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September 13, 2007

Time to Shine!
by Puru Saxena

Precious metals are on the verge of a major rally within their ongoing bull-market. After consolidating since May 2006, both gold and silver spent the past 16 months building large bases and now it seems that the much anticipated advance has arrived.

I started investing in precious metals in 2001 when both gold and silver were significantly cheaper, however even today they represent great stores of value for the long-term investor. In a world of high monetary inflation and elevated asset prices, precious metals are still relatively inexpensive when compared to financial assets such as bonds, non-resource related stocks and leveraged real-estate.

Figure 1 highlights that the S&P500 outperformed gold throughout the 1980's and 1990's. Back then, US financial assets witnessed their biggest bull-market as the world of tangibles contracted. During that period, US stocks rose 15-fold whilst gold's value declined by roughly 70%. However, at the beginning of this decade, the mega trend reversed in favour of gold. And since then, the yellow metal has appreciated much more than the S&P 500.

Figure 1: Gold extremely depressed compared to US stocks!

Source: Dr. Ed Yardeni

Now, in order to determine what the future might bring, I would like to analyse the current situation. Over the past few months, the media has bombarded the public with the "Sub-prime Crisis" and the ongoing credit crunch in some segments of the capital markets. All this negative news has caused investors to panic and the "deflationary bust" debate is back in fashion once again. Several analysts have also started to lean over in the deflation camp and are advising investors to liquidate en masse and raise cash. So, should we also join the herd and panic? Or is this the time to reflect and ascertain how the establishment will respond to the ongoing crisis?

I am of the opinion that over the weeks and months ahead, the US establishment and various central banks will orchestrate a massive monetary and fiscal bail-out. Remember, we are in the third year of the US Presidential cycle and the people in power will do whatever they can in order to inflate asset-prices heading into the election. In fact, Mr. Bush's recent "aid program" to help low to middle-income homeowners is a good indication of what lies ahead. If my assessment is correct, another bout of widespread inflation (money-supply and credit growth) will come to the "rescue" as the central bankers open the monetary spigots and flood even more liquidity into the ailing monetary-system.

It is worth noting that after the technology bubble burst in March 2000, the Federal Reserve created massive inflation through its ultra-loose monetary policy. And this easily available credit found a home in real-estate all over the world. After being burnt in the stock-market, the investing public decided to direct their speculative juices towards bricks and mortar. As easy money flowed thanks to record-low interest-rates, home prices were bid up in the majority of countries. There was a total disregard for risk as the "real-estate never goes down" mantra replaced the "New Economy" nonsense. This party continued for a while until the "bubble-blowers" decided to remove the punch bowl by raising the cost of borrowing. As the tide of liquidity went out, numerous people were found swimming naked! The "Sub-prime Crisis" had arrived.

Now, given the fact that the masses have lost a lot of money in technology and real-estate, it is highly unlikely that the next bout of central bank sponsored inflation will benefit these sectors of the economy. In other words, the next bubble is not likely to form in these previously "hot" markets. In fact, this time around, I suspect the easy-monetary policy will create a gigantic bubble in precious metals and other natural resources. Already, it seems as though the market senses the next wave of inflation as the US Dollar is declining and gold has broken above US$700 per ounce. In the period ahead, I expect gold to appreciate significantly not only against the US Dollar but also against the other currencies which are being inflated at a ridiculous pace! Take a look at the annual money-supply growth rates around the world -

Now, you don't have to be a NASA-scientist to figure out that as the quantity of money increases, each unit of money will continue to lose its value or purchasing power against assets whose supply cannot be increased at the same pace. This confiscation of purchasing power has bullish implications for precious metals.

Today, several highly-intelligent economists and analysts are anxiously waiting for "The Crash" which will wipe out the value of the Dow Jones by 50-60%, cut the value of gold by half, cause an economic depression and create a vicious bear-market in asset prices. In my humble opinion, these people are going to be disappointed because "The Crash" will be stealth and will take place via plummeting currencies rather than an outright collapse in nominal asset-prices. Those who are forecasting a significant decline in US asset prices need to look no further than Zimbabwe where stocks have been making record-highs, albeit in a collapsing currency! So, given a choice between an outright deflationary bust and an inflationary bail-out, I can assure you that every establishment will opt for the latter outcome. In fact, central banks will continue to print money until the world runs out of trees.

The truth is that most people do not understand inflation and feel wealthy as long as their asset-prices continue to rise (never mind the state of the currency). So, the inflation-pill is a lot easier to swallow than an economic depression. And this is exactly what we are going to witness.

The modern-day monetary system is far from ideal, however we all have to live within the system and try our best to protect our wealth from the ravages of inflation. As a money-manager with the capability to invest in global assets, I have invested our clients' capital in the world of tangibles. Recently, we have added to our positions in precious metals on the belief that we could witness an explosive run-up over the coming months. Furthermore, from a sentiment perspective (with the majority of investors fearful and bearish), the current conditions seem ideal for the next advance in the ongoing secular bull-market in precious metals.

Puru Saxena
www.purusaxena.com

Puru Saxena publishes Money Matters, a monthly economic report, which highlights extraordinary investment opportunities in all major markets. In addition to the monthly report, subscribers also receive "Weekly Updates" covering the recent market action. Money Matters is available by subscription from www.purusaxena.com.

An investment adviser based in Hong Kong, he is a regular guest on CNBC, BBC, Bloomberg, NDTV Profit and writes for several newspapers and financial journals.

Copyright © 2005-2010 Puru Saxena Limited. All rights reserved

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