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.
4/15/2008: Gold consolidates after record highs
In this issue ofAGE's Gold Market Commentary:
Gold consolidates after record highs Gold consolidates after record highs
Classic gold coins ready to surge
Inflation and the dollar
Gold consolidates after record highs
Wow! We have a lot to talk about since our last update. Gold, platinum, and oil have all set new record highs; silver and palladium surged strongly in price; and the U.S. dollar set new lows on the U.S. dollar index chart. The U.S. Federal Reserve, in an unprecedented shift in policy, has become the lender of last resort for investment banks on the heels of the Bear Sterns collapse. In a sign of how dire things were, the Fed took the stunning step of cutting rates by 0.25% on a Sunday night, March 16, before the Bear Sterns “buy out” was announced, hoping to head off a financial panic One of the better editorial comments we have heard is, “we are witnessing the socialization of losses and the privatization of profits.”
Cutting rates by an additional 0.75% during their regularly scheduled meeting two days later, the Fed's quick and decisive action was admirable, and probably prevented the entire U.S. financial system from coming unglued, which would have, in turn, spilled over into global equities markets. But the cost will almost certainly be much higher inflation down the road, clearly to the benefit gold and all hard assets.
Precious metals all surged dramatically in mid-March as the fear-factor in the market ratcheted up to levels we’ve never seen before. The deepening U.S. recession, plummeting dollar, spreading global fallout from the subprime mortgage debacle, tightening credit markets, and ongoing Middle East turmoil have stoked profound concerns in financial markets. With its startling steps to protect Bear Sterns, the Fed sent the message that it would do whatever it takes to keep asset values inflated. The dollar rallied on the news and optimism (however misguided) began to rise. As the fears receded so did precious metals prices.
But deeper cuts in rates, while they may help the ailing U.S. economy in the short term, are leaving the beleaguered U.S. dollar vulnerable to further declines as the differential grows between U.S. interest rates and those of other countries. Inflation, which has been rising in the U.S. anyway, can only accelerate as the dollar's international purchasing power continues to decline. In addition, rampant local inflation in China, running at an 11-year high of 7.6% in January, will almost certainly be passed on to U.S. consumers, adding to our own. And India's inflation also threatens to run out of control, shooting up to a 15-month high of 6.68% in the week ended March 15, far above expectations. We have never seen an environment so detrimental to the value of the dollar internationally, and so ripe for continued, strong gains in precious metals and classic U.S. gold coins. This bull market still has a long way to go before it hits the top!
Let’s take a look at the latest precious metals charts.
Once gold broke over the psychological resistance level of $850 in January, it climbed relentlessly through February to over $1,000 in mid-March. Subsequent profit-taking pulled the price down, first through support at $940, then $915, and then into the mid-$870s before it rebounded and stabilized in the $915 to $940 range. In the present environment, we believe gold is fairly valued between $950 and $1,000, which means it's undervalued by 3% to 8% at present. As we like to say, buy the dips! We’re in one now!
Gold’s traditional role as currency of last resort has come to the forefront over the last three to four months. Sales of physical gold by dealers across the country have risen dramatically as many people who call themselves traditional investors (stocks, bonds, mutual funds) have started shifting some or all of their capital toward hard assets. While the U.S. remains the dominant world economic power, growing competition from China, India, and the oil producing nations (flush with petro dollars) will buoy the gold price if any serious price weakness occurs. The latest price correction for gold, when compared to the previous major correction, is an excellent example of its underlying fundamental strength.
As you can see, the contours of the last two major gold rallies have been remarkably similar. Both gained around 62% over 8 to 9 months, gave some back, and then consolidated quickly with net gains of around 44%. The only major difference is the contraction in the current rally, which was less severe than the one in 2006 and much shorter in duration, but has resulted in almost the same net gain. The gold market is showing excellent resilience, attributable in large part to the world's growing desire for assets that offer protection and profitability in times of major financial turmoil and inflationary fiscal policies. Clearly, gold shines in these conditions and will continue to do so. In fact, a growing chorus of financial gurus is calling for gold prices in excess of $2,000 and even $3,000 an ounce. We continue to believe that gold will move over $1,200 to as high as $1,800 or $2,000 before this bull market runs its course. We've been saying this publicly since 2001, when we first published our special report, Gold at $1,700? You Better Believe It!
