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 www.paulvaneeden.com).
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
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
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
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 www.paulvaneeden.com
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
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