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When will the gold bull market resume?
May 14, 2004

The next section of my conversation with Doug Casey and Rick Rule deals primarily with non-precious metals but because of the recent decline in precious metals prices I decided to post the letter that I sent to my subscribers last week. I’ll continue the interview transcript next week.

Typically I restrict my subscription-based newsletter to discussions about the specific companies I buy and sell, and the reasons why (for more information about my newsletter please visit Last week, however, I felt compelled to comment on the metals markets.

From 1998 to 2002 I firmly believed that gold would rise significantly, and exceed four hundred dollars an ounce, as a result of dollar-weakness. The dollar did weaken, and we can think of the increase from $250 to $400 as the first leg of a major gold bull market (in dollar terms). The second leg up will most likely take gold to over five hundred dollars an ounce. All bull markets, however, are interrupted by counter-cyclical corrections.

I’m not a witch doctor, so I can’t tell you the date on which gold will resume an upward course, but I can tell you what needs to happen before it does.

The gold price is still very much a function of the US dollar exchange rate. The dollar is far more important than Central Bank sales, Indian jewelry demand, hedging, de-hedging, or anything else. And right now the relationship between interest rates and the dollar is controlling the gold price.

Here is a recap: the gold price in US dollars is a function of the US dollar’s exchange rate. If the dollar strengthens the gold price declines (this is because the average gold price in the world remains fairly constant, rising gradually in proportion to total fiat money creation). The rise in the gold price from 2001 until recently occurred because the dollar lost value on foreign exchange markets -- nothing more. The recent decline in the gold price is due to temporary strength in the dollar, on the back of higher interest rates, and the prospect of them rising even further.

US interest rates actually bottomed around June last year, even though the trend appeared to continue downwards after then. In March this year there was another significant up-tick in interest rates, which strengthened the dollar and put pressure on the gold price. The recent decline in the gold price is solely a result of that increase in interest rates and the resulting increase in the dollar exchange rate.

Higher interest rates in the US are a foregone conclusion, guaranteed by the US Budget Deficit. The Budget Deficit has to be financed by issuing bonds at a rate of five hundred billion dollars a year. There is no reason to believe the Budget Deficit will decline anytime soon; on the contrary, it is more likely to increase. Obviously issuing five hundred billion dollars’ worth of bonds every year will have a negative impact on bond prices, hiking interest rates. Think of it this way: the annual Budget Deficit equals about seven percent of the total amount of outstanding Treasury Securities. Every bond investors and bond trader out there knows that the total amount of Treasury Securities outstanding is going to increase by, at least, seven percent per year for the foreseeable future. That’s an enormous amount of overhanging supply, and the reason why interest rates have started moving up.

Higher interest rates are the Achilles Heel of the US economy. We have too much consumer debt, too much credit card debt, too much mortgage debt, too much corporate debt and too much government debt. Higher interest rates are not only going to choke economic growth in the US, they could easily precipitate a collapse in real estate and the stock market. Don’t, for a minute, believe that the worst is behind us.

The probability of the US economy in its current state experiencing economic growth while bearing the weight of higher interest rates is slim. Even Alan Greenspan is worried about it.

Last week’s Wall Street Journal (Online Edition) reported that Greenspan said the US Budget Deficit threatens the nation’s economic stability. There is only one reason for him to worry about the Budget Deficit. He knows that it will cause interest rates to rise and that higher interest rates will kill any chance this economy has of averting a serious downturn.

But let’s not forget about the Trade Deficit, which is also in the order of five hundred billion dollars. The Trade Deficit has to be financed with foreign investment and I find it very, very hard to believe that the United States will continue to attract half a trillion dollars in foreign investments every year. Especially when economic growth stagnates, or declines, under the burden of outstanding debt and higher interest rates.

Even though the US debt problem has been looming for decades, a crisis has not yet materialized because US bonds have been rising since 1981. The resultant decline in interest rates not only mitigated the impact of outstanding debt, but also enabled the debt to grow exponentially. Now, however, we are entering a period of increasing interest rates in an environment of severely compromised credit quality and a fragile economy.

The bond market has already figured out that the bottom is in; the twenty-three year bull market in bonds is over and from here onwards interest rates go up. The currency market, on the other hand, has not yet figured out that higher interest rates will spell the end of the US economic boom. When it does, the dollar will commence a second decline in its secular bear market, and that will cause the gold price to rise.

Here is the key: we need dollar-weakness on the news of higher interest rates before the gold market resumes a sustainable upward trend. Currently the dollar is strengthening on the prospect of higher interest rates, but that will change.

It’s an election year in the United States, so I fully expect to see government intervention in both the currency and bond markets, in an attempt to mitigate a decline in either. The government cannot, however, keep the game up for very long because of the Budget Deficit. So the rally in the dollar (and the downturn in gold) is unlikely to last much beyond the end of the year and, given the precarious state of the government’s finances, it may not even last that long.

In the meantime use this market to your advantage: sell stocks that you now regret you bought in the first place and replace them with the shares of companies you are glad went down, so that you can buy more at a lower price. That’s what I am doing, and it’s why this downturn in gold doesn’t bother me in the least.

If you want to know specifically what it is I’m selling, or have sold, and what I am currently buying, you should subscribe to my newsletter. Please visit for more information.


Paul van Eeden

Paul van Eeden works primarily to find investments for his own portfolio and shares his investment ideas with subscribers to his weekly investment publication. For more information please visit his website ( or contact his publisher at (800) 528-0559 or (602) 252-4477.


This letter/article is not intended to meet your specific individual investment needs and it is not tailored to your personal financial situation. Nothing contained herein constitutes, is intended, or deemed to be -- either implied or otherwise -- investment advice. This letter/article reflects the personal views and opinions of Paul van Eeden and that is all it purports to be. While the information herein is believed to be accurate and reliable it is not guaranteed or implied to be so. The information herein may not be complete or correct; it is provided in good faith but without any legal responsibility or obligation to provide future updates. Neither Paul van Eeden, nor anyone else, accepts any responsibility, or assumes any liability, whatsoever, for any direct, indirect or consequential loss arising from the use of the information in this letter/article. The information contained herein is subject to change without notice, may become outdated and will not be updated. Paul van Eeden, entities that he controls, family, friends, employees, associates, and others may have positions in securities mentioned, or discussed, in this letter/article. While every attempt is made to avoid conflicts of interest, such conflicts do arise from time to time. Whenever a conflict of interest arises, every attempt is made to resolve such conflict in the best possible interest of all parties, but you should not assume that your interest would be placed ahead of anyone else’s interest in the event of a conflict of interest. No part of this letter/article may be reproduced, copied, emailed, faxed, or distributed (in any form) without the express written permission of Paul van Eeden. Everything contained herein is subject to international copyright protection.

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