Centennial Precious Metals, Inc: Serving Gold Coin & Bullion Investors Since 1973

7/05/05

A publication of USAGOLD-Centennial Precious Metals
Serving gold investors since 1973

Note: This market update will be published intermittently during the summer months.

Overview . . . .

Traditionally, the summer months have been the best time for investors to buy gold. The past two summers serve as an illustration. In the summer of '04, gold traded in the $390 range. As the year ended, it hit its high for the year at $455. Similarly, in the summer of '03 gold hovered in the $360s. In December gold traded in $415 range. In fact, during the past two years, most of the gold's upside occurred between August and the New Year. So before heading for that fishing stream, it might pay to first do some summertime bottom-fishing in the gold market. If the past is an indicator, we may not see current prices again for some time.

The Aden sisters, who have made some pretty good calls over the last few years, say that gold will either "consolidate for the summer before beginning a strong rise" or start a strong rise now. It is important for gold owners to keep in mind that much of gold's recent rally occurred while the dollar was rallying against its major competitors. There were good reasons for the break out and none of these were suddenly reconciled because the Fed decided to move its target interest rate up a quarter of a point.

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Special Client Advisory . . . .

Gold vs. the Conundrum
How the Fed lost control of monetary policy and inspired a new world-wide move to gold ownership

Some analysts believe that gold's descent end of last week was a direct reaction to a combination of rising rates in the United States and a potential rate cut in Europe, a scenario that could put upward pressure on the dollar. This thinking ignores the more dominant trend of heavy capital flow from international sources (primarily Japan, China and Europe) inundating the market and driving dollar rates, and inevitably the dollar itself, lower. The process, if it goes unchecked (and no one at the moment seems to have a clue as to how to stop it), will be a tour de force for gold, the one primary asset that remains completely detached from the world's paper monetary system.

In the real world (the one that keeps shattering the economists' models), interest rates are steady to down on mortgages and longer term Treasuries despite the Fed's efforts to push interest rates higher. In other words, Alan Greenspan's Fed is being frustrated by the marketplace. The Fed has moved the fed funds rate progressively higher -- from 1.25% in June, 2004 to 3.25% now. 30-year mortgage rates during that same period have gone from roughly 6.25% to 5.5%.They have not been affected by the rate increases.

In last week's "Market Perspectives" Byron Wien, the resident sage at Morgan Stanley, relays this view from someone he calls The Smartest Man in Europe:

"There are two important trends going on in the world that will determine the course of financial markets for some time to come. The first is generally recognized - the shift of manufacturing from West to East. The second is less well understood, and that is the enormous buildup in liquidity almost everywhere. . .The high price of oil has flooded the Middle East with cash, and Asian exports to the West have built up liquidity throughout Asia. All this money is looking for a place to go and provide a reasonable return. In the 1980s Japan was in a similar cash surplus situation and put the money in the US equity market, which eventually resulted in the Crash of 1987. I worry that a similar asset bubble is developing, only this time it's in the bond market and real estate because the equity markets generally do not look especially underpriced and investors are wary of them. You know you are headed for trouble when Alan Greenspan, the most powerful central banker in the world, says he doesn't understand why long-term interest rates are so low. That tells you he has lost control of the economy."

More precisely, it tells us that the Fed has lost control of monetary policy. The traditional brake on the economy -- rising interest rates -- has been taken away from the Fed and placed neatly in the hands of Tokyo, Beijing and Frankfurt.

The speculation among mainstream economists is that the Fed may be nearing the end of the tightening process. However, the reality might very well be that there never was a tightening process in the first place. Every effort the Fed has made to raise interest rates and stop the inflationary onslaught has been met with ever-larger repatriations of dollar capital.

We used to worry about the Fed monetizing the debt. Now it is America's foreign creditors, not the Fed, who are monetizing the debt, and thus far the Fed has been powerless to act against it. The Fed might simply find it expedient to go on raising interest rates while the exporting nations find it equally expedient to go on pouring capital into the American economy. At some point along the way, the process will ignite the inflationary fires. Only this this time around the Fed, the institution which has the responsibility for monetary policy, might prove (through no fault of its own) to be completely ineffective in combatting it. That is not a comforting thought. No wonder Greenspan has said that he doesn't understand the processes at work in the world economy.