Silver has been on a tear. It pushed over $20 an ounce for the first time in this bull market, reaching as high as $20.78, and looked like it would hold on to most of those gains before the Bear Sterns bail out was announced. Subsequent profit-taking pushed it sharply lower when speculators headed for the exit door. As we've said in the past, silver can be much more volatile than gold during market corrections. It quickly consolidated with support above $17.00 and is now trying to establish a $17.75 to $18.25 trading range. We continue to believe silver is undervalued below $18.50 and fairly valued in the $19.50 to $20.50 range for now.
Physical silver has suddenly become a very hot commodity. Twice this year, for the first times ever, the U.S. Mint suspended sales in mid-year of the popular 1-ounce American Silver Eagle coins. While the Mint always stops selling bullion coins for a week or two when it closes out a yearly issue, these mid-year suspensions are unprecedented. Quickly following suit, the Canadian and Austrian mints also suspended sales of their own 1-ounce silver bullions coins. The reason for these stoppages is because physical demand for silver has completely outstripped available above ground-supplies and, until further notice, these three mints are not delivering silver coins to authorized dealers. During our nearly 30 years in the precious metals markets we've never seen this happen! We expect sales to resume in the near future, but the suspensions are yet more evidence of how hot the metals markets—and how odd the world's finances—have become.
Fortunately for our customers, we do have a great offer on physical silver: Canadian Silver Dollars in Brilliant Uncirculated condition, pictured below. Minted from 1936 to 1966, these classic silver dollars are the last issues from the era of real silver coinage, containing 0.60 ounces of pure silver in each coin. We highly recommend them as a best buy in bulk silver today.
Platinum and palladium
Platinum and palladium have both corrected sharply since they went stratospheric two months ago following the announcement of severe problems with electricity in South African mines. We correctly anticipated, because the mining problems were manmade, that they would be addressed quickly and market equilibrium would soon return. When a market with an existing supply deficit is hit with a delivery problem, prices are destined to spike as speculators pile in. When the problem is solved, the speculators flee just as quickly and prices drop. This dynamic is exactly what happened with platinum and palladium, and it's the reason why they've corrected more sharply than gold and silver.
As you can see, platinum made a 43% gain this year, moving from just under $1,600 to $2,280 an ounce before the inevitable correction occurred. After bottoming at $1,880, it has settled into a $1,950 to $2,050 trading range for a net gain of around 25%. Platinum has been a great speculative investment for people with nerves of steel and the time to watch it trade every day. For most us, however, this market has been too highly priced and volatile, so we've stayed out for the most part, as our regular readers know. With platinum still so highly valued relative to gold, silver, palladium, and classic U.S gold coins, we'll continue to side-step this market. Making price predictions from these lofty levels is very difficult: platinum could move $200 lower just as easily as $200 higher. We like the odds offered by gold, silver, palladium, and classic U.S. gold coins much more.
Palladium made a huge 52% gain in price this year, rising from $385 to a peak of $585 before correcting sharply. As the graph shows above, it has given up most of the speculative gains achieved during the mining problems. Today it seems fairly valued in the $445 to $465 price range. It's a great buy under $400 and a good buy under $425. At $450 we're neutral, although we expect palladium to challenge the $500 level over the next twelve months. Buy on the dips and don’t sell until we see $500 or higher. And congratulations to our customers who took profits over $500 last month!
Classic gold coins ready to surge
Classic U.S. gold coins have lagged precious metals during this year's rally, but they're beginning to heat up. Most of the myriad new investors entering the market have been bullion buyers driven, understandably, by the fear of bank failures. The market psychology reminds us of the Y2K scare (remember that?), when bullion was selling like hot cakes and coin sales lagged. Our favorite coins have proven to be far less volatile than precious metals and offer superior opportunities now. When gold, silver, platinum, and palladium all fell sharply, most of our recommended coins barely budged. The exceptions were the commonest coins most directly tied to the gold price.
