Gold - Heading for $200 or $10.000?

• Hedge Fund investors turn to gold
• Emerging economies eye gold reserves as dollar fears rise
• Total gold demand up 84% in Q4 2008
• Central banks net gold buyers in January
• China central bank sees rebound in metals, new gold peak

Related articles:

GoldDrivers 2009 – Extraordinary bullish outlook for gold – part I

GoldDrivers 2009 – Extraordinary bullish outlook for gold – part II

Eric Hommelberg

March 16, 2009

Gold came tumbling down last week (but rebounded sharply thereafter) prompting the deflationists to come out again with their predictable gold crash scenarios. Never mind they’ve done so ever since $320 gold (November 2002), never mind since they will be proven wrong again. Popular deflationist tunes circling the internet these days calling for $200 gold this year are likely to result in promoting the authors to the famous hall of shame in short order. This as a result of gold soaring towards new all time highs instead of $200 which could surprise even most of the gold bulls today. $10,000 gold before the year of 2015 is not unthinkable which of course doesn’t represent appreciating purchasing power of gold itself but rather a total confidence collapse in all paper currencies.

Yes, the gold debate is heating up these days. I’ve tried to capture the spirit of the ongoing gold debate in a fictitious conversation between a mainstream investor (MI) and a gold bug (GB) in which the mainstream investor challenges the goldbug with popular bearish arguments.

In writing this I realized I could have written a hundred page document but I hope to have captured the spirit of the ongoing gold debate in this 5 page document.

At the end of this article you’ll find some chart updates for both gold, silver and HUI..

MI: I’ve heard that gold is an awful investment asset and should be avoided like the plague

GB: Oh really? Now why would that be the case?

MI: Because gold doesn’t pay any dividend and doesn’t produce any cash flow, therefore it’s impossible to assign any real value to gold.

GB: Who is telling you that?

MI: My investment advisor. Furthermore he points out that if you had invested in gold in 1980 you would have had a very poor result after almost 30 years. He recommends me to invest in the DOW since the DOW always performs well in the long term. Furthermore he warns me that gold has been a hype as of late therefore a top must be near by.

GB: Your investment advisor is insane.

MI: Why? It sounds all reasonable to me…

GB: It’s all about cycles. Your investment advisor is programmed to think linearly like eg, “the DOW always goes up”, “housing prices always go up”, etc… Your investment advisor can’t think cyclical.. There are times to be invested in the DOW but there are times to be invested in gold as well (see I at end of article). Now did your investment advisor tell you about gold’s performance since 2001 compared to the DOW? Has he told you that gold appreciated by almost 300% during this decade while the DOW has lost about 50%? Now what would you prefer? The thing is these kind of investment advisors are always selecting a time frame which suit their agenda best. Since they don’t want to make fools of themselves they argue that gold didn’t perform since 1980 and therefore has been a bad investment choice.. Again, ask your investment advisor why he has failed terribly to get you into gold in 2001.

MI: Again he would argue that it’s impossible to assign any real value to gold since it doesn’t pay any dividend and doesn’t produce any cash flow. Why should it be justified to see gold at $1000, not at $500?

GB: Explain to your investment advisor that gold is money and that gold always remain the ultimate form of payment in the world (Alan Greenspan, Testimony before US House Banking Committee, May 1999.), in other words, gold is the one and only true safe haven when confidence in all other paper currencies evaporates like snow in hell. This is exactly what you see happening now.

MI: My investment advisor says that gold will fall anyhow from here since jewelry demand will collapse as a result of the economic crisis. Since jewelry demand counts for two third of total gold demand demand is most likely to fall off a cliff thereby driving gold prices down.

GB: Really? Again, it would suit your investment advisor to do his homework.. Look at India, world’s biggest gold consumer.. Now how would your investment advisor explain to see India’s gold demand growing from about 600 tonnes a year to about 850 tonnes a year on the back of rising gold prices from $400 to $1000? Did you know that even in the midst of all economic woes total world gold demand increased 84% during the fourth-quarter of 2008 compared to the same quarter of 2007, led by a spectacular 107% rise in jewelry demand?

MI: A 107% rise in jewelry demand in the fourth quarter of 2008? Wow! So the argument of decreasing gold demand as a result of current economic woes doesn’t hold any ground then.

