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.
7/7/2009: Gold's bullish outlook for 2009
In this issue of AGE's Gold Market Commentary:
Precious metals gaining momentum Precious metals gaining momentum
Physical bullion in short supply
Of TARPS, helicopters, and quantitative easing
Gold's bullish outlook for 2009
Precious metals gaining momentum
As everyone knows by now, the global recession is severe and getting worse. By every measure—from unemployment to housing prices to manufacturing output to consumer confidence—the U.S. economy is plumbing depths not seen in many decades, perhaps since the Great Depression. So in this issue of AGE's Gold Market Update, rather than detail the current economic fundamentals like we usually do, let's take a closer look at the proposed solutions—bailouts—and how they're likely to affect the gold market in 2009 and beyond.
But first, to put things into context, let's review the recent price action in the precious metals and related markets. Following the extreme volatility of September through mid-November, when the gold price dropped by around 20%, precious metals prices have regained their footing and are now moving higher once again. Since mid-December, gold, silver and platinum have all moved above their short-term upside resistance levels and are showing cautious but solid upward momentum. We think this shift bodes very well for gold in the New Year. In fact, as we explain in detail toward the end of this update, we believe gold is well-positioned to have an explosive 2009 and 2010.
Here are the latest charts.
After setting its highest price ever in March 2008, gold entered a classic consolidation phase through July. Then the dramatic commodity sell-off accompanying the first waves of the financial crisis caused price action for gold to become extremely volatile, setting a series of lower highs and lower lows through mid-November. The blue lines on the one-year chart above show this downward trend, which began to reverse itself in mid-November.
Gold has been trending higher since the November bottom and is now in breakout mode, as indicated by the red circle. The movement above its downward trend line in mid-December was the first indication that gold was finally regaining its footing. The small, W-shaped bottom at $840 and, more importantly, the follow-through move over $870 in late December have given us the confirmation we’ve been looking for that price momentum has shifted to the upside.
Gold should enjoy solid support at $840 as it climbs to a higher trading range. Although it may experience technical resistance at $905 to $910, we believe will move higher and test resistance at $950 to $970 in coming weeks or months. So we look for gold to establish an $840 to $940 trading range throughout January and February with bias towards the high side in the near term.
Silver set a new high for the 21st century in March of 2008, followed by a consolidation period through mid-July before selling off dramatically through October, forming a double-bottom in October and November at just below $9.00. Now it's moving higher once again, as indicated by the blue trend lines on the chart above. This chart shows very strong support at just under $9.00. During its bottoming phase silver was unable to break $10.50; in December, it broke that barrier and has been holding its gains, establishing the steady uptrend channel we see above.
Trading today at 2005 to 2006 price levels, silver is the most undervalued of the four traditional precious metals. In the current environment, it offers tremendous value under $12.00. We expect to see silver priced between $12.50 and $14.50 in coming months.
Like silver, platinum peaked in March, consolidated, and then suffered a stunning sell-off. It's now trading at its lowest prices since 2003, though developing a solid uptrend channel in the $900 to $1,050 range, with momentum clearly towards the upside. Platinum should track the gold price in the near term. If gold climbs above $950, as we expect it will, platinum will likely see similar gains. Our readers know we've shunned platinum over the last five years because it became so overvalued relative to gold and palladium, its sister metal. Trading today at about a $100 premium to the gold price, or a little more than 10%, platinum is now reasonably priced for the first time in five years.
Our valuation formula for platinum is relatively simple. Buy when it's priced at 90% to 120% of the gold price and sell it when it hits 140%. Since the early 1980s, this has been the standard gold-to-platinum price ratio. Today platinum is about 110% of the gold price, so it’s a buy. The problem is that we cannot source platinum from any of the world’s major bullion producers. Dealers who have platinum for physical delivery are quoting at least 10% above the spot price, if not more, which we believe to be an excessive premium.
Palladium continues to consolidate in price following its sharp July to October sell-off. Currently trading at $200, it remains in a bottoming phase, establishing a firm $185 to $215 trading range. Until it moves over $225 it will not be in a firm uptrend, in our opinion. Gold and silver have monetary value in addition to their industrial use as commodities. Platinum is popular in jewelry in addition to its commodity value. Palladium, however, remains primarily a commodity—a cheaper if less flexible alternative to platinum. Widely used in catalytic converters, it is suffering along with the automobile industry, so we see little reason for palladium to make a strong move to the upside in the near term. Rather, we think it'll continue to consolidate for a month or two in its current trading range.
Ironically, one of the few investments that actually gained in 2008 was the U.S. dollar! After dropping almost continuously for three straight years, it rallied sharply in the second half of 2008, reaching its highest point on the U.S. dollar index chart since 2006. We think it’s a short-term bubble that inflated sharply in October and November but started bursting in December. In fact, the dollar index chart now shows a clear head-and-shoulders formation developing, which suggests further declines are likely.