Now is an excellent time to stock up on U.S. gold coins. Although dealer inventories remain remarkably low, most of our favorites are still undervalued relative to gold and silver bullion by 10% to 25% or more, and are ready to move up. While there are millions of ounces of gold and silver in the world, the survival rates of the coins we like are under 100,000 known specimens, and, in many instances, under 25,000. And remember that only tiny percentages of these known survivors are available in the national market at any time. When the markets rally, this scarcity can add sizeable—sometimes immense—leverage to the rising gold price.
As we said above, a sense of normalcy has temporarily returned to the major financial markets. Investors are beginning to invest again and classic U.S. gold coin sales are picking back up, despite the fact that we're in tax season. Savvy investors who understand how much leverage classic U.S. gold coins offer through their scarcity are taking advantage of the lag in price. We urge you to do the same.
Above is our Hard Asset Scorecard since the latest gold rally began last summer. You can see how precious metals were leading most U.S. gold coins through the metals peak in mid-March, and how coins held their values during the correction. The coins with the red asterisks were our top recommendations last August. Two out of three have proven to be top net performers. The coins in blue are our current top recommendations. Our policy at American Gold Exchange is transparency, and we're proud of our track record. Congratulations to our customers who bought our recommended U.S. gold coins last fall!
In the current market we highly recommend the following classic U.S. gold coins.
For conservative investors who want to build or add to their core holdings:
British Gold Sovereign “Kings” (scarce European gold at common bullion price)
Power Pair #1 (undervalued by 10% right now)
Power Pair #2 (undervalued by 20% or more right now!)
For investors who want the potential for greater returns:
$10 Liberty MS64 (previous market high $6,300)
$10 Indian MS64 (previous market high $6,300)
As you probably know already, the price of oil has also set records over the last six weeks, rising to more than $112 per barrel. With the dollar's fall continuing and financial markets roiled by the credit crunch, commodities like oil have been drawing increasing numbers of investors. Expensive oil and gas are now facts of life, and we can expect them to get even more expensive in the future. Goldman Sachs sees average selling prices of $95 a barrel for 2008, $105 for 2009, and $110 for 2010. The high end of Goldman's predicted range is $135 a barrel—but they warn that prices could be headed far higher because of supply restrictions and exploding demand. Goldman now predicts a peak oil scenario of $200 per barrel, which is astonishing to contemplate. (See full story.) Because gold trades as a commodity and currency, any peak oil scenario will lead to significantly higher gold prices.
For those of you who don’t quite understand why precious metals and oil have risen so high over the last three years, this picture is worth a thousand words. We’ve talked at length in previous updates about how much the dollar has fallen in value since 2002, and about how critical the support level at 80 on the U.S. dollar index chart was for the health of the greenback. We wrote on June 20, 2007 that if the dollar fell 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%. That has proven to be the case. (Read the article.)
Since last summer the dollar has finally succumbed to the cumulative weight of massive debt, continued reckless deficit spending, and a weakening U.S. economy. The subprime debacle that began last August has proven to be the straw that broke the back of the buck, dragging it down to its lowest valuations ever against many other major world currencies. Since the dollar has lost so much purchasing power, everything we import now costs proportionally more. This is inflation at its most basic level, and it's the fundamental reason why so many analysts believe the bull market will continue for the next several years at least, with predictions of $2,000 to $3,000 gold.
Unfortunately, the financial problems we've created for ourselves have yet to be addressed in any responsible or meaningful way by our lawmakers. Until we get our fiscal house in order, there is no reason to believe things will improve for the dollar anytime soon. In fact, we probably won’t see any meaningful improvements until two or three years after we’ve begun to make real changes in our national debt and deficits. Like watchmen on the Titanic, we could see the iceberg looming in the distance. If the dollar were the Titanic, we grazed the iceberg when it dropped below 80 on the index chart last summer. Our focus as a nation should now be on fiscal damage control before any more gashes are opened in the hull. If the ship continues to sink, our luxurious standard of living will sink with it. Gold remains the fiscal life preserver we all need in times of trouble like these.
