-->Gold To Rise

The Daily Reckoning

Paris, France

Friday, 24 January 2003

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*** Consumers...up, down...getting a lesson from Mr.
Market?

*** Happy birthday to the California Gold rush...Gold Up,
Dollar Down...GUDD, the trend of the decade...

*** President's pick-me-up may not be enough...if the
housing bubble bursts...Where are the pigeons? (They are
all around us...)

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What to make it?

Building permits hit a record high in December.

But now a"plunge in consumer mood" (Atlanta Journal-
Constitution) causes sharp"dip in mortgage applications"
(Reuters).

Investors are fed up after 3 years of falling stock
prices...still, more than 50% of households own stocks,
according to yesterday's news. And Wall Street strategists
are as bullish as they've ever been, recommending near-
record levels of stock market exposure.

Investors no longer believe the hallucinations of the
bubble period. They no longer think that they'll get rich
quickly and easily just by being"in the market".

Now they think they'll get rich over a longer period of
time by more carefully selecting their investments.

The first illusion was knocked out of them when the stock
bubble deflated. Beginning in 2000, business borrowing and
capital spending absolutely caved in. By the 3rd quarter of
2002, business borrowing was running at an annual rate of
just $10.7 billion - down from $400 billion in 2000.
Profits plunged and the smart money realized right away
that it was time to get out.

The new lumpeninvestoriat who had been lured into stocks
during the boom had no idea what was going on. The poor
schmucks believed all the nonsense from Wall Street...and
thought they could just hold for the long term. Stocks
always go up in the long run...right? Heh heh...

Now, Mr. Market, dressed in black and leaning over the
pulpit with an accusatory glare, is delivering a long and
painful lecture. He's warning that nothing goes up
forever...that neither an individual nor an economy can
expect to prosper without saving, discipline, forbearance
and hard work...and that Wall Street's real function is
moral, not financial; it makes investors poorer, but wiser.

The little guys don't want to believe it. They can't admit
to themselves that they've been the market's patsies."This
year, stocks have to go up...they never go down 4 years in
a row," they whisper to themselves."Nothing beats stocks
over the long term,' they chant,"even if there are some
'soft patches' along the way."

And so the second illusion will have to be beaten out of
them, too, for now it's the consumer sector's turn to be
de-leveraged. Since the '60s, the consumer has added to his
debts...first, cautiously in the '70s...and then recklessly
in the in '90s. While GDP rose 283% during this period,
consumer debt shot up much faster - by 473%.

"You can't do that forever," says Mr. Market."Sooner or
later, you have to straighten up, stop spending so much and
save a little."

"The profitless, consumption economy is on the verge of
ruin," adds Kurt Richebächer, crying from the wilderness of
the French Riviera.

In the front pews, America's 79 million baby boomers look
down at their hands...or gaze nervously at the window. They
squirm in their seats. Maybe they're not quite ready to
change their habits...but they can't help thinking about
it. Retirement is too close. Instinctively, the boomer
knows Mr. Market is right. He's old enough to want to start
saving tin foil...and paper bags...and Christmas wrapping
paper - the instinct dates to the time his race had fur.
Why fight it? Glory hallelujah...and so he makes up his
mind to save a few bucks next week...and waits for the next
sermon...

Eric...what fire and brimstone is Mr. Market sending down
upon us?

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Eric Fry, reporting from New York...

- GOLD! GOLD! GOLD! Like a Presidential sex scandal, the
yellow metal's surprising ascent is front-page news day
after day, at least on the front page of the business
section...Or maybe just on the front page of the Daily
Reckoning. Yesterday, the gold price jumped $4.80 to
$364.70 - that's up more than $110 from the low of $253.85
that gold hit nearly one year ago. The 'barbarous relic' is
conducting a very civilized bull market.

- In other news, bonds fell, stocks rose and the dollar
fell. The Dow gained 51 points to 8,369, while the Nasdaq
popped about 2% to 1,388.

