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by Michael J. Kosares

 1/03/05

Gold Forecast 2005 Issue

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"As I write, Japanese and European authorities are deploring the unwanted appreciation of the yen and the euro. They are weighing joint intervention to stop it. Such talk underscores a vital fact. In 2005 a strong currency is the Old Maid of the monetary deck. Nobody wants it, not even George W. Bush. But I observe that the universal yearning for weak currencies is tantamount to a yearning for a strong gold price. I believe that these complementary longings will be fulfilled. Count me as bullish on gold--still."

James Grant, Grant's Interest Rate Observer

Overview:

I foresee two potential scenarios for gold in 2005.

First, in keeping with the average over the last three years gold could register another year with roughly a 20% gain. That would put gold at the $525 level. It seems that G-7 is attempting to keep gold, the euro and yen in bands with the end goal being to prevent the dollar from dropping off a cliff. I do not envision much downside in gold, and if it does fall I expect the recoveries to be quick and complete. I will continue to monitor policies relative to both the dollar and euro in 2005 as the best indicators as to where gold might be going in the future. Over the past three years, gold has risen 1.2% for every 1% rise in the euro.

There is a second, more troubling scenario to be considered. Though the intent of G-7 policy-makers is to allow the dollar to fall within well-defined bands, there is a weakness in the policy that needs to be taken into account. U.S.-based manufacturers, the sector targeted as the beneficiary of the weak dollar policy, are a dying breed. The devaluation medicine (the weak dollar policy) is aimed at buttressing an old economy, one that does not exist on the scale it did when Richard Nixon launched the U.S. dollar devaluation policy in the 1970s. A policy failure of this magnitude could run the dollar off the rails and invite a massive speculative attack on the part of hedge funds and/or other heavily capitalized groups. Such an attack, coupled with an evacuation of the dollar market on the part of key holders of the currency, could send gold well over the $600 mark, and there may be nothing to stop it there.

Note: This week's Overview is a lite version of my Gold Forecast 2005. The complete Forecast is available at the link below.

Gold Forecast 2005

The Gold Market: The year-end downdraft in the gold price was probably due to year-end profit taking on the part of the commodity and hedge funds. I suspect these positions will be bought back at the beginning of 2005. Betting against gold or the euro is a bet on the dollar and dollar bulls are few and far between at this juncture -- even in the world's central banks. In my view, the number one gold story for 2004 was Germany's decision not to sell any portion of its reserves. This decision will play a major role in gold market fundamentals as we move through 2005. Not only will the German gold stay in the vaults, the decision might encourage others, particularly France, to hold their gold off the market. The German decision signals a sea change in central banker thinking. Even the modest sales goals of the Central Bank Agreement will be difficult to achieve. This bodes well for the gold market going forward.

Report in yesterday's (1/1/05) Australian Financial Review illustrating the point:

The People's Bank of China and the Bank of Japan, as well as other central banks in Asia, are in trouble. They have accumulated vast foreign exchange reserves, estimated at more than $2 trillion but almost all of these reserves are in US dollars -- which are rapidly losing their value. All policy options for Asia's central banks appear equally unattractive. If they do nothing and simply hold on to the dollars, their losses will increase, but if they buy more in an attempt to prop up the dollar, they will only have a bigger version of the same problem.

Why Incorporate Gold in Your Retirement Plan: With the $5.7 billion bailout of the United Airlines pension plan last week and problems with several other major plans in the news, many are beginning to question whether or not their retirement savings are going to be there when the time comes. "Those of us still working," says the Rocky Mountain News in a sobering editorial over the holidays, "will have to take more responsibility for our retirement. Your employer could easily run into trouble, and you can't count on the government to cover all failing pension plans." The old knock on gold is that it doesn't pay interest and therefore it doesn't make sense in growth-oriented retirement plans. But gold doesn't pay interest for good reason. It is not an asset which is simultaneously someone else's liability. Gold in other words cannot be defaulted on. In the present financial environment, investors are increasingly viewing this unique quality to be a plus. Using your retirement plan to purchase gold makes a lot of sense in these precarious times. USAGOLD-Centennial Precious Metals offers a tried and true IRA program for retirement planners.

