Archive for economics

GOLD: Summer Consolidatation — Bull Market Alive and Well

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Gold prices have fallen sharply in recent weeks from their all-time high over $1265 on June 21st in New York.  By mid-July, gold was briefly below $1180 — a drop of some seven percent.

Faint-hearted gold investors need to remember that bull markets never move straight up.  When they do, it’s called a “bubble” . . . and bubbles do burst.

Instead, this market is moving up — and will continue to move up — in a stepwise pattern with occasional high volatility and big corrections on the road to much, much higher prices in the months and years to come.

For the most part, this summer’s gold-price weakness reflects two recent developments:  First, the reassessment of U.S. economic prospects by some gold traders and investors . . . and, second, an abatement in perceived European sovereign risk.

The economic news in recent weeks (particularly indicators of retail sales, consumer confidence, business inventories, housing starts, home prices, residential construction, etc.) is prompting rising expectations of an intensified U.S. economic downturn — the so-called “double dip” — and with it we are seeing renewed and growing concern about U.S. consumer price deflation.

Meanwhile, across the Atlantic, a successful refunding of some Greek government debt brought a collective sigh of relief from world financial markets . . . and the rush from Euros into safe-haven assets, namely the U.S. dollar and gold has, for now, abated.

None of this has, in any way, reduced our long-term bullish view of gold-price prospects.

In fact, the recent sell-off — and any further short-term price decline that may occur in the next few days or weeks — simply makes gold that much more attractive to long-term investors.

Double Dip to Stagflation

Unlike mainstream economic forecasts — and indirect opposition to the public predictions of Fed Chairman Bernanke, Treasury Secretary Geithner, and the Obama Administration’s economic minions — we have long expected (and discussed on this NicholsOnGold website) another U.S. business-cycle downturn followed by years of sub-par economic growth for the U.S. economy.

As readers know, we’ve long held the view that the U.S. economy would sink back into recession or, at best, a long period of sluggish growth insufficient to produce any meaningful gains in employment.

Longer term, we see years of “stagflation” for the United States and European economies — with sub-par economic growth, unacceptably high unemployment, and a troubling rise in inflation led by higher prices for many commodities, much like we saw in the 1970s.

For more on our U.S. economic forecast, see our recent post “Gold and the Double Dip.”

More Inflation Ahead

And, unlike most mainstream economic forecasts, we see accelerating inflation — NOT deflation — on the road ahead.

Inflation is the flipside to the monetization of Federal government debt, rapid money growth, and a loss of confidence in fiat money.  As the supply of U.S. dollars continues to grow more rapidly than the demand for money, each dollar becomes worth less (or some would say “worthless”) and the general price level rises.

Not only is the demand for dollars growing less rapidly at home due to sub-par business activity, high unemployment, a rising savings rate, and a loss of confidence in the economy and those in the economic driver’s seat . . . but the demand for dollars from America’s chief financiers, especially foreign central banks and in particular the People’s Bank of China, is also slowing — and this, along with a weakening U.S. economy, will push the Fed into a still-more expansionary and inflationary mode.

Deflationists and inflation doves say that we needn’t worry about inflation — because with so much slack — idle capacity and unemployment — in the economy, there’s plenty of room for rising economic activity and money supply growth without inflation.

What they have forgotten is that throughout thousands of years of recorded economic history most periods of persistently high inflation have occurred not when the economy was growing vigorously but when the economy was sluggish or sinking . . . and confidence in money was eroding.

Today, we are witnessing a loss of confidence in the dollar both at home and even more so abroad, that is capable of driving inflation higher even in the absence of high rates of capacity utilization and low rates of unemployment.  This loss of confidence has already contributed to the rise in gold prices over the past few years . . . and will continue to drive gold still much higher in the years to come.

Back to Europe

Returning to the causes of the current gold-price correction, we also think the abatement in perceived European sovereign risk has nearly run its course.  Rejoicing that Greece completed its latest sovereign debt refinancing without a hitch will soon be replaced with new worries as other countries come to the financing trough and find the markets less accommodating.

It went without much notice last week when Portugal was again downgraded by one of the debt-rating agencies.  And it went with even less notice this past weekend when Hungary’s talks with the IMF and the European Union over financial aid and debt reduction broke down in disagreement.

Europe’s sovereign debt crisis will soon heat up as other countries are downgraded by the rating agencies, as German remains recalcitrance to bail out the more profligate euro-zone nations, and even more unwilling to help other European Union members that retain their own currencies, like Hungary and Poland, bridge their sovereign financing requirements.