- Most folks hope and believe that the President's nifty
$687 billion stimulus plan will be a perfect little pick-
me-up, like the first cup of coffee in the morning. We
think the plan is more like the tenth cup of coffee on the
night before final exams - that's the cup that speeds the
heartbeat, while causing indigestion, failing to increase
productivity one whit and preventing sound sleep.

-"The [President's] proposed pick-me-up, even if passed
intact, is too weak," says James Grant."That's because]
state and local governments are biting bullets even as the
federal government is shooting them off." Most states in
the Union are facing severe budget shortfalls and are
rapidly reining in their spending. That's not good news,
given the fact that the 50 state governments combined are
much bigger spenders than Uncle Sam - and that dude knows
how to throw money around! The expenditures of the state
and local governments - equal to 12.2% of GDP - are nearly
double those of the Federal government."In short," says
Grant,"the actions of the state and local governments will
be an offsetting drag to any federal stimulus."

- Nor should we look for much stimulating spending out of
the private sector. Neither corporations nor consumers are
in much of a position to step up their borrowing and
spending...Didn't they do that already?

-"There's no question that we have a debt bomb," says
Morgan Stanley economist Stephen Roach,"but I'm not sure
how long the fuse will turn out to be." Nor do we. But we
are fairly sure that the fuse is glowing brightly and
getting shorter by the day.

-"If the U.S. debt bomb ever explodes, the detonator
probably will be the residential mortgage market," asserts
Barron's Jonathan R. Laing."Home prices have nearly double
the impact on consumer spending than does the 'wealth
effect' from rising or falling stock prices. And home
prices have been on a tear, rising nearly 50% nationwide
over the past six years...Consumers have tapped this
surging equity value through wave after wave of cash-out
mortgage refinancings, transforming homes into ATMs."

- Because homeowners have been withdrawing cash from their
homes like so many $20 bills, they are sucking the equity
out of their homes even faster than the red-hot housing
market is adding to it. Thus, the housing wealth effect is
more vulnerable to reversal than ever. If, heaven forbid,
home prices should fall rather than rise, we might finally
hear the miserable"Boom!" that Laing anticipates.

-"Gary Shilling calculates that 39% of U.S. homes are
owned free and clear," writes Laing,"and that the
remaining homeowners have debt burdens exceeding 80% of the
value of their homes. In other words, many Americans have
little margin of safety should home prices level off or
should they fall as much as 20%, as they did in many
overheated areas in the late Eighties."

- Last year, Americans sucked about $250 billion worth of
equity out of their homes that they did NOT reinvest in
real estate. A sliver of this quarter-of-a-trillion dollar
pile of cash found its way into savings accounts. But most
of it was spent on stuff like yoga classes, Disneyworld
vacations and Eminem concerts. The memories remain, but the
money does not.

- In other words, a big portion of the refinancing proceeds
has gone to money heaven. And now that refinancings are
slowing down, what other cash-flow rabbits could we
possibly pull out our macroeconomic hat? The President's
"pick-me-up" cannot begin to compensate for the dwindling
refinance activity.

-"If the housing bubble bursts, instead of gently
deflating, the nation's economy could be in for a major
meltdown," Laing concludes."In essence, then, the American
home is a bulwark for the economy. As long as housing
values stay high, the nation is sheltered from a detonation
of the debt bomb."

- If the bomb does detonate, we should expect numerous
secondary explosions throughout the U.S. financial markets.

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Back in Paris...

*** On this day in 1848, traces of gold were discovered on
the Californian lands of Swissman Johann Sutter...and thus
was born the great Gold Rush of 19th-century California.
What will progeny think of the great Gold Up, Dollar Down -
GUDD - trend of the early 21st century, we wonder?
Hmmm...Keynes' 'barbarous relic' has made quite a dent in
history for itself...

