By Louis James, Senior Analyst/Editor, Casey’s International Speculator

At a recent Casey Research editors’ meeting, the team took on the question of whether the somewhat steady recovery since last February’s washout bottom in the broader markets had any of us thinking that the recession might be over. The gathering of minds included: Doug Casey, Managing Director David Galland, CEO Olivier Garret, Casey Chief Economist Bud Conrad, Senior Energy Analyst Marin Katusa (my counterpart on the energy side), myself heading the metals division, and several other editors.

Doug’s guru-vision remains locked on the disaster channel. The U.S. economic problems, he says, remain so profound and, if anything, have been worsened by the government’s actions, that Americans are headed for a significant lowering of their standard of living.

As this reality unfolds, it will send out shock waves that will impact much of the world: the Greater Depression.

And the next step, Doug believes, will be a change in interest rates. The Bright Boys in DC will resist doing this, but while they seem willing to let the dollar slide to ease their mounting debts, they don’t want it to crash. They may soon be forced to raise interest rates. When that happens, Wall Street usually moves in the opposite direction – which could be the end of the “Things Aren’t as Bad as We Thought” rally of 2009.

Bud Conrad – in proper, responsible chief economist-style – considered the question carefully and conceded that there do indeed seem to be many “green shoots” now, but still concluded that conditions will continue deteriorating. He sees the government deficits in the driver’s seat, the main variable to keep a watch on.

As the U.S. government persists with its spending spree, valiantly dousing the deficit fire with more debt-gasoline, it will continue destroying the dollar, and that will push ever more people into gold.

A year ago, Bud predicted that gold would top $1,150 by year-end 2009. His call was bolder than most forecasters’ – but he was right. Looking at the numbers today, Bud’s new baseline 2010 forecast is for gold to top $1,450. He sees a “possibility of further international instability or currency debasement as adding to that baseline.” In plain language, Bud’s confident that resource stocks of all sorts will, on average, benefit greatly from the demise of the U.S. dollar.

Somehow, I can’t shake the image of Bud singing Don’t Fear The Reaper with Blue Öyster Cult for back-up… but that’s really more like something Marin would do.

Speaking of Marin Katusa, he commented that there is money to be made in the current rebound environment, but speculators should be extremely cautious: “You should know you’re dancing with the devil in the pale moonlight. You need to make sure you know the dance steps: get in early and exit before you get the dip by the devil at the end of the song.” (Marin not only has made huge amounts of money for our subscribers, he sings in a rock band, so he knows what he’s talking about.)

My own thinking has evolved into seeing 2009 as being like the eye of a monstrous storm. Read More…

Porter Stansberry:

The U.S. dollar has reigned as the world’s reserve currency for more than 30 years. That’s a real anomaly in the history of paper money, according to Stansberry & Associates Investment Research founder Porter Stansberry, but the dollar’s days on the throne are numbered. With a sea-change in the monetary system on the horizon—and drawing ever-nearer as more and more U.S. creditors turn toward hard assets and away from paper dollars—he tells The Gold Report in this exclusive interview that the world is approaching a return to “at least a de facto gold standard.” Porter does not recommend bullion as “insurance” (because that suggests hope for the dollar when there is nothing to pin hope on) but rather as “the perfect natural money.”

The Gold Report: As someone who invests in many sectors, Porter, what major trends are you watching in the global economy?

Porter Stansberry: The major trend is a switch in central banks’ recycling of dollars. As you know, the United States has been a net debtor to the world each year since 1976, I believe. We’ve put a huge amount of dollars out into the world and those dollars have to be recycled in some way.

Up to this point, central banks have been buying mostly U.S. Treasuries. Over about the last 10 years they organized so-called sovereign wealth funds (SWFs) and have been buying trophy properties mostly, but also some operating U.S. businesses as a way to recycle those dollars. The most interesting thing I’ve seen in a very long time is that suddenly some central banks have decided to begin to exit the dollar system by using trade surpluses to buy gold instead of either U.S. Treasuries or U.S. assets. I happen to believe that this is a sea-change in the gold and monetary system that will ultimately result in a return to at least a de facto gold standard.

I know my view is pretty far outside the mainstream, but historically, paper monies don’t last. Our paper money, which has been exclusively a paper system—not backed by any precious metals since 1971—is getting long in the tooth and U.S. creditors are beginning to seriously doubt its sustainability. At some point, they will say, “This is ridiculous. We’re not going to let you pay us back in dollars that you print. We’re going to dump our Treasuries and buy gold because you can’t print it.” Gold has always been the stable basis of money and credit because it’s very difficult to produce and it’s timeless. It isn’t consumed, it doesn’t rust. An ounce of gold mined 10,000 years ago is very likely still in circulation today.

TGR: Granted, the U.S. dollar is the reserve currency, but could a single currency drive the whole world to return to a gold standard?

PS: If you want to understand how one currency could replace the U.S. dollar as the global reserve currency, look into Gresham’s Law. Historically, bad money always drives out good. Accordingly, if a central bank anywhere in the world sets up its currency to be backed by any kind of hard currency, it would cause people all around the world to desire that currency for their savings, rather than dollars.

The Swiss don’t do it anymore, but suppose, for example, that China decided to back all of its currency in silver. That would make a big difference in the market for dollars in particular because there are so many excess dollars around the world that have to be purchased every year that it would displace the dollar very quickly. All you would need is a country with a large role in global trade deciding to establish a currency based on a hard commodity standard, whether gold or silver or a bi-metal standard. Those standards historically have always been very respected.

