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Client only. E-mail gold market letter.

by Michael J. Kosares

 4/1/06

Gold: Historic spike ahead?
by Brian Durant

USAGOLD
Centennial Precious Metals, Inc.
_________________________________
since 1973

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as well as the needs
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Michael J. Kosares is the founder of USAGOLD - Centennial Precious Metals, Inc., the author of "The ABCs of Gold Investing: How to Protect and Build Your Wealth with Gold" and numerous magazine and internet articles and essays. He is frequently interviewed in the financial press and has over 30 years experience in the gold business.

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It your purchase of gold from USAGOLD-Centennial Precious Metals that nourishes these pages.

"Career gold bulls may wince at the new found popularity of the orphan they alone once cherished. But we believe they should choke back the impulse to exit the market on the grounds of it being overcrowded. If we are right about the problems facing the dollar--and indeed, about those confronting most of the managed currencies that compete with the dollar--the bull side of the gold market is destined to become far more crowded than it already has."

James Grant, Grant's Interest Rate Observer

Overview: The Grant comment above made in December of 2004 proved prophetic as gold since has become the "currency" of choice in the fast-moving world of modern finance. Where cautious money managers and investors might have hedged their bets in euro or dollar bonds in years past, they are now opting for positions in the physical metal, gold ETFs, and bullion bank gold deposits. This dramatic change in the bastions of money has created a whole new gold market substantially different from anything we have seen before. Gold has come of age and the small private investor who owns it has been among the beneficiaries.

As Grant says, it has indeed become far more crowded on the bull side of the gold market and the company may have become a bit more high-brow than that to which we are accustomed. Hardly a day goes by than some mainline Wall Street firm doesn't come out with a bullish forecast on gold, the most recent being Merrill Lynch. Last Friday it announced (in a leaner than lean public announcement) that gold should outperform equities for the next few years and hit the $850 mark. Some weeks before, the giant French bank, Credit Agricole, predicted a gold spike in the $2000 range based on massive short covering on the part of the bullion banks. (Please see Notable & Quotable below).

But even more impressive than the financial mainstream's jumping on the gold bandwagon has been various nation states announcing their own interest in the yellow metal. Russia, China, South Africa and Argentina are not only bullish on gold; they have had made public pronouncements that they stand ready to buy in the open market should the opportunity present itself. As it turns out, official sector selling, the long term bane of the gold market, will likely to be met with heavy official sector buying. Who would have thunk?

Such publicly-stated interest, of course, puts a floor under the market. This change in the composition of the gold market will serve as warning to anyone short the market. It seems that gold has acquired a parachute. In recent months any dips showing up in the price didn't stay on the board for long. That reflects the short-covering Credit Agricole is talking about.

In short, all the factors which seemed to have conspired against gold in the recent (and distant) past are now working in its favor. The lonely gold bulls have definitely attracted some well-heeled company and new-found friends. For long-time gold owners and advocates, this is fundamentally different from the gold market we cut our teeth on in the 1990s. It will take some getting used to, but I think most would say that the change is agreeable.

Kim Thanh: If you've read "The ABCs of Gold Investing," you probably recall the story of the couple who escaped certain reprisal at the end of the Viet Nam war, sailed into the China Sea with nothing more than the clothes on their back and 30 ounces of gold, and ended up in my offices selling that gold to finance their new life in the United States. Somehow that story resonates with people. Many have referred to it during their conversations with me. It is about the enduring value of gold and its importance as a safeguard to one's wealth. Here's a photo of Kim Thanh, the type of gold they sold to me, from my personal holdings, offered here so you can now put a picture with the story.

The Picture of a Bull Market: I couldn't resist showing you the charts on gold as they appeared this past weekend at our USAGOLD chart page (See below). In virtually every instance -- five year, ten, twenty year, the charts portray a strong bull market in progress.. If you haven't book-marked our gold chart page, you might want to. To me the twenty year chart is the most impressive with its long term bottoming "bowl" formation and the breakout to 20 year highs. Our thanks to Gal Marley for the use of his excellent chart service.