We said it last time and it still holds: more than anything else, the buck's counter-trend strength has been a result of reflexive flights to safety in U.S. Treasuries during the economic meltdown. In order for foreign investors to buy Treasuries, they must first convert to dollars, which drives up their value. It matters little that the dollar is yielding little; cash is king during periods of extreme risk aversion, and U.S. Treasuries, for all of our deep fiscal problems, are still considered the world's safest bet.
So far the dollar has benefited from the crisis but for how long? Its underlying fundamentals could not be much worse and they're deteriorating. The U.S. economy is weaker than those of most other developed nations, our interest rates are lower, and our budget and trade imbalances are much, much worse. Inflation was higher in the U.S. than in most of the G8 nations before the crisis; and given the staggering increases in our monetary base as a result of the bailouts (discussed in detail below), inflation is likely to be much higher in the future. When the world's finances begin to stabilize again and the current bubble in Treasuries sells off, we're likely to see a massive dumping of dollars. Gold, of course, because it's denominated in dollars, will see huge increases in demand and value.
As the one-year chart shows, few commodity prices suffered more than oil over the last six months. After rising steadily for four years it's now back to 2004 prices. During oil's six-month decline, the price of gold almost completely decoupled from the price of oil— after trading in lock-step, and inversely with the U.S dollar, since 2004. We expect the normal, negative correlation between gold and the dollar to continue, but the positive correlation between gold and oil might not. We'll have to see whether OPEC gooses the price by constricting supplies, as they've said they will, and how the current global recession unfolds.
Physical bullion in short supply
As many of you probably know, supplies for physical gold for immediate delivery, especially modern bullion coins, have been severely strained during the last three to four months. Record demand completely overran existing “on the shelf” supplies of gold from mid-September through November. In December, demand returned to relatively normal levels but supplies remain strained. Mints around the world have been scrambling to meet backorders, often interrupting deliveries. Finally, we're beginning to see some parity between physical supply and demand but we're not back to normal market conditions. Buy/sell premiums for all forms of physical gold remain higher than normal, though they're starting to inch back down to pre-October levels as government mints are catching up.
The U.S. Mint continues to allocate 1-ounce U.S. gold eagles in burps and spasms, but there have been no half-ounce, quarter-ounce, or tenth-ounce allocations for months now. We do not expect to see any fractional gold eagle allocations for the foreseeable future.
Classic European gold coins
We highly recommend classic European gold coins as a superior substitute for modern gold bullion coins. Minted mostly pre-1935, these classic coins from many nations offer all of the benefits of bullion plus additional ones like extremely limited supply, constant collector demand, and complete financial privacy. Few investors are aware of them. Because of their fundamental scarcity, these classic gold coins have the potential to gain faster than bullion during a rising gold market. Plus, they're steeped in history and often quite gorgeous in design.
Although supplies of classic European gold coins remain tighter than normal and buy/sell premiums remain higher, they're the only smaller-sized, bullion-related gold coins reliably available for immediate delivery, and will be for the foreseeable future. The best values can be found in Swiss 20 franc "Helvetias", French 20 franc "Roosters", and the slightly larger Dutch 10 guilder "Queens", all in Brilliant Uncirculated condition.
Circulated U.S. gold coins
In lieu of modern gold bullion and classic European gold coins, many of our customers are buying common date U.S. gold coins, minted pre-1933, in Almost Uncirculated condition. For the same reasons as European gold coins—true scarcity, complete financial privacy, and added profit potential—we prefer these classic U.S. coins to modern bullion.
We favor the larger-sized U.S. $20 Liberty, U.S. $20 Saint-Gaudens, and U.S. $10 Liberty gold coins in Almost Uncirculated condition as providing the best values today. All are highly recommended and ready for immediate delivery.
Silver bullion has been in extremely short supply since September, too. During the last few months, the U.S. Mint intermittently suspended sales of their popular 1-ounce American Silver Eagles, and the Royal Canadian Mint stopped deliveries of 1-ounce Canadian Silver Maple Leafs. As we enter 2009, supplies of the both remain spotty at best.
Fortunately for our silver investors, we've been able to source a limited supply of U.S. 'junk' silver coins, which are pre-1964 dimes, quarters, and half dollars all containing 90% pure silver. And we also have high quality 1-ounce silver rounds, which are privately manufactured .999 fine silver coins that meet our high standards of purity and minting. Both are inexpensive and efficient ways to own silver bullion and are highly recommended.
