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The Mother Lode

December 5, 2005


The rally in the Gold market has certainly captured everyone’s attention on Wall Street and on Main Street…Finally!! Gold has been going bananas for the last 58 months, since it traded at $252 in Feb. 2001. That is a double and then some in the same 4+ years that the stock market has been steadily going nowhere. It is really only now that it has rallied almost 11% JUST since it’s November 04, 2005 closing low that the price move has caught people’s attention.

The buzz around gold right now is much like the buzz around oil prices in the days and weeks since Hurricane Katrina. However, I think that the dynamics of the pricing mechanisms for gold are much different than for crude oil. Except for the last $40 or $50 in the move in gold; the price action has been very bullish technically – both short term and long term.

What’s behind this very quiet rally is a combination of things economic, political, and technical. The political turmoil in the world is having a definite effect on the price of gold. In these anxious times of war and terrorism, “smart money” tends to find its way into hard assets like precious metals (and to some extent real estate). The rally in gold began to accelerate after 9/11/01. In the old days gold was perceived to hold its value better than most other financial assets, and in fact appreciated relative to other alternatives during these periods. This is still the case.

Generally, in times of perceived economic distress or weakness – i.e. high inflationary and/or recessionary cycles – gold is also a harbinger of value. Many in the smart money crowd appear to be betting this way on the global economy at large currently. I think that there is a perception out there that maybe China is not the healthy growth driver we all first thought, or perhaps the U.S. economy is not as rosy as it seems, or maybe the rally in European stocks this year is a bit overdone, and or maybe the rally in emerging markets is played out too. Oil certainly looks like it has peaked for now.

Although our economy appears to be very healthy by most of the government data that comes out on a regular basis; it could be argued that that this data is only capturing a small slice of what is going on for real. Due to pronounced structural changes in the make-up of our economy it could be rightly argued that the data being captured and the way in which it is captured no longer reflects the most crucial pieces of the economy. In other words, perhaps the economy is really much weaker than reported. This is certainly possible if you think about the fact that as late as the 1970s the U.S. economy was driven by industrial labor which now resides in Asia and Latin America.

I, for one, think that employment picture is much worse than the numbers are telling us due in large part to the fact that the labor force participation rate is much lower than reported. This tends to flatter the unemployment data by making it look like less are out of work than really are. Plus, I think that many Americans are paying more for less and are making less on an inflation-adjusted basis since 2000. It is certainly true for food, energy, taxes, education, and health care – all of which have seen rapid rises in prices with only a 2% average annual gain in disposable income.

Let’s not forget that supply and demand certainly have something to do with the price action too. Asians have had boom times in their economy the last couple of years on top of their insatiable appetite for gold. India as a country consumes a large amount of gold. And let’s not forget emerging super power China. Just last week the Russian Central Bank announced that they were going to hold 15% MORE of their reserves in gold as opposed to foreign currency denominated assets. Smart move? We’ll see.

Long term, I think gold continues to go higher but not in the parabolic fashion we’ve seen in the last few weeks. I think we could see much higher prices before Mr. Bush leaves office in 2008. Gold has already taken out the 1983 and 1987 high of $500; its all-time high was $665 in 1980. Will gold go there again? There is certainly a lot of momentum right now. I think a small short correction in the price is due to take out the short term overbought condition; but from there who knows. Higher seems like the path of least resistance.

On December 5, 2005 2:11 PM, Pat Barua said:

Mr. Smith is probably too young to remember that gold went over $800 an ounce in the early 1970’s or so.

And then it descended to the two hundreds by the 90’s.

So buyers beware. It’s not an investment for the faint of heart.


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