It's been an exciting couple of months. Gold
broke out to a 16 year high rising to near $460 and the U.S.
dollar fell a nine year low. This week, however, gold was
down sharply. So what's going on?
In recent months we've been to several investment conferences.
One impression from these conferences is that many investors
aren't fully aware of the big picture and what's happening
in the economy or the markets. They seem more focused on short-term
events, but they also know something's not right.
While certainly important, short-term events have essentially
reinforced the major trends which have already been underway
for a few years in both gold and the dollar. But these markets
have been rising or declining for other reasons.
The most important factor driving these markets has been
the new era that started in the late 1990s. Since then, the
stock market bubble burst, deflation forces intensified, interest
rates were cut to 45 year lows, monetary stimulation exploded,
gold embarked on a major bull market rise, and so did oil
and commodities while the U.S. dollar began a major bear market
decline.
Events following 9/11 basically fueled this new era. In record
time, the government budget surplus quickly turned into the
biggest debt and deficits the world has ever known as the
war on terrorism took hold. The massive military spending
for Iraq and Afghanistan combined with tax cuts sent the deficit
soaring to an unprecedented $600 billion this year.
The current account deficit is also at record highs and these
twin deficits combined with low interest rates have been the
main reasons why the dollar's been dropping. This in turn
has kept upward pressure on gold and commodities, but there's
more…
INFLATION HEATING UP
Gold is a leading inflation indicator and its quiet rise
since 2001 has been signaling inflation is coming. This year
we began to see this with the most obvious sign being the
super rise in the oil price. Energy prices, for instance,
soared at an annual rate of 82% in October and nearly 22%
in November, pushing producer prices up the most in 14 years
to a whopping 13% annualized rate in the past two months.
This strongly suggests inflation is far more likely to be
the economic concern moving forward rather than deflation.
Plus, unprecedented government spending, and the debt and
deficits nearly guaranties it. If the war on terror continues,
which is nearly certain, this deficit spending is going to
fuel even more inflation, which is going to be bullish for
gold and bearish for the U.S. dollar.
For now, the markets are looking ahead and the breakouts
last month are telling us they expect no end in sight to the
spending, debt and deficit situation. Wars are expensive and
many will argue the spending is justified, but that isn't
the point. The point is, we've been spending on a scale never
seen before in history.
That's the big picture and it's basically why the markets
are behaving the way they are. Understanding this is important
in making good investment decisions.
GOLD: At onset of major rise
As time passes and seeing how big picture events are unfolding,
we're more inclined to believe this bull market in gold is
going to be a big one, which could surpass the old highs at
$850. If that proves to be true, then this mega bull market
will likely be composed of three psychological phases.
The first phase is when the so-called smart, big money buys.
In the second phase, mutual funds and some investors start
moving in, attracted by rising prices. The third phase is
when the public jumps in, which pushes prices up to levels
higher than most expected. That's what happened to gold in
1980, Japan in 1990 and tech stocks in 2000.
Interestingly, our dear friend Chris Weber was at a barbecue
near Monaco several months ago where several billionaires
were present. (Chris is an extremely successful investor and
he writes a great newsletter we highly recommend; www.weberglobal.net.)
When the conversation turned to investments one of the party
goers wondered what to invest in these days. Almost in unison,
the billionaires all said gold. They obviously bought in the
first phase of this bull market. Another dear friend Richard
Russell believes we're now in the early second phase and this
tends to be the longest phase.
WHERE GOLD STANDS NOW
Last month gold broke above $430, triggered by the drop in
the U.S. dollar, which was very important for several reasons…
First, it meant gold was entering a stronger phase of the
major bull market. It also meant the rise was on track and
it completed its function by hitting a new bull market high,
which reinforced the bull market in gold is strong.
But no bull market goes straight up or straight down. There
are downward corrections along the way and gold is now starting
a downward correction following its steep rise since September,
which is completely normal.
By now you know that gold's been moving in an
A through D cyclical pattern since the 1970s (see Chart 1A,
which shows gold since 2001). The As and Cs coincide with
intermediate gold rises while the Bs and Ds coincide with
intermediate declines. Gold has been in a C rise, which are
the best rises in the cycle.
The timing of the C rises has been fairly consistent. Since
1999, for instance, they've lasted eight to 10 weeks on average.
On that basis, the current C rise was due to end at any time.
Plus, gold's leading indicator was at the level of previous
C peaks (see Chart 1B). This told us gold may not go much
higher for now. This week gold declined below $445 and if
it now stays below that level, the C rise will clearly be
over and a D decline will be underway.
These declines are the steepest ones in the cycle and if
you want to take some profits, this would be the time to do
it. But as we said earlier, we believe this gold bull market
is going to be a big, long lasting one and it's best to stay
invested throughout the major rise. So if you do sell some,
continue to hold your core gold, gold shares and other metals
for the long-term. Gold's major trend will remain up above
$404, its 65-week moving average.
Regardless of the upcoming D decline, it's interesting
to note that gold is stronger than stocks or bonds on a mega
trend basis (see Chart 2). In other words, gold is still where
your focus should be and normal downward corrections within
the major bull market shouldn't sway you. Instead, look at
these downward corrections as another buy area.
*******
Mary Anne and Pamela Aden are internationally
known investment analysts and editors of The Aden Forecast,
a market newsletter providing specific forecasts on gold,
gold shares and other major markets. Click here to visit their
website at http://www.adenforecast.com
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