We have not been able to source any platinum or palladium since October 2008. We expect this drought to continue. These days, the only platinum or palladium available for immediate physical delivery is from the secondary market, not the mints, so premiums are prohibitively high, anyway.
Of TARPs, helicopters, and quantitative easing
The U.S. government has pledged a staggering $8.5 trillion dollars to a variety of bailout programs, of which $3.2 trillion has been spent thus far, according to the San Francisco Chronicle and Bloomberg. The Treasury Department's $700 billion Troubled Asset Relief Program (TARP) has received all the media attention but it's only one small fraction of the total cost. With little fanfare, the Federal Reserve has dedicated more than $5.5 trillion in a series of fifteen obscure and confusing programs; the FDIC has three programs totaling $1.5 trillion; the Treasury Dept. has three totaling $1.1 trillion; and the Federal Housing Association will give away $300 billion. Most alarming is the Fed's $5.5 trillion. An independent entity, the Fed needs no congressional approval to disburse the funds, nor must it provide any public accountability for how the funds are spent. So much for the official statements that these bailouts would be transparent!
All of these programs commit taxpayer money for loans, credit guarantees, mortgage renegotiations, equity investments in financial companies, and outright subsidies. Their immediate goal is to get frozen credit markets working again. To this end, the Fed slashed interest rates in December to 0.25%, though the actual impact on lending is likely to be minimal because rates were already so low and banks continue to sit on their money. Despite the fact that yields on short-term Treasuries have reached into negative territory, U.S. companies are still paying the highest borrowing costs on record, an average of 10.8% on their debt in November, up from 6.53% last January, according to Merrill Lynch.
And while inter-bank lending rates and the TED spread have fallen since Congress approved TARP, most bank lending to consumers remains tight and interest rates high. The Fed said consumer credit fell by $6.4 billion in August, the largest drop in 65 years, and then by $3.5 billion in October, the first time since 1992 that there were two months of declines in a year, according to Bloomberg. The average rate on credit cards was 14.33% on Dec. 16, according to IndexCreditCards.com in Cleveland, almost the same as in October 2007, when it stood at 14.41%. As Chairman Bernanke said on December 1, "at this point the scope for using conventional interest rate policies is obviously limited."
Unconventional times call for unconventional measures, and the one Ben has in mind is known as "quantitative easing," which is Fed-speak for cutting interest rates effectively to zero and flooding the economy with immense quantities of newly printed money. It is what economist Milton Friedman referred to when he famously declared that government could combat deflation simply by dropping money from helicopters. In a 2002 speech to the National Economists Club entitled, "Deflation: Making Sure 'It' Doesn't Happen Here," Bernanke cited Friedman's approach with approval and earned himself the nickname, "Helicopter Ben." Now it looks like he's ready to make good on his moniker.
While it only became official policy in early December, quantitative easing has really been underway since the Lehman failure in mid-September, which prompted the Treasury to issue $558 billion of "supplemental financing" securities to protect the financial markets. Paulson and company deposited the proceeds with the Fed, and the Fed used the money to carry out various rescue operations. All the money needs to be repaid to the Treasury. How will the Fed do that and still fund its ongoing rescue facilities for troubled banks, brokers, insurers, money market funds, etc.? They'll print $558 billion in crisp new bills. They have no other choice.
Similarly, according to a plan announced in late November, the Fed will directly buy at least $600 billion in mortgage-backed assets, starting this month. The money will not come from its balance sheet. Instead, as the New York Federal Reserve website states in its FAQ section, "these operations will be financed through the creation of additional bank reserves." Translation: the Fed is simply going to print the money.
And whence the rest of the Fed's $5.5 trillion in pledged bailouts? We think you know the answer: printing press.
It all adds up to a mind-bending volume of new fiat money flooding the economy. Prior to the Lehman collapse in mid-September, the Fed had been offsetting the impact of its new lending facilities by selling Treasury bills, which drains away the excess funds. Not anymore. "The Fed doesn't like to talk about this," said Simon Johnson, a former chief economist of the IMF and a professor at the MIT Sloan School of Management, to Forbes recently. "They think it will scare people."
Quantitative easing may, indeed, be the only way to heal the markets and the economy but there's no guarantee it'll work. The Bank of Japan embraced it with little success from 2001 to 2006. The Fed is being far more aggressive than the BOJ: in its first year of quantitative easing, Japan increased total bank reserves fivefold; the U.S. has increased reserves by nearly fourteen fold in about two months, according to Capital Economics in London. The more the merrier, we can only hope.