To most economists, pundits, and investors worldwide—in fact, to just about everyone outside of the current administration, which continues to pass it off as little more than a "rough patch"—the U.S. recession is established fact. Even Chairman Bernanke is beginning to whisper the "R" word, so you know things are worse than they seem, and they don’t seem good. Aside from the Fed bailout of Bear Sterns and the recent false-spring rally it triggered in stocks, financial news is almost relentlessly grim. Housing values continue to plummet, leading to record foreclosures and the outright abandonment of homes. Debts, personal and national, continue to mount. Oil and gasoline have passed through the stratosphere on their way to the ionosphere. And we still can’t see to the bottom of the subprime mortgage sinkhole through all the murk. Banks will continue to write down multi-billion dollar losses until all of the toxic waste is unearthed, and that could take another year or more. Indeed, economists are now saying we won’t be confidently out of the subprime crisis until a full year has passed since the final write down has been announced, whenever that might be. In the mean time, with credit paranoia rampant, the wheels of commerce can only grind in place if they grind at all.
The only real debates are whether this recession will be deep or shallow, lengthy or brief. Structural changes in the U.S. economy mean the current economic slowdown could be milder in terms of job losses than the usual recession, but it could also last much longer before robust employment growth picks up again. To be sure, there are residual strengths in the economy, including the aggressive stimulus from the Congress and the Federal Reserve. And while the banking system and consumers are up to their ears in dicey debt, much of the corporate sector is in good financial shape and inventories are at very low levels. According to Neal Soss, head of U.S. economics at Credit Suisse, these factors "could limit the severity of the downturn, although we suspect that the credit excesses that need to be unwound imply a lengthy period of sluggish growth even after the worst of the cyclical adjustment is behind us" (see full story).
But many economists—and most American citizens—are not so sanguine about the prospects. In its latest World Economic Outlook, the IMF predicts the U.S. economy will shrink each quarter of this year and remain stagnant through 2009, creating one of the longest recessions of the post-war period. In the past few decades the immense U.S. economy has fallen into recession only twice, in 1990-91 and 2001. Both were relatively shallow and short, averaging around eight months. In both cases, consumer spending, the engine of the economy, barely paused. This time promises to be different. Consumers are caught in a perfect storm of falling asset values (especially their homes, which many have used as an ATM for most the past decade), super-tight credit, steeply higher food and energy costs, and rising unemployment.
Consumer sentiment is beginning to show the strain. According to a recent New York Times poll, more than 82% of Americans think general conditions are getting worse. And last week the Reuters/University of Michigan consumer sentiment index, one of the most widely respected barometers of public opinion about the economy, fell to 63.2, its lowest point since 1982. Only twelve times in survey's 50-year history has confidence been lower, according to Index Director Richard Curtin. And the Conference Board's measure of consumer confidence is even grimmer, reaching its lowest level since the deep and nasty recession of 1973. Because U.S. shoppers account for 70% of GDP, the prospects for spending our way out of this recession are approaching nil.
The housing bubble played a big part in getting us into this mess, and only recuperation in the now-exploded housing market will get us out of it. But don’t hold your breath. New housing construction starts are at less than half of their peak and builders are continuing to cut back. National inventories of unsold homes are approaching a 10-month supply, which is a 26-year high. And because of this excess supply, prices are plummeting, off 13% since their peak so far. In the last quarter of 2007, they fell at an annual rate of 25%, according to the S&P/Case-Schiller index. As a result, according the Economist, more than 10% of mortgage holders are now upside down on their loans, owing more on their house than it's worth! More than 6% are behind in their mortgage payments, and when only subprime mortgages are considered, the number climbs to 17%. Lenders are already foreclosing on more than a million homes and the totals will only increase, driving down prices even further. But even after the housing market recovers it'll take a long time before Americans feel wealthy again. With disappearing home equity, monumental credit card debt, and a national savings rate of merely 0.3% of income, there's little left to spend.
Inflation and the dollar
We've said for years now that the easy money policies of the Federal Reserve and other central bankers are a main culprit behind the recent housing bubble, and the tech bubble before it. Money supply, both at home and abroad, has gone through the roof, encouraging excessive risk-taking and debt, and precipitating hedge fund failures, collapsed investment banks, and rising individual bankruptcies. So while the Fed's recent injections of massive mounts of liquidity into seized credit markets may have prevented a systemic meltdown, its longer-term consequences won't be so healthy.
