The Era
of Gold's Return
is Fast Approaching
By Dr. Richard S. Appel, editor
Financial Insights
Rarely
in history, in the early stages of an important price advance,
has it been so obvious that a major, secular Bull Market was
developing. Normally, a Bull Market gradually arises from the
ashes of an earlier vicious Bear Market. And, in so doing, it
attracts the attention of but a few knowledgeable, astute and
value orientated individuals. This occurs in the context of the
first stage of a Bull Market. Later, after the price has advanced
sufficiently to attract casual observers, the second phase of
the Bull Market occurs as more participants enter the market
and bid up the item's price. Finally, during the third stage,
information permeates the marketplace giving obvious support
for the Bull Market. During this final stage prices move sharply
higher and take the price beyond known values. Not so with today's
gold market! If the bells truly rang out to usher in a great
Bull Market, they would be echoing from the hilltops and from
all directions regarding the future of gold!
There are numerous
obvious signs that a substantially higher price for gold is in
the offing. This circumstance is quite surprising given the fact
that it is such a short distance above its $252 Bear Market low,
and so far from my initial upside price objective. It is likely
that the long period in which the gold price has been artificially
suppressed has fostered this condition. Had gold been allowed
to freely attain its market-clearing price it would trade far
higher than it is today. However, due to this delay, the underlying
financial and economic factors have had time to develop and build.
These factors, I believe, are destined to engender a far higher
price for the yellow metal. For this reason it is not surprising
that we are now presented with an extremely rare and potentially
highly profitable window of opportunity.
The price of gold is
simply a reflection of the value of the currency in which it
is quoted. If a nation's currency is not allowed to depreciate
via unsound fiscal and monetary policies, gold's price will remain
subdued. On the other hand, if a government follows a path destined
to damage their currency's value, gold will rise in price.
In our country, two
primary factors have long been in progress that have undermined
the viability and value of the dollar. First, our government
has been inflating our money supply for decades. This was greatly
accelerated after December 1993. Further, during the past year,
when the Federal Reserve first realized that a recession was
inevitable, they increased the rate of monetary creation in hopes
of averting it. Excessive monetary creation, that in excess
of the amount needed to represent the total value of the goods
and services offered in the economy cheapens the value of all
dollar credits in existence. Second, our nation's Balance
of Payments Deficits have been a disgrace for many years. This
underscores the degree to which the other major nations of the
world have been duped by our politicians. Instead of actually
paying for the foreign goods and services that we have consumed
with something of value, or of like kind, we paid for them with
dollar credits. These were primarily in the form of bookkeeping
transfers or with easily manufactured currency. The amount of
dollars accumulated in the coffers of the other nations has reached
levels that are finally giving thinking and knowledgeable individuals
cause for great concern. At some point our entire Balance of
Payments Deficits will either be repaid or defaulted upon! This
will occur when foreign nations return our dollars to us and
demand payment with things of value.
Our
country's policy of fostering global free trade was a brilliant
method of attracting cheaply manufactured goods to our nation's
shores. This is a prime reason why our citizens have enjoyed
an unsurpassed standard of living. Further, the U.S. dollar has
been exhibiting significant strength since early 1995. This has
further acted to reduce the dollar cost of imported items as
it took fewer dollars to purchase foreign currency denominated
goods and services.
The inflation, which
would normally be expected to result from the combination of
the enormous level of excessive purchasing media and our obscene
Balance of Payments Deficits, has been held at bay. This is due
to the ready availability of these cheap foreign products. Further,
their widespread presence has acted to pressure domestic enterprises
from increasing their prices. Finally, the dollar appears to
be weakening! This may represent one of the first indications
that the world is awakening to these conditions, and to the dollar's
greatly overvalued and thus highly vulnerable state.
Another factor that
has acted to artificially suppress the gold price has been the
active forward sales by the world's major gold producing companies.
For the past decade not only have the major gold miners sold
their entire production each year, but they also borrowed and
sold additional gold. This they leased from various bullion banks
at 1% interest or less. The gold originated from the coffers
of several central banks. The gold producers then sold the gold,
invested the proceeds at a higher rate of interest, and pocketed
the difference. It has been estimated that annually, for the
past decade, about 250 tons of borrowed gold has been sold into
the market via this method. This represents an increase in supply
of about 10% per annum.
