-Doug Casey

Apr 21, 2004 - The Daily Reckoning

Since reaching a recent peak of $427.25 on April 1, gold has dropped about 7%, with most of the action happening in the last few days. Silver, which peaked at $8.29 on April 2, has come down even more, losing about 14% to $7.15 as I write. These moves have apparently scared a lot of people (mostly latecomers in the market) and they're wondering if the steep drop signals an end to the metals bull market.

In my view, the fall shouldn't concern anybody but a futures trader who was long and who didn't have a close enough stop-loss. Markets fluctuate more or less randomly in the short run, which helps account for why 95% of futures traders walk away losers. People with such a short time frame shouldn't be in the markets; they should go to casinos.

The skilled speculator and the experienced investor, however, take a longer view. The key is to identify major trends in the markets, understand why they're occurring, and stay with them for as long as possible. Jitterbugs that worry about daily movements will eat their capital up with commissions, fees, taxes, and bid/ask spreads in the process of whipsawing their accounts to death with the vagaries of their own psychology.

I don't have a crystal ball, but I do have a sense of market history. Most of the people that were active players in the last real gold bull market, from August 1971 to January 1980 (which took gold from $35 to over $800) are now either dead or retired. Most of the players in today's markets only know of gold as a dog, dropping from over $800 to under $253 in July of 1999. Those few who even watched it came to see every rally over a 22-year slide as nothing more than a selling opportunity.

Understandably, people tend to predict the future by the past. So they expect both bull markets and bear markets to go on forever. Right now, most of those who've even noticed gold has moved from $252.80 at the bottom to its present levels see it as just another rally in a never-ending bear market.

How do I know they're not right? Well, nobody can know that until long after the fact. But I've been long both the metal and gold stocks since the late 90's (I was early; generally speaking only liars buy at the exact bottom), and I'm planning on staying long for the indefinite future, but at least several years. Why am I so bullish? The purpose of this article isn't to make a definitive case for gold, but I will list six outstanding factors worth noting.

1. THE FOREIGN TRADE DEFICIT. The U.S. is currently importing about $500 billion more than it exports every year. That's been going on for many years, so there are trillions of U.S. dollars now held outside of the U.S. Since U.S. dollars are only "legal tender" within the U.S., whether foreigners continue holding them depends on whether they have confidence in the dollar. Confidence can vanish like a pile of feathers during a hurricane. I would suggest that they're becoming increasingly aware that the dollar is, in fact, an "IOU Nothing" on the part of the U.S. Government, which is itself bankrupt.

2. U.S. GOVERNMENT DEFICITS. The U.S. Government is also running $500 billion domestic deficits, and that number is not only grossly understated - because of (a) off-balance- sheet spending; (b) cash rather than more appropriate accrual accounting; and (c) the adding of Social Security funds into the general revenue - but it's likely to go way, way up. Why? It's being financed with some of the lowest interest rates in history, and when rates cyclically rise to more normal levels (forget about the 15% long rates of the last generation - which I expect will be exceeded), the deficit could reach a trillion. That's not counting greatly diminished tax revenues and the greatly increased government spending that always accompany a recession. And I think we're heading for something worse than a recession.

3. THE WAR. My guess is that the adventures in Iraq and Afghanistan are, for reasons I won't go into now, going to get much, much uglier. And likely spread to other parts of the Islamic world. The U.S., which has troops in over 100 countries, isn't going to withdraw; it's going to become more involved. This could be a $200 billion-per-year drain, on top of the regular Defense Department and Homeland Security budgets, for many years to come.

4. SUPPLY/DEMAND. Although most of the gold that's ever been mined is available (either as bullion, coins, or jewelry), the fact is that more is being consumed than is being mined each year by a substantial margin - by about 640 tons in 2003 alone. Most of this deficit has been made up by sales and loans from Central Bank inventory, compounded by forward sales from gold mining companies. The loans and forward sales constitute a short position of substantial size that will have to be covered. And my suspicion is that, at some point in the next few years, Central Banks will go from being net sellers to net buyers.

5. THE REAL PRICE. At $35 in 1971, gold was artificially suppressed in price by government edict. By the time it reached $800 in 1980, it was caught up in a speculative mania. Since then it's been able to achieve something of an equilibrium. But $400 today is really only worth about $75 in 1971 dollars - so it's quite under-priced. And, in real dollars (whatever they may be), gold isn't down just 50% from its 1980 peak; it's still down about 85%. I expect the conditions that drove the bull market in the 70's are going to be much, much stronger this time around.

6. GOLD AS A CURRENCY. Take your pick: a piece of paper with less than zero intrinsic value, or a tangible and relatively rare metal that has been viewed as a store of wealth over thousands of years? In addition to holding the physical metal, new services such as that offer electronic transaction services based on gold will revolutionize the ways you can buy and sell the metal.

In essence, you want to own gold because of all these reasons. But above all, you want to own gold because it's the only financial asset that is not simultaneously someone else's liability - which is why I expect Central Banks around the world will increasingly be selling dollars and buying gold in the future.

I believe we're looking at a gold bull market of historic proportions in the years to come. Retrenchments such as we're seeing now are not only normal, but trivial. You should use them to buy bullion and aggressively add to your mining share positions. Despite returns of 5-to-1 almost across the board in these stocks, there's every reason to believe that when the gold bull really gets under way, these stocks will be wilder than Internet stocks were in the late 90's.


Doug Casey, for The Daily Reckoning

Editor's note: Doug Casey, author of bestseller Crisis Investing, has been seeking and finding incredible opportunities around the world for over 25 years. He has lived in seven countries and visited over one hundred more, actively - and successfully - speculating in international stock, bond, commodity and real estate markets.

DISCLAIMER: All of the information in this story is believed to be true, however errors are possible.
Past performance is no guarantee of future performance. All investments have risk. -SATC

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