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December 28, 2004

Why Gold Shares are Limping
by Alex Wallenwein

The name of the game has changed. Completely.

While during the nineties gold-control was designed to support the dollar, since 2003 it has actually allowed the dollar to fall faster and further - but without doing damage to the number-one symbol of "Amerikan" economic power: the mighty Dow.

In fact, the Dow was the main beneficiary of this recent dollar-drop, as you can see here:

(Focus mainly on the last two months of action here. The red boxes refer to points made in an earlier essay.)

The interesting part here is that, since mid-2003, whenever the dollar even stabilized the Dow has resumed a downward moevement. The last two months should convince anyone that there is a definite negative correlation in effect.

At first blush, this makes no sense at all.

How could a rapidly deteriorating dollar be good for US stocks? A falling dollar makes US assets less attractive to foreigners because repatriated profits are worth less when changed to the home currency. It also makes foreign goods more expensive at home, so Americans have less money left over to invest in stocks, one would think, right?

Welcome to the brave new world of terminal fiat-decay.

In this "new economy" nothing makes sense anymore. Formerly predictable relationships between economic parameters are turned on their head: (1) Gold and the Dow are moving up and down in sync. (2) During the most serious recent phase of dollar-decay from September to December 2004, US treasuries have remained largely stable. (3) Gold bullion outpaces the mining shares. (4) During the recent 2001 recession and subsequent flip-flop recovery, US consumers have loaded up on debt like never before - instead of saving like their forebears did. (4) Official CPI numbers are slightly up but still benign as could be, but the Fed is raising rates every chance it gets - and that even though the official stance on the dollar is down and rising rates tend to support the dollar.

What gives? And now, gold control is supposed to enable the dollar to fall rather than support it, as one would normally expect??

Yep.

How does that work?

It works because gold is no longer the real threat, and that's because an artificially high dollar is no longer desirable. The US needs a drastically lower dollar to (hopefully) start getting the mounting current account deficit to reverse course.

It also needs a low greenback because the euro needs to be torpedoed if the dollar-reserve system is to have any chance at survival. The US regime further needs its currency to fall to attract foreign manufacturing to the US to make up for the jobs lost to China - a brand new trend that most people are not even aware of. And the recently inverse dollar-Dow relationship is now amply documented by the charts above.

What the US cannot tolerate, however, is a powerful rising trend in gold shares.

Gold shares are the only thing that can attract mainstream US investors away from the mainstream stocks and so lead to a gold blow-off and a Dow collapse. Americans don't invest much in bullion. Having been paper-trained' for several generations now, they consider it "too cumbersome." You can't sell bullion in your basement by calling your broker or making a few clicks online - but with gold shares, you can do it.

The New Face of Gold Manipulation?

Apparently the bullion banks that are so short gold have either cleaned up their act somehow or have otherwise insulated themselves against rising bullion prices. As previously observed, all the several alleged "Maginot Lines" were crossed without any apparent hickups in the financial system. (Or maybe the gold camp's estimate of the bullion banks' resources were wrong, and the real line is $500 gold? Who knows.)

The point is, rising gold no longer appears to be the number one enemy. As long as the Dow is rising along with gold, a rising POG now seems tolerable to the system.

If you were in the "gold-price management" business and wanted to keep US investors from getting too hyped up about gold, what would you do? Would you keep shorting gold when everybody and their brother is already on to your game, or would you shift it to the shares, where nobody expects you to be active - yet?

Would you do it in the price of bullion, into which you know few investors are actually putting their money - or would you do it in the market segment they all are piling into when gold starts looking good?

That's one way of explaining the lagging share prices. So far, it's pure speculation and extrapolation from a few know factors. Maybe someone with a stronger motive to prove this will look into it and find the evidence, but the point is that bullion is the clear winner in this new era.

What is Driving Bullion Prices?

Another way to explain this consists of looking into who and what is pushing the price of "physical", and whether those factors lie sufficiently within the US government/banking sector's control to do anything about them. It's more than "just" the falling dollar. The dollar has fallen about 40% since its early 2002 peak - but gold has risen about 70% since its mid-2001 bottom!