THE COMING GOLD SHORTAGE

Last week's pull back in gold had to do with a misreading of what the Greenspan Fed is up against. Somewhere along the way, the realities of the Greenspan conundrum will become the measure of these markets -- gold included. It is that important. A number of analysts, including gold experts report that they are at a loss to explain the factors pushing the international gold price. Judging from the observations of Byron Wien's Smartest Man in Europe, some insiders may have already gotten ahead of the curve, and that may explain the sudden pressure on the available gold supply. Tocqueville's John Hathaway reports that Swiss gold refineries are running seven days a week to keep up with the demand. Notably, he warns that there is no metal in storage. Could it be that big international money has already read the handwriting on the wall?

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Follow-up note:

The Washington Post has published an article under the headline, "China Tells Congress To Back Off Businesses; Tensions Heightened by Bid to Purchase Unocal." This is the first time that China has tied the CNOOC, Ltd bid for the oil company to their prodigious dollar holdings.

The Unocal bid is an interesting side panel to all of this. What better way to recycle dollar fiat than to acquire hard western assets including oil companies, gold miners (?) -- and resource companies and business infrastructure in general. What price is to high to pay when you have banks and government coffers splitting at the seams with dollar reserves?

We can see that the Chinese do not particularly like the idea of being closed out on utilizing their reserves to purchase key U.S. assets. It wouldn't be far-fetched to expect more severe consequences down the road as positions harden on both sides. There is always the implied threat of dollar dumping, and now China faces the specter of Japan possibly beating them to the punch.

Acquisitions in the West will become a release valve and the Bush administration is going to be faced with some pretty peculiar problems from both countries as we move forward. We aren't talking about golf courses and ski resorts here. We are talking about vital interests to the West. "We invest too much in U.S. federal bonds, and they don't make us much money," Pan Rui, a professor at the Center for American Studies at Fudan University in Shanghai, told the Washington Post. "Now we're learning to invest more wisely, to try to invest in American companies and industries."

Quotes of the week. . . . .

"As former Fed Chairman Paul Volcker warned recently, the real tragedy is that no one in a position of responsibility wants to put an end to this madness (see his 10 April 2005 op-ed in the Washington Post, "An Economy on Thin Ice"). Congress is focused on fiscal profligacy and China bashing. The White House is fixated on "transformational politics." The Fed remains steeped in denial. And the rest of the US-centric world is begging for another spin around the track. Sadly, bad growth begets more bad growth - until it's too late. Following this week's likely rate hike, the US central bank will have only 325 bp in its arsenal, literally half the 650 bp of ammunition it had five years ago when the first bubble popped. With the aftershocks of the property bubble likely to be far more worrisome than those of the equity bubble, this time the Fed may be ill equipped to face an increasingly treacherous endgame."

Stephen Roach, Morgan-Stanley
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"As a result of many years of persistent trade surpluses with the United States, the Japanese government holds dollar reserves of approximately $1 trillion. China's accumulation of dollars is approximately $600 billion. South Korea holds about $200 billion. These sums give these countries enormous leverage over the United States. By dumping some portion of their reserves, these countries could put the dollar under intense pressure and send U.S. interest rates skyrocketing. Washington would really have to anger Japan and Korea to provoke such action, but in a showdown with China-over Taiwan, for example-China holds the cards. China and Japan, and the world at large, have more dollar reserves than they require. They would have no problem teaching a hegemonic superpower a lesson if the need arose."

Paul Craig Roberts, former assistant Treasury secretary under Ronald Reagan

Short & Sweet. . . . . .

