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May 24, 2002

Gold Defies Naysayers
by Adam Hamilton

"You've got to trust your instinct … And let go of regret … And [BLEEP] the naysayers cause they don't mean a thing" - Lyrics from the popular song "All Mixed Up" by rock band "311", ca 1995 AD

When I use quotes to open Zeal essays, I usually try to dig far back into the dark dusty corners of world history to search out wisdom that might be relevant to investors in today's chaotic world. While the quote above is not millennia old, not centuries old, not even decades old, I just couldn't shake it out of my head all week as I pondered gold's spectacular action. Forgive me. I certainly don't consider rock bands fonts of wisdom on life, but I just love 311's comment on naysayers!

Watching the legions of gold naysayers squirm in misery this week was certainly an exquisite pleasure for long-suffering gold investors. Gold not only marched ever higher, but it graced the technical gold chart with a gorgeous breakout for the entire investing world to marvel!

As I have been discussing for quite a while now in the past "Goldtrends" essays, the Ancient Metal of Kings has been locked in a rock-solid uptrending trading range since early 2001. The restraints of this trend pipe bound above by the blue lines were certainly not a bad thing, as the primary gold trend has been unmistakably bullish. The trading channel seemed to exert such a powerful force on technical gold investors that I have been patiently waiting during the last couple months for gold to take a breather and head back down towards its bottom support line.

Boy was I ever wrong! I don't think it has ever been so much fun watching the merciless markets slice and dice my own thoughts into quivering bloody pulp littering the trading floor. Thankfully my clients, partners, and I have remained heavily invested in gold and world-class gold shares and are only ready to sell certain short-term trading positions on rock-solid stop-losses, not mere conjectures on future trends, so our capital didn't miss one second of the glorious breakout noted above. Another couple months of this kind of action and the technicians will have to redraw an entirely new uptrend pipe for gold!

Even disregarding this week's fantastic upside breakout, the gold action since the early 2001 bottom is magnificent as it has exhibited such profoundly different character compared to all the gold action witnessed since the mid-1990s. It is really the first relentlessly consistent bullish trajectory the world has seen in dollar gold since the last gold rally gave up the ghost in early 1996. Gold is slowly and steadily powering higher like a Saturn V rocket right after launch, not just leaping up in fleetingly short panic spikes that soon collapse as in recent years.

Unmistakably there is real meat to this current glorious gold rally we are witnessing. With more and more capital consistently romancing gold, this rally is vastly fundamentally different than anything in recent memory. Check out the first graph of "Gold Challenges $300!" and the last graph of "Real Rates and Gold" if you wish to examine the longer-term gold charts with your own eyes. It has been almost seven years since gold has held a bullish trajectory for more than a few months and this latest gold rally is very different than anything investors have seen in at least that long. Exciting times!

With gold defying the naysayers and bursting through the corral fence of its top resistance line like an unstoppable rhinoceros with an attitude, short-term tactical predictions for gold are all of a sudden up in the air. On a spectacular breakout of this magnitude it would not surprise me one bit to see gold gallop higher now that it is gradually gaining attention and winning investors' affections worldwide. On the other hand, my inner belligerent contrarian whispers that gold could just as easily plunge to the strong support at the bottom of its trend channel in the coming months, roughly $285 these days.

My perpetually deluged e-mail inbox tells me that there are a lot of gold speculators out there really concerned about whether the yellow metal will explode to $350 or plunge to $285 first. Personally, I would not waste a second of concern on either contingency. If gold runs higher count your blessings and rejoice as your gold investments rocket up in value. If gold instead decides to visit its bottom support trendline again to regroup for its next assault on the heavens, then it is the perfect opportunity to borrow a bull-market maxim from our suffering NASDAQ brethren, "Buy the Dips!" As long as the gold price stays above that lower blue support line, I don't think there is any cause for short-term tactical concern regardless of where gold migrates.

Gold investors have been tearfully trudging through a long, hot, parched, brutal desert of scorn, ridicule, and losses for what feels like eons now. As we are finally blessed to see the first hints of the legendary oasis on the sun-scorched horizon, it is just a wonderful time to sit back and enjoy the caravan ride.

The global markets don't care what you or I think one bit! Like the proverbial 800lb gorilla in the jungle, they can do whatever the heck they want. Gold will do what it will tactically whether we worry about it or not. Because the fundamental strategic backdrop for gold in the remainder of this first new millennium decade remains dazzlingly bullish as I discuss later below, the short-term tactical gold gyrations will take care of themselves.