GB: Exactly, by now you’re already better informed about gold than most investment advisors. Furthermore keep in mind that any decline in jewelry demand is easily being offset by the tremendous increase of investment demand. In fact investment demand is skyrocketing and absorbs almost all the mine supply coming onto the market these days. On top of that we see mine supply going down coming years

MI: But wait, I still don’t get it..Maybe demand is overwhelming supply indeed these days but isn’t that gap filled by central banks dumping their gold into the market? According to my investment advisor gold doesn’t fulfill any monetary role anymore thereby making it a useless asset for central banks. Now if gold isn’t a good asset for a central bank, why would it be good for us investors?

GB: Your investment advisor is giving me a headache. Did you know that in 1971 when Nixon closed the gold window analysts were predicting gold to collapse from $35 to $7 an ounce? They argued that since gold had lost its monetary role it would lose its value. They thought that the dollar gave value to gold but sure enough it was the other way around, it was gold that gave value to the dollar. After delinking the dollar to gold gold didn’t collapse to $7 but took off to $850. Gold took off because investors didn’t trust the dollar any longer, in other words, investors preferred gold as a safe haven, not the dollar. Now in order to restore confidence in the paper system central banks had no other choice than to sell gold and bring gold prices down thereby creating a false picture of strong paper currencies.

MI: So what you’re suggesting is that central banks and governments don’t want to see higher gold prices?

GB: Exactly! The whole system is based upon faith and backed by nothing.. A skyrocketing gold price would set off all kinds of alarm bells and could lead to a dollar collapse. This is the one and only reason central banks have been dumping gold (through sales and leasing) into the market for so long..

MI: Is this just your opinion? Could you back it up with facts?

GB: Sure, for example former FED president Paul Volcker said in his memoirs (referring to the dollar crisis of the 70's) that joint intervention in gold sales to prevent a steep rise in the price of gold was a big mistake. The price of gold rose rapidly, and that knocked the psychological props out from under the dollar. The US government however tried to prevent a dollar collapse by gold sales on its own. On Nov 1 1978 the Carter administration worried about the falling dollar announced that the Treasury would use gold sales and foreign borrowing and draw on its reserves with the International Monetary Fund to defend the dollar. You see? The big picture is simple, dollar weakness can only be addressed by attacking gold’s strength.

MI: So gold market interventions kept the dream of a fiat currency system alive you say?

GB: You bet!

MI: But where’s the proof? Are there any banking officials admitting these kind of activities?

GB: Well, what about this one. William S. White, the head of the monetary and economic department of the Bank for International Settlements said in a speech (June 2005) to a BIS conference in Basel, Switzerland, “There are five main purposes of central bank cooperation and one of them is "the provision of international credits and joint efforts to influence asset prices, especially gold and foreign exchange, in circumstances where this might be thought useful." You see? Joint efforts to influence asset prices, especially gold, sounds similar to what Paul Volcker said, what more proof do you need?

MI: OK, sounds very compelling indeed but still I don’t get it why I should buy gold while I know that central banks stand ready to intervene at any time. How can they ever lose control about the gold market?

GB: Look, central banks have been filling a supply/demand gap of 1500 tons for years and now they are running out of ammunition to continue their battle against gold. On top of that, demand is soaring at ever an increasing pace. I told you before that almost all mined supply is being taken out by investment demand only these days. Then we’re hearing about new hedge funds pouring into gold almost on a daily basis now, and last but not least there is a strong possibility that China will be turning to gold big time. China is worried about their US$ holdings and many officials are calling for diversification of China’s reserves into gold. The Chinese central bank is expecting new record highs for gold in 2009! Now why is that you think? It’s simple, the Chinese do understand that gold will perform better than the US$

MI: So what you’re basically saying is that a tsunami of fresh gold demand will dwarf all central banks’ efforts to contain gold prices?

GB: Yes. The result will be an explosion in the gold price which will stun the entire investment world.

MI: Please explain?

GB: Look at it this way, like a compressed coil. The more you compress it the more volatile its reaction after releasing the pressure.. This applies to the gold market as well. More than 10 years of extensive gold leasing has led to a gold short position of about 15.000 tonnes which can never find its way back to the central banks vaults without causing the price of gold to explode.

MI: Maybe the central banks don’t want their gold back so there won’t be a huge short cover after all?

GB: Could be but the thing is that the central banks still have the gold on their books as reserve assets. In other words, they still claim the leased gold as part of their reserves. Now if a central bank chooses to settle the leased gold with cash instead of demanding back the gold itself then one day investors will wake up and realize that half of all central bank is gone and hanging around the necks of Indian and Chinese women. What will happen then is rather predictable, investors world wide will be bidding up gold prices to levels unimaginable today.

