Is The Gold Bull Market Over?
In an April 28, 2005 news release, GFMS announced that the year-end price of gold could reach a 22 year high of US$500. With the price of precious metals in a trading range and mining stocks experiencing double digit declines this announcement comes as a surprise to many gold bugs and analysts. It is particularly noteworthy, since GFMS is notoriously conservative when it comes to predicting future gold price trends.
Of even greater significance are the two main reasons behind GFMS's position.
First, GFMS states first that growing US deficits, a weakening US dollar and the prospect of a marked US economic slowdown will push up the market value of gold bullion this year and next. Ally that with an event driven rally in the oil price then gold heading for the $500 mark no longer looks fanciful. Second, the downside for the gold price is negligible. This is because of a "robust demand" for physical bullion, and an increased willingness on the part of investors to buy gold on price weakness.
In its Gold Survey 2005, GFMS mentions several developments that together show an increasing interest in physical gold ownership.
- Gold coin fabrication rose 7.0 percent in 2004.
- Bar hoarding rose a whopping 38 percent in 2004.
- Producer de-hedging rose to record levels of just over 440 tonnes in 2004.
- Gold mine production fell by 5 percent.
- Net official sector sales dropped 23 percent to a five-year low.
- Scrap gold supply fell to a three-year low of just 828 tonnes.
Based on my own research, which dates back to 1997, I concluded that precious metals were about to begin a new bull market that would likely last for decades and surpass the previous bull market of the 1970s. This conclusion was based primarily on the growing money supply in most western economies, but especially in the US, as well as the unsustainable mountain of debt at every level.
In three recent presentations to the US congress Chairman Greenspan warned that the great American growth machine may be in trouble and admonished government officials to reduce today's massive spending and trade deficits, or face a marked slowdown in economic growth.
Previously, Greenspan's warnings have included the many other vulnerabilities looming over the US economy, such as derivatives, Fannie Mae, Social Security, Medicare, consumer credit, consumer savings, energy costs, and costs incurred by the ongoing conflict in Iraq.
Others, such as former Fed Chairman Paul Volker, Congressman Ron Paul and Stephen Roach have issued similar warnings:
"I think we are skating on increasingly thin ice. On the present trajectory,
the deficits and imbalances will increase. At some point, the sense of confidence
in capital markets that today so benignly supports the flow of funds to the
United States and the growing world economy could fade. Then some event, or
combination of events, could come along to disturb markets, with damaging volatility
in both exchange markets and interest rates. We had a taste of that in the
stagflation of the 1970s -- a volatile and depressed dollar, inflationary pressures,
a sudden increase in interest rates and a couple of big recessions."
Congressman Ron Paul recently warned:
"The economic situation today is reminiscent of the 1970s. The economic malaise of that era resulted from the profligacy of the 1960s, when Congress wildly expanded the welfare state and fought an expensive war in south east Asia. Large federal deficits led to stagflation-- a combination of high price inflation, high interest rates, high unemployment, and stagnant economic growth. I fear that today's economic fundamentals are worse than the 1970s: federal deficits are higher, the supply of fiat dollars is much greater, and personal savings rates are much lower. If the federal government won't stop spending, borrowing, printing, and taxing, we may find ourselves in far worse shape than 30 years ago."
Morgan Stanley Chief Economist and Director of Global Economic Analysis, Stephen Roach, paints an equally dismal picture of future American economic growth. In a recent article entitled Trapped, Roach calls what some politicians refer to as another economic "soft patch" a very real "ongoing post-bubble shakeout of the U.S. economy."
Roach believes that overly generous fiscal and monetary policy has left the US economy without effective and sufficient policy stimulus. Highly accommodative interest rate and tax refund policies over the past few years have depleted the government's ability to prod the economy into higher, sustained productivity. Roach says:
"It was a great ride on the US growth front for a while. But post-bubble excesses have only been compounded during this cyclical respite. An unprecedented drawdown of saving and an ominous build-up of debt, in conjunction with a lasting shortfall of organic income generation [employment and wage growth], solidified the emergence of the Asset Economy. If the US economy were truly healthy, the Fed should target the federal funds rate in the 5% to 5.5% zone. However, with America's cyclical impetus fading, post-bubble fault lines could deepen - making it all but impossible for the Fed to normalize real interest rates. Under those circumstances, this week could mark the Fed's last rate hike of this cycle."
US financial markets have not yet fully accounted for this highly possible prospect of economic stagnation. If Roach's observations are correct, this situation will put corporate growth and earnings expectations at risk and cause stock markets to fall. Another equity market rout would cripple US economic growth for years and cause chaos in investment markets worldwide. This is bad news for stock investors.
However, it is good news for precious metals. As history is fond of reminding us, gold prices tend to rise as economic growth declines. This occurs because people purchase more gold bullion to help protect purchasing power as other assets and asset classes decline in value.
As the world's reserve currency continues its decline other nations will be forced to take measures to reduce their currencies against the US dollar in order to maintain export competitiveness. Eventually all paper currencies will decline against precious metals. As the price of imported goods and services rises, the US Federal Reserve will be forced to increase interest rates. This will result in higher debt service costs to governments, corporations and individuals while at the same time curtailing consumer demand. If the Fed looses control this could easily lead to a prolonged period of stagflation.
As long as today's economic vulnerabilities continue, or become worse, the bull market in precious metals is not over but is only in it's first phase. As it experiences the cyclical corrections and pullbacks, typical of any bull market, many investors, will misunderstand these corrections and sell their holdings.
Richard Russell, editor of the Dow Theory Letters, has said that bull markets are like a rodeo bull.
When you are in a long-term bull market it will do everything in its power to throw you off and make you leave prematurely. The safest, easiest way to accumulate real wealth in these conditions is to hang on until the ride is over.