Before the wildly positive strategic gold scene is laid out however, it is interesting to take a little diversion into the red-hot world of gold stocks. As gold's current rally picks up steam and accelerates, the cream of the planet's gold stocks are soaring.

Is this a magnificent sight to behold or what? Unhedged gold stocks, the gold companies actually in the business of mining gold instead of betting on commodity prices like Vegas gambling addicts, are achieving phenomenal gains!

The current bull run in gold stocks began galloping across the financial plains like a herd of runaway bison in late 2000, before gold turned north. Both the HUI and XAU gold stock indices bottomed within mere days of each other in mid-November 2000. The HUI, of course, is the American Stock Exchange's Gold BUGS index (Basket of Unhedged Gold Stocks). The Amex BUGS only accepts gold mining companies that have not hedged their gold production beyond a year and a half.

The more popular but gradually fading XAU is the Philadelphia Stock Exchange Gold and Silver Index. Unfortunately the XAU is dominated by gold companies that are heavily hedged. Hedging gold companies have made the macro bet that future gold prices will be far lower so they perpetually try to lock in a projection of today's gold prices for tomorrow's sales via a twisted variety of incredibly complex and cryptic private contractual arrangements with bullion banks. The XAU is utterly dominated by some of the most notorious gold hedging major miners on the planet today. As of May 22nd, Barrick Gold (ABX), AngloGold (AU), and Placer Dome (PDG) constituted a massive 51% of the XAU, tragically annihilating its performance in our new gold bull market.

These "mega-hedgers", which I define as having already hedged more than the equivalent of one year's total gold production, often actually earn lower profits as gold runs higher due to their bad bets enriching bullion bankers. Who on earth would own a gold stock if they think gold is going lower? The whole sad concept is preposterous. Shareholders ought to kick these Vegas gamblers out of the management positions of these major gold mines and place the mines back in sound managers' hands who fully understand that they are in the business of mining gold for their shareholders and not running private hedge funds.

For a magnificent and brilliant essay on how convoluted and dangerous these hedging activities truly are, I strongly urge all gold investors to go carefully read GoldenSextant's Bob Landis' latest essay "Readings from the Book of Barrick" on Barrick's Frankenstein's monster of a hedgebook. Barrick Gold is the most infamous gold mega-hedger in the history of the world. Before I read this fantastic essay the first time myself, I thought it was impossible to write a brilliant and entertaining essay on the baffling mechanics of Barrick's gold hedging.    Mr. Landis has pulled it off though! His rapier-sharp wit helps illuminate an extraordinarily important issue that all gold stock investors need to understand.

Just as the first chart above of gold's uptrend makes an unassailable case that gold is indeed in a young bull market, the gargantuan performance delta between the pure gold miners and the mega-hedgers should once and for all slay the myth that rampant producer hedging is anything but disastrous for gold shareholders.

Since November 15th, 2000 (marked by the first yellow arrowhead above), the unhedged HUI is up a spectacular 276%! This is a magnificent 18-month return even by the lofty standards of the NASDAQ bubble days! Gold investors who were smart enough to buy unhedged gold stocks have already reaped a king's ransom since the gold rally began in earnest. For comparison, the benchmark US S&P 500 index plunged 22% over the same period of time. Talk about a performance delta!

The XAU, with the heavy mega-hedger anchors chained around its neck, has only managed to tread water with a 99% return over the same time frame. 99% is certainly not bad on the surface, but it is relatively horrible compared to the HUI's glowing performance. Simply because the XAU is dominated by companies who have hoodwinked their shareholders into owning hedge funds rather than primary gold mines, these shareholders have in effect suffered a massive 177% "hedge-tax" opportunity cost on their gold stock holdings. This hedge-tax is the difference between the unhedged HUI's glorious return and the hedged XAU's flaccid showing.

The hedge-tax is absolutely unacceptable!

The dire situation is even worse if the concealing cloak of the indices is torn away. Notorious mega-hedger Barrick Gold is only up 70% since mid-November 2000. Compare this to world-class unhedged miner Goldfields (GFI today, formerly known as GOLD, which was certainly the greatest stock symbol in the history of the universe, tomorrow who knows what they will call it?), which is roughly the same size of Barrick in terms of annual ounces of gold mined. GFI is up a wondrous 492% since mid-November 2000! A staggering 492% return in GFI less an anemic 70% return over the exact same period in ABX yields a crushing hedge-tax of 422%!

