“Policymakers Should Be Cautious Seeing Gold’s Drop As A Vote Of Confidence”

In principle, holding gold is a form of insurance against war, financial Armageddon, and wholesale currency debasement. And, from the onset of the global financial crisis, the price of gold has often been portrayed as a barometer of global economic insecurity. So, does the collapse in gold prices – from a peak of $1,900 per ounce in August 2011 to under $1,250 at the beginning of July 2013 – represent a vote of confidence in the global economy?

To say that the gold market displays all of the classic features of a bubble gone bust is to oversimplify. There is no doubt that gold’s heady rise to the peak, from around $350 per ounce in July 2003, had investors drooling. The price would rise today because everyone had become convinced that it would rise even further tomorrow.

Doctors and dentists started selling stocks and buying gold coins. Demand for gold jewelry in India and China soared. Emerging-market central banks diversified out of dollars and into gold.

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The case for buying gold had several strong components. Ten years ago, gold was selling at well below its long-term inflation-adjusted average, and the integration of three billion emerging-market citizens into the global economy could only mean a giant long-term boost to demand.

That element of the story, incidentally, remains valid. The global financial crisis added to gold’s allure, owing initially to fear of a second Great Depression. Later, some investors feared that governments would unleash inflation to ease the burden of soaring public debt and address persistent unemployment.

As central banks brought policy interest rates down to zero, no one cared that gold yields no interest. So it is nonsense to say that the rise in the price of gold was all a bubble. But it is also true that as the price rose, a growing number of naïve investors sought to buy in.

Lately, of course, the fundamentals have reversed somewhat, and the speculative frenzy has reversed even more. China’s economy continues to soften; India’s growth rate is down sharply from a few years ago. By contrast, despite the ill-advised fiscal sequester, the US economy appears to be healing gradually. Global interest rates have risen 100 basis points since the US Federal Reserve started suggesting – quite prematurely, in my view – that it would wind down its policy of quantitative easing.

With the Fed underscoring its strong anti-inflation bias, it is harder to argue that investors need gold as a hedge against high inflation. And, as the doctors and dentists who were buying gold coins two years ago now unload them, it is not yet clear where the downward price spiral will stop. Some are targeting the psychologically compelling $1,000 barrier.

In fact, the case for or against gold has not changed all that much since 2010, when I last wrote about it. In October of that year, the price of gold – the consummate faith-based speculative asset – was on the way up, having just hit $1,300. But the real case for holding it, then as now, was never a speculative one. Rather, gold is a hedge. If you are a high-net-worth investor, or a sovereign wealth fund, it makes perfect sense to hold a small percentage of your assets in gold as a hedge against extreme events.

Holding gold can also make sense for middle-class and poor households in countries – for example, China and India – that significantly limit access to other financial investments. For most others, gold is just another gamble that one can make. And, as with all gambles, it is not necessarily a winning one.

Unless governments firmly set the price of gold, as they did before World War I, the market for it will inevitably be risky and volatile. In a study published in January, the economists Claude Erb and Campbell Harvey consider several possible models of gold’s fundamental price, and find that gold is at best only loosely tethered to any of them. Instead, the price of gold often seems to drift far above or far below its fundamental long-term value for extended periods. (This behavior is, of course, not unlike that of many other financial assets, such as exchange rates or stock prices, though gold’s price swings may be more extreme.)

Gold bugs sometimes cite isolated historical data that suggest that gold’s long-term value has remained stable over the millennia. For example, Stephen Harmston’s oft-cited 1998 study points to anecdotal evidence that an ounce of gold bought 350 loaves of bread in the time of Nebuchadnezzar, king of Babylon, who died in 562 BC. Ignoring the fact that bread in Babylon was probably healthier than today’s highly refined product, the price of gold today is not so different, equal to perhaps 600 loaves of bread.

Of course, we do not have annual data for Babylonian gold prices. We can only assume, given wars and other uncertainties, that true market prices back then, like today, were quite volatile.

So the recent collapse of gold prices has not really changed the case for investing in it one way or the other. Yes, prices could easily fall below $1,000; but, then again, they might rise. Meanwhile, policymakers should be cautious in interpreting the plunge in gold prices as a vote of confidence in their performance.

