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by Michael J. Kosares

 12/14/04

"This combination of events has led some economists to ponder the once unthinkable: might the dollar lose its reserve-currency status? Over the past 2,000 years, the leading international currency has changed many times, from the Roman denarius via the Byzantine solidus to the Dutch guilder and then to sterling. The dollar has been the dominant reserve currency for more than 60 years. . .In 1913, at the height of its empire, Britain was the world's biggest creditor. Within 40 years, after two costly world wars and economic mismanagement, it became a net debtor and the dollar-usurped sterling's role. . . If America continues on its current profligate path, the dollar is likely to suffer a similar fate." PK Consultants, Ltd.

Overview: Last week's financial news was dominated by talk of intervention in forex markets to strengthen the dollar. Given thelack of follow through, one wonders if it's not a sound and fury signifying nothing. Meanwhile back at the White House, the president decided to keep John Snow Secretary of the Treasury -- an event which serves notice to all that the weak dollar policy is likely to remain in place for the second term. Were the weak dollar policy about to be scrapped, the Bush administration would have signaled the policy change by giving Snow his walking papers. It didn't. Though the financial markets overlooked what was implied by Snow's contract renewal, it's not likely to be overlooked in the weeks ahead.

Meanwhile, the financial press reports a long list of countries contemplating paring their central bank dollar reserves: Japan, China, Russia, Taiwan, South Korea, Nigeria, South Africa and India -- to name a few. There was a time when any one of the above suggesting they might dump dollars would have put the dollar into a funk. Now all eight are threatening it. Though China continues to deny paring its dollar holdings, many wonder if secretly the reality is the opposite. Argentina has acted on the threat and purchased gold. Oil producing nations as a group reduced their dollar reserves over the past three years from 75% to 61.5%. Japan's opposition party took concerns about the dollar to a new level last week by threatening "enormous capital flight" from the dollar. Even the Bank of England warned recently that the "overseas investors are unlikely to continue accumulating dollar assets at the current rate indefinitely."

This is not a prety picture.

The long term reality of nations moving away from the dollar essentially in self-defense far outweighs the threat, or even the actuality, of short-term forex interventions. Perhaps that's why intervention has remained a talking point and not a policy. Intervention at this juncture would be like dropping a dime into a black hole.

ALERT!

DAILY US OPEN MARKET POINTS
Monday, December 13, 2004 10:37 GMT
Daily Report
by Forex Capital Markets LLC
http://www.fxcm.com

BOE Spooks the Dollar

Spurred by an ominous warning from the Bank of England that a further decline in the dollar may create risks to the stability of world's financial system, euro bulls were out in force during early European trading session liftingthe pair nearly 100 points back to the 1.3300 handle. Writing in the semi-annual Financial Stability Review, Andrew Large, the central bank's deputy governor for financial stability stated, "In the present benign environment, there is a possibility that lenders, borrowers and investors may be inclined to under- estimate long-run vulnerabilities and take on too much risk."

The Gold Market: We just completed a nasty week for the gold price (essentially a $20 correction), but in retrospect we all need to take into account that in order for gold's bull market advance to gather strength these corrections are necessary. Market corrections are indicative of a healthy two-way market, as opposed to the straight-line bubble psychosis that marked world stock markets in the 1990s. We all know by now where that sort of thing leads us, so I'll take these corrections any day over the phoney new paradigm markets which defined the previous investing era.

The interesting aspect of the correction is the fact that it was touched off by a 15-tonne sale by the StreetTracks gold trust. In a short analysis I posted to the USAGOLD forum when news of the trust sale became public, I pointed out that in order to tame the beast (gold trust funds) we must first come to understand it. These gold trust funds are designed to attract capital out of stock mutual funds. Mutual fund managers are not known for their loyalty. They certainly are not generally viewed as friends of gold. The mutual fund manager, unlike the true-believers in gold who built this bull market bottom up, will sell into up-trends to take their profits hoping to return as buyers on pullbacks.

As I argued in my forum post, this mind set will add a great deal of volatility to the gold market with this past week being an example. Those of us who are long-term holders of the metal for asset preservation purposes (as well as long term profits) would be best served by becoming accustomed to the volatility rather than losing sleep over it. The overarching economic trends which have fueled this young bull market in gold haven't suddenly reversed since Monday of last week, they have intensified. Don't let the trading mentality now entering the gold market in full force deter you from your own well-thought out strategy. For those looking to buttress their gold holdings, price pull-backs are simply buying opportunities. As I have advised for years: Sell the upticks in stocks and bonds and buy the dips in gold. Under the circumstances, you'll be better for it in the long run.

"It's a thrill for us to receive them. It's a mystery. It's a legend. It's a tradition in many respects." Capt. David Werner after reports of gold coins appearing in Salvation Army kettles in communities across the country

The Gift of Gold on the First Christmas

We wish you and yours a Merry Christmas and Prosperous New Year.
With special thanks for choosing us as your gold firm.

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

 

 

 

"Higher levels of inflation won't only drive capital from the dollar and conventional investments; it will drive capital into gold. It bears repeating that gold is the only financial asset that's not simultaneously someone else's liability. And that's why, as fear and uncertainties increasingly stalk the world, the world will increasingly turn to gold." Doug Casey

"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

"Gold hedge books are real liabilities that will continue to grow and likely sink more gold companies."
Pierre Lassonde, CEO, Newmont Mining

"While the French government announcements a few months ago to dishoard gold made headline news, a tiny article buried in the August 19th Financial Times said: 'The Bank of France has already sought to renew France's love affair with gold by rebuffing government attempts to sell some of its 3,000-tonne hoard to ease the budget deficit.'"
James Turk, Freemarket Gold & Money

"In the past there was another parallel period, between today's deficits and the deficits of the seventies. In the seventies, the deficits surged with a war in Vietnam, an oil crisis and a surge in global inflation. The Fed Fund rate increased a net 14 times from 4.5 percent to 20 percent. Inflation soared to 20 percent and the dollar fell 70 percent. Gold moved from $35 an ounce to $850 per ounce. Today, the deficits are even larger and we have only begun gold's second leg. The dollar has fallen only 15 percent so $510 per ounce continues to be only an interim target."
John Ing, Maison Placements Canada

"Let us be blunt about it. The U.S. is now 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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