My dear friends and fellow investors, is owning a mega-hedger worth taking a gaping 422% mauling in your precious capital returns?

If you compare ABX to market-darling Durban Roodepoort Deep (DROOY) over the same period, little Durban, mining only a quarter of the gold of Barrick, was up 689% compared to Barrick's 70%! I suspect that any investor in history would have to admit that an order of magnitude difference in absolute returns within the same industry is staggering.

Mega-hedging kills returns!

If you are unfortunate enough to own a mega-hedger, spend some time and examine its two-year performance relative to a real dedicated unhedged gold mine. Stock price charts do not lie. The relentless and merciless global capital markets reward the pure gold plays and punish the gold hedge-funds-in-drag. If you believe gold is going higher, you are best off ditching these dogs and buying quality world-class unhedged leveraged gold mines.

If you are an indirect investor through a gold stock mutual fund, check and make sure your fund manager doesn't own any of these mega-hedgers. Tell them that you will not hesitate to liquidate your holdings in their fund and move your precious capital to a superior fund manager elsewhere if they continue to drag your capital across the coals of the mega-hedgers.

The longer you own a mega-hedger directly or indirectly, the higher your opportunity costs will rise in this great new bull market in gold. The higher the gold price runs, the more onerous the hedges become. The hedge-tax is a dark plague on capital and you have the choice of whether or not you are willing to suffer through it.

Once you have burned the mega-hedger dross out of your portfolio with napalm and extreme prejudice the big strategic questions emerge. Day-to-day tactical noise aside, every gold investor on planet Earth ponders two questions. How long will our current gold rally last? How high will gold really go?

As we are all mere mortals, I don't believe any human can answer these questions with certainty. I know I certainly can't! But, in the great spirit of investment and speculation, educated guesses are appropriate. Investing and speculation is all one giant numbers game. Investors and speculators absorb a vast amount of data, crunch the numbers, and then assign probabilities to potential outcomes. If a particular investment or bet seems to have sufficient odds of success in light of all available information, capital is deployed.

Occasionally in history the probability of major new future strategic trends unfolding becomes incredibly high. Great waves cascade through financial history. Investments oscillate up and down, out of favor and back into favor over many decades. Sometimes stocks are hot as in the 1990s, sometimes they aren't worth a bucket of warm spit as in the 1970s. Sometimes gold is submerged beneath the glamour of other assets as in the 1990s, other times it shines brighter than a supernova as in the 1970s.

As I have articulated in numerous past Zeal essays including "The Great Commodities Bull of the 00's", I strongly believe that we are just entering a decade where general paper assets will suffer and hard assets will soar. The world hasn't witnessed an investment environment like this since the 1970s!

Our final graph this week is merely a flight of fancy. Please do not try to read more into it than is appropriate as it probably has zero short-term tactical prediction value. Strategically however, it does offer a tantalizing glimpse of what a real Great Gold Rally is like. It has been so long since such an event that I suspect most investors playing the game today have forgotten how magnificently gold can move when investors around the world begin seriously romancing it.

All we did to build this graph is take monthly gold data from the last Great Gold Rally, the 1970s, and superimpose on top of it the current gold bull since 2001. The old 1970s gold data below is blue and tied to the left axis. The current 2000s gold data is golden yellow and slaved to the right axis.

If you glance back up at our first chart above, gold's current uptrend looks steep and spectacular. Please allow me to suggest, as exciting as today's action is tactically, that gold's behavior so far is almost unnoticeable strategically. Gold is up 19% in the 17 months since January 2001 in our current gold rally. Amazingly, gold was up a similar 16% in the first 17 months of the 1970s. Extremely provocatively, our current gold rally tracks almost perfectly with the very earliest stirrings of the mighty Great Gold Rally of the 1970s!

Feast your eyes on this flight of fancy!

Gold's current rally, magnificent as it looked in the first short-term graph above, is merely in its earliest infant stages of what a Great Gold Rally looks like! In other words, we ain't seen nothin' yet!

Today virtually every gold investor and analyst on earth thinks they are being optimistic in expecting $400 gold and wildly optimistic in expecting $1000 gold. If our current gold rally truly unfolds into a Great Gold Rally as I suspect it will in the coming five to seven years, $1000 gold is merely the first stage. Even a moderate strategic gold rally could carry us well above $1500 gold in a few years. And once the great-unwashed masses of general public investors began salivating over gold, hold on to your hats!