MI: So let’s see, we have a severe supply/demand deficit for years to come, we’re facing an economic depression which will result in an increased safe haven buying into gold, the US$ losing confidence fast, central bank’s sales threat on the wane, potential major short cover in gold…It’s hard to come to any other conclusion than gold is on its way up. What gold prices are possible then?

GB: There are many ways to calculate a hypothetical gold price which would counterbalance most of world's debt. In the 70's for example Jim Sinclair predicted that gold would seek a price high enough to offset the public debt held in foreign hands. He proved out to be right. A similar approach these days would require gold prices exceeding the $10,000 mark.

MI: $10,000?

GB: Yes, $10,000. Look, it sounds absurd these days but $1000 gold sounded absurd back in the early seventies as well, yet Mr. Jim Sinclair predicted we would see $900 gold before all was said and done. He proved to be right since gold hit a high of $887 in 1980. Another tool suggesting $10,000 gold would be possible is the DOW/Gold ratio. Look, as said before, there are times to be invested in equities and there are times to be invested in gold. Unfortunately, these cycles take so much time to unfold that our human minds don’t recognize where we find ourselves in these cycles and where we’re heading to, unless you’ve studied history extensively.

MI: Could you explain a bit more?

GB: Sure, it’s simple.. Again there are times that mainstream equities are the place to be. During these times you’ll see equities outperforming gold. Therefore you’ll see a rising ratio of the DOW vs gold, in other words, the DOW/Gold ratio will rise. When the DOW/Gold ratio tops out it will be heading down for years to come. This happened in 2000. So when the DOW/Gold ratio tops out you’ll be buying gold since gold will be outperforming equities for years to come. You will sell your gold again when the DOW/Gold ratio bottoms out and you’ll be buying equities again. Since the DOW/Gold ratio bottoms out about every 35 years or so at a DOW/Gold ratio of 1 you can expect gold continue to appreciate for another couple of years until gold reaches parity with the DOW. This could be eg with DOW 4000 as gold at $4000.. During a blow-off phase, however, anything could happen and gold could spike up to $10,000.

MI: But when do you know exactly when gold would be topping out then?

GB: You just don’t know exactly but as long gold doesn’t double in value in a time frame of a year then I wouldn’t be worried about gold topping out. The momentum build up in gold just cannot be stopped and odds are this will end in a mania stampede into gold. We’re not there yet, what we’re seeing now is just the beginning.

MI: It all seems too good to be true but what about all these bearish reports on gold claiming gold will collapse to below $300 due to a deflationary collapse of the world economy?

GB: The deflationists had it wrong ever since $320 gold back in 2002. So why listen to them now? Every time gold dropped by $10 they came out declaring deflation had arrived and called for a collapse in gold.

MI: Yes, but now it’s different, we see all commodities collapsing, we have the worst downturn in world economy since the great depression of the thirties.

GB: Again, the deflationists don’t realize that gold is money. When confidence in paper currencies evaporates likes snow in hell then investors will flee into gold en masse since gold will always retain its value, it simply did so for more than 6000 years. Claiming gold will collapse to below $300 is saying that the dollar will be gaining purchasing power and act as a safe hafen investment. Nothing however could be further from the truth since any bankrupt nation will see its currency fall into oblivion. History leaves no doubt about it. In the end ALL paper currencies fail!

MI: So you’re suggesting the US is bankrupt then?

GB: Technically yes, look, the problems we’re facing now emerged from too much debt.. Now the government is trying to fix these problems by issuing even more debt.. A trillion dollars here, a trillion dollars there, it doesn’t stop. There is no way these extensive debt levels can ever be repaid, not even by raising income tax to 95%, so the inevitable conclusion is that only inflation could provide the budgetary resources needed to cancel out these debts.. This is what happened to the German Reichsmark and more recently to the Zimbabwean dollar..

MI: Are you suggesting hyperinflation in the US?

GB: Again, it’s a confidence game. When confidence is gone, the currency is gone. Needless to say confidence in the US$ is fading fast since trillions of fresh added debt are surfacing almost on a daily basis now. The US doesn’t have that money, the Chinese won’t lend it to them any longer, so they have to print it..

MI: But what could be done then to solve this mess?

GB: I really don’t know. Maybe an option would be to revalue gold and to restore some kind of link to the dollar. If gold would be revalued to $10,000 then the gold owned by the US would balance the US debt (public) held in foreign hands. But again, I don’t think gold needs to be revalued since gold will seek this value ($10,000) on its own.

MI: Now how would you play a move to $10,000? Would you invest in gold itself? Gold shares?