Source: http://www.zerohedge.com/news/2013-07-08/ken-rogoff-policymakers-should-be-cautious-seeing-golds-drop-vote-confidence

We Are Beginning To Approach The End Game

With tremendous volatility continuing in global markets this summer, John Williams, of Shadowstats, released an incredibly important report which contained an ominous warning.  Below is a key portion of this tremendous report, and King World News wanted to pass it along to our global readers:

Here is the ominous warning from John Williams of Shadowstats:

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Beginning to Approach the End Game.  “Nothing is normal: not the economy, not the financial system, not the financial markets and not the political system.  The financial system still remains in the throes and aftershocks of the 2008 panic and near-systemic collapse, and from the ongoing responses to same by the Federal Reserve and federal government.  Further panic is possible and hyperinflation remains inevitable.

Typical of an approaching, major turning point in the domestic- and global-market perceptions, bouts of extreme volatility and instability have been seen with increasing frequency in the financial markets, including equities, currencies and the monetary precious metals (gold and silver).  Consensus market expectations on the economy and Federal Reserve policy also have been in increasing flux.  The FOMC and Federal Reserve Chairman Ben Bernanke have put forth a plan for reducing and eventually ending quantitative easing in the form of QE3.  The tapering or cessation of QE3 is contingent upon the U.S. economy performing in line with overly-optimistic economic projections provided by the Fed.  Initially, market reaction pummeled stocks, bonds and gold.

Source: http://kingworldnews.com/kingworldnews/KWN_DailyWeb/Entries/2013/7/3_John_Williams_-_We_Are_Beginning_To_Approach_The_End_Game.html

Gold Bug Bashing, 1976 Edition

The Golden Cycle

The New York Times had the definitive take on the vicious sell off in gold. To summarize one of their articles:

Two years ago gold bugs ran wild as the price of gold rose nearly six times. But since cresting two years ago it has steadily declined, almost by half, putting the gold bugs in flight. The most recent advisory from a leading Wall Street firm suggests that the price will continue to drift downward, and may ultimately settle 40% below current levels.

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The rout says a lot about consumer confidence in the worldwide recovery. The sharply reduced rates of inflation combined with resurgence of other, more economically productive investments, such as stocks, real estate, and bank savings have combined to eliminate gold‘s allure.

Although the American economy has reduced its rapid rate of recovery, it is still on a firm expansionary course. The fear that dominated two years ago has largely vanished, replaced by a recovery that has turned the gold speculators’ dreams into a nightmare.

This analysis provides a good representation of the current conventional wisdom. The only twist here is that the article from which this summary is derived appeared in the August 29, 1976 edition of The New York Times. At that time gold was preparing to embark on an historic rally that would push it up more than 700% a little over three years later. Is it possible that the history is about to repeat itself?

At the time The Times article was written gold had fallen to $103 per ounce, a decline of nearly 50% from the roughly $200 it had sold for in the closing days of 1974. The $200 price had capped a furious three-year rally that began in August of 1971 when President Nixon “temporarily” closed the gold window and allowed gold to float freely. Prior to that decision gold had been fixed at $35 per ounce for nearly two generations. That initial three year 450% rally had validated the forecasts of the “gold bugs” who had predicted a rapid rise in gold prices should the dollar’s link to gold be severed. The accuracy of these formerly marginalized analysts proved to be a bitter pill for the mainstream voices in Washington and Wall Street who, for reasons of power, politics and profit, were anxious to confine the “barbarous relic” to the dustbin of history. Incredulous as it may seem now, with gold still priced at $35 per ounce, official forecasts of both the Secretary of the Treasury and the Chairman of the Federal Reserve were that demonetizing gold would undermine its value, and that its price would actually fall as a result.

Of course government experts could not have been more wrong. Once uncoupled from the dollar, gold‘s initial ascent in the early 1970′s was fueled by the highest inflation in generations and the deteriorating health of the U.S. economy that had been ravaged by the “guns and butter” policies of the 1960′s. But the American economy stabilized during the mid-years of the 1970′s and both inflation and unemployment fell. When gold reversed course in 1975 the voices of traditional power elite could not contain their glee. When the gold price approached $100 per ounce, a nearly 50% decline, the obituaries came fast and furious. Everyone assumed that the gold mania would never return.