A Word about the USAGOLD Daily Market Report: Our Daily Market Report now competes with our Discussion Forum for the USAGOLD site's most visited page. The strong traffic has to do with the no nonsense, strong presentation of gold market news and views. Randy Strauss, our long-time sitemaster, is in charge and does an excellent job getting the information to our readers in a concise, easy-to-use format. Included in the page is a comprehensive gold and financial news feed based in London that we have used for years. I don't think there's a better daily gold market report on the internet than the one at USAGOLD. It is also first in the Google rankings under "gold market report" -- for good reason I might add.

Short and Sweet

In the month of February, the United States government added $87 billion to the national debt. If that isn't a record, it's close and that in the shortest month of the year. The national debt now stands at $8,363,536754922.14 and counting. Almost $100 billion has been added to the debt since Congress approved the new "ceiling"$9 trillion in mid-March.

China intends to double its gold reserves to 1270 tonnes this year according to its National Development and Reform Commission. That amounts to 635 tonnes of gold over the next nine months and over 20% more than what the central banks are slated to let go through the auspices of the Washington Agreement and just less than a third of the annual mine production. In a report issued Monday morning, Wang Yuanlong, an official with the Bank of China, stepped up the China-gold speculation. In a Reuters report he is quoted saying that the China should reduce its dollar holdings and buy gold as a diversification.

No sooner does one dollar recycling scheme crash on the rocks than someone comes up with another one. Larry Summers, the former secretary of the Treasury in the Clinton administration, has resurfaced with a new plan for all those petrodollars, Chinadollars and Tokyodollars accumulating overseas. He suggests a new dollar recycling unit within the International Monetary Fund which would take dollars in from the long list of international holders and then recycle them in the Third World. China, which has a dollar recycling program of its own, intimately tied to its foreign policy, might be difficult to bring aboard.

Worried about your retirement savings? We can help you turn them to gold. Contact George Cooper Extension #102.

The British are suddenly feeling substantial anxiety over the fact that their Chancellor of the Exchequer, Gordon Brown, sold most of the nation's gold for a song. We asked a long time ago what was behind Gordon Brown's "preoccupation" with gold and now $275 later Britain's mainstream press is asking the same thing.

Economist Walter J. Williams says to forget inflation or stagflation. We are headed soon for a hyperinflationary depression -- shades of the Nightmare German Inflation if he's right.

From a weekend Bloomberg piece on the gold market: "Gold rallied 32 percent in the past year as investors poured money into commodities, seeking better returns than U.S. stocks and bonds. Some bullion owners speculate the economy will slow, eroding the value of the dollar as the Federal Reserve ends more than a year of interest-rate increases." Have you noticed that some of gold's strongest rallies -- like the $10+ uptick on Friday (March 25) -- comes on interest rate news? On Friday, the worst new housing sales numbers in years were released by the federal government. Gold promptly went higher on the hope that the Fed would see this as an incentive to halt the interest rate increases.

Recently I rewrote and reconfigured the Disturbing Trends table for the retitled piece, "Disturbing Trends: Why Gold Is the Buy of a Generation." This short essay is included in our introductory information packet. In doing the statistical research, I discovered that with the recent run-up in the price, gold returns over a thirty year period nearly match those of the stock market. I doubt you will see that little nugget of information touted by CNBC, the Wall Street Journal or Barron's. Here's a link to the table along with my brief commentary.

Notable & Quote:

"Strategically, gold is one of the two most important commodities (with crude oil) on the planet, but its role as the ultimate store of value and method of payment has been forgotten by many investors. The perception of gold has
been affected by the last remnants of a Gold Standard being as long ago as 1971, a 20-year bear market and persistent central bank selling. In a scenario of financial stability and fiscal prudence, gold's monetary role retreats into the
background, but even then it never goes away. In today's world of massive deficit spending, inflating currencies (i.e. excessive growth in the money supply) and financial imbalances, gold's monetary role is reasserting itself.
Investment demand for gold is increasing and the remonetisation of gold has begun.

We are raising our mid-cycle gold price estimate from $750/oz to $900/oz. Covert selling (via central bank lending) of gold has artificially depressed the price for about a decade, but Bank for International Settlements' data
on gold derivatives suggests its impact is on the wane. Our $900/oz mid-cycle estimate takes into account the long-term average ratios between the gold price and the prices of oil and the Dow Jones Industrial Average. We also see
the possibility of a spike to $2,000, or higher, if the story on diminished central bank gold reserves becomes widely accepted, if central banks in countries with large US dollar holdings compete to buy gold and diversify forex reserves away from dollars and if the US economy slides into either high rates of inflation or deflation.

