$600 Gold: We Have Only Just Begun

By: Emanuel Balarie | Thu, Apr 13, 2006
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Even though gold prices have risen to over $600/ounce, investors are still failing to acknowledge that we are in a fundamentally driven precious metals bull market. Instead of focusing on the specific fundamentals(declining US dollar, central bank buying, inflationary concerns), that have driven this bull market from the start, your average investor and Wall Street pundit is attributing this move up to "geopolitical unrest" and unnaturally high" oil prices. While it is true that those factors have contributed to gold prices moving to a 25 year high, they are by no means the reasons why we have seen gold prices double over the last several years. In fact, the same fundamental reasons that have driven the price of gold from its lows in 2001 will continue to drive it still higher in the years to come. As such, it is important for investors to note that we have only just begun, and it is not too late to participate in this gold bull market.

Putting $600 Gold into Perspective

As a point of reference, it is important for investors to realize that the real all time high for Gold is not $850 an ounce. Although the nominal all time high is indeed $850, the inflation adjusted all time high for Gold is closer to $2150. Comparing today's price of Gold with the price of Gold in 1980, fails to take into account the rise of inflation over the last 25 years. Simply put, $850 could buy you a lot more in 1980 than it can today. In 1980, you could buy a house for under $100,000, buy a cup of coffee for less than a dollar, and put gasoline in your car for under a dollar. Having this perspective, allows you to realize that the price of Gold is still cheap at these levels.

Dollar Decline Will Continue to Fuel This Bull Market

Since the US dollar experienced significant appreciation in 2005, many people have forgotten that we are in a multiyear downtrend in the dollar.

In fact, if you compare it against the Euro, the Dollar is down over 40% from its high. The same factors that initially triggered the US Dollar decline will continue to add towards this sell off. In the past, the dollar was the world's reserve currency. It signified strength and security in a growing US economy. Investors all over the world where scrambling to purchase our US dollar assets. Today, we are no longer a booming and growing US economy. Sadly, we have become an economy that is driven by consumers that are going further into debt everyday and areal estate market that has been pushed up by artificially low interest rates. Although this has fooled your average American to believing that the economy is strong, it has not fooled central banks around the world that are looking at diversifying out of the US dollar. The United Arab Emirates and other Middle Eastern countries have already switched or are looking at switching some of their US dollar reserves into Euros and Gold. Russia, Korea, and other countries have also reacted in the same manner.

The China Factor

The Chinese government has also stated that they are looking diversifying out of the US dollar into Gold. This news in itself holds tremendous significance towards the overall direction of Gold. Presently, China has under 2% of its reserves (850 billion +) in Gold. Most of their reserves are US dollar assets. According to the World Gold Council, the world average is 9% of its reserves. The EU average is at 25%, and the US holds 60% of its reserves in Gold. In comparison, China's percentage of its reserves in Gold is unbelievably low. As China continued to become a world economic power, they will continue adding Gold to their reserves. Even if they only reached the 9% average, the amount of Gold that would be taken off the market would have a significant impact on the price of Gold.

In the past year, China has begun laying the groundwork for substantial Gold investments from both its citizens and its Central Bank. Floating their currency and allowing the average Chinese citizen to own Gold were the first steps. The Bank of China will start facilitating US dollars for Gold transactions within recent months. The Bank of China also reported last month that they will slash the spread on gold trading by up to 20 % for a trial period. All of these factors combined with continued demand for Gold jewelry (as Chinese citizens continue to increase their standard of living) will continue to fuel this Gold bull market.

Yes, Virginia...We Do Have Inflation

The question of whether we have or don't have inflation is a hotly debated topic. On one end of the debate, you have data dependent individuals that argue that the Core Consumer Price Index does not show that we should be concerned about inflation. Therefore, all of this talk about inflation is incorrect and purely speculative. On the other end of the debate, you have the price of Gold (which has always been an anti-inflationary hedge), rising to a 25 year high. So who is right?