Money is being printed at a faster rate than ever before, and the result will surely lead to higher inflation and a weaker dollar. According to economist John Williams, the broadest measure of the national money stock, known as M3, grew at an annual rate of 17.2% in March, the most in history. Williams publishes The Shadow Government Statistic Newsletter, which tracks distortions in government statistics used to produce the official figures for CPI, PPI, GDP, money supply, and more. While his rhetoric can be a bit inflammatory (he's ticked off at the distortions, and who can blame him?), his figures and conclusions carry weight because he was one of the original creators of the Consumer Price Index, so he knows his stuff. Like the renowned economist Milton Friedman, among others, he believes M3 growth, which the U.S. government conveniently stopped reporting a year ago, is a better gauge of inflation than the CPI. After all, to paraphrase Friedman, inflation is always and everywhere a monetary phenomenon; the more money in the system, the less its worth in real buying power. So rather than the 4.2% inflation rate claimed by the government, the real inflation rate is far higher—well into double-digits, according to Williams' measurements—which comes as little surprise to any of us when we look at our household budgets. His website is rich in statistics and thought-provoking analysis, and we recommend a perusal.
So the Fed's recent actions will fan the flames of inflation and help to undermine the U.S. dollar, which is teetering already. Last quarter it plummeted against the 16 most actively-traded currencies except the Canadian dollar, South Korean won, and South African rand. It declined the most against the Swiss franc (12.4%) but also posted its biggest quarterly decline against the euro since 2004 (7.6%) and its largest slump against the yen in almost a decade (10.8%).
The near future doesn’t look much better. Deutsche Bank AG, the world's largest foreign-exchange trader, and Royal Bank of Scotland Group Plc cut their dollar estimates last month as global credit market losses climbed above $200 billion and reports of the U.S. recession started pouring in. Deutsche Bank expects the dollar will weaken this quarter to $1.60 per euro, the lowest since the European currency began trading in 1999. Royal Bank of Scotland in Edinburgh, the fourth-biggest foreign-exchange trader, forecasts the dollar will trade at $1.57 per euro by June 30.
"We now view the U.S. economy as having slipped into recession while the rest of the world slows more modestly,'' said John Horner, a currency strategist for Frankfurt-based Deutsche Bank. That scenario "argues for further dollar weakness,'' he said. International asset managers and arbitrage traders tend to agree. "We hold a bearish dollar outlook,'' said Thanos Papasavvas, London-based head of currency management at Investec Asset Management; "It's impossible to forecast where the bottom is going to be'' (see full story).
These gloomy predictions are mainly in response to the deepening U.S. recession. Factor in the widespread belief that mounting subprime losses will force even tighter credit and more major write downs in the financial sector in coming months, and the future of the buck looks even darker. "There are great concerns about additional unrealized losses on subprime loans, the size of which we can't reasonably forecast,'' says Hiroaki Hoshi, who oversees the equivalent of about $5.7 billion as a senior fund manager at Daiwa Asset Management Co. in Tokyo. "Once these are realized, the dollar will fall,'' he said. Banks, brokers, and hedge funds may report $460 billion more in credit losses, Goldman Sachs predicted last month.
As we've said before, if the Fed cuts rates further to stanch the wounds of the subprime credit crisis and stave off recession, not only will it increase inflation, it will also encourage foreign investors to dump even more dollars and U.S. assets. If the dollar loses too much value, these foreign holders of our dollar-denominated assets could easily abandon ship, leaving our stock and bond markets to sink along with the buck. Indeed, the abandonment of U.S. assets is already underway. China announced a few months ago that it plans to diversify part of its gargantuan currency reserves out of the weakening dollar. Foreign investors have slashed their holdings of U.S. securities by huge amounts in recent months as the credit squeeze has intensified. According to the latest Treasury figures, foreign investors sold a net $38.2 billion in U.S. securities in January, the most since September.
Once again, the dollar is losing to other major currencies and the gold price, concomitantly, is reaching new record highs. When all of this monetary inflation finds its way into the price indexes—and it's starting to already—gold will be due for even greater gains because it is the primary go-to asset during periods of high inflation.
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 inherently 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 or financial innovation. In this era of dangerous new financial instruments, it's ironic that one of the world's oldest assets is showing its mettle. 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!
As always, thanks for your time!
Dana Samuelson, President
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