Short & Sweet . . . . . . . . . . . . . . . "Thus, it's difficult to envision a bright future for the dollar," says Dow Theory's Richard Russell. "This is the real reason for holding gold. To put it simply, the reason for holding gold can be stated in three words. We hold gold 'just in case.' One more thought -- this is early in the gold bull market. At some point ahead, the rise in gold will accelerate. 'What do we do then?' you ask. My answer -- 'What we'll be doing then is that we'll probably be buying more gold at much higher prices. We'll be buying more gold because the dollar will be in its death throes, if not as a currency, at least as a reserve currency.'"................... What some have missed in their analysis of the dollar devaluation -- and this is important to forecasting the gold price -- is that in order for the dollar decline to produce the desired results, it must be engineered over a period of years. It's not like waving a magic wand-- the dollar falls and all's well. This means that the gold bull market could extend over many years period of time. . . . . . . Posted by John Brimelow at Le Metropole Cafe 12/31/04: "As noted yesterday, the small, 3705 contract decline reported for Wednesday's heavy trading implies only about a third of the week's open interest build was eradicated. If the expansion this week, mainly put on as world gold tried to clear $445, was short selling, the shorts are going to be in difficulty next week facing an energized India and the other physical buyers. This would imply a sharp rally. If the growth substantially reflected a long seller (most likely Official) a rally would more likely be slower. But unless the seller is willing to continue at the same large scale ­ 35 net tonnes of Comex gold on Monday and Tuesday this week ­ a rally is inevitable." . . . . . . . . .I should add that Brimelow's "energized India" comment is a reference to the push for physical metal that sometimes follows natural disaster in the East. Many of us recall the news video of the Japanese woman pulling the family gold stash out of earthquake rubble a few years back -- a scene which touched off the "Japanese housewife" gold buying phenomena. . . . . . . .Those unfamiliar with the gold market are sometimes taken back when they learn of the popularity of this metal largely vilified by the mainstream financial press. What they come to understand eventually is that the disdain for gold held by Wall Street (as manifested in financial press reports) is largely the result of enlightened self interest on the part of stock and paper asset promoters. In a solid example of gold's enduring qualities, Bloomberg reports that the recently created Street Track's gold trust fund - designed primarily as a vehicle for mutual fund managers who are banned from owning the metal outright -- has recorded "the most successful start for an exchange-traded fund since the securities were created in 1993" garnering over $1.29 billion since mid-November. . . . . . What if Saudi Arabia became another Iraq? The prospect came to mind when the bombs exploded in Riyadh last week. Most of the year-end gold forecasts I have seen do not take into account an abrupt shock like a revolutionary war in Saudi Arabia -- the world's primary oil producer. . . . . . . . . . . . .We'll bring this week's Short & Sweet in for a landing with the thoughts and observations of Warren Buffett concerning the U.S. dollar. As many of you know Buffett began to place his multi-billion bet against the dollar in 2002 and he has enlarged Berkshire Hathaway's position in foreign currencies each year since. Recently, Forbes magazine described Buffett as full of "doom and gloom" on the dollar with the sage of Omaha warning against financial "chaos". . . . "If lots of people try to leave the market," says the Sage of Omaha, "we'll have chaos because they won't get through the door" -- a prospect investors who do not own gold might want to plug into their analysis. The stampede for the dollar exit will queue up at the gold window.

Quote of the Week:

"As I said, it is very difficult to make any economic calculations or financial calculation or estimates if you have a government that manipulates the markets. Under a planning economy, we had central planners planning the economy and steering the economy and it ended in disaster. I suppose that today's equivalent of the central planners of the communist regimes are the central bankers like Mr. Greenspan in that they can steer the economy with just one tool, monetary policy. I think the same way the planning economies ended in disaster, central banking as we know it today, will end in disaster. If there was a tribunal whose laws or criteria were sound money, Mr. Greenspan would be hanged."

Marc Faber

The Armchair Economist:

Excerpted from James Grant's Yes, But column just posted at Forbes magazine. Still bullish for 2005:

In the red-letter year of 1986 the United States became a net debtor: The value of foreign-owned assets in the U.S. topped (by a small margin) the value of American-owned assets outside the U.S. Thomas Gale Moore, a member of Ronald Reagan's Council of Economic Advisers, said not to worry. "We can pay off anybody by running a printing press, frankly, so it's not clear to me how bad [a net debtor status] is," he declared.