We see the market action of late last week as more a one-off event than a change in gold dynamics. The market was already in something of a retreat earlier in the week due to end of quarter book squaring. This pushed the metal through stops and caused further selling. By Friday, fund selling was the dominant factor in pushing gold $8 lower . . . . . . . . . . . . .A recent Gallup poll finds that 56% of Americans express confidence in the Federal Reserve chairman Alan Greenspan down from 63% a year ago and 74% in 2001. . . . . . . . The World Gold Council reports official sector selling of 53.8 tonnes in May from within the Euro-system, but say the seller[s] have not been identified. Another 3.4 tonnes was sold by Germany for a coin minting program. Of late, official sector sales have averaged roughly 50 tonnes a month, so it appears that nothing unusual is going on in Europe, the gold selling capital of the world. . . . . . . . . The United States, Germany, France, Netherlands and Portugal all hold 50% of their reserves or better in gold. Gold comprises 1.3% of Japan's reserves; 3.9% of India's reserves; and, 1.4% of China's reserves. All three countries simultaneously hold very large dollar reserves. . . . . . . . . . . .Gold wasn't the only market that had its wings clipped by the last week's Fed action. Commodity prices fell across the boards (with the exception of oil) and stocks dropped on heavy volume. . . . . . . . . . . . . . . . . . .The U.S. national debt now stands at $7.836 trillion -- $60 billion higher during the month of June and $457 billion higher since last October, the start of the government's fiscal year. . . . . . . . . . . . . .The following is clipped from an MSNBC article: "Peter Kanans, a coffee farmer whose house has no running water and a leaking roof, said he had a message for the leaders of the world's richest countries who will meet at the G-8 summit next week: Unfair trade practices are enriching African officials and international coffee chains while village farmers grow steadily poorer. 'Even if they cancel the debt, even if they give our governments aid money, ordinary Africans will not benefit,' he said. 'That money will only make the corrupt people richer and Africans international beggars for decades to come.'" . . . . . . . . Bank Credit Analyst reports that balance of payments data show a huge recent demand for dollars from the United Kingdom and Switzerland. BCA surmises that the demand might be loan repayments to cover hedge fund and other large speculator dollar short positions. They go on to say that if the recent dollar rally was little more than short-covering, it may be short-lived. If so, it might kick the props out from under the dollar. . . . . . . . . . . . .

SUMMERTIME!

"It is related of the illustrious Sandy McHoots that when, on the occasion of winning the British Open Championship, he was interviewed by reporters from the leading daily papers as to his views on Tariff Reform, Bimetallism, the Trial by Jury System, and the Modern Crave for Dancing, all they could extract from him was the single word 'Mphm!' Having uttered which he shouldered his bag and went home to tea. A great man. I wish there were more like him." P.G. Wodehouse For many years, we published this Wodehouse quote in the masthead of our News & Views newsletter (the publication which preceded this one). Our clientele enjoyed the reference to summer's respite. One July we replaced the Wodehouse with something more current. Several clients called to ask why we felt it necessary to stray from the McHoots tradition. Since then we have not failed to inaugurate the summer with this happy anecdote. Have a good summer, my friends.

Nuggets. . . . .

DIJA- gold price to cross at 2000 to 2500
by Richard Russell/Dow Theory Letter

"In other words, it now takes only half as many ounces of gold to buy a share of the Dow as it did six years ago in 1999. Wait, let me bring the study up to date. The ratio low of 21.07 was recorded in February 2003. Since then the ratio has risen a bit to 23.7 today. From here on, we're forced to guess at the future of the ratio. Will the cycle continue as it has occurred before, and will the ratio decline to 1, 2 or 3? My guess is that it will. And if so, where will gold be, and where will the Dow be? I'm going to hazard a guess. I think we'll see the gold to Dow ratio decline to near 1. If the ratio is going back to 1, my guess is that we'll see both gold and the Dow at around 2000 to 2500. Fantastic, impossible, absurd? Never use any of those words about the markets -- where the markets are concerned, anything can happen!"

Full article

A process of elimination - a speculation on gold and the credit cycle
by John Hathaway/Tocqueville Funds

The notion that capital will flow into gold is a speculation on macroeconomic events external to gold. It is helpful to this speculation that the goings on in the world of gold itself are quite supportive of a substantially higher gold price. In brief, the metal is very tight.

