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Update:
Gold
Brian
Trumbore
President/Editor, StocksandNews.com
From time to time I like to deviate
from the norm for this space and supply you with a
little update on gold, courtesy of my friends at Van
Eck Global. Back during my days in the mutual fund
industry, I worked closely with these fine folks and
my friends there have granted me permission to reprint
some of the thoughts from their portfolio management
team.
Gold
has been rallying again, recently, largely on continuing
weakness in the U.S. dollar, even as the Federal Reserve
sends out strong signals it is concerned with the
prospects for deflation. Counterintuitive, perhaps,
but for more of an explanation we turn to the guru
of gold investing, John Van Eck, who issued the following
comments on May 1, 2003.
*For
the record, I do NOT personally own any gold shares
myself at this time, nor am I going to purchase any
in the foreseeable future.
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After
the dollar price of gold peaked at $385 an ounce in
February, it began a correction which lasted until
April 7 when its price reached $321. Many investors
unwound the risk-averse and speculative positions
they took before the Iraq war. At this price it returned
to the December breakout level from its six-year "bottom."
It then began to strengthen and closed the month of
April at $339.10.
Gold-mining
share prices broke above their twenty-one year bear
market trend last year as the general stock market
and the U.S. dollar declined. The Philadelphia Gold/Silver
Stock Index (XAU) climbed from 42 in October 2000
to 89 in May 2002, up 112%. It then began to consolidate
this rapid move. After reaching 62 in late March,
it began to firm up and closed at 65.3 by the end
of April.
Although
there has been a short-term divergence in the price
performances of gold and gold mining shares, both
have established uptrends from the lows of February
2001 and October 2000, respectively. Gold's uptrend
is approximately 14% annually, and the XAU's uptrend
is approximately 20% annually. No one knows how long
these trend rates will last, but, in our view, both
have begun new bull markets that will continue for
the foreseeable future. This update outlines some
macroeconomic reasons for this view.
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Possibility
of a Prolonged Low Growth Period:
A 'Growth Recession'
Monetary
Stimulation May Become Ineffective
After
the stock market bubble burst in 2000, the Fed eased
monetary policy aggressively in order to avoid a recession.
During the past two years, it cut the fed funds target
rate 5.25% to below zero in real terms (ed. including
the rate of inflation), stimulating interest-sensitive
borrowing and spending. The political authorities
hope for, and current market opinion expects, a renewed
cycle of business investment and debt expansion.
However,
The World Bank in April stated, "A worrisome characteristic
of the current economic environment is that macroeconomic
policies may be running up against their limits."
Credit expansion may gradually reach a "liquidity
trap" and become ineffective in stimulating borrowing,
which could make standard econometric model forecasts
useless. Lower economic growth may be inevitable in
spite of equilibrium levels. Remaining possible imbalances
could include over-consumption, over-capacity, low
corporate profitability, excessive size of the debt,
record balance of payments deficits, and still relatively
high stock prices. Corporate profits may remain under
competitive pressures, and an upturn in investment
demand may be delayed longer than expected. Consumer
demand may weaken. Aggregate demand may remain less
than potential. The rate of growth of real disposable
income may decline. Financial problems may restrain
spending and growth. The remaining imbalances may
inevitably contribute to an unintended period of low
growth until they are corrected. A low growth rate
may be under the rate needed to create enough jobs
to match the growth in the labor force; so unemployment
may tend to rise. A period of stagflation cannot be
ruled out if low interest rates and rapid liquidity
creation result in higher inflationary expectations
in the future.
Weaker
Consumer Demand: Vulnerability in the Housing Market?
The
growth rate of consumer spending and of household
debt formation may decline. Consumer demand has supported
economic growth, especially in the last two years.
Consumption has expanded from about 70% of GDP growth
in the 1980s to approximately 87% in 2002. The Fed's
relatively low interest rates stimulated the growth
of outstanding household debt which has expanded from
$1.4 trillion (72% of disposable income) at the end
of 1980 to $8.4 trillion (108% of disposable income)
at the end of 2002, up an average rate of 8.5% annually.
Consumer car and housing demand responded positively
to recent low interest rates. Median existing home
prices have risen approximately 38% in the last five
years. Both regular mortgage originations and refinancing
of regular home mortgages made all-time records in
2002, totaling over $4 trillion net of cash-outs,
possibly putting debt levels on depreciating assets
into dangerous territory and setting the stage for
instability in the longer run. Detailed IMF research
shows that housing market busts regularly follow booms
of the scale recently experienced and have much longer
lasting negative effects on economic performance than
equity market downturns.
Federal
Deficits May Prolong a Period of Low Growth
The
Federal government's budget surplus in fiscal 2001
slid into a deficit of over 3% of GDP in fiscal 2002
and could approach 5% of GDP this year. State and
local budgets also are incurring huge deficits. Deficits
normally add to aggregate demand in the short-term,
but they reduce the funds available for net domestic
investment and they may raise long-term interest rates.
Thus, they may raise the cost of capital and so limit
growth. They and "social" laws also may unintentionally
tend to prevent a possibly needed market adjustment
of national labor compensation costs to lower equilibrium
levels and so to increase unemployment and to decrease
corporate profitability. These factors may tend to
delay renewed business expansion and to extend a period
of sub- par growth.
Summary
Interest
in gold as an investment has slowly increased. If
a prolonged low growth period and its possible consequences
of increasing financial distress, bear markets and
continuous negative real yields materialize, investors
could become more risk-averse and seek to preserve
their capital and to obtain a real return. They could
diversify more of their portfolios into cash and gold
as an alternative investment. Gold is a debt default
risk-free and currency devaluation risk-free monetary
asset, and has historically been a reliable long-term
store of value in periods of global monetary disorder.
It has a low or negative correlation with equity stock
prices and so when added to an investment portfolio
could improve its performance.
Gold's
price may have renewed its historic long-term uptrend
(as fiat paper currencies were inevitably depreciated).
If this trend is accompanied by a "growth recession"
and an increased investment demand for gold, a rising
price may offer gold- oriented investors a real annual
return. As gold prices rise and investors gain confidence
in gold's uptrend, investment demand could accelerate.
Of course, gold's price is volatile and erratic as
a result of shifts in short-term investor attitudes.
Another exponential upward move may eventually be
under way, as occurred in the 1970s.
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Wall
Street History will return next week.
Brian
Trumbore
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