The gold mining companies
were joined by a number of other financial institutions that
used the opportunity to borrow gold at below 1%, sell it, and
profited from investing the money at a higher rate of return.
All of this sold, borrowed gold pressured its price lower as
the supply was artificially increased far above normal, world
production levels. However, this borrowed gold must one day be
bought and replaced!
I have been chronicling
the negative gold statements and actions of world public officials
for several years. These have occurred at times when gold was
trending higher and were timed to terminate any advance in its
price. Each time gold threatened to move sharply higher either
a nation announced that it would sell gold, or a politician stated
that the sale of gold was under consideration.
The Tide Is Turning In Favor Of Gold
The
unprecedented inflating of the U.S. money supply and Balance
of Payments Deficits could continue to build for a number of
years without setting off an inflationary spiral. However, despite
the fact that the average American does not understand the significance
of the potential threat, there are numerous wealthy individuals,
hedge fund managers and financial entities that recognize the
risk. They understand that all that is needed to set off an inflationary
episode in this country is a decline in the dollar.
The reason that foreigners
hold our currency is because they believe that it will maintain
its value. A dollar decline will shatter their confidence in
our currency, which, in turn, will foster the massive return
of earlier exported dollars to our shores. The result will be
a sharp loss of purchasing power for the dollar and a return
of inflation.
The past two months
have witnessed a reversal in statements and policy by a number
of major gold producing hedgers. AngloGold first stated that
they had reduced their hedge book by 4 million ounces during
the last quarter of 2001. This was followed by Barrick Gold.
They stated that for the first time in fourteen years they would
sell 50% of their production on the spot market, rather than
use their entire production to cover their earlier forward sales.
During the past fourteen years Barrick has hedged their entire
annual gold production. Thus, they would reduce their future
hedging by 50%. A small beginning! Anglo then shortly followed
by stating that they were continuing to "aggressively"
reduce their entire position.
These events
are of monumental importance to the gold market! First,
they indicate that the amount of hedging by the gold mining industry
will be limited. Further, the major gold producers will now become
a new, important source of gold demand, if they follow as AngloGold
has stated, and begin to reverse their gold short positions.
If producer gold hedging is reduced, and they cover their outstanding
hedges, the supply:demand equation will move strongly in favor
of gold. The net effect will be far less gold entering the market
through the actions of the gold miners, than has been the case
for the past decade.
The first signs that
the major nations of the world are losing control of the gold
market occurred last month. Ernst Welteke, President of the Bundesbank,
announced that they were considering selling gold and investing
the proceeds in equities. The initial reaction by gold was, as
has been typical during the past many years, to decline. However,
surprisingly, only a modest price fall ensured. The Washington
Agreement was signed in September 1999, by 15 European central
banks. It limits their annual gold sales until 2004. Thus, his
statement was quite transparent. It could only have been meant
to damage gold's price as the Bundesbank could not sell additional
gold for another two years.
What is more important
to my thinking is the fact that if this was the best threat to
gold that the governments could muster, they must be running
out of ammunition! Either they are frightened of the consequences
of further depleting their gold reserves, or they cannot entice
or coerce any further official gold sales at this time.
It is amazing how conditions
favoring a gold advance are falling into place and simultaneously
how those that have acted to depress its price are lifting. In
any event, during a secular Bull Market news tends to confirm
the market's direction. And, we are now witnessing them in spades
regarding gold!
I believe that the
recent release of a Beacon Group Advisors report on future gold
production seals gold's fate. They conducted an analysis of future
global gold mine production. It was commissioned by Barrick Gold,
AngloGold, Gold Fields, Newmont Gold, Placer Dome, among other
major gold mining companies. In their final report Beacon concluded
that if gold remained at $275 an ounce, global production would
begin to sharply decline by the middle of this decade. Further,
by 2010, mining would only produce 60 million ounces versus 83
million ounces, for a 29% decline in gold output. They further
projected that at a constant $300 gold price the reduction in
world gold production would still result in an incredible 22%
shortfall from today's levels. It is anticipated that annual
gold production for 2002 will be 2% below last year's level.
We are just beginning to experience the decline in gold production
that was primarily generated by the six-year artificial suppression
of its price.
The damage to the gold
mining industry by the extended decline in the gold price, has
already canceled or delayed the mining decisions for a number
of new gold mines. Further, it has resulted in the closing of
a number of important viable mines. It normally takes a minimum
of six to eight years from the time that a prospective gold property
is first explored until a mine is constructed and is in production.