Even though trading houses in New York and Europe seem to find plenty of paper gold to trade in a knee jerk fashion according to the news of the day, the real stuff is hard to come by. It is hard to mine and it is hard to buy in any large quantities. Just ask managers of the Swiss precious metal refineries. Their daily run rates are 30% above year ago levels and their managers are not above making urgent but discrete inquiries for gold in quantity. They are running seven days a week when they can get their hands on metal, less when they cannot. According to one contact, there is almost no metal in storage. The turnaround time for incoming metal, whatever the source is 4 to 5 days at most.

Full article

Jim Puplava's interview of Marc Faber
Financial Sense

The problem of this high inflation we have in asset prices in the US and on the high inflation we had in Latin America, and in the Weimar hyperinflation in Germany, is that it impoverished the typical household, because they were not able to capitalize on the speculative earnings: through the financial markets; through the exchange markets; through the real estate markets; and so forth. And this book by Bresciani-Turroni, The Economics of Inflation, is a very, very good study of what happens socially, economically, to prices, to the exchange rate, to stock prices, in hyperinflation countries. And I strongly recommend to your listeners to actually study this book and buy it. It's not easy to get it but it's an outstanding book. And the consequences of high inflation rates, I am really concerned, if Mr Greenspan and Mr Bernanke really lead the US into high inflation rates, the end result for the United States will be a total disaster. It would be much better to take a recession now, to push interest rates up, to control the speculation and the real estate speculation ­ one could also control it through increasing margin requirements, in other words you can only borrow this much against the house, that could be implemented easily ­ and to bring the country to sanity again this way.

Full article

A man's home is Uncle Sam's castle
by Selwyn Duke/The Intellectual Conservative

Possession may be nine-tenths of the law, but not when the law wants your possessions.  This past Thursday was a dark day for freedom in America, as the Supreme Court once again proved that its contempt for the Constitution is only matched by its willingness to court communism.  In a ruling that struck a blow for the powerful at the expense of the little guy, the Court ruled that states had the right to use the principle of eminent domain to seize private property for commercial development.  In other words, if Donald Trump wants your land so he can erect another casino and knows what palms to grease, you can be kicked out of your home.

Full article

D is for Diversification: Now more than ever

(Excerpt)

Diversification - distributing one's assets across a spectrum of investment alternatives-is one of the hallmarks of prudent portfolio management. For most, diversification amounts simply to dividing one's available capital among stocks (including mutual funds), bonds, and cash savings. However, if gold is excluded, such a division of assets is superficial at best, because it fails to take into account the corrosive effects of currency depreciation on the overall portfolio.

Chairman of the U.S. Federal Reserve Alan Greenspan has made many favorable comments about gold over the years. Even as chair of the Fed, he has remained one of the most eloquent defenders of gold, a position he has maintained for most of his life. The following comment, given during congressional testimony some years ago, goes to the heart of the issue with respect to gold's overall portfolio role:

"I do think there is a considerable amount of information about the nature of a domestic currency from observing its price in terms of gold. It is a longer-term issue. It is an issue which I think is relevant, and if you don't believe that, you always have to ask the question why it is that central banks hold so much gold which earns no interest and which costs them money to store. The answer is obvious: they consider it of significant value, and, indeed, they consider it the ultimate means of payment, one that does not require any form of endorsement. There is something out there that is terribly important that the gold price is telling us. I think that disregarding it is to fail to recognize certain crucial aspects of the value of currencies."

This brief but revealing statement from a man who spends a good part of his day worrying about currency values illustrates the importance of gold in portfolio diversification, for private investors as well as central banks. As a matter of fact, if you were to ask a hundred gold buyers why they own gold, a respectable majority would immediately answer, "For diversification." Most investors equate diversification with peace of mind. Diversification implies preparation for a variety of potential economic events. If the portfolio is properly structured, it matters not if stock markets crash, bonds lose value, or currencies suffer debasement. The hard assets of the portfolio will pick up the slack.

