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Golden Needles

by R.E. McMaster

In a nutshell, what is taking place globally is a deflationary, depressionary credit and economic implosion, triggered by and triggering competitive currency devaluations. The kicker is, however, that these competitive currency devaluations globally result in inflation in the countries in which the devaluations occur. In fact, inflation and higher interest rates both occur, as well as higher import prices. Moreover, the price of gold increases in terms of these competitively devaluing currencies. Question: Will we see this in the U.S.? Will the devaluation (decline) in the U.S. dollar result, in equal opposite fashion, in higher gold prices? So far, the answer is, "Yes!" The September U.S. Dollar Index fell from a high of 102.67 on August 27 to a low of 95.99 on September 11. By contrast, December Gold made a bottom on August 28 at $275.50 and rallied to a high of $300.20 on September 11. That is almost an exact inverse correlation. Moreover, since August 31, gold stocks have risen 40% on average.

Supporting this scenario is the fact that gold has moved up against T-bonds since August 31. As you will recall, the only paper asset that both the CRB Index and gold were still declining against (August 27 Reaper) was not stocks, but U.S. Treasury bonds. As this chart clearly reveals, this is no longer the case with gold. Gold has been improving against T-bonds since August 31, making it clearly the preferred asset to U.S. paper.

However, the leaders in all markets, possibly representing the upcoming euro, are the major European currencies against both the U.S. dollar and gold. The German D-mark has been in an uptrend against gold, as has the Swiss franc, since mid-first quarter 1977. But it is interesting that even these two currencies have weakened against gold since August 28.

As I've written in previous Reapers, gold needs to close above $300 an ounce to issue an intermediate buy signal, and above $315-$320 to issue a major buy signal. Also, as I've previously penned, if I were a global central banker, and I wanted to "kick start" the global economy, what I would do is depreciate (devalue) the value of the world's reserve currency (the U.S. dollar) and inflate the price of gold. This would increase the velocity/turnover of money and encourage borrowing and spending, exactly what they need presently globally. (The other alternative is a war.)

Look at it another way- If all the currencies in the world are devaluing competitively, including the U.S. dollar, gold is going to rise by default. Gold, after all, is the only financial asset which is not simultaneously someone else's liability. It is historically real money. Gold is "ground zero" when it comes to debt-free cash, Gold also moves up when fear and uncertainty abound for investors, and certainly there is enough of that around presently. What follows are other reasons why we could have a major change in trend, a new bull market, in gold.

First of all, time is up. Gold has been in an 18-year bear market. That is an old bear market. Gold is at the 5.6-year cycle low, the 62-64 year cycle low, and seasonally gold often bottoms in September. We are on track in this regard. We have also entered the 29-year social unrest cycle, and war cycles, too, are dovetailing over the next few years, along with major climatic change cycles all of which are potentially bullish for gold.

Fundamentally, gold has been languishing for some time due to investor complacency regarding stocks. Fundamental reasons which should have propelled gold higher did not do so. When a market ignores emerging (building) fundamentals, those fundamentals tend to become like a tightly coiled spring, like a volcano under increasing pressure. When they blow, they blow big and compensate in short order for the lack of price action response which did not occur earlier. This could be what is occurring in gold. The cash market in U.S. gold coins has been red hot this year, as has the numismatic gold coin market. The gold stocks and the gold futures are just now catching up with those two markets. Moreover, the September Japanese yen has strengthened from an August 11 low of .6807 to a September 11 high of .7685. The September Australian dollar has likewise rallied from an August 27 low of .5465 to a September 11 high of .6045. The reversal up by these two currencies has supported gold.

There have been concerns regarding more Russian sales of its $14 billion worth of gold as a result of the collapse of the Russian economic and financial system. Gold held in Swiss bank inventories has suddenly increased from 50 to 700 tonnes. Swiss banks are the principal agents for Russian gold operations. However, it is more likely the Russians will lend their gold rather than sell or dump it on the market. Or, sales will occur at higher prices. Also, European central bank gold sales are all but done if not totally over. The European central bank has announced that gold will comprise 15% of its foreign reserves. This long, lingering uncertainty is thus removed from the gold market. More importantly, any future sales of gold held by individual central banks in Europe will have to be approved by the European central bank. This is unlikely due to the strongly pro-gold members of the European central bank, specifically Germany, France and Italy. Wouldn't it be something if, in fact, this latest financial debacle led to central bank buying of gold as a hedge against financial collapse. We know that coordinated financial Islam is considering a gold-backed currency, the Dinar. Will Asian central banks now buy gold? Certainly we are close to the cessation/ completion of Asian gold selling.

The hedge funds that have been heavily short gold are showing indications that they are covering their short positions and even lightly going long gold. Commercials/mining operations who have two to three years of production of gold sold short (6000-8000 tonnes) could very well cover these shorts once gold closes above $315-$320 an ounce. In fact, they could panic to buy back their short positions.

