Gold's been slowly rising over the past couple
of years but it hasn't attracted a lot of attention, yet.
Gold's bull market is solid, however, and it's now poised to
rise to new bull market highs in the months ahead.
Interestingly, silver, and gold and gold shares
seem to be anticipating the rise. Silver shot up this month to
a one year high while silver shares soared. We don't think it's
a coincidence that silver is now flexing its muscles for the
first time in years at a time when gold is ready to rise
further.
Gold shares are even more sensitive. The HUI
gold share index hit a new bull market high. Plus, gold shares
are now strongly outperforming gold. This too suggests the
upcoming gold rise will be impressive.
The overall foundation is strong for gold, both
technically and fundamentally. But the big news this month was
the sharp drop in U.S. bond prices. Surprisingly though, gold
and bonds are linked, and the rise in gold and drop in bonds
are a reaction to what's been happening.
Considering the overall environment, we thought
this would be a good time to review some of the most important
happenings and try putting them into perspective. This will
help explain why gold is likely headed higher.
INFLATION OR DEFLATION?
For a long time, the forces of deflation and
inflation have both been pulling at the global economies. Over
the past few months, deflation pressures intensified with
import and producer prices plunging at double digit rates in
the U.S.
The Federal Reserve (Fed) has been very
concerned about deflation and it's been pumping out money like
mad while dropping interest rates to near zero to keep
deflation from taking hold. Its actions have been inflationary,
which is why these two crosscurrents, inflation and deflation,
have been bucking heads.
CHINA: A deflationary force
But the Fed can't control China and that's
where a lot of the deflation pressures are coming from. Since
China is the world's largest producer of inexpensive goods,
consumers have been buying these products like hotcakes.
Chinese exports have tripled over the past nine years. So
manufacturers outside of China have had to keep prices low to
compete.
Plus, with help from global companies, China
has been building factories, in part with all the dollars
that've been flooding in, which has transferred millions of
factory jobs from the U.S. to China where workers make a
fraction of what U.S. workers make. This has kept U.S.
unemployment high since factory jobs have accounted for 90% of
job losses over the past couple of years and it's estimated
that over three million U.S. jobs will be sent overseas over
the next decade or so.
GROWING DEBT MONSTER
At the same time, the massive U.S. trade
deficit and low interest rates have caused the U.S. dollar to
fall. But a weak dollar and low interest rates are needed to
help fight off deflation pressures, which have been keeping the
economy sluggish. Then there's the federal debt, which is also
a drag on the economy.
Just since the 1990s, for example, the U.S.
government has accumulated more new debt than all the debt that
was built up since the U.S. became a nation. So the U.S. is
dependent on the rest of the world to keep accepting their
paper dollars in exchange for goods. But the U.S. thirst for
consumption, debt and military adventure cannot continue as is.
Something's going to give and it may already be happening.
DEBT AND BONDS
The government finances its debt by selling
bonds, and foreign investors hold about 40% of U.S. government
debt. But as Stephan Roach notes, there comes a time when
foreigners demand a premium for funding a savings-short
economy. The breaking point usually occurs when the current
account deficit hits 5% of GDP. That typically triggers the
classic current account adjustment characterized by a weak
currency and higher real interest rates.
The U.S. is now at 5.1% of GDP, which require
inflows of about $2 billion a day, and it could grow to 7% by
the end of next year. So there's a real possibility foreign
investors are now looking for compensation in the form of
rising real interest rates, which could explain in part why
bond yields have been soaring.
The Fed also buys bonds by creating money out
of thin air. This helps fight deflation too but the extra money
created is inflationary. For now, the economy is picking up,
but that doesn't mean it's out of the woods.
The decline in U.S. bond prices, however,
suggests that deflation pressures are easing and inflation has
become a concern. The record spending and deficits nearly
guaranty it because the Fed will have to keep the money flowing
to cover ongoing expenses, now estimated at a $44 trillion
shortfall for the years ahead. But the puzzle is still
unfolding and neither scenario is a done deal.
This month's sharp rise in long-term interest
rates, for instance, also drove mortgage rates up to over 6%.
And since mortgage refinancing has been a big factor keeping
the U.S. economy afloat because it kept consumers spending,
it's now worrisome that refinancing has dropped more than 50%.
Consumer confidence also declined to a four month low and these
two factors could threaten not only the U.S. recovery, but the
global economy as well, because the U.S. is the world's engine
and consumers drive the U.S. economy. If the consumer cuts back
on spending, everything could grind to a halt, again increasing
the deflation risk.
In fact, the public is beginning to sense all
is not well. Bush's popularity has dropped 29% over the past
few months due to his justification for going to war, the
casualties in Iraq and expenses of $4 billion a month to keep
150,000 troops there, the deficits, but mainly because of the
economy and unemployment.
WHAT DOES THIS MEAN FOR THE MARKETS?
Just look at the chart and it'll tell you.
Massive debt and deficits for years to come are keeping the
U.S. dollar down and it's fueling gold's bull market. Gold has
clearly been the winner and since gold and the dollar move in
opposite directions, as the dollar heads lower, more investors
will turn to gold because it's real money and it represents
safety.
If inflation picks up, it'll be super bullish
for gold. But even if deflation gets the upper hand, the Fed
would have to create even more money, which would be bearish
for the dollar and bullish for gold. Basically, gold rises
during uncertain times, and these are uncertain times.
Low interest rates are also bullish for gold.
Gold pays no interest but since short-term interest rates are
now extremely low, they're not competing with gold and it
becomes more attractive.
In fact, demand for gold has been picking up.
Plus, gold producers have been lifting their hedge policies and
gold production declined last year for the first time in seven
years. Growing demand with less supply is a bullish
combination. Not to mention the fact that China is buying gold
and encouraging its one billion population to buy too.
Bonds, on the other hand, have turned down
sharply and stocks are looking vulnerable for the months ahead.
If these two markets eventually head lower as we suspect,
gold's glitter will shine even brighter.
On the technical side, gold is very bullish.
It's major trend is up above $334. A new rise we call C is now
beginning and it tends to be the best rise in the cycle. The C
rise is underway as long as gold now stays above $350 and it'll
gain momentum above $365. But once gold closes above its
February high at $380, it'll then be on its way to our target
at $415. Above that level, $500 would then be the next target.
Based on average timing, this C rise could last until October.
As for silver, if it closes clearly above the
$5.10-$5.20 area, it could rise to near the $6.50-$7.00 level.
Gold shares are already very bullish. But if
the XAU gold share index closes and stays above 88, a major six
year bottom will be complete and they could then soar with the
XAU eventually rising to the 160 area. This alone is exciting
because if the C rise performs as it consistently has over the
decades, a clear breakout for the gold shares could happen at
any time.
*******
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