GB: Look, we’re living in extraordinary times with exceptional risks so please go for safety first which indeed means the physical metals themselves. When I say physical metals I really mean the metal itself, not an exchange traded fund like GLD or SLV. Avoid as much counter party risk as possible and buy the physical stuff.

MI: Besides the physical stuff, would you recommend buying some gold shares as well?

GB: The gold shares have been trading at extreme depressed levels last year but bounced back nicely by 100% since October last year. Yes, I expect the senior gold shares to do well and some even extremely well but again, go for safety first which means the physical metals themselves.

MI: What about the junior gold shares, they seem to be comatose. Will they survive?

GB: The juniors have been hit extremely hard last year. Most of them are priced at bankruptcy levels and as if gold were still trading at $250 back in 2001. The reason is simple, most juniors had a business model of raising cash, drilling away that cash, raising cash etc…. Needless to say this type of business model doesn’t work anymore in our current financial woes. It is extremely difficult for most juniors to raise money at the moment. The conclusion is a simple one, many juniors will bleed to death.

MI: But what about the ones that will survive? Would it be good to own a few of these?

GB: Absolutely! Look, no business system stays in extreme conditions for ever. In other words, after staying at extreme depressed levels for a while, juniors that will survive will be returning back to historical ratios compared to their senior brethren. And yes, items swinging back from extreme depressed levels to historical averages could easily overshoot to extreme overvaluation on the upside as well over the next few years, thereby returning astronomical yields unimaginable these days. But again be careful here, don’t invest too much in a single junior..

MI: Why are you so sure some of these juniors will do so well coming years?

GB: It’s simple, juniors own the right of future gold supply. 75% of all new discoveries are made by juniors. Gold will go to $5000 and maybe more, the major gold producers cannot replace the mined reserves they produce so they have to open their checkbooks and buy the ounces from the juniors that have them.

MI: OK, but how can you recognize a junior that will survive and do well coming years?

GB: Well, of course no guarantees can be given but I would say avoid those companies who have put themselves in hibernation mode waiting for better times to come. Go for those companies that managed to turn these challenging times into new opportunities. Go for those companies who are financially secure and which do have the ounces proven. Go for those companies who are producing or will go into production shortly. Go for those companies which management has a proven track record of success.

MI: Well, guess I have to do some homework now!..Thx for the update

GB: You’re welcome

END.

We will be publishing a series of interviews in the coming months with CEO’s of junior mining companies that will survive in our opinion and could do well in coming years. These publications are for our premium members only. Readers interested could take advantage of our special Lifetime Premium Membership offer which details can be found HERE

I) Dow/Gold ratio chart

The DOW/GOLD chart is a powerful tool in order to determine major turnarounds. It's simple, when the DOW/GOLD chart tops you buy gold, when the DOW/GOLD chart bottoms you buy equities. Once you've established your position you can ride the wave up or down for at least a decade. The DOW/GOLD chart flashed a 'buy' for gold again in the year 2000 and indeed almost 9 years later gold is almost up 300% from its lows since then. If it were all that simple why don't we hear that much about this powerful tool?

Well, the thing is the DOW/GOLD ratio chart isn't a useful indicator in order to predict yearly price movements. Next year could very well clock higher readings than this year instead of expected lower readings thereby losing confidence as being a reliable indicator. Unfortunately that's the same analogy as denying that higher temperatures will arrive in summer based on a single day temperature drop in spring. The problem is that the DOW/GOLD cycle has a wave length that's so big that we humans have a hard time to figure out where to position ourselves into this cycle.

Chart updates Gold, Silver, HUI

Gold Chart Daily

Gold has been successfully held back below the $930 mark by the gold bullion short sellers last week and needless to say another attack could be expected here. Gold will find support at $900, then $883 (38% FIB retracement from 681 – 1007 move). Technicals are slowly turning positive for gold but key remains the $930 mark.

Silver Chart Daily

Silver is struggling to breach its 200 dma to the upside and is caught now between its own 50 dma and 200 dma. Support is to be found at $12.50 , then $12.24 (38% Fib retracement from 8.40 – 14.61 move). Technicals are slowly turning positive for silver but we would like to see silver taking out its 200 dma to the upside first before a major BUY could be issued.

HUI Chart Daily

The HUI is struggling to overcome its 50 and 200 dma to the upside. At the downside we find support in the 250 – 260 zone. The technicals however are slowly turning more bullish but a strong BUY hasn’t emerged yet, therefore we definitely need to break the 200 dma to the upside first.

END.

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Comments are welcome at: ehommelberg@golddrivers.com

Eric Hommelberg The Gold Drivers Report

www.golddrivers.com