Indeed, Germany is calling on other European nations to tighten their own fiscal seatbelts by cutting spending and raising taxes.  This is a roadmap to slower economic growth if not outright recession — and is likely to lead to a worsening of the sovereign debt crisis, continuing downgrades by the ratings agencies, and further capital flight into gold by Europeans and others seeking protection from increasing difficult times for Europe’s economy and common currency.

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Gold and the Double Dip

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Many business economists and financial journalists are again talking about a “double dip” or renewed downturn in U.S. business activity.  As our clients and readers of this website know, we’ve long held the view that the U.S. economy would sink back into recession or, at best, a long period of sluggish growth insufficient to produce any meaningful gains in employment.

Longer term, we see years of “stagflation” for the United States and European economies — with sub-par economic growth, unacceptably high unemployment, and a troubling rise in inflation led by higher prices for many commodities, much like we saw in the 1970s.

Stripping away the contribution to growth from temporary stimulus programs (like the recently expired tax breaks for first-time home buyers) and the positive effects of business inventory accumulation in the fourth quarter of last year and the first half of this year leaves a gloomy picture of a stagnating economy. Read the rest of this article »

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Why I’m Pessimistic on the Economy . . . and Optimistic on Gold

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The following rather lengthy post is the full text of my June 9th speech, unabridged and unedited, to the Mines and Money Conference in Beijing, China:

To begin with my conclusions, I believe we will continue to see gold generate lofty returns for years to come.  By year-end, I expect we will see gold hit $1500 an ounce — and sometime in the next few years $2000 seems very likely . . . with $3000 or higher quite possible.  And, in my mind, these are quite conservative forecasts.

At the crux of my bullish outlook is this:  History demonstrates time and again that excessive government spending, rapid money supply growth, and negative real interest rates are always accompanied or followed by rising gold prices.

And these are precisely the conditions that have characterized the U.S. and European economies for the past few years . . . and why gold prices have been and will continue to trend higher.

But even with “gold-neutral” macroeconomic policies in the older industrialized nations, there are good, solid reasons to expect much higher gold prices for years to come.

Just so you know where I’m going, let me quickly list the top nine bullish factors that support this forecast — and then, in turn, discuss some of these bull points in more detail.

  • First, as I just mentioned, inflationary U.S. monetary and fiscal policies — past, present, and future — along with the coming second dip in the U.S. business cycle.
  • Second, Europe’s intractable sovereign debt crisis, which has greatly undermined the euro’s appeal as an official reserve asset . . . and is pushing the European Central Bank to pursue inflationary monetary policies.
  • Third, moderate, well-managed rates of economic growth in the “gold-friendly” newly industrialized or emerging economies . . . especially, and most importantly, in China and India.
  • Fourth, continuing — if not growing — interest by the official sector, principally the central banks of a number of newly industrialized or emerging nations to diversify official reserve assets.
  • Fifth, rising private-sector investment demand in the “western” older industrialized nations reflecting fear of inflation, currency depreciation, and a loss of confidence in governments to deal effectively with today’s economic challenges.
  • Sixth, rising long-term saving and investment demand for gold from India, China, and other gold-friendly nations enjoying healthy growth in household incomes — growth that is likely to continue for the next several years.
  • Seventh, the continuing maturation of what I call the “gold-investment infrastructure” — in other words the development of new gold investment products and channels of distribution in many important geographic markets.
  • Eighth, the continuing long-term downtrend in world gold-mine production for at least the next five to ten years or longer.
  • Ninth, the relatively small size of the world gold market compared to other capital markets — such as equities or currencies — so that even small shifts in portfolio preferences away from currencies, or equities, or real estate, for example, may have little price effect on these big markets but will have a relatively large, indeed profound, effect on gold.

Let’s look at some of these bullish factors more closely . . . beginning with the U.S. economy.

Despite relatively favorable data on retail sales, industrial production, and consumer prices over the past half year or longer, I believe the economic statistics will soon indicate a renewed cyclical downturn, an end to the recovery seen by most business and government economists along with rising price pressures.

What I see down the road for the United States and Europe is an extended period of stagflation — much like the 1970s, with below par business activity and continuing high unemployment along with above par price inflation led by rising prices for oil and other key commodities.

Stripping away the contribution to GDP growth resulting from the temporary federal stimulus programs (like the just-expired tax benefit to first-time home buyers) and the positive effect of inventory accumulation during the fourth quarter of 2009 and the first half of this year, leaves a gloomy picture of an economy that is dead in the water.