Maybe we are going to find out. Foreigners now own $2.4 trillion more of us than we do of them. The U.S. current account is in deficit in a sum equivalent to 5.7% of U.S. gross domestic product. The dollar is in a bear market. The dollar printing press to which Moore so lightly alluded is working overtime.

Complete article: The Paper Standard

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Excerpted from Grove City College's Dr. Hans F. Senholz's widely-circulated essay on the dollar ( With permission,12/28/04):

With reference to the dollar devaluation he asks:

"Why should [most private investors] be troubled about the financial affairs of money traders and dealers?"

He answers:

This economist is ever mindful that debts do not fade or pass away. Individuals must face them, deal with them, or renege in bankruptcy. Governments have an additional option: as the issuers of their own currencies they may inflate and depreciate their debts away. The United States government has done this ever since it cast aside the gold standard and imposed the dollar standard. It undoubtedly will continue to do so as far as the eye can see. It is an iniquitous road which individuals would soon be barred from traveling but governments love to take, shedding their debts one percent at a time. It is a road of the dollar standard designed at Bretton Woods, built by the U.S. government, managed by the Federal Reserve System, and financed largely by creditor central banks in Europe and Asia. It is a road on which the fall in dollar value has inflicted losses on all foreign dollar holders each in proportion to the amount of dollars held. It is the political road of debt default the magnitude of which amounts to trillions of dollars, undoubtedly the largest in the history of international relations. It will be remembered for generations to come.

It is unlikely that the Federal government and the Federal Reserve will soon mend their ways, but it also is doubtful that foreign creditors will continue their support indefinitely. The U.S. dollar is bound to continue to depreciate and gradually surrender its role as the world's primary reserve currency to a multiple reserve-currency system resting on the euro, Japanese yen, Chinese renmenbi, and the American dollar. The multiple-standard system is likely to perform more efficiently and equitably than the dollar standard. Competition would avoid the abuses and inequities of a monopolistic system. Confining the powers of the Federal Reserve System and constraining the deficit aptitude of the U.S. Treasury, it would ward off any further inundation of the world with U.S. dollars.

In idle reverie of years long past, this economist is tempted to compare the gold standard with the dollar standard. Throughout the long history of the gold standard the balance of payments of gold-producing countries was usually "unfavorable." Since the birth of the dollar standard the United States has assumed the position of the gold-producing countries; its balance of payments usually is unfavorable. Much capital and labor were spent to find, mine, refine, and market gold; the United States bears minuscule expense in the production of its money. The quantity of gold coming to market was limited by market forces; the quantity of dollars depends on the judgment of Federal Reserve governors who are appointed by the President. In times of turmoil and war the quantity of gold mined does decline; in such times the stock of fiat dollars tends to multiply and its value depreciates quickly. The quantity of gold is limited by nature and its value is enhanced by many nonmonetary uses; fiat and fiduciary moneys have no such uses or limitations. They are the sorry creation of politics.

Complete article: Shades of the Dollar Standard

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And the final addition to the Armchair Economist with thanks to James Turk, GoldMoney.com:

Don't be lulled into thinking that domestic US prices are not rising, just because the Consumer Price Index has not yet reached levels at which red flags would be flying. In fact, red flags are flying most everywhere else. This phenomenon is neatly dissected by Richard Benson in "Inflation Disinformation", an wonderful article from which I obtained the following data.

Price Increases - November 2003 to November 2004
Gasoline...........................................................47.5%
Crude Materials...............................................25.9%
Intermediate Materials......................................9.7%
Groceries at Supermarket..................................6.1%
Finished Goods...................................................5.1%
Consumer Price Index.......................................3.5%
 
Increase in National Housing Prices  
Third Quarter '03 to Third Quarter '04..........13.0%
Third Quarter '04 Annual Rate........................18.5%

As Mr. Benson sensibly observes:

"The prices above surely indicate there is a whole lot of inflation going on now and in the 'price pipeline'. The magnitude of real inflation is around us everywhere. An example of this could be seen in New York where taxi cab prices increased by 25 percent, while nationwide college tuition, health care, insurance, drug prices and property taxes are, in most cases, running near or above double digit annual rates of price increase."