Investors can answer the question themselves, if they truly step back and look at what is happening around them. The first aspect to consider is the fact that the Core CPI index does not take into consideration food and energy prices. As a result, even though we have experienced high oil prices, this is not immediately reflected in the Core CPI data. Although $70 oil is not initially reflected in the Core CPI data, it will eventually pass through to the Core CPI index as manufacturers pass through the higher costs of producing the goods to the consumer. Additionally, copper, zinc, aluminum, and other raw materials have steadily risen higher over the last several years. These costs will also pass through to the consumer. It is important to note, however, that this pass through effect will not be immediate. Manufacturers typically have contracts where they are required to sell their products for a certain amount for a fixed period of time. I do believe, however, that we will experience a sharp jump in the Core CPI numbers by 3 rd or 4 th quarter of this year, as the high energy and raw material prices we have experienced for the last several years finally are reflected in the Core CPI numbers. At that time, I expect another influx of gold buying from investors who finally acknowledge that we do have inflation.

The continually higher energy and raw material costs are not localized strictly to the United States. Inflationary concerns can be seen throughout Europe and even Japan. In the same manner that Americans will likely buy more gold as inflationary concerns seep through the economy, the same will be true for Europeans and the Japanese. Magnifying these inflationary concerns is the fact that there has been a tremendous increase in money supply across the globe. Although the below chart shows the increase in money supply for the United States, the scenario is true for a number of different countries.

Look at the below Chart of the M3 (Money Supply):

The immediate implications of Central Banks flooding the markets with excess liquidity, is that it paints a false picture of wealth. The more money that is created might offer an initial stimulus to the economy, but it actually serves in diluting the purchasing power of their currency. In turn, as the decline in purchasing power of fiat currencies is magnified, Gold will start attracting even more interest from individuals that are seeking an alternate "currency".

Any of the above mentioned factors (and others that I have not written about) would in themselves, increase Gold demand and push Gold prices much higher. A combination of those factors is creating the greatest precious metals bull market in history. Additionally, continued geopolitical concerns further propel this bull market, as investors are naturally drawn to a historical safe haven during times of instability. Going forward, I expect Gold prices to consistently make new highs as the true fundamentals that are driving this market can no longer be ignored. If you have been on the sidelines, the time to act is now.

Gold from a Trend Following Perspective

Even if you ignore the above fundamentals, you cannot ignore that Gold has been in an obvious uptrend over the last several years.

A number of our trend following systems, that do not take fundamentals into consideration, have triggered buys on Gold and other precious metals based purely on technical indicators. The basic logic behind long term trend following is that you cut your losses quickly and you let your winners run. This long term trend following strategy can also be applied to other commodity markets. With trend following, you are able to follow trends (both on the up and downside) regardless of fundamentals. Often times, this allows you to participate in markets that move higher in the face of contradictory fundamental data. For example, Gold prices have trended higher even though Core CPI data has not revealed inflation. If you waited for the Fed to scream "inflation", you would have missed out on Gold prices more than doubling in price.

If you are interested in learning more about trend following and how it can compliment a fundamentally driven portfolio you can request one here.

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Lastly, if you would like to hear more about my thoughts and on gold, I will be speaking at the Atlanta Investment Conference on May 6 and the Las Vegas Money Show on May 15. I will talk about "The Secular Bull Market In Commodities and the 5 Commodities you Have to Own" If you would like to attend or receive additional information on these events please click here.

Best Regards,



Emanuel Balarie

Author: Emanuel Balarie

Emanuel Balarie

Emanuel Balarie is the Editor of Commodity News Center and the author of the highly acclaimed book, Commodities For Every Portfolio: How You Can Profit From The Long-Term Commodity Boom.

Mr. Balarie's industry experience ranges from commodity stocks to futures to alternative investments. He is a highly regarded advisor to clients and institutions on the commodity markets and managed futures investments, and has had his research published all over the world. In addition to his several CNBC appearences, Balarie is frequently quoted in financial publications such as The Wall Street Journal, Reuters, Marketwatch and Barron's.

Mr. Balarie was one of the few market strategist to correctly predict this multi-year bull market in commodities, the decline in the US dollar, and the downturn in housing.

The risk of loss in trading commodity futures contracts can be substantial. You should therefore carefully consider whether such trading is suitable for you in light of your financial condition.

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