As Washington’s stimulus programs wind down — and with the inventory cycle not longer contributing to growth in Gross Domestic Product — the U.S. economy will stall . . . and, very possibly, sink back into recession.

In addition, there are other good reasons to fear a renewed business downturn and years of sluggish growth with higher inflation.

The United States economy depends on consumer spending — spending that typically accounts for about 65 to 70 percent of Gross Domestic Product.  But, American consumers are in no shape, mentally or fiscally, to continue spending at the pace of the past decade or two.  Here’s why:

Savings rates are rising as consumers spend less and save more to rebuild household balance sheets after years of excessive borrowing . . . and, as a precaution in uncertain economic times.  To be sure, high unemployment, the increasing duration of unemployment, and fear of future unemployment is enough for many households to cut back.

In addition, the declining value of household assets — including home prices and retirement savings invested in stocks and mutual funds is also discouraging consumer spending — something we economists call the “wealth effect.”

Consumer spending will soon take another hit when the tax cuts enacted nearly ten years ago under the Bush Administration, tax cuts that favored upper income brackets, expire later this year.

It’s not just consumers who are spending less:  State and local public-sector budgets are also in crisis across American.  With most states and cities legally prohibited from operating in deficit, falling tax revenues are beginning to trigger public-spending restraint — including layoffs, reduced benefits to workers and retirees, cuts in social programs, and so on.

Next we have the continuing squeeze on small- and medium-size businesses resulting from the reluctance of banks to offer credit and financing to this important segment of the economy.  Small- and medium-size businesses are the engine of economic growth and expanding employment — but they are dependent on lines of credit from America’s banks to run their businesses.  And, many banks have been and continue to be reluctant or unable to lend to this important sector of the economy.

And, let’s not forget the impact of Europe’s sovereign debt crisis — which is pushing a good part of the continent into recession or sluggish growth.  Just as in America, heightened uncertainty is causing consumers and businesses to curtail spending and investment . . . while attempts at fiscal restraint in some countries will cut directly into spending by households and businesses.

Europe’s downturn — aided by the fall in the euro against the dollar — will soon, and for some time to come, reduce the contribution to U.S. economic activity from America’s international trade.

You may be asking: “What does all this have to do with gold?”  Well, a lot, actually!

Disappointing U.S. economic activity will have serious detrimental consequences for the Federal budget deficit, for Treasury funding requirements, and for the U.S. dollar — all of which will benefit gold.

This “double-dip” scenario of renewed recession or merely slower than expected activity means:

First, the Federal Reserve, America’s central bank, will maintain near-zero interest rates for longer than most market participants generally anticipate.

Second, future U.S. Federal budget deficits will be significantly bigger than now expected as projected tax revenues fall short.  This will erode confidence in the dollar among those central banks and institutional investors who have traditionally bought our debt and financed our deficit — leading to higher medium- to long-term interest rates in the United States.

Third, even more pressure on the Fed to monetize a growing share of Treasury debt.

All of this will produce more inflation — and more demand for gold.

In the interests of time, I’m going to skip over a more detailed discussion of the European sovereign debt crisis — except to highlight three brief points:

First, the crisis has created fear and uncertainty about the future viability of Europe’s common currency, the euro.

Second, it has created and fear and uncertainty that some of Europe’s biggest banks, banks that have invested heavily in now-questionable sovereign debt, will be pushed to insolvency or require government bailouts.

Third, the euro — which had increasingly been viewed by central bank reserve managers a legitimate diversifier to reduce dollar dependence — has suddenly been tarnished and discredited as viable alternative reserve asset.

Together, these fears and uncertainties have touched off a gold rush of demand for physical gold investment products — small bars, bullion coins, and gold exchange-traded funds — by private investors, not only in Europe, but around the world.

This brings me to the official sector — and the increasing interest among some central banks to hold gold as a reserve asset, dollar alternative, portfolio diversifier, and investment asset.

Even before the euro’s sudden and surprising demise, some central bankers began to take a fresh look at the yellow metal . . . and, last year, a few countries even began adding to their official reserves.

After two decades of selling, at an average annual rate of some 400 tons per year, the official sector became a net buyer of gold in 2009, adding more than 425 tons to total official-sector holdings.  I believe the official sector continues to be an important net buyer of gold — and could easily add another 150 to 300 tons or possibly more this year with sizeable net purchases continuing for years to come.

As you know, last year the People’s Bank of China (PBOC) announced that it had purchase 454 tons of gold from domestic mine production since 2003 . . . but it did not include these acquisitions in its official reserve accounts until last April.