Complete Article: The Impact of a Declining Dollar

Note: Some of you may have missed the recent Dow Jones article by Jim Hawe covering my expectations for the gold market for year-end and beyond. If so, here is the link:

Worth keeping/Comments from past issues

"As time passes and seeing how events are unfolding, we're more inclined to believe this bull market in gold is going to be a big one, which could surpass the old highs at $850. If that proves to be true, then this mega bull market will likely be composed of three psychological phases. The first phase is when the so called
smart, big money buys. In the second phase, mutual funds and some investors start moving in, attracted by rising prices. The third phase is when the public jumps in, which pushes prices up to levels higher than most expected. That's what happened to gold in 1980, Japan in 1990 and tech stocks in 2000.

Interestingly, our dear friend Chris Weber was at a barbecue near Monaco several months ago where several billionaires were present. When the conversation turned to investments one of the party goers wondered what to invest in these days. Almost in unison, the billionaires all said gold. They obviously bought in the first phase of this bull market. Another dear friend Richard Russell believes we're now in the early second phase and this tends to be the longest phase. These psychological phases are different from our own technical steps, which show the upside targets as the bull market progresses. The bottom line is, gold is headed higher and you should continue to hold."

The Aden Sisters: www.adenforecast.com

"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) citing gold's 16-year high and record Comex open interest

I'm going to revise my thinking on the phase gold is in. I've stated that gold is still in its first psychological phase. I've revised my thinking on that. Often the first and second phase of a bull market is divided by a severe correction. I believe that the July 2004 correction was the correction that ended the first psychological phase of gold, and that we are now in the second psychological phase. The second phase of a bull market is usually the longest (in duration) phase. It's in the second phase that the public begins to be interested in an item. And it's in the second phase that the funds start to take their initial positions in an item. I believe we're at the start of the second phase in gold. The sharp July correction followed by a second correction in August -- these two corrections, served, I believe, to knock out late-comers and "in-and-out traders" and solidify the technical position in gold. Only the "believers" held on, and in many cases bought more. All of which takes us to the second psychological phase of gold. Let the second phase begin.

Richard Russell, Dow Theory Letters

"We conclude with ardent conviction, the more so for our isolation, that the dollar's role as the global reserve currency has run its course. The transition to a new basis for international credit will be lengthy and difficult.  The repercussions of a transition are not reflected in the financial markets.  For this reason, gold is inadequately priced.  The best strategy, under these circumstances, is to own as much as possible of what so few have in their possession, physical gold. While gold mining shares will perform well along the way (and should certainly be owned), they are much easier to manufacture than the metal is to extract. The same is true for derivatives, or paper gold.  A private banker recently told us how he had protected his clients with gold-indexed notes issued by his employer, and that this practice was widespread in his department.  We hear similar stories from Asian and European investors.  No institution contemplating gold in four digits would issue such paper."

John Hathaway, Tocqueville Funds

"In an age of increasing concerns about market volatility and political upheaval, at a time when the largest segment of the US population is approaching a potentially prolonged and expensive retirement, the preservation of wealth is paramount. A virtually indestructible asset, gold offers investors a potential, tangible hedge against unpredictability. Since time immemorial, from the ancient Sumerian civilizations to the present day, gold has shaped the evolution of humanity in our quest for freedom, sustainability and wealth. As it has been for thousands of years, so it remains today; gold, as a store of value, is universal and enduring."

"The Case for Gold: Preserving Wealth in an Age of Uncertainty"
State Street Global Advisors

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

 

 

"It is beyond belief that we know so little about how people get rich or poor, about how it is they come to dwell in comfort and health or die in penury and disease. Financial markets are the machines in which much of human welfare is decided; yet we know more about how our car engines work than about how our global financial system functions. We lurch from crisis to crisis; so little is our knowledge that we resort not to science but to shamans."
Benoit Mandelbrot

Investors should never forget the lessons of the South Sea Bubble and John Law's experiment with paper money. The Mississippi Scheme in particular is relevant to the current situation in the United States; in fact, there are several lessons contemporary investors can learn from John Law's rise and ultimate demise.
 
It is true that Law's policies were initially a great success, boosting the French economy considerably. In fact, at his peak in 1719, Law was one of the most admired personalities in continental Europe. But the Mississippi Scheme failed, and Law fell from grace because the Banque Royale held for too long the firm belief that it could solve every problem simply by increasing the supply of paper money. When Law finally realized that the enemy was a loss in confidence in paper money and accelerating inflation, the damage had already been done.
 