Central banks have loaned out 10,000­15,000 tonnes of their gold reserves, between a third and a half of the reported total. Gold loaned by central banks to bullion banks or their counterparties is immediately sold into the physical
market for conversion into jewellery, etc. This creates a short position between the central bank and the bullion bank/its counterparty. This short position is the foundation for the gold derivatives market which grew rapidly in the 1990s and currently has a notional value of c.$300bn. Non-gold producers account for the majority of the short position and may not be able to cover their shorts without causing a spike in the gold price."

-- Paul Mylchreest, Credit Agricole Cheuvreux Bank/London

"I think it's possible for both gold and silver; and I know many people who are worried about it. I remember asking panelists on the Gold Commission for assurances that the federal government would never again resort to confiscating gold, and nobody would commit to it. It may seem a bit far-fetched today, but we should remember that governments always assert emergency "powers" during economic crises, as our own government demonstrated in the 1930s. Few Americans understand the true causes of the Depression even today, and still believe FDR's government programs magically cured the economy. So we should understand that public anger in the event of another economic depression may well be misdirected, and gold could be made a scapegoat."

-- Congressman Ron Paul, 3/17/06 interview with Jay Taylor

Editor's Note: If you are concerned about the possibility of gold seizure there is a way to protect yourself -- safely and inexpensively. We invite you to read our client memorandum:

"China has put Gordon Brown's investment philosophy to shame by enjoying a near-doubling of the value of its gold reserves....China almost doubled its gold reserves to the 600 tonne level between 2000 and 2002, at a time when the Chancellor was a bullion seller. British taxpayers missed out on £3.6 billion (£2.1 billion) worth of gold profits because Mr Brown sold most of the country's reserves during the 1998-2002 gold price slump. Mr Brown's dismal record is matched only by his counterparts in Switzerland and the Netherlands, which have been among the most active sellers of gold over the past five years."

-- London Times, 3/25/06

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"The price of a fine suit of men's clothes can be used to show anyone who is not familiar with the price history of gold just how very cheap gold is today. With an ounce of gold, a man could buy a fine suit of clothes in the time of Shakespeare, in that of Beethoven and Jefferson, and in the depression of the 1930s. In fact, this statement was still true in the 1980s, but not in the late 1990s. The suit standard now implies a gold price of perhaps $1000 per troy ounce. Today, a really good man's suit can easily cost 4 ounces of gold, and that is without a vest, which once was standard."

-- The United States Geological Survey

"[E]astern writers developed a still more powerful myth in the tale that the magi had brought to Bethlehem samples of all the wealth of nature, wealth that had always existed and could ever reappear in future times. . .Already referred to in the fifth and sixth century Opus Imperfectum, this lost book of the East says that the three gifts of the Magi came from a treasure cavern filled by Adam himself from the wealth of paradise. The magi's gold especially was prelapsarian in origin and had to be understood within a cosmic historical context. Coming from paradise, over the centuries it too was made to reappear at historical moments. Abraham had it. Alexander the Great had possessed the gold before the magi gave it to the infant. . ."

-- Richard C. Trexler, The Journey of the Magi: Meanings in History of a Christian Story

Final Word :

We'll give Timothy Geithner, president of the New York Fed, the Final Word in this issue of our Client Letter.

"They [derivatives] have not ended the tendency of markets to occasional periods of mania and panic. They have not eliminated the possibility of failure of a major financial intermediary. And they cannot fully insulate the broader financial community from the effects of such a failure.

"There are aspects of the latest changes in financial innovation that could increase systemic risk in some circumstances, by amplifying rather than dampening the movement in asset prices."

While Geithner's boss, Ben Bernanke, talks the talk of "transparency," he walks the walk. What he's really saying is something that Fed officials for the most part wouldn't touch with a ten-foot pole: Once a derivative-based crisis begins in this $300,000 billion market, there may be no practical way to stop it. It seems ironic that 100 years after "financial panic" dominated thinking on Wall Street (and provided the impetus for the founding of the Federal Reserve), we would find ourselves in approximately the same place. With General Motors apparently on the brink of a derivative driven bankruptcy, Geithner's warning could not have better timed. Hence, we pass it along.
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So we come to the end of our first issue after a long sabbatical. Happy trails, my fellow goldmeisters, until we meet again.

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