I believe that China continues to buy gold discretely from domestic mine production — but chooses to hold this metal “off the books” so to speak as periodic announcements of PBOC purchases and inclusion of this metal in its official reserve accounts would probably result in higher world market prices making subsequent purchases that much more expensive.

In contrast, Russia and recently Kazakhstan have bought gold from their own domestic mines — but unlike China have chosen to publicize their purchases each month, perhaps as a matter of prestige or to improve their appearance of creditworthiness in world financial markets, something that China and the PBOC need not consider.

Last year, India bought 200 tons “off the market” directly from the International Monetary Fund, which has a one-off program to sell 403 tons over several years to fund its own operating expenses and benefit its poorest members.  Sri Lanka and Mauritius also purchased small amounts last year from the IMF.  All three, like Russia, announced their purchases to benefit from the publicity and prestige that comes with owning gold . . . and, in the case of India, perhaps to make a statement that they’ve arrived as a big-league economic power.

The IMF has some 152.8 tons remaining to be sold under the existing program, having announced sales into the market this year of 38.5 tons through April.  Quite possibly some or all of this gold found its way into the vaults of one or another central bank preferring anonymity.  In any event, this metal was easily absorbed into the market without detrimental effect on the price.

In another twist, the China Investment Corporation, China’s largest sovereign wealth fund, announced purchases early this year of about 4.5 tons.  While not a central bank, it is likely that the investment had the blessing of the PBOC.  Interestingly, the CIC purchased this gold via the SPDR Gold Trust, the NYSE-listed gold ETF.

At the very least, even if a one-time isolated purchase, it further signals China’s very positive “pro-gold” official attitude . . . and gives private investors greater confidence to buy gold for their own saving and investment programs.

Another very important factor — one that has been especially apparent in recent weeks and months has been rising private-sector investment demand for gold from across the old industrialized world.

Private investors in the United States and Europe, both individuals and institutions, are buying more gold reflecting the same concerns and fears that are driving central banks to accumulate the metal.

They are increasingly concerned about the huge deficits and debt of governments on both sides of the Atlantic . . . and that accelerating inflation and depreciating currencies will eat away at their other savings and investments.

Just as the European sovereign debt crisis has gathered steam, we’ve seen a substantial rise in physical investment demand across Europe — from Germany, Switzerland, France, the United Kingdom and other countries — like the United States.  And, just as we’ve seen on earlier price advances, mints (like the United States Mint, the Austrian Mint, and others; refineries (that manufacture small investment bars); and precious metals dealers report very strong demand from retail investors, so much so that premiums on small bars and coins have risen in recent weeks.

Importantly, as in earlier big advances in this gold bull market, these are mostly long-term investors — and their purchases, unlike those of traders and speculators, are not likely to return to the market anytime soon.

Similarly — and perhaps even more important to the long-term outlook for gold — we have seen rising long-term investment demand from India, China, and other newly industrialized nations.

Gold has historically been a preferred medium of savings in India, China, and many of the other Asian countries.  As incomes rise, as more people enter the middle class, and the numbers of truly wealthy increase, it is only natural to see some of this money flow into gold.

Both India and China, because of their huge populations and the movement of millions of people each year from poverty to middle class, and from rural areas to the cities, have tremendous potential in terms of the volume of gold investment that will be purchased in future years.

For gold savings and investment demand in these countries to grow requires only moderate growth in personal income.  Inflation or financial market uncertainties are not required, though their presence may encourage even more savings-related demand.

I believe the economic outlook for in these countries is propitious for gold. Cautious measures to counter excessive speculation (in real estate or equities, for example), prevent overheating, restrain inflation and will keep these economies growing at moderate rates that will benefit gold demand in the years ahead.

Let’s take a closer look at each of these countries so important to the very bullish long-term outlook for gold.

As long as I can remember, Indian gold demand has always been extremely price sensitive — with rising prices quickly restraining purchases and often evoking a return flow of old scrap as holders of gold seek to take profits.  As a result, the ebb and flow of India gold interest has often had a significant effect on the world market — stopping strong rallies when Indians think the price is too high and establishing floors when they think prices have fallen enough.

But, importantly, we’ve seen the Indian gold buyer adjust to higher and higher price levels.  A year ago, reflecting India restraint, the world market had difficulty moving higher when prices neared $1000 an ounce.  Today, Indians are still buying at $1200 an ounce.  I see this behavior continuing — but at higher and higher price levels over the next few years.

