at a like or faster pace. If growth in money supply slows, so does the price growth of financial assets. A big slowdown, like we've seen in the housing and mortgage markets, can knock the props right out from under these 'false wealth' assets, which, in turn, could knock the props right out from under our economy.
U.S. family income, debt, and savings
While the illusion of wealth via cheap mortgages and easy credit has made many Americans feel more prosperous, the reality is that family incomes and savings have decreased substantially during the era of easy money. From 1999 to 2005, according to Hodges, the median family income in the U.S. declined by 6 percent. What's more (or less), household savings has dwindled into the negative while household debt as a measure of income is now at an all-time high!
This chart shows a 46-year trend of the U.S personal savings rate, or that part of disposable income that has been saved. Prior to 1970, the rate of personal savings was rising consistently, along with family incomes. As inflation-adjusted family incomes continued to stagnate, the saving ratio started falling rapidly, plummeting since 1992.
As of last summer, the U.S. savings rate dropped to negative 1.6 percent — an all-time record low, not only for the U.S. but for any leading global economic power in modern history, according to Morgan Stanley economist Steven Roach. Americans have not saved so little since the depression of the 1930s. Rather, we have been on a spending binge well beyond our growth of income, and it shows in soaring household debt ratios during the past two decades.
As savings have dwindled, debt has exploded, creating a double-whammy for U.S. households. The chart shows household debt increasing twice as fast as economic growth. The debt ratio started slowly and then exploded to today's historic record high debt ratios, which are currently 110% of national income, or $11.5 trillion in 2006, an increase of 11.7% over the prior year. Household debt ratios increased 90% faster than the growth of the economy since the late 1960s, when real median family incomes stopped rising. In other words, debt rather than savings has been the driving force of our so-called economic growth in recent years.
Subprime mortgage meltdown
Nothing has driven economic growth and debt levels faster than the easy money housing boom, which is now causing a fiasco in the subprime mortgage sector and creating record-high levels of mortgage defaults and foreclosures.
Subprime mortgages are offered to lower-income borrowers with spotty credit records, allowing them to purchase homes that they couldn’t afford otherwise. According to the San Francisco Chronicle, subprime loans to people with poor credit have ballooned to $1.3 trillion, accounting for 20 percent of all new mortgages last year. In 2000, they were less than two percent of total mortgage loans.
So it's hardly a surprise that U.S. homeowners are increasingly unable to keep up with their mortgage payments, according to the Mortgage Bankers Association. In the fourth quarter of 2006, the rate of homes entering the foreclosure process hit a record 0.54%, and the delinquency rate on U.S. home loans leapt to 4.95 percent from 4.67 three months earlier. The rise was led by subprime mortgages, where delinquencies increased to a seasonally adjusted 13.33 percent from 12.56.
And now, it seems, the subprime meltdown is spreading elsewhere in the home loan market. So-called Alt-A loans, which are considered less risky than subprime mortgages, are experiencing problems. Originally designed for borrowers with clean credit records, Alt-A loans may have lower credit quality than prime loans, or require borrowers to provided fewer documents or even no documents showing what they earned.
Because subprime mortgages are so ubiquitous and have grown so quickly, their collapse could create a plethora of painful consequences. Defaults could hammer Wall Street with heavy losses, slam the breaks on consumer spending, and trip up an already staggering housing market. If lenders overtighten their standards, money becomes harder to find, revenues drop, businesses don’t grow, and the economy stops expanding. Not unlike the savings and loan crisis of the 1990s, a real meltdown in the mortgage business could trigger an outright recession. Congress is "looking at ways to shore up the industry," but that's a bit like Beanstalk Jack fixing the barn after trading the family cow for a handful of magic beans. Only this time it's no fairy tale, and this giant won't be so easy to dodge when it falls to earth. Easy money usually comes with some pretty hard lessons.
Global M3 and yen carry trade
Unfortunately, the deepening malaise of easy money is not merely a U.S. problem but one of truly global dimensions. In the past year, global central bankers have fostered money supply growth rates that are truly stunning. Brazil's M3 grew by 18.2% last year, India's by 19.5%, China's by 17.8%, England's by 14%, and the Eurozone's by 9.7% (source NowandFutures.com), to name a few of the most important. Most of the major industrialized nations have made cheap and plentiful money a fundamental aspect of their economic policy, mainly to support inexpensive exports, reduce trade deficits, build asset valuations, and stimulate consumer spending.
While their U.S. counterparts remain largely mum on the subject, European central bankers, at least, are beginning to sound the alarm. Last month, governing council members Nout Wellink and Jose Manuel Gonzalez-Paramo signaled concern about money-supply growth fueling inflation.
``We see the risks of a lot of money in circulation and growth in money supply,'' Wellink said in a DNB Magazine interview, according to Bloomsberg.com. Gonzalez-Paramo said in a speech in Spain that credit growth is "a cause for concern.''
In discussions about money supply growth, as in so many economic discussions, China remains the 900 pound gorilla in the room. China's economy, the world's fourth-largest and fastest growing, expanded by 10 percent in 2006, its quickest pace in 11 years. Their trade surplus surged nine fold in February from a year earlier to $23.8 billion, the second-highest on record, after reaching $177.5 billion in 2006.
China's money supply expanded by a staggering 17.8 percent in February, the most in six months, and by 16.9 percent overall in 2006. Record overseas sales are pumping cash into China's financial system, and China prints yuan to convert the foreign currency derived from exports of clothes, electronics and steel, which swells the money supply. The People's Bank then sells bills to soak up some of the cash, but much of it ends up buying things like mineral rights and infrastructural upgrades in Africa, and U.S. assets of all sorts.