Here is what may explain bullion's rise:

1. Muslims, Chinese, Indians, and Russians have no intention of enriching companies of countries like South Africa, Australia, Canada - and especially the US - by investing in their mining shares. They understand the value of the metal itself (maybe with the exception of private Russian investors), so that's what they go for. As far as these countries and areas' official policies go, they don't mind destabilizing the dollar at all, as along as it doesn't hurt them too much. Pumping money into US company stocks - and therefore into the US economy - isn't these groups' top priority, really. (When it comes to US productive assets, however, China doesn't seem to mind. Gives it some nice leverage for the future, rather than potential stock-loss risks)

2. In the long term, gold miners, though they profit from higher prices in their own currencies, still have to operate in their own economies. As far as US miners go, only those holding metal instead of cash as their assets will be able to post serious profits when inflation goes from tame to hyper as the world-wide dollar- drubbing continues.

3. India may be setting itself up to becoming the major bullion player in the world. That only makes sense - because it already is. India's official gold reserves are far below those of the major financial powers of the world, but look at how much the population is estimated to own according to India's Commerce and Industry Minister, Khamal Nath: Currently 9,000 tons, and soon expected to become 15,000 tons. That's about what GATA and many others estimate al of the world's central banks to have left in terms of actual, unencumbered gold reserves. (Which country do you think is better prepared to weather the coming storm: the US - or India?)

4. Chinese and Japanese official gold buying is gaining momentum. At the same time China intends to align its now spot-oriented domestic trading to the world wide futures trading system, intending to become a major player in the international gold trading arena. Yet, despite this official trend toward derivatives and hedging practices, individual Chinese savers are expected and officially encouraged by their government to buy and hold physical to hedge against financial and currency risks. More on that in the next section.

None of these factors lie within the sphere of US legislative or Fed control.

China's Role

It is by now almost unanimously accepted that China will succeed the US in being hte world's economic locomotive at some point in time. It is only reasonable to co0nclude that China is also slated to dominate the world's future financial order, just as the US has since Bretton-Woods.

In the light of that, the following takes on a humongous significance for the future of gold and its role in any future world monetary system: Zhou Xiaochuan, the governor of the Peoples Bank of China, stated his vision of how gold will figure into China's future monetary policy on September 6, 2004 at the London Bullion Market Association's Annual Precious Metals Conference in Shanghai. In his statement, he observed that:

"From the micro-economic perspective, allowing people to hold assets in gold can improve social welfare benefitting both the country and its people. Also, the dual characters of being an ordinary commodity and a currency allow gold to well hedge against risks. So it is practical to develop individual gold trading business."

One can only hope that "Amerikan" monetary officials will some day dispense similarly profound and truthful advice to their own subjects.

By officially acknowledging that the Chinese regime is encouraging its people to save gold bullion to hedge against currency risks, he points to the nature of the emerging world financial order (of which the creation of the euro was only the first step):

Fiat will be earned and spent
- while gold will be saved.

Even the world's central banks will eventually join this trend, because the dollar as a reserve-asset is now largely history - and the euro is not really set up to take over its function in that regard. The euro's cornerstone is "price-stability, i.e., limited printing! A currency so limited cannot assume the dollar's "print on demand" character that is so necessary for fulfilling its sole-reserve currency objective Any current movements from dollar into euro-reserves are temporary. The world's future reserve asset is gold, make no mistake about it.

(Does this mean that free markets will return and gold investors can breathe easier? Unfortunately, no. Markets can only really be free if they have a true free-market currency to operate on. It is still necessary to establish a private, parallel bullion currency to achieve that.)

So, does it make more sense to bet on gold shares to start bucking this trend again - or is it better to jump on the bandwagon and do as the Chinese do?

Personally, I'd go with the latter.

Does this mean that gold shares are "finished"?

Not by any means. But it pays to be discriminating. There are only a handful of shares that managed to follow bullion in finishing 2004 higher than they started, and there are only one or two gold mutual funds that repeated that feat. More details on that, plus forecasts on where gold, the dollar, rates, oil, and the yuan are headed are available to subscribers of the EURO VS DOLLAR CURRENCY WAR MONITOR.

Got gold?

Alex Wallenwein
Editor, Publisher
The Euro vs Dollar Monitor

Just like driving your car, investing only makes sense if you can see where you are going. The Euro vs Dollar Monitor is your golden windshield wiper that removes the media's greasy film of financial misinformation from your investment outlook. Don't drive your investment vehicle without it!

Copyright © 2003-2008 Alex Wallenwein

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