Traditional Swiss money managers, renowned for their ability to handle money and who manage investments for some of the world's wealthiest people, traditionally recommend a diversification into gold of 10 to 20 percent for good reason. Beyond the normal risks of market fluctuations associated with stock and bond investments, there is the additional danger of depreciation in the currency underlying the stock or bond. Denominated in a domestic currency (pesos, yen, euros, and dollars), these investments rely on sound central bank and government currency management policies to maintain their value. It is conceivable that a corporation or municipality, for example, could be perfectly managed, yet its bonds could still erode in value due to politically expedient currency debasement on the part of federal authorities.

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Archives

NEW Disturbing Trends: Is Now the Right Time for Gold?

2005 Gold Market Forecast - "I foresee two potential scenarios for the gold market in 2005. One involves a see-saw market which culminates with a roughly 20% gain on the year in keeping with the average over the last three years. This would take gold to the $525 level. The other involves a substantial price spike resulting from an uncontrolled deterioration in the value of the dollar. In that scenario, gold would threaten and probably exceed the $600 level."

Market Update 6/08/05 - "The question might legitimately be asked, 'Russell, why only 15% of assets in gold?' And my answer runs like this -- Every fiat paper currency in history has ended up in the ash can. The dollar and the euro and the yen will end up the same way unless they are ultimately backed by something real like gold. Therefore, why not be invested say 50% or even more in gold? The answer is timing. And nobody on God's green earth knows the correct timing." -- Richard Russell, Dow Theory Letter

Market Update 6/01/05 - The European Union will muddle through, and the euro will plug along, but gold is likely to become one of the key longer term beneficiaries of Sunday's rejection of the constitution. It could take years for Europe to sort out the repercussions from the French referendum, and the unforgiving financial markets will begin to wonder immediately what is going to happen between now and then. Investors too will be checking to see if they are still in one piece once the smoke clears. These are the sorts of events which usually send investors to gold as a refuge, but because of the coupling of gold and the euro in recent years, the initial reaction may be negative. At the same time, to think that a good many Europeans would not go to gold coins and bullion with these new uncertainties darkening their door is to overlook the lessons passed down in continental families for generations. I would suspect that many a preliminary inquiry is being made into gold this very day. Though I doubt that any renewed European interest in gold would affect the market radically in the near term, over time it will become a major factor on the bullish side of the ledger -- every bit as important to the international gold market fundamentals as Chinese demand (if not more so). European investors are in the same boat as Americans. They must hedge their portfolios against the possibility of a currency breakdown. That may have always been the case, but after Sunday's vote, the immediacy resonates with the clarity of a Stradivarius.

MarketUpdate 5/23/05 - The threat of a dollar crisis and rolling financial breakdown continues to dominate the financial pages. This issue, like the last two, focuses on the reasons for this concern and related developments around the world.

MarketUpdate 5/16/05 - The madness of crowds can pop up anytime, anywhere. No era is immune; no individual beyond its unflinching grasp. And crowd madness pays no heed to intelligence or experience. In 1841, Charles MacKay wrote an important book titled "Extraordinary Popular Delusions and the Madness of Crowds -- the book that Bernard Baruch called the secret to his incredible wealth. In it MacKay points out that Roger Bacon, "by far the most learned man of his age" believed that the philosopher's stone could turn lead to gold. (Book link provided)

MarketUpdate 5/09/05 - Last week systemic risk was in the air. General Motors and Ford's bonds reduced to junk status. Rumors of at least one hedge fund and possibly others on the ropes. Talk of several major American corporations in financial trouble. Amidst all of this, the Chairman of the Fed raised the specter of systemic risk citing Adam Smith's "invisible hand" and the forces of chaos and creative destruction in the market.

MarketUpdate 5/02/05 - The brief history outlined in this week's masthead quote speaks volumes why gold makes sense for the average investor. The graph to your immediate right supports Mr. Bonner's reference to the "5¢ dollar." Modern nation states have a way of running their currencies into the ground. Germany, Turkey, Argentina, Mexico, Brazil, Russia, Poland, Greece, Hungary, China, Austria, Thailand, Chile and Yugoslavia (just to name a few) experienced wipe-out inflationary episodes in the 20th century. The damage was significant enough to leave an indelible mark on the indigenous population for generations to come.

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