Additionally, if a substantial project ready for a mining decision
is shelved, it will take two to three years before the first
gold production can be poured. For this reason, if gold moves
sharply higher in price it will take a minimum of three or more
years before any significant increased production will be generated.
Further, given the fact that many of the world's largest mining
projects are running out of reserves it is questionable if even
a $500 gold price will easily reverse the accelerating, declining
trend in production.
I have discussed the
various long-term forces that have acted to depress the gold
price as well as those that have been long building that will
ultimately converge to advance its price far further than most
people can imagine. Yet, there are other recent developments
that are coming into play that will act in concert to create
a background against which gold can further rise in price. First,
Japan has recently withdrawn its government insurance for many
bank deposits. In April 2003, they will eliminate their coverage
of virtually all financial accounts. The Japanese people are
already concerned about their future. Their economy has been
slowly but progressively declining for over a decade. Their jobless
rate has been increasing and their fear for their future employment
has likewise increased. The Japanese people have long been known
to be among the greatest savers in the world. Now they have reason
to fear for the savings for which they have worked hard their
entire lives. They have already increased their purchase of gold.
It is likely that they will further add to this as they recognize
that the government withdrew its protection for a reason. That
reason is their politicians realize that their government is
in jeopardy of failing! Given the enormous amount of Japanese
savings it is likely that they will have a tremendous impact
upon future gold purchases. Further, the U.S. has left a fleeting
period when our government has posted a fiscal surplus. Due to
our war against terrorists, Congress is already preparing to
vote to raise the nation's debt ceiling. Deficits will again
become the rule.
Amazing! Only a few
months ago our politicians were talking about a tax surplus.
How quickly that has not only vanished but has been replaced
by a deficit! Finally, the flare-up of violence in the Mideast
between the Palestinians and Israel threatens to escalate. Until
this is resolved it will produce great instability in the region.
The hundreds of members of the Saudi Royal Family have long been
suppressing their people, and have accumulated immense wealth
for themselves. If Israeli-Palestinian tensions escalate their
control and dominance may be threatened. If the Royal Family
believes that their future is in jeopardy I believe that they
will convert much of their wealth into gold.
Gold has already risen
$50 in its tortuous path from its Bear Market low. It is difficult
for me to believe that we have already entered the second phase
of this Bull Market, given my belief that we will experience
a $1,000 gold price within the next three to five years. However,
the writing is on the wall and the bells are truly ringing. To
ignore them will prevent us from profiting from one of the few
times in one's life that an investment offers both unusual profits
with minimal risk.
Gold's
Secular Bull Market Will Likely Last
At Least Three To Four More Years
Given
the unfolding of events as described above, which I believe are
converging to generate a substantially higher gold price, I believe
that major positions in both gold and silver are warranted. I
believe that gold's secular Bull Market will likely last at least
three to four more years. It should be anticipated that it
will be punctuated by periods when the actions of various governments
temporarily interrupt its advance. Further, given the unfolding
of events, I believe that gold's all-time high of $875 will likely
be surpassed. It will take time, and likely much anguish, as
the major governments do everything in their power to reverse
the trend. However, it is likely that U.S. and world economic
and financial conditions will deteriorate which will mitigate
towards a far higher ultimate price for the yellow metal than
few now believe possible.
A fly in the ointment?
The Commitment of Traders Report indicates that the Commercials,
the producers and wholesale users, have built up an enormous
short position in both gold and silver. It must be remembered
that these people have the greatest amount of information regarding
the market and are correct on the majority of occasions. It has
been further postulated that they are preparing to drive both
metals sharply lower in one final effort to cover some of their
short positions. I recognize that this may occur. However, while
they may be successful in driving the price of silver lower,
I question if they can have a material affect upon the gold price.
Yet this potential, combined with the knowledge that the central
bankers will fight a rise in gold with tooth and nail, must always
be carefully watched. If the shorts temporarily overwhelm either
the price of gold or silver it will only offer a better opportunity
to acquire positions in either metal, or in the shares of companies
that either explore for or produce them.
Editor's Note: Dr.
Richard S. Appel is editor of Financial Insights, P.O.
Box 793-Z, Oakhurst, NJ 07755, 1 year, $135. Dr. Appel provides
commentary on finance, gold, and unique investment opportunities
in his monthly newsletter.
