2009 Will Be Golden Year Lance Lewis Dec 31, 2008 12:30 pm

http://www.minyanville.com/articles/...

Dear Professor Lewis,

Your backwardation comments in November were correct, prescient and ahead of the chorus of backwardation articles that followed (by such luminaries as Fekete, Sinclair, etc.)

I would be greatly interested in your thoughts on where gold will go in the first quarter of 2009, particularly given its recent run-up to $880, then retreat back to $830 for support.

What are the remaining odds for a Comex short squeeze in gold for the February contract ?

Best regards,

Minyan George

Dear Minyan George,

First, thank you for the kind words.

Second: 2009 should be a good year for gold, in my humble opinion.

Given the Fed’s titanic inflationary efforts, I suspect all asset classes are going to rally (in terms of dollars) in January. But that will just be a bear-market rally for stocks (especially when adjusted for inflation).

At the same time, because of its monetary properties, gold (and gold mining stocks) should outperform the broader market by a wide margin. This jibes with the SPX/gold ratio chart below, which is once again toying with falling below 1 (indicating that gold is about to rise above the S&P in terms of price, which is a major shift, one not seen since 1973).

For example, let’s say the S&Ps manage a bear market rally back to 1000 in January (a move of about 12 percent), we should expect to see gold trade up well over 1000.

The SPX might therefore rally in nominal terms, but when denominated in gold, it will continue to collapse in real terms, just as it has consistently since its inflation-adjusted peak in 2000.

The very fact that gold was the only other asset -- besides US Treasuries -- positive on the year in terms of dollars in 2008 is already getting people’s attention; that proof of gold’s “money-ness” will benefit it in 2009, as well.

As for the gold miners, they were giant disappointments in 2008 since they were treated by the market as “just another stock” - despite gold being up on the year, and despite the miners’ costs having collapsed due to the decline in the price of oil. The market sometimes overreacts in the short term (both to the upside and the downside), and I believe we’ve seen such an overreaction in the gold stocks in 2008, too.

Regardless of what the economy is like, or what the rest of the stock market is doing in 2009, if gold miners are earning more and more dollars (which they will be next year, especially in light of their dollar-denominated costs collapsing in the latter half of 2008), people will bid them up in dollars. In fact, I would argue that gold miners may be one of the only equity groups that will actually see positive earnings growth next year, and that should actually earn them premium valuations too.

We’re even already seeing a taste of this “standalone performance” in December, given that Royal Gold (RGLD), a gold royalty company, has been one of a small handful of stocks to make a new all-time high over the past couple weeks.

With the dollar squeeze having ended, the Fed cranking up the printing presses, and the financial markets beginning to reliquify once again, the turn of the year could even kick off a precipitous decline in the dollar and a meltup in gold and gold stocks.

The fact that the Fed announced yesterday that it would begin monetizing MBS in early January may just provide the “catalyst” for that acceleration too.

Remember, the system literally cannot function without inflation, and the US is a debtor nation on an epic scale. That leaves only 2 choices: Default, or debase, and they both lead to more inflation at the end of the line.

We saw a mere taste of this back in September and October, after Lehman went bust and blew a giant hole in the credit-derivative structure. The result was a freezing of the entire financial system and a step towards default.

The massive amount of new money created by the Fed can never be taken out of the system, though some seem to think it can - any attemp to do so would leave the system just as frozen as it was back in September and October. These hopeful individuals miss the reason why the Fed is being forced to inflate in the first place: The system needs more and more inflation at a parabolic rate simply to sustain itself. This is Greenspan's real legacy - a much larger version of Madoff’s Ponzi scheme.

Speaking purely from a mechanical standpoint, the only way the financial system (as dysfunctional as it has become over the years) can remain intact is via massive inflation, period. And just as we’ve seen over the past several months, politicians don’t have the stomach to allow the system to collapse, which could unleash social anarchy.

I’ve been saying this very same thing for several years, and I believe the events of 2008 have clearly borne that out - though they admittedly didn’t do so exactly in the order or precise manner that I thought they would (i.e. the Fed failed to inflate fast enough mid-year in 2008 in order to prevent Lehman and the rest of the credit dominos from falling, and that produced the global “margin call” back in the fall - one that even weighed on gold, to some extent).

Nevertheless, the fact that the Fed failed to inflate fast enough then only means it’s now having to inflate at an even greater rate - and the inflationary consequences will be much more dire as a result.

A resumption of the dollar’s decline and the reliquification of the financial system go hand in hand, because without inflation there would be no financial system. Importantly, gold (and other hard assets, to a lesser extent ) will be the assets that benefit the most from that inflation going forward.

The inflationary/hyperinflationary path is now precisely the road we’re going down, given the trillion-plus dollars by which the Fed has grown its balance sheet over the past several months; it will likely grow an additional trillion early next year.

The Fed’s latest experiment in actually monetizing agency debt and agency-mortgage backed securities is just more inflationary icing on the cake. By the time the herd realizes that this liquidity cannot be withdrawn, gold will be in the high triple digits, and gold stocks will have risen multiples of not only their prices today, but also multiples of their 2008 highs, as well.

As for a squeeze speciifcally in the February gold contract, I’m not sure. But in the near term, I'm watching the “monkey zone” on gold.

This is the zone in between the 2 final downtrends on gold’s chart - the place where the chart monkeys will begin to get interested in gold again. Several well-known chart monkeys have already flip-flopped as of yesterday, and apparently have gone from recommending gold as a “short” just last week to now recommending putting a toe in on the long side.

Why the sudden change of heart? They’ve turned slightly bullish simply because we’ve entered the “monkey zone.” As we cross through the $900 to $930 area, these same monkeys should turn into rabid bulls once the downtrend is broken, thereby providing enough fuel (along with short covering and new bulls coming into the fold) to take us to a new all-time high. My bet is that the new high will come sometime in January.

As for backwardation, the 3M GOFO continues to dangle just above the zero line (below which would indicate official backwardation), and it’s a good bet that we will see gold once again move into backwardation as it trades back just as it briefly did back in November when the dollar index topped out and gold’s current rally kicked off.

The fiat dollar-based monetary system in place since 1980 is collapsing before our eyes. All the historic currency volatility of the past several months confirms this, in my view. History tells us that when a monetary system collapses, the world runs to gold. As we can see in the chart below, that's what's happening now, as well. Note the new all-time highs gold has already made in both Canadian dollars and British pounds over the past several weeks.

In short: Will 2009 be a golden year? I suspect it will be, but then, I'm long gold and gold stocks going into 2009 (just as I was going into 2008). So perhaps I'm biased.

But with gold having closed higher every year for the past 7 years (and looking to do so again this year), the trend is your friend, as they say.

Until that trend changes, don’t fight it. Embrace it.