But it’s not just prices that matter to the Indian gold buyer.  Indian demand is now picking up and momentum improving thanks to the country’s strong economic recovery, growth in personal incomes, and — as I’ll explain later — new distribution channels that are gradually “westernizing” India’s gold market.

Last year, in 2009, gold demand was hurt, not just by resistance to rising prices, but from poor monsoons, low crop yields, and greatly diminished demand from the gold-friendly agrarian sector for whom gold has always been a traditional form of personal saving.

Now, weather forecasters (who have a much better track record than even the best gold forecaster) are predicting good monsoons and more than adequate rainfall this summer, with abundant harvests this fall, and healthy gains in personal income . . . some of which will, as it always does, find its way into gold jewelry and investment products.

What can we say about China?

After more than five decades of prohibiting private gold investment, China’s government legalized private gold investment only some three years ago . . . and today private gold investment is not just legal, it is encouraged and endorsed.

Five decades of pent-up and unrealized gold demand, the development of gold spot and futures markets, the evolution of a national gold-investment distribution system through banks and other retail outlets, the growing Chinese middle and rise in wealth across the population, inflation anxieties, and the country’s long-standing cultural affinity to gold assures that China will have an increasingly important influence on global gold supply and demand trends — and a powerful positive effect on the metal’s price for years to come . . . and this doesn’t even take into account the on-going “official” or “government-related” purchases that I’ve already mentioned.

We also see some very important institutional and structural developments occurring in the world of gold.  New gold investment products and channels of distribution are making gold more readily accessible to more investors, both individuals and institutions, in more markets around the world.

For example, gold exchange-traded funds, that allow investors to purchase gold via an equity-like vehicle, were introduced only six years ago.  Now there are more than 18 such funds traded on many stock exchanges around the world — and a new gold ETF is just now being launched in Japan.  Since their introduction, the total quantity of gold held on behalf of ETF investors has grown to more than 1900 tons.  This is more than is held by the central banks of all but four countries.

Another example:  In China, private gold investment was legalized only three years ago after five decades of proscription.  Now, not only is gold investment legal, it is encouraged by the central government.  Five national banks have been authorized to trade gold and make gold investment products — small wafers, bars, coins, passbook programs and accumulation plans — available across China.  In addition to these banks, physical gold is also available to investors at stand-alone gold investment retail shops and at department stores.

Similarly, in India, we are seeing the introduction of new products in the past few years, including a gold ETF traded on the Mumbai Stock Exchange, as well as online physical investment products offered online by a number of financial service firms.  Beginning in September the postal service there will begin selling small coin-like medallions at post offices in rural agrarian communities where there is great interest in gold but a paucity of banks and financial firms for savers to purchase the metal.

These new products, distribution channels, and other advances in the gold investment infrastructure are resulting in a permanent upward shift in the demand curve for gold — so that the average price of gold, stripping away the big cyclical swings, will in future years be much higher than most of us would now imagine possible.

Well, I think I’ve already talked too long but I do want to make a point about declining world gold-mine production.

Global gold-mine production has been in a downtrend for decades.  Despite a small uptick last year and possibly again this year, the fall in world mine output will continue for at least for the next five years . . . and probably for years longer.

The ebb in mine production reflects many factors, including the depletion of existing deposits, the continuing drop in ore grades, the decline in operating depths at many mines, the rise in energy and labor costs, the expense and time required to meet increasingly restrictive environmental regulations, unfriendly government attitudes toward foreign investment in some gold-producing countries, and the lack of financing available to many gold-mining exploration and development companies.

Even if the expected leap in the price of gold triggers much more exploration and development . . . and even if new significant economic deposits are discovered . . . it can take five to ten years or longer to bring a large discovery into sizable production.

So there you have it, my reasons and analysis behind my positive outlook for gold.

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GOLD & SILVER: Speech to the ResourceOne Conference, New York - April 21, 2010

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Those of you who know me know that I am quite optimistic about the outlook for gold and silver.  This may be good news for those of us in the mining business or invested in precious metals assets.

Unfortunately, to be bullish on gold means that I’m pessimistic about the U.S. economy, particularly the outlook for inflation and economic growth, over the next few years.  More about this in a few minutes . . .

Price Projections

But first, at the risk of sounding like a gold bug — which I’m definitely not — let me give you some numbers:  I believe we will see gold back near its all-time high around mid-year.  In other words, around $1227, give or take a few dollars, by the end the end of June.  And, by year-end, New Year’s Eve, we could be celebrating $1500 an ounce.

Now, if these prices seem extreme, let me remind you that last year, we saw gold move up 35 percent in the space of five months from July to its early December record high.  A similar performance from today’s price puts gold a few dollars above my target of $1500 an ounce.