A gold bubble, which will probably ultimately happen as a way to climax the coming gold mania maybe five to seven years out, could easily launch gold above $5000 per ounce. As the monthly data above smoothes away daily extremes, the actual top of a new gold bubble at the final pinnacle of another Great Gold Rally could conceivably touch $6000+ per ounce!

It sure makes the current gold rally seem small in comparison eh? I believe that in strategic terms gold investors today don't need to get concerned about selling until gold starts rising parabolically relative to a long-term chart with a zeroed axis, just like the one above. As soon as gold starts exploding vertically on this type of chart, as marked by the yellow arrows above, that is the time to start planning an exit as the investing public fights to get into the action right before the peak of the mania.

Sound crazy? Why couldn't it happen?

In the late 1960s the US and British governments actively suppressed the global gold price in the London Gold Pool to protect the fragile US dollar. Gold exploded in the 1970s after the central banks ran out of steam in their ages-old campaign against gold. In the late 1990s the US and British governments once again attempted to covertly suppress the global gold price as GATA has so abundantly documented. Artificially suppressed markets always explode to the upside and vastly overcompensate once the artificial marginal supply is eliminated. In economics this is as inevitable as summer following winter.

There is a massive structural supply/demand global gold deficit today, with investors buying 60% to 100% more gold each year globally than the 2,500 tonnes that is chiseled out of the bowels of the earth by all the gold mines on the planet each year. Due to the capital-intensive economics of gold mining the only way to eliminate this structural deficit is to have a long-term massive gold rally to entice fresh mined supply to come online. Even once the alluring incentive of higher gold prices is dangled in front of the miners like a golden carrot long enough so they have faith, years, it takes even more years to actually construct new mines. As gold demand dwarfs gold supply, a gold price explosion is inevitable.

As Bill Murphy bellows with all the glorious unrepentant zeal of a mighty colonial preacher pounding the pulpit as he thunders down on the masses, there is also an enormous gold short position of maybe four to six years of total global gold production. The only way to unwind these huge shorts is to buy massive, massive quantities of physical gold. If the shorts panic at some point, which seems inevitable, the gold price could even shoot up faster and further in percentage terms than it did in the 1970s. The world has simply never even come close to seeing a gold short position of the sheer magnitude that exists today. It is bullish beyond words!

When all these hyper-bullish structural factors are combined with the generally chaotic and dangerous global investment environment today, we certainly have all the ingredients for another Great Gold Rally like the 1970s in this decade.

On the financial front, fiat currencies are failing and central banks need to keep their gold to retain what little international credibility they have left. Inflation and drastic fiat currency debasement are tragically ubiquitous across the globe. The US dollar is headed for choppy sailing for many reasons, including the gargantuan US trade deficit. Vastly overvalued equity markets are cratering worldwide in the worst financial carnage since the 1930s.

US corporations can't seem to come anywhere close to earning enough profits to justify their lofty stock prices. Rogue central-banker Alan Greenspan seems hell-bent on raping prudent savers worldwide by artificially manipulating short-term interest rates far too low. The current backbreaking personal, corporate, and government debt load in the US is unprecedented in the history of our great republic.

On the geopolitical front, militant Islam is on the rise again, crushing all resistance with the sword just as it did in centuries past. Empire America is fighting back, also crushing all resistance with the sword. Our out-of-control imperial capital of Washington DC and all its meddling bureaucrats just can't seem to quit badgering everyone else on Earth. Their unacceptable power-trip is anathema to the great ideals the USA was founded on. US taxpayers are being bled dry to finance all kinds of ridiculous and dangerous police-state actions worldwide. The world is launching a vicious trade war on the US in response to Bush's socialist steel tariffs and pork-barrel political farm subsidies. China, not exactly a big fan of the US, is evolving into a superpower. The Middle East remains a tinderbox.

The terrible list goes on and on as you well know. What a bloody mess our world has become today!

Gold and other hard assets will more than likely be the investments of choice in the chaotic decade of the 2000s as paper assets reap the bitter whirlwind from their 1990s supercycle bubbles. Let the gold naysayers eat cake.

Long live the Ancient Metal of Kings!

Adam Hamilton, CPA
Zeal LLC.com

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Mr. Hamilton, a private investor and contrarian analyst, publishes Zeal Intelligence, an in-depth monthly strategic and tactical analysis of markets, geopolitics, economics, finance, and investing delivered from an explicitly pro-free market and laissez faire perspective. Please visit www.ZealLLC.com for more information, www.zealllc.com/samples.htm for a free sample, and www.zealllc.com/subscribe.htm to subscribe.

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