There will surely be a time when the present "chain letter" type of fiat money operation practiced by the U.S. Federal Reserve Board will similarly no longer work and lead to a sharp depreciation of the U.S. dollar. The other possibility, of course, is that the dollar begins to depreciate, not compared to foreign currencies, but -- as was also the case at the time of John Law -- against commodities and real assets."
Marc Faber

"I want to say something about owning gold and gold shares. Personally, I have an easier time owning gold over gold shares. Wife Faye, who has a different personality, has no trouble holding gold shares, and she has held many for years. I don't view gold, the metal, as a trading vehicle or something akin to stocks. I view gold as pure wealth. The economic world can roll over on its fannie, my house can burn down, any stock can crash and burn (think MRK) -- but gold as wealth is as old as civilization. Gold is pure wealth -- it was wealth in 2000 BC, it was wealth in the 1400s and the 1600s, and it's wealth today. The people at the Fed may tell you that gold is just an ancient "relic," but gold will be accepted as wealth when these yo-yo's at the central banks are gone and forgotten along with the whole un-Constitutional Federal Reserve system and its currency-printing operations."
Richard Russell, Dow Theory Letters

"Although there are only a few reserve currencies, an appalling lack of discipline is demonstrated by the US dollar. As things stand today, the United States is indebted to the external world to the tune of $3 trillion. This sum actually exceeds the total official currency reserves of all the nations of the world -- including the USA. . . The evolution of the reserve role of the American currency in recent years gives grounds for a pretty pessimistic prognosis. The relationship between the state of the dollar and the value of gold is obvious. In relation to our discussion today, this means that gold continues to have particular monetary attraction in the minds of all prudent financial investors."
Oleg Mozhaiskov, Deputy Chairman, Bank of Russia

"Evidence of the government's 'active hands' in the markets continues to grow. First, there is the manipulation of the gold market that has been solidly documented but not widely disseminated in the press. Beginning under the Clinton Administration, the dollar has been made to look strong by holding down the price of gold. This legal and logical market manipulation has been accomplished by central bank gold sales and by lending gold to bullion banks that could, in turn, sell the gold to earn carry trade profits. You might wonder why our government is so actively involved in keeping the price of gold down. Well, a logical reason would be that when the price of gold takes off, even the investment masses will focus attention on the real problems of massive trade and federal deficits and world-wide money creation. For investors with a long-term view, the price of gold is being subsidized and held well below market. If you like government subsidies, you can get one by buying gold."
Richard Benson, Specialty Financial Group, LLC

"FIVE major risks threaten the world economy. Three centre on the United States: renewed sharp increases in the current-account deficit leading to a crash of the dollar; a budget profile that is out of control; and an outbreak of trade protectionism. A fourth relates to China, which faces a possible hard landing from its recent overheating. The fifth is that oil prices could rise to $60-70 per barrel even without a major political or terrorist disruption, and much higher with one. Most of these risks reinforce each other. A further oil shock, a dollar collapse and a soaring American budget deficit would all generate much higher inflation and interest rates. A sharp dollar decline would increase the likelihood of further oil price rises. Larger budget deficits will produce larger American trade deficits, and thus more protectionism and dollar vulnerability. Realisation of any one of the five risks could substantially reduce world growth. If two or three, let alone all five, were to occur in combination then they would radically reverse the global outlook."
Fred Bergsten, The Economist

"Let us be blunt about it. The U.S. is now on the comfortable path to ruin. It is being driven along a road of ever rising deficits and debt, both external and fiscal, that risk destroying the country's credit and the global role of its currency. . .What cannot last will not do so, as the late Herb Stein famously remarked. But we can choose now it changes. The U.S. authorities can allow things to take their course or they can develop a policy to reverse these trends. The essence of the needed changes is quite clear: a further substantial devaluation of the dollar. . ."
Martin Wolf, Financial Times

"The reality of horrific multiple U.S. deficits, a worsening energy crisis, a geopolitical landscape that must get worse before it can get better, and a polarizing national election [will]give the support gold needs to go to new highs and challenge $500 in the next 12 months or less."
Peter Grandich/The Grandich Letter.

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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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