What about silver?  In an up market, I expect silver will do about as well, if not better, rising to $25 an ounce, give or take 50 cents.

Longer term — without being too specific about the timeline — I think there’s a high probability gold will reach $2000 . . . and, quite possibly, $3000 or higher before this bull market reaches its inevitable cyclical peak and prices start moving in reverse.

Importantly, I think these markets will remain quite volatile with big moves up . . . and down — so much so, that sharp declines may lead some observers to prematurely declare the bull market in precious metals is over.

Bullish Building Blocks

There are a number of solid long-term building blocks that assure higher gold prices in the years ahead.  In brief, these are:

  • Number One: Inflationary U.S. monetary and fiscal policies — with record monetary creation, negative real interest rates, and record Federal deficits promising accelerating inflation and a diminishing appetite to hold U.S. government debt.
  • Number Two: An inherently unstable European currency — with divergent fiscal policies and sovereign risk continuing to be an important theme in currency markets the euro is in no shape to assume a larger role in the world monetary system.
  • Number Three: Expanding investor interest in gold, both demographically and geographically — with more people and institutions around the world currently and potentially investing in gold and silver via new investment channels and vehicles that make these precious metals more accessible than ever before. In particular, Asia is emerging as a sponge for gold and silver, for jewelry and investment with important implications for the future price of these metals.
  • Number Four: Rising central bank and sovereign fund accumulation — with the official sector becoming a significant buyer of gold last year, after two decades in which central banks as a group sold, on average, about 400 tons a year.
  • And, Number Five: Declining world gold-mine production in the years ahead — even in the face of sharply rising prices, mine output will continue falling for at least a few more years as existing mines are depleted, ore grades drop, operating depths fall, energy costs rise, and the cost of developing new mines continues to rise.

The Economy — Not So Rosy

Let’s look at a few of these “bullish building blocks” in more detail, beginning with U.S. economic prospects:

Unfortunately, the U.S. economy still faces significant and painful adjustments in the years ahead following (and a consequence of) many years of profligacy in which federal and local governments along with private individuals and households spent more than we could afford on borrowed time and borrowed money.

Despite recent optimism and signs of continuing recovery in the U.S. economy, the past year’s severe contraction in the broad measures of U.S. money supply — in nominal and in real terms, that is adjusted for inflation — presage a significant deterioration in business activity.

And, with U.S. inflation also heading higher we are heading into a period of stagflation, much like we saw in the 1970s.

The key indicator, the broadly defined M3 money supply for the United States, is now down by 3.7 percent from a year ago . . . and, in real terms it is down 5.8 percent over the past 12 months.  The historical evidence suggests there is a strong correlation between changes in the growth of M3 money supply and changes in economic growth, measured by real Gross Domestic Product some six to 12 months later.

Several factors, in addition to the contraction in broadly defined money supply, make a “V” shaped recovery implausible . . . and suggest a “double dip” or, at best, a very sluggish recovery with continued high unemployment for years to come.

  • First, households are saving more — as they must to restore household balance sheets follow years of excessive consumption and imprudent borrowing. In addition, heighted uncertainty and job insecurity encourage increased “precautionary” saving. With consumers accounting for approximately 70 percent of total demand, it is hard to imaging a robust recovery when households attempt to save more and spend less.
  • Second, falling personal incomes reflecting lost jobs, salary cuts, reduced hours, and lower sales commissions mean that many consumers have less to spend.
  • Third, the crisis in state and local budgets is reducing spending on capital projects and social programs. Even local school districts are cutting budgets and laying off staff.
  • Fourth, rising home vacancies and foreclosures, empty retail space (like the vacant Circuit City stores we see across the country), and unused commercial and industrial capacity.
  • Fifth, limited credit availability to households and especially to small businesses that are so important to the overall economy as banks continue to keep their belts tight and are reluctant to take on risk in this risky business environment.
  • Sixth, and quite important, the coming rise in medium-term and long-term interest rates. Foreign central banks and institutional investors are just starting to require higher rates of return to compensate for perceived sovereign and inflation risks.As higher interest rates cascade through U.S. credit markets, private borrowing by corporations and households, for everything from revolving credit to new mortgages, discourages borrowing and retards economic growth. Since many mortgage rates are linked to the yield on 10-year Treasury notes, existing home prices could take another hit along with the residential construction industry.

