In our comments a few weeks ago we went
off on a tirade about the lack of coverage of Gold in
the popular media. We have found no reason to change
our view of the dismal work being done by journalists,
generally speaking that is as some do try to rise above
the pack. In particular we read one over the past weekend,
in a very respected business magazine, that lamented
the possibility of Gold doing well. The author thought
that would be a shame as Gold is boring. Hey clod, investing
is not about excitement. Excitement was JDSU and TYC.
Investment is about getting your principal back along
with some return on that principal.
The whole matter gives one headaches. But as so many
responded after the last commentary as long as the popular
media is still talking about INTC or CSCO or ORCL or
whatever, our positive attitude toward Gold is safe
as can be. What is really baffling is not that so many
investment people do not understand Gold, but that they
still keep their jobs owning things like TYC. Totally
Like many we get insecure some mornings, but then we
pick up the paper. This past week The Wall Street journal
had an article, "Was That the End of the Gold-Price
Rally?" The author seemed to imply that Gold investors
were worried after the small correction of that week.
Personally, worry should not have been a concern that
day. Later in the article an economist for a prominent
brokerage firm was quoted as not understanding the positive
move of Gold. No words could be ever more reassuring.
If a Wall Street economist ever started understanding
Gold, or anything else, we will have some real concerns.
This was to be the second in a two-part series. However,
after thinking about it this will be the second in a
three part series. The reason for that is we want to
talk about inflation and the potential of that force
to aid the price of Gold. Inflation is to be a special
situation this time, being driven by currency devaluation.
Inflation results from creating more money than people
want to hold as money. If the central bank produces
more money than people want to hold then two things
can happen. One, they might get rid of those dollars
by buying "something" which would push up
the price of "somethings". Such is the inflation
process of which we traditionally think. However, a
second possibility does exist.
If the Federal Reserve produces more dollars than people
in the world want, those dollars will be sold in the
foreign exchange market. That selling of dollars and
buying of another currency will push down the purchasing
power of the dollar. The price of "somethings"
in the U.S. would therefore rise. Such is the type of
inflation the U.S. is more likely to experience in the
period ahead. Global financial markets will be a unique
influence on the future inflation environment.
Currency values are the issue. For example, inflation
has burst forth in Argentina, 18+% in the past year,
as a result of that nation's currency problems. U.S.
inflation has appeared to be tame as the dollar has
not yet come under serious attack. However, the Gold
market and the foreign currency markets are starting
to suggest that the purchasing power of the dollar is
in trouble. That means that inflation in the U.S. is
likely to accelerate in the future.
Space precludes a thorough discussion of inflation.
First, inflation is not defined by the consumer price
index produced by the government. Second, inflation
is a concern not only because of the impact on the consumers'
purchasing power. Inflation distorts the investment
process. Just as bad as "inflation" are price
bubbles as we witnessed in the U.S. stock market and
the Great Greenspan Housing Bubble now building toward
If one reads the laws giving guidance to the Federal
Reserve no where will be found that one of the goal's
of the Fed is to be control of the consumer price index(CPI).
Price stability is the assigned goal. That means that
price bubbles in financial assets should be avoided.
That means that price bubbles in housing should be avoided.
The Federal Reserve has no legal mandate that blesses
the creation of financial bubbles.
Unfortunately, we need to move on. Let us do so by
considering the graph titled, "Inflation Measures."
Two measures of inflation are included in the graph.
The first of those measures is what we refer to as the
"Naive CPI," and is the thin line in the graph.
We give it that name cause anyone that truly believes
a government number is naive. The second measure is
a much better indication of the central tendency of
inflation. The talented elves at the Federal Reserve
Bank of Cleveland produce each month a "Median
CPI," and is the bold line. This data and an explanation
can be found on their web site. (For a discussion of
this matter see "$1245 GOLD.")
The Median CPI is a better measure of
the entral tendency for inflation. We will go into this
more in the next article as we want to set the stage
here. The Median CPI as can be seen in the graph is
running just off the highest level since the early 1990's.
On a year-to-year basis this measure indicates that
inflation is about 3.7%. The Naive CPI, used by the
Federal Reserve for decision making, is up 1.6% on a
year-to-year basis. The better measure of inflation,
the Median CPI, is more than twice the rate indicated
by the government statistic used by Federal Reserve
to set monetary policy.
This Median CPI has another use. We can
use it to create buy and sell signal on the Naive CPI.
This is done by using the simple difference between
the two measures. When the difference between the Median
CPI and the Naive CPI gets too large the tendency is
for Naive CPI to change directions . We have plotted
those signals in the graph with triangles. The danger
in this situation will be explained in the next article.
Now let us go an interesting step forward
by plotting those signals along with the monthly average
price of Gold. This has been done in the next graph.
An interesting picture develops.
Since most of us are interested in how
we invest let us focus on refining the use of these
signals. For that purpose we will consider only the
first signal in a series that is a change from the previous
signal. What this means is that in March 1978 we got
the first buy signal on inflation since the previous
sell. Then we use the first sell signal that develops
next for our signal to sell.
If one had bought Gold in March 1978 and
held till recent times, a gain of about $126 would have
been achieved. If one had used the first buy/sell signals,
the gain would have been about $386. The first signals
produced a gain three times as large as buying and holding.
the spirit of disclosure, the last first buy signal
was in October 1998 at a monthly average price of $296.
While certainly we would have all liked to buy at the
1999 bottom, few of us did. In any event, that signal
is profitable and still in control. And we might add,
that signal is a whole lot better advice than we got
on the cable shows.
As the end of this effort is slowly approaching,
let us summarize. The next bout of inflation in the
U.S. will be a result of currency problems as being
experienced in Argentina. The Federal Reserve uses the
Naive CPI for decision making, a problem we will discuss
in the next article. Using the Median CPI and Naive
CPI we can develop buy and sell signals on the Naive
CPI. These signals are useful in the timing of Gold
purchases. The last signal on U.S. inflation is a buy
signal. The last inflation signal on Gold was a buy.
As the Federal Reserve sets monetary policy
based on the Naive CPI, a reversal in that measure as
is likely will probably cause a change in policy. As
the Naive CPI is likely to move higher we can expect
monetary policy to move in a way that will pop the Greenspan
Housing/Mortgage Bubble, damaging the illusion of growth
in the U.S. economy. The U.S. dollar will be adversely
impacted and Gold will benefit.
And finally, an important note. Today's
inflation rate is never tomorrow's inflation rate. Pick
any point on the graph for a test. Is the inflation
rate a year later the same as at that point? No, of
course not. That is an important lesson not learned
by economists and strategists at Bay and Wall Street
or the Federal Reserve.
Ned W. Schmidt,CFA,CEBS publishes
THE VALUE VIEW GOLD REPORT, a monthly review
of the developing Gold Super Cycle. His major report,
$1,245 GOLD, 150+ pages with 70 charts
and graphs, is essential reading for investors wanting
to understand the coming Gold Super Cycle. As a special
offer "$1,245 GOLD" is available for $45.
This report can be ordered by contacting Ned at email@example.com
or by clicking on this button