The long-term inflationary risks of quantitative easing are extremely high. Pushing the economy to re-inflate is, after all, the whole point of the Fed's strategy. In principle, inflation is good in small doses because it encourages current consumption and makes debt more affordable over time, stimulating consumption and GDP growth. But with so much new money in the system, inflation is going to be extremely difficult to contain once the current deflationary spiral ends. According to John Williams' Shadow Government Statistics, the growth of M3, the economy's broadest measure of money supply, rose in December to 10.4%, up from 8.9% the month before. He projects M3 growth to hit 18% or higher in the first quarter of 2009, exceeding even the record-high 17.4% recorded last March. Furthermore, the St. Louis Fed Monetary Base, which is the Fed's normal instrument for manipulating the money supply, almost doubled in 2008, with the lion's share of its expansion coming in the last quarter of the year.
Surely, with deflation sending trillions of dollars to money heaven, the Fed will have to print a lot of more just to stay even. Nonetheless, monetizing debt to this extreme creates the perfect environment for massive price inflation and a profound devaluation of the dollar—things that Chairman Bernanke has acknowledged but dismisses as issues for the future. "For now," he says, "the goal of policy must be to support financial markets and the economy." In other words, whatever it takes. But when credit eases and the threat of deflation recedes, inflation is likely to be upon us faster than you can say the TARP is off the helicopter, and gold will be a big beneficiary.
Gold's bullish outlook for 2009
The silver lining, at least for gold investors, is that 2009 is shaping up to be a very big year for the gold market. Certainly, precious metals have been in turmoil. Paper gold moved into "backwardation" recently for the first time, with futures contracts priced more cheaply than actual bullion prices. One main reason is because hedge funds and other large, leveraged investors are being forced to sell gold futures to cover losses elsewhere and meet redemptions by clients, driving down the paper gold prices. The global hedge-fund industry lost $64 billion in November, on top of $110 billion in October, and more losses are on the way, according to Bloomberg.
At the same time, however, as we said above, physical gold is seeing record increases in demand. Retail investors—and perhaps some big players—are buying gold coins and bars in record amounts to store in vaults and safe deposit boxes. The latest data from the World Gold Council shows that demand for coins, bars, and ETFs doubled in the third quarter to 382 tonnes compared to a year earlier. Demand for gold had reached an all-time quarterly record of $32 billion between July and September, 45% higher than the previous record in the second quarter of 2008.
And global demand for physical gold should only increase. China is now talking about dramatically increasing its reserves, a move that would have huge ramifications for the gold price. China has the world's largest foreign-exchange reserves at an estimated $1.9 trillion, and it's also the largest overseas holder of Treasuries after Japan. Legitimately concerned that TARP and its associated measures will cause significant declines in the U.S. dollar and Treasuries, and aware that gold will climb as a result, China may increase its physical reserves by up to five times, from its current 600 tonnes to several thousand, according to Bloomberg.
Indeed, in the potentially hyperinflationary environment produced by quantitative easing, commodities in general are likely to soar as the dollar deteriorates. Legendary investor Jim Rogers, who co-founded the Quantum Fund with George Soros, believes commodities, and especially gold, are the only assets for which the fundamentals are unimpaired after the credit disaster. “Commodities will be the place to be if and when we come out of” the downturn, Rogers told Bloomberg recently. “I own some gold and if gold goes down I’ll buy some more and if gold goes up I’ll buy some more. Gold during the course of the bull market, which has several more years to go, will go much higher.”
Even Morningstar, which typically has little use for hard assets, is now looking toward gold as one of the best investments on the horizon: "What we are arguing is that in either mode of general pricing instability—inflation or deflation—gold is making a strong case as a disaster hedge. Even those who sit in the 'deflation today, inflation tomorrow' camp can look to establish their gold position today rather than trying to time the market."
And Citigroup agrees that gold is the asset of choice for 2009 and beyond. In a recent internal note to clients, as reported by the U.K. Telegraph, the U.S. banking giant argues that gold could blast through $2,000 in 2009 as central banks flood the world's monetary system with money.
"They are throwing the kitchen sink at this," said Tom Fitzpatrick, Citigroup's chief technical strategist. "The world is not going back to normal after the magnitude of what they have done. When the dust settles this will either work, and the money they have pushed into the system will feed though into an inflation shock. Or it will not work because too much damage has already been done, and we will see continued financial deterioration, causing further economic deterioration, with the risk of a feedback loop."
Citigroup concludes that the global gamble on bailouts and quantitative easing is likely to end in one of two extreme ways: with a powerful resurgence of inflation or a "downward spiral into depression, civil disorder, and possibly wars." Both outcomes, they say, "will cause a rush for gold." We think war and civil disorder are far less likely than massive inflation. But taking all the risks and conditions together, we have to agree with Citigroup that demand for gold will escalate in either environment. Now more than ever, gold is the asset of choice for protecting wealth in 2009 and beyond. We urge you to stock up while prices are still at bargain levels!
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