Indeed, the hoped for recovery that many mainstream economists and politicians see in the economic tea leafs is not recognized my most Americans.  That’s why the latest readings on consumer sentiment are deteriorating.  What recovery we’ve seen to date has been underwritten by extraordinary monetary and fiscal stimulus provided by the Fed and Treasury.  Take that stimulus away and the economy wouldn’t have a leg to stand on.

So, I am sorry to say, soon comes the second dip of the “double-dip” recession that will be characterized by:

  • A further significant rise in unemployment,
  • Contracting consumer spending and weaker retail sales,
  • Still lower home prices, more foreclosures, and a further reduction in residential and commercial construction,
  • Shrinking federal, state, and local tax revenues,
  • Worsening public-sector deficits and financing difficulties,
  • A wider risk premium on medium- and long-term Treasuries with more pressure on the Fed to monetize a growing slice of American debt, and
  • Continuing erosion in the dollar’s purchasing power, both at home and abroad.
  • And, importantly, for precious metals — an erosion in the dollar’s “safe-haven” status that sends more scared money into gold and silver.

Even if economic growth hobbles along without an actual double dip and unemployment remains high, we can expect additional stimulus from Washington that aggravates our fiscal dilemma, keeps the Fed’s foot on the gas so that the funds rate remains near zero for longer than now anticipated and quantitative easing further undermines the dollar — all of which benefits gold and silver.

Real Interest Rates

While I’m talking economics, one time-tested indicator of future gold and silver prices I like to watch is “real” or “inflation-adjusted” interest rates.

The historical data show that real interest rates are a very reliable precursor of the U.S. dollar’s performance on world currency markets, of future price inflation here at home, and of the direction of dollar-denominated gold and silver prices in the next year.

As day follows night, low or negative real interest rates (on short-term Treasury bills, for example) are followed some time later by rising precious metals prices.

Not surprisingly, the current bull market for gold that began in 2001 (with gold near $255 an ounce) has, for the most part, been a period of low or negative real interest rates.

Before this, the great bull market for gold and silver in the late 1970s culminating in the January 1980 high points was also a period of negative real interest rates in the United States.

Today, as most of you are aware, real interest rates are still low . . . and I believe this points to higher gold and silver prices in the year ahead.

In fact, I’d allege that, for a variety of reasons, U.S. consumer price data are today under-reporting actual inflation . . . and that real interest rates are actually well into negative territory.

Too Little, Too Late

At some point, perhaps later this year, the Fed may begin raising short-term rates — and precious metals may sell off sharply on the news.  But I think any Fed tightening will be too little, too late to reverse the rising trend of inflation, instill renewed confidence in our currency, and break the bull market in precious metals.

As long as the rise in U.S. inflation outpaces each incremental step up in nominal interest rates — so that real rates remain near zero or in negative territory — monetary conditions will remain supportive of the upward trend in gold and silver prices.

It is said that economic forecasters are “often wrong but never in doubt.”  Well, suppose I’m totally wrong about the U.S. economy, about U.S. monetary and fiscal policy, about inflation, and real interest rates.  Where would this leave us in terms of the outlook for gold and silver?

Gold Investment Infrastructure

I believe that the expansion of precious metals investment interest and the continuing development of what I call the “gold investment infrastructure” will be sufficient to push gold and silver prices substantially higher over the next few years.

Developments in key geographic markets along with new investment vehicles are making gold and silver more accessible and more mainstream to more investors around the world — and the result is a permanent upward shift in the demand curve for these metals such that much higher prices will be the norm rather than a temporary cyclical episode.

ETFs — Volatility Up and Down

The introduction and growing popularity of gold exchange-traded funds (ETFs) are having a profound influence on the gold market.  As you know, gold ETFs are gold-backed stock-market securities that track the ups and downs of the metal’s price . . . but as stock-market securities they attract investors for whom direct ownership of bars or coins is too cumbersome and allow institutional investors prohibited from investing in physical commodities or futures contracts a loop-hole through which they have bought many tons of gold.

In fact, since the introduction of gold ETFs about six years ago, the quantity of gold held in trust for fund investors has risen to 58.45 million ounces as of a few days ago.

However, the rapid growth of exchange-traded funds is a two-edged sword, increasing volatility both up and down.  ETF investors can just as easily exit the market, selling their gold as quickly and easily as they might sell any equity.

Contributing to the anxiety among gold investors this past week was the news that hedge-fund mogul, John Paulson was an important player in the Goldman Sachs debacle.  Paulson’s hedge funds have also been substantial investors in gold, so much so that Paulson & Co. is the largest institutional holder of the SPDR Gold Trust, the largest gold exchange-traded fund.