Simple diversifications of assets by investors out of stocks and bonds could lead to much higher gold prices. Even a 5% shift out of paper assets would lead to enormous demand for the precious metals. After all, the leading gold mining stocks are worth only $50-$55 billion, a tiny percentage of the value of all stocks. In fact, only a fraction of the value of Coca Cola. Do not be surprised if we see equity fund money managers move a small percentage of their assets into gold stocks, since that is one of the few areas of the stock market that is performing well now, along with the Dow Jones Utilities. Small investors in the U.S., Europe and some parts of Asia have been buying gold the last two and a half weeks.

Fundamentally, the supply of gold is less than the annual demand, with consumption greater than production to the tune of 1200-1500 tonnes per year. This is somewhat suspect, however, since 80% of the demand for gold is for use in jewelry. But, low gold prices have resulted in gold producers cutting their production by 15 million ounces (466.5 tonnes) over the next three years.

Gold should benefit from the definite shock upcoming from the Y2K problem and from the ongoing lame duck Clinton White House crisis. Clinton, who is now openly revealed to be a sexually and power-addicted sociopath, could very well put us in a national state of emergency through a trumped up war (Wag the Dog), or for some other reason (terrorism) in order to maintain power. (So far, it looks like Slick Willie will survive and the Monica Lewinsky scandal will blow over.)

Terrorism is a real threat to the United States, particularly since our ill-advised missile assaults on Afghanistan and Sudan. ABC (atomic/biological/chemical) blackmail has already occurred.

The threat of a global financial meltdown still exists. Perhaps 20 Japanese banks are technically bankrupt, and the Nikkei Dow needs to hold above 14,000 to withstand the increasing pressures of a collapse there. So far, no cigar. Russia has already collapsed and debts of $1.8 trillion (according to the BIS) are now directly threatened in developing nations as a result of Russia's default, not to mention the pressure the Russian default put on any institutions that made direct loans. Many of China's banks are effectively belly up, with China's nonperforming loans nearly $1 trillion ($915 billion). This makes China more dangerous than Russia militarily. The Chinese yuan has already been devalued 20% on the black market of Shanghai. An official Chinese devaluation of the yuan is all but a certainty in 1999, as is an accompanying devaluation of the Hong Kong dollar. How about the craziness of the Hong Kong government recently spending its foreign reserves to support the Hong Kong stock market? Expect a lower Hang Seng Index! Indonesia faces 50% unemployment and effectively an economic black hole by the end of this year, with soaring triple digit inflation rates. Oil is critical to Indonesia. In fact, if oil falls below $12 a barrel and stays there, it will bankrupt Indonesia, Mexico, Venezuela, and even Saudi Arabia (Russia is already bankrupt.).

Then there are the building war tensions in the oil rich Middle East, where Islam is coordinating a potential attack against Israel when the Y2K problem hits the U.S. next year.

Certainly, normal disintermediation out of the U.S. dollar back to euro currencies with the onset of the euro (possibly up to $400 billion immediately), and to the Asian currencies as they stabilize (Japanese yen and Australian dollars strengthen), will weaken the U.S. dollar and strengthen gold. Also, the very fact that investments have historically moved from being grossly undervalued to grossly overvalued would suggest a flow of funds from overvalued stocks and fully valued bonds back into undervalued commodities such as gold (and energy). Gold historically has been seen as a hedge against inflation (a depreciation in the value of currencies), and also as a deflation hedge during debt defaults, since gold is the only financial asset which is not simultaneously someone else's liability/debt. Already, investors are moving toward liquidity (cash) (real money), from stocks to bonds, to CDs, to cash (greenbacks and strong foreign currencies) and to gold. If two of the primary gold currencies strengthen, the South African rand and the Australian dollar, such should also strengthen gold.

In this present chaotic environment, which has quickly deteriorated from the complacency where all seemed well in mid July, it is logical that investors would look for some safety, comfort and security in gold and gold stocks. For all is not as it seems to be. As the Clinton White House has unraveled like Monica Lewinsky's dress seams, it just makes sense to sew things up tight with some "Golden Needles."

by R.E. McMaster / The Reaper
October 15, 1998

Editor's Note: If you would like to see what Mr. McMaster specifically prescribes given the current financial situation, we highly recommend his widely read newsletter, The Reaper, P.O. Box 84901, Phoenix, AZ 85071, or call 1-800-528-0559 for subscription information. I have personally followed the thinking of Mr. McMaster for years and consider his newsletter among the best available. --MK

Copyright © 1998 by R.E. McMaster. All Rights Reserved.

Reprinted by USAGOLD with permission of Mr. McMaster. No further reproduction without permission.

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