Understandably, China's central bankers are getting very nervous about all this incredible growth. Over the weekend they raised interest rates for the third time in eleven months to curb inflation and reduce asset bubbles. The central bank raised interest rates in April and August, and last month ordered banks to set aside more money as reserves for the fifth time in eight months in order to rein in the money supply.
Premier Wen Jiabao admits that his nation's economic expansion and growth in liquidity are worrisome. "China's investment growth is too high, lending growth too fast, liquidity excessive,'' Wen said at a news conference in Beijing last week. "The biggest problem in China's economy is that the growth is unstable, imbalanced, uncoordinated and unsustainable.'' Indeed.
But Wen has resisted calls from Europe and the U.S. to let the yuan strengthen at a faster pace, making China's exports more expensive and reducing its excessive cash. The yuan is kept weak to make China's exports cheap, U.S. lawmakers say. America's trade deficit with the Asian nation swelled to a record $232.5 billion last year, with so much our own excessive liquidity just lapping up those inexpensive Chinese goods.
While many nations have been tightening interest rates in the past few years in vague attempts to reduce inflation, it's a matter of too little and too late. So far, higher borrowing costs have shown few signs of cooling money-supply growth. There can be little doubt as to the excess in global liquidity which is keeping interest rates in the U.S. artificially low while creating an inflationary scenario that will surely come back to haunt us all.
Just as U.S. households have been borrowing against equity to finance their spending sprees, the international investment community has been borrowing against the inexpensive yen in order to finance increasingly risky investments. The cheap yen has been an international liquidity-producing machine, enabling investors to get something for nothing as though they could print their own money. But the chickens are coming home to roost.
For more than a decade, investors have profited by borrowing yen at ultra-low interest rates and using the funds to buy higher-yielding investments based in other currencies, known in Wall Street parlance as the yen carry trade. While it's difficult to quantify the size of the yen carry trade, investors have borrowed yen aggressively to fund a wide range of investments, from safe assets like U.S. Treasuries to far riskier investments in emerging markets. Last month's market swoon has brought the true risk of many of these investments back into focus, and a number of these borrowers have been unwinding those trades lately.
"There's been complacency and underpricing of risk across the board," said Nouriel Roubini, chairman of Roubini Global Economics, a research firm. But now many big investors, as well as policy-makers, are bracing for more volatility in the markets, he said.
While the yen carry trade became popular after Japan started holding interest rates steady near zero six years ago, it's only recently that a variety of hedge funds, insurance companies and mutual funds are getting out of those bets, and removing a key source of support for stocks. In the process they sparked a swift rise in the yen as they bought yen to repay their loans, liquidating other investments like precious metals in the process. This abrupt liquidity crunch was one of the main reasons why metals lost ground at the same time as stocks recently, as yen borrowers scrambled for cash to cover their carry trade obligations.
Much of the yen carry trade was finding its way, via hedge funds and large institutional investors, into the emerging market equities and fixed income investments. In the past five years, the most important emerging markets, Brazil, Russia, India, and China (collectively known as BRICs) have seen astonishing growth, with the stock markets in each nation at least tripling. With international tides of cash looking for a place to go, seemingly impervious to risk, it's no wonder these risky markets have been primary recipients.
But all of this unsustainable growth is beginning to create real problems in the BRICs, stoking inflation, straining production, promoting speculation, and undermining the environment. China is raising rates to stem growth and liquidity; India, the second fastest, is stepping up price controls; and Russia's energy producers face higher costs to develop oilfields. What's more, the stock market of each BRIC has taken a pounding so far this year. In India, for example, where the economy is expanding at a 9.2 percent annual rate, the benchmark Sensitive index, known as the Sensex, has dropped 9.8 percent this year. The measure had more than quadrupled since the end of 2001.
All of these developments promise to be bullish for gold. The U.S. and world money supply is likely to keep expanding to cover our enormous and increasing trade imbalances, deficits, and debts. As the sea of easy money rises, the result is likely to be massive pricing inflation both at home and abroad.
Gold has returned to favor as an international currency in large part because it's not a debt. Rather, gold has intrinsic value and is intrinsically liquid. 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 of it 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. We urge you to stock up now while prices are still relatively low.
Recommended classic U.S. coins
These are the classic U.S. coins we recommend most highly today:
Power Pair #1 – An inexpensive pair of classic U.S. double eagles (a P-Mint $20 Saint-Gaudens in MS63 plus a pre-1900 $20 Liberty in MS62) at low premiums relative to gold bullion. Appropriate for conservative investors who like modest leverage to gold and complete financial privacy. Premiums on these classic gold coins are extremely low at the moment, making them a great, conservative buy right now.
U.S. $20 Liberty gold coins, MS64 – Our most popular investment coin. True scarcity, near-gem quality, and large gold content at low, low prices!
U.S. 10 Indian gold coins, MS65 – Fantastic value! Combines extreme scarcity, gem quality, and very low premiums with huge upside potential.
U.S. Peace silver dollar rolls, BU – The smart way to buy silver. Inexpensive with excellent scarcity for the price.
And be sure to take a look at our superb inventory of classic U.S. gold coins. Please call 1-800-613-9323 and speak to one of our friendly rare coin experts if you see anything of interest or want to learn more.
That's it for now. As always, thanks for your time.
Dana Samuelson, President and Owner
Dr. Bill Musgrave, Vice President
AGE Gold Commentary
Gold is gathering momentum to begin its assault on the previous record high of $1,911 and then push above $2,000 ... read more