My back-of-the-envelope math puts Paulson’s total gold ETF holdings at more than three million ounces (about 95 tons).  If investors in Paulson’s funds start pulling their money out, Paulson may need to sell gold to cover redemptions — putting a temporary dent in the price of gold . . . and, I might add, offering an excellent opportunity to establish or add to your gold investments.

Asian Action

India, the historically the world’s largest gold-consuming market has also seen the introduction of new investment products that are beginning to make this largest market even larger.  A gold ETF now trades on the Mumbai stock exchange.  Financial-service companies are offering a variety of products to their clients via the Internet.  A gold physical exchange trading spot gold has been established to rationalize the Indian gold market.  The Indian postal service in the past year or so began selling small gold coins, making gold investment more accessible in some of the rural or agrarian communities that lack local banking and other financial institutions.  These are important developments that will, over time, support significant growth in Indian gold consumption.

In China there are even more important developments.  The Chinese government allowed private gold investment only two years ago and has subsequently encouraged its citizens to buy and accumulate gold.  A gold investment distribution system has developed rapidly — and gold bars, bullion coins, and other gold-backed vehicles are now available across the country through the banking system, at jewelry and department stores, and through gold retail shops that have sprung up in many cities.

Gold investment markets are expanding through the East Asia region — from Thailand and Vietnam to Hong Kong and Taiwan to Singapore and Indonesia.

Last month, when the price of gold dipped below $1100 an ounce, physical demand from India, China, and other gold-friendly countries in the Asian region stepped in as Western investors abandoned ship.

A year earlier, these very same price levels engendered selling from India and restrained demand in China.

It is important to recognize that the price points that trigger both buying and selling by gold jewelers and investors throughout the gold-friendly Asian region are fluid — and, in the past few years have moved significantly higher.

This is a trend I expect will continue . . . aided in some countries by currency revaluations that temper the rise in local-currency gold prices.

Moreover, strong economic expansions and rising personal incomes across the region mean that residents in these countries will have more money to purchase gold jewelry and more money to save and invest in the form of gold — gold that has been a favored medium for savings and investment in these countries for centuries.

Many countries across Asia and the Mideast share an historic affinity and allegiance to gold an adornment, as a symbol of wealth and good fortune, and as a preferred vehicle for saving and investment.  Even gold jewelry in many of these counties is purchased for its investment characteristics and as a symbol of wealth and status.

Longer term, as their share of global income and wealth continues to increase, these countries will demand a growing share of global gold supply for jewelry, for private-sector and sovereign wealth investment, and for additions to central bank reserves.

Importantly, much of the gold bought by savers in many of these countries will probably never come back to the market, at least not for many years unless gold prices multiply several times over . . . or if political and economic developments prompt distress sales.

Mine Production — Renewed Growth Years Off

While I could talk about gold all day, the conference organizers have limited me to 20 or 25 minutes — and with miners and mining investors in the audience I do want to say a few words about the downward trend in world gold mine output.

Annual world gold-mine production peaked in 2001 at 2645 tons — and has been more or less falling ever since.  Despite a brief uptick in global production last year and possibly again this year, the long-term downtrend is expected to continue for another few years . . . and by 2011 output will likely have dwindled to less that 2300 tons — a decline of 14 percent over the prior ten years.

Over the long term, mine output is a reflection of price versus the rapidly rising cost of production and the increasing difficulty and expense in finding new deposits large enough to offset the loss of production from the on-going depletion of existing mines.

In addition, increasingly stringent environmental regulations are adding to costs . . . and unfriendly government attitudes toward mining or foreign ownership are discouraging exploration and development in some countries.

Moreover, the global economic crisis has slowed funding for exploration and development — particularly for exploration and junior mining companies.

As a result of higher prices in the past few years and expectations of still much higher prices in the next few years, I expect that total world gold-mine output will begin rising during the second half of the decade.

At the same time, the continuing rationalization of the mining industries and exploration of virgin territories in countries like China, Russia, Mongolia, and Kazakhstan could possibly contribute significantly to the recovery in world output.

It is interesting to note that the locus of world gold-mine production is shifting from the previous “big four” producing countries — South Africa, the United States, Canada, and Australia to the emerging market nations — especially China and Russia, both of which appear intent on consuming or hoarding most, if not all, of their gold-mine output, rather than sell bullion into the world market.

Ladies and gentlemen, there’s so much more to say about the price outlook for gold and silver, but time is limited.  I hope these highlights give you some food for thought.  But I’m running short on time . . . and I do want to leave some time for questions . . .

Thanks again for your attention.

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