*** Like a teenager forced to go to cotillion, your editor
is frequently manacled, muzzled and taken to dinner parties
by his wife. None of these soirées are entertaining enough
for prime-time reality TV, but they are occasionally
interesting enough to keep him awake.

"The American landing in North Africa changed the course of
the war...it was the beginning of the end for the Germans.
They had to move two divisions from Stalingrad to Libya.
The rest is history."

Speaking, Mr. Junot...a former terrorist (against the
German army)...army officer...politician...father-in-law to
Princess Caroline of Monaco...was not so much recalling the
events of history as reliving the events of his own life.

"Mr. Junot is 87 years old," explained our host later.
"Throughout the 20th century, he seemed to have an uncanny
way of being present at the major events of French
history...or knew people who were."

"You know," Mr. Junot turned to your editor,"we had the
biggest, most powerful army in the world - at least on
paper. But it was unbelievable how stupid people can be...

"My own uncle was in WWI...he was in the cavalry. He
actually charged the German lines on a horse with a saber
in his hand. Unbelievable, but true. And his enemies were
holding lances!

"And then, at the beginning of the Second World War,
Gamelin [Maurice Gamelin, in charge of French and British
forces when the war began] went to the front, where the
German tanks were racing through the north of France...and
asked 'Where are the pigeons?' He wanted to send a message
to Paris and thought it was still the era of carrier
pigeons.

"My uncle was so patriotic. But he had gone deaf from his
war wounds...so he couldn't listen to the radio. And the
newspapers were all tightly controlled by the Germans and
the Vichy government...

"Ah...WWII that was a completely different. No one knew
exactly who the enemy was. We had many French people join
the Germans. You know, it was the French soldiers fighting
for the Germans who were the last to surrender in Berlin.
They must have figured they had no choice. They would be
killed by the Russians...or by the Allies...might as well
fight to the bitter end....

"People just wanted to fight...there were the Resistance
fighters...the Pétainists...the Fascists...the
Communists...

"Well, my uncle was an old soldier. And he was loyal to
Pétain. So when his sons were old enough, he sent them to
join the Milice [Petain's army, then supporting the
Germans]! He had probably never heard of de Gaulle and had
no idea that there were Free French Forces fighting too.
One of the sons showed up in Orléans to enlist - while I
was there, working for the Resistance. The Allies had
already landed in Normandy. Joining up with the Pétainists
at that point would have been a disaster...so I took him
aside and explained to him what was going on...

"What a time!"


The Daily Reckoning PRESENTS: What a difference almost
three years makes, no? Long live GUDD...and all hail to the
kindness of strangers... This essay was originally
broadcast on the 23rd of February, 2000.


GOLD TO RISE
By Bill Bonner

I have a report in my hands that is helping me understand
the gold market."Understand" is too confident a word.
Because the gold market is too complex for mortals.

Is it a commodity? Is the market rigged? Is there a
conspiracy against gold? How come the price has not
responded to the biggest credit expansion in history?

It was easy to forecast the future of gold in '73. Nixon
had"closed the gold window" two years earlier - meaning
that foreign governments could no longer trade their
dollars for gold. For the first time in a very, very long
time, the dollar was nothing but a piece of paper - with no
connection to precious metals.

Nixon had, after all, stopped redeeming dollars for gold
for a reason. There were too many people who preferred the
metal to the paper. At $38 per ounce, gold was an
irresistible bargain.

Rather than devalue the dollar against gold, Nixon simply
cut the link between the two...letting the market do the
devaluing itself.

Mr. Market took up the challenge with great gusto and
resolve. Within seven years, the price of gold had risen
more than 20 fold. Mr. Market, you see, is given to excess.

Since then, the price has collapsed, and has traded in the
$300 to $400 range ever since (except for a drop of around
20% in the late `90s). Now, gold is at $307.

If you go to Sears rather than Brooks Brothers, you can
still buy a suit of clothes for the price of an ounce of
gold - just as you could during the Roman Era, when an
ounce of gold would get you a decent toga and belt.

