The Mystery of the Gold Market - Conclusions on the Selling Pressure

By Kenneth J.Gerbino Mar 20 2008 9:30AM www.kengerbino.com

It was very obvious to me after 35 years investing in the mining sector that something was very strange when two very unusual facts were present in the bullion and gold mining share market over the last nine months.

• The junior mining stocks were going nowhere while the big cap stocks were relentlessly strong since the summer of 2007 as gold went from $650 to the recent high of just over $1,000. The fact that the gold move was that strong and the juniors were not participating had never happen before.
  
• Both Goldman Sachs and Morgan Stanley were both issuing bullish forecasts for gold in the summer and fall of 2007. A first as far as I can recall.

I have no doubt that the U.S. Treasury and the Fed were very aware of the sub prime problems long before it became headline news. I am also sure that they had concluded and decided that if the situation did get out of hand they would basically have no choice but to put as much liquidity and cash into the system as was needed. At all costs they were not going to let the financial establishment of the United States go down in smoke and then have to deal with the aftermath.

Since the establishment banking elite in this country and most other countries are either Keynesians, Samuelsonistas, or Galbrathians, (the three worst famous economists that ever lived beside Marx) they are very comfortable with printing money anytime it is useful to them politically.

The extent of the eventual investment crisis that ensued was most likely not envisioned by the Fed or the Treasury but I am sure they knew that there were going to be plenty of problems.

My thesis is that the following happened:

1. Insiders, cronies, major $10-$30 billion elite fund managers and friends who hob-nob in high places were aware of two things: That the banking system may have to take a big hit in late 2007 or early 2008 and that the Fed would print as much money as needed and lower rates dramatically to handle these problems. Therefore buying gold was a no brainer. The Fed would easily do what would be bullish for gold.
   
2. These well connected and savvy players then became short term believers in gold, (knowing little about gold philosophically). They did know, as time went on, that indeed the banking situation was getting worse and possibly out of hand.
   
3. They were probably not told outright in a conspiratorial manner about the intentions of the Fed but they knew that the Fed was probably without a doubt going to turn on the spigots and lower interest rates which would move gold even higher and the dollar lower.
   
4. Hedge Fund managers with the momentum of the bullion market and the major gold mining stocks then joined the party.
   
5. Then as the gold buying reached a high point, a perfect selling opportunity to “sell into the news” presented itself when the most outrageous bullish event took place for gold. That was this Monday, March 17.
   
6. The bail out of Bear Stearns, the lowering of the discount rate and the ¾ reduction of the fed funds rate signaled to anyone that gold was going to go through the roof. A perfect time to sell and take profits….since they and the gold price had already discounted this action evidenced by the huge move since the summer.
   
7. One of the clues to the possibility that this thesis was true were the facts above, but the fact that gold enthusiasts usually buy majors, intermediates and the junior mining companies. These groups usually move in tandem when gold is very strong. If only the majors were really moving, then this new buying was coming from big money and it was new money.

If the gold price was not bulled up abnormally by this new well informed and confident group it could easily still had a strong and respectable advance from $650 to let’s say $800 from last summer to this March.

If that had been the case, then the announcement by the Fed on Monday (which was very bullish for gold) may have likely seen gold jump $100 to $900. But tha did not happen because this bullish news was discounted already and that is why gold was over $1,000. Gold is now $958. It is still up significantly since last summer. The gold stocks and bullion bought by this new money group are being dumped in the markets right now. Other players are following along as well making things worse.

What to do Now

Along with this “new money” buying gold, the metal also had become over extended, jewelry demand was drying up in China, India and the Mideast, and the dollar was so beaten up it was due for a rally or at least a dead cat bounce. These other circumstances also helped create selling pressure as well, and combined with the usual panic selling that accompanies any market that is retreating badly all worked together to create the situation we are now faced with.

Wait for the dust to settle and be patient in the short term. This could be the start of a decent correction. Gold could reach $830-850. But there are also plenty of money managers and investors that missed the gold move the last few years and have been waiting for a correction to jump in. Therefore the extent of the correction could be shortened by these investors.

The facts remain the same:

• The Fed will print as much money as is needed and bail out the big names.
  
• The big Wall Street banks and other institutions still have exposure to third party defaults that have not been declared or acknowledged or are even known about at this time.
  
• There are plenty of deflationists believing in a financial blow up who will buy gold to protect themselves.
  
• There are plenty of others believing in inflation who will also buy gold to protect themselves.
  
• Inflation is in the pipeline and everyone sees it everyday when they buy goods. This is a global phenomenon and will take gold higher in the coming years.

Gauging a Price for Gold

The one misleading analysis that is in print on many pro gold websites is based on taking the gold price at its very high of $850 from 1980, then adjusting it for inflation and coming up with a gold price of over $2,000 for 2008. This is a grave error. The gold price then had nothing to do with economic reality. It was a four month spike that did not reflect anything from an economic standpoint except fear and greed and speculation. It collapsed shortly afterwards.

The gold price adjusted for inflation from 1789 (when our Founding Fathers were in control) to 1980 should have been around $360 based on wholesale price increases. Adjusting the gold price since then based on inflation to 2008, (using an untrustworthy CPI index from the Bureau of Labor Statistics from 1979 of 72.6 to February of 2008 of 211.7 the increase in prices is 191.6%) one comes up with $1,050 as a reasonable current price for gold. This price to me is reasonable and leads one to the conclusion that owning mining stocks that can produce gold for less than $400-450 an ounce in the coming years has to be a smart way to think.

I remember back in 1974 when gold peaked out at $200 in the face of plenty of bad economic news and plenty of inflation. By 1976 it hit $103. Then it took off to $850 in 1980. We could be seeing the same sort of reaction here before the resumption of the bull market. Luckily for gold investors there are some major new developments this time. These are: India, China, money supply increases now that make Nixon and Burns (ex Fed Chairman) look like choir boys, the derivative market, and the Wall Street banking crisis brought on by the U.S. housing speculation and two decades of easy money policies by Alan Greenspan.

Conclusion:

Gold is going a lot higher but right now in our managed accounts we are waiting until the dust settles and buying only three types of mining companies, I suggest you do the same:

• Companies with the goods in the ground and close to production.
  
• Producers with reasonable cash costs and growth from projects in the pipeline.
  
• Companies with huge mineral resources that could be acquired.

Good luck.

For more information about gold, the economy, and Wall Street please visit our website at www.kengerbino.com

Ken Gerbino
March 19, 2008