Although the writer of The Times piece did not yet know it, the bottom for gold had been established four days before his article was published. Few realized at the time that the real economic pain of the 1970′s had (to paraphrase The Carpenters 1970′s hit) “Only Just Begun”. When inflation and recession came back with a vengeance in the late 1970′s, gold took off (to quote another 1970′s gem), like a skyrocket in flight. By January 1980, gold topped out at $850 an ounce. The second leg of the rally proved to be bigger than the first.

The parallel between the 1970s and the current period are even more striking when you look closely at the numbers. For example, from 1971 to 1974 gold prices rose by 458% from $35 to $195.25, which was then followed by a two-year correction of nearly 50%. This reduced total gains to just under 200%. The current bull market that began back in 2000 took a bit longer to evolve, but the percentage gains are very similar. (We should allow for a more compressed time frame in the 1970s because of the sudden untethering of gold after decades of restraint.) From its 1999 low to its 2011 peak, gold rose by about 650% from $253 to $1895 per ounce, followed by a two year correction of approximately 37%, down to around $1190 per ounce. The pullback has reduced the total rally to about 370%. The mainstream is saying now, as they did then, that the pullback has invalidated fears that rising U. S. budget deficits, overly accommodative monetary policy, and a weakening economy will combine to bring down the dollar and ignite inflation. But 1976 was not the end of the game. In all likelihood, 2013 will not be either.

The biggest difference between then and now is that until 1975 ordinary Americans were barred by law from buying and owning gold. About the only route available to participate in the earlier stage of the precious metal rally was by hording silver dimes, quarters and half dollars minted prior to 1965. My father indulged in this process himself by sifting through his change, the cash registers of any merchant who would allow him (exchanging new non-silver coins and bills for silver), and by sifting out silver coins from rolls he bought from banks. It was a time-consuming process, and most of his friends and family members thought he was crazy. After all, he had $10,000 worth of pocket change earning no interest.But the $10,000 face value worth of those coins he collected had a melt value of over $350,000 when silver hit its peak.

By the mid 1970′s none of the problems that initially led to the recession in the early years of the decade had been solved. Contrary to the claims of the “experts” things got much worse in the years ahead. It took the much deeper recession of the late 1970′s and early 1980′s, which at the time was the worst economic down-turn since the great Depression, to finally purge the economy of all the excesses. The lower marginal tax rates and cuts in regulation implemented by President Reagan and tight money under Volcker helped get the economy back on track and create investment opportunities that drew money away from gold. As a result gold fell hard during the early 1980′s. But even after the declines, gold maintained levels for the next 20 years that were three to four times as high as the 1976 lows.

Although the economy improved in the 1980′s, the cure was not complete. Government spending, budget and trade deficits continued to take a heavy toll. The U.S. was transformed from the world’s largest creditor to its largest debtor. When the time came to face the music in 2001, the Fed kept the party going by opening the monetary spigots. Then when decades of monetary excess finally came to a head in 2008, the Fed open up its monetary spigots even wider, flooding the economy with even more cheap money.

Unfortunately just like 1976, a true economic recovery is not just around the corner. More likely we are in the eye of an economic storm that will blow much harder than the stagflation winds of the Jimmy Carter years. And once again the establishment is using the decline it the price of gold to validate its misguided policies and discredit its critics. But none of the problems that led me and other modern day gold bugs to buy gold ten years ago have been solved. In fact, monetary and fiscal policies have actually made them much worse. The sad truth is that as bad as things were back in 1976, they are much worse now. Whether as a nation we will be able to rise to the occasion, and actually finish the job that Ronald Reagan and Paul Volcker started remains to be seen. But I am confident that the price of gold will rise much higher, and that its final ascent will be that much more spectacular the longer we continue on our current policy path. Don’t believe the mainstream. Just as before, they will likely be wrong again.

Source: http://www.zerohedge.com/news/2013-07-01/gold-bug-bashing-1976-edition