We contrarian investors look for aberrations. Nothing seems
to be out of order with the price of gold. It is where it
ought to be...more or less...in terms of what you can buy
with it - but for one very glaring exception.

While the price of gold was in full flower, in the late
`70s, the stock market had lost its bloom. The Dow was,
believe it or not, within a few dollars of the gold price.
You could buy an ounce of gold for $850 at its high. That
amount would also get you a unit of the Dow - with enough
change left over to buy a unit of the Nasdaq, too, which -
coincidentally - opened for business the very same year
Richard nixed the gold sales.

Since then, the Dow has risen about 15 times. And the price
of gold has fallen in half. So the difference is about a
factor of 30. The Nasdaq action has been even more
excessive. Nasdaq prices rose from under 100 (from what I
can tell by looking at the chart on the Nasdaq web site) to
over 4,500. This represents a 45-fold increase. Compared to
the gold price, the Nasdaq is 90 times greater than it was
in the late `70s.

Something is clearly out of whack. Partly, it is the gold
price. Gold was in a bubblish fever back in the late `70s
from which it recovered quickly. Its condition has been
stable ever since. But the big aberration is in the Nasdaq
- apparently it contracted the bubble bug from gold and is
now suffering its own fever. Had gold been at the same
price in '78 as it is today, you could have bought three
units of the Nasdaq for one unit of gold. Instead, an ounce
of gold gets you considerably less than one-tenth of one
Nasdaq unit. Even deflating the gold price, therefore,
still leaves a 3,000% gap between the Nasdaq and gold.

Regression to the mean alone suggests that the Nasdaq must
return to some more modest position vis-à-vis gold. How
this will be accomplished is the subject of this letter.

The report I mentioned at the beginning was written by Paul
van Eeden, a broker at Global Resource Investments. It
points out that for all the many tales concerning gold, the
yellow metal continues to function as it always has - as
the ultimate money. Alan Greenspan and all the world's
central bankers realize this."Gold still represents," said
Greenspan in May,"the ultimate form of payment in the
world...Gold is always accepted."

Unlike a commodity, the gold price seems oblivious to both
supply and demand."During the past 10 years," Paul writes,
"the annual supply of gold, including scrap sales, has
fallen short of the fabrication demand for gold by a
cumulative 2,764 tonnes. This is more than one year's total
supply of gold from mining." You would think that such a
shortfall would boost the price of gold. On the contrary,
there appeared to be no correlation.

It is perhaps a happy coincidence that the supply of gold
tends to rise at about the same rate as the supply of
everything else. GDP and population figures increase at a
real, net rate of between 1% and 2% annually. Gold mining,
which benefits from technological improvements, increases
production at about the same rate. Thus, gold is not only
money, but very stable money - it inflates at no greater
speed than the things it is used to buy and sell.

Even gold jewelry, Paul argues, is really a form of money.
People in ancient times found it convenient to wear their
wealth. They still do.

Instead of following supply and demand figures, the price
of gold, Paul tells us, tracks, inversely, the world's
reserve currency...the dollar. As the dollar rises, it buys
more gold. As the dollar falls, it buys less. So if the
dollar were to fall, the gold price would rise.

It is almost certain the dollar will fall in the months
ahead...the U.S. dollar price depends on the success of the
U.S. 'new paradigm' economy. America has a huge balance of
trade deficit - the largest ever recorded by any nation in
history. It can only be financed by foreigners who are
willing to invest in stocks, bonds and other U.S. dollar
capital assets. As long as Wall Street seems to be going
up...foreign investors will probably be willing to invest
their money in the American miracle. But when Wall Street
goes into a decline, as is now happening, they will switch
to more promising investments. This will cause the dollar
to fall against major foreign currencies - and the price of
gold to rise in dollar terms.

I don't know how high gold will go...or how low the Nasdaq
will go, but it seems likely that an ounce of gold will buy
more of the Nasdaq in the future than it does today.

Regards,

Bill Bonner