Then as soon as you have a hard currency standard, people will begin to hoard that currency and dump the dollar. For example, the U.S. bi-metal standard in the 1800s undervalued silver relative to gold. Within about 10 years—from 1810 to about 1820—no silver coinage was left in the country. That happened in the 1960s as well, by the way. At that time, the face value of silver coins in circulation, the pre-1964 quarters, for example, was lower than the value of the metal. So they disappeared from circulation almost overnight.

The same thing would happen were another currency to be made more secure—with backing from gold or silver, for example—than the dollar. People would begin to hoard that currency and dump the dollar.

I believe that’s what we’re beginning to see with the central bank purchases of gold. It may be hard to believe, but it’s true, that central banks have been net sellers of gold since the end of Bretton Woods. It’s really an anomaly that for 35-plus years, there has been no challenge to the dollar standard. There’s never been a time before in human history that the world reserve currency wasn’t backed by gold or by a combination of gold and silver.

TGR: Is there enough gold in the world to return to a gold standard?

PS: Not enough, perhaps, to return to the earlier standard of $35 per ounce of gold. There are far too many dollars out there to make that conversion work. Clearly, the exchange rate would have to differ dramatically. Estimates I’ve seen say that if you divide the U.S. gold reserves by the total number of Federal Reserve base money, you get something $6,000 per ounce of gold. It just needs to be a new hard standard that the either the central bank begins to enforce or you abolish the central bank and set up state banks or private banks based on a firm foundation of gold.

TGR: With gold at $6,000, the doom-and-gloomers say the government would confiscate it from private investors. Is that a legitimate concern?

PS: You wouldn’t want to underestimate the perfidy of the government. I have no doubt that the government will need to increase revenues substantially to avoid default on either debt or social welfare promises. How they will increase those revenues, I can’t predict. It seems unlikely that they’ll be able to effectively increase revenues by raising taxes because it just doesn’t work. People will find ways to reduce their income to avoid the taxes or simply leave the country. So I wouldn’t be surprised at all to see some kind of a land grab or an asset grab. I don’t believe it will focus on gold because there just isn’t enough privately held gold in the country to make a real big difference in revenues. I think they’ll go after something else, perhaps a tax on net worth, which I’ve seen discussed in Congress already.

TGR: If central banks accumulate enough gold and if a major economic power moves to gold, how long would it be before we have a de facto gold standard?

PS: I don’t think it would take very long at all. And in reference to a de facto gold standard, you can look at the European Central Bank. Of all the central banks in the world, it’s really the only one that has been reducing the size of the balance sheet over the last couple of years. It’s doing so because the Germans, in particular, have a memory, a recent history, of hyperinflation. They greatly fear hyperinflation so they’re keeping the balance sheet relatively sound compared to the others.

That’s why you’ve seen the Euro go so high against the dollar and why lots of people around the world demand Euro-based contracts. Brazilian Supermodel Gisele Bundchen, who’s married to New England Patriots quarterback Tom Brady, is the highest-paid model in the world and she was supposedly insisting on Euros in her contract instead of dollars.

Speaking of Brazil, there’s a country that may be strong enough to influence a global gold standard. It has almost no gold reserves now, but I think that in the next 12 months Brazil will buy enormous amounts of bullion. I also think you’re going to see the same thing from countries in Asia, particularly South Korea and China. I’m telling you, it won’t take very long to set off a firestorm of panicked gold buying by the world’s central banks. Read More…

John Browne
Dec 17, 2009

As the price of gold has pulled back from its recent run up to $1,200, many investors are left to ponder what exactly drives the movement of such an important and financially sensitive commodity.

Most people are aware that gold prices respond to inflation expectations and that central banks, as the largest holders of gold, are big players in the market. But there is a very murky understanding as to why and how these players affect prices, and what their ultimate goal may be.

Although I profess no great insight into how central bankers from Bombay, Berlin and Beijing are looking to manage the global gold market, a better understanding of how our current system came to be provides some clue about gold’s recent behavior.

The First World War was not only catastrophic to an entire generation of Europeans, but it also left the international financial system in tatters. After the war, the great powers met in Rome to re-establish a workable international financial system. The British pound sterling, which had always been fully convertible into gold, was selected as the official ‘reserve currency.’ Then, during the Great Crash of the 1930’s, the collapse of Austrian and German banks triggered a run on sterling for conversion into gold. Unable to withstand the assault, sterling was replaced as the reserve by the U.S. dollar. Although the dollar was also convertible into gold, the Roosevelt administration had limited the risk to the U.S. Treasury by restricting redemption to central banks.

In 1944, the newly established International Monetary Fund (IMF) selected the U.S dollar as its ‘international reserve asset’, which enshrined a quasi-gold standard to undergird global financial transactions. However, the inflationary policies of most governments caused the market gold price to rise above the official price of $35 an ounce.

In 1961, as the price of gold drifted higher relative to the dollar, the major central banks formed the London Gold Pool, a ‘gentleman’s club’ to coordinate gold sales in order to stabilize gold prices. But by 1971, the dollar’s devaluation had overwhelmed their coordinated interventions. Ultimately, President Nixon was compelled to break the dollar’s last links to gold by closing the ‘gold window’ to other central banks. For the first time in human history, the world monetary system ‘floated’.

Since then, major central banks have continued to debase their currencies at pace with the U.S. dollar. In 1978, via the IMF, they moved to demonetize gold, which stood to expose the true inflation rate.

This was first carried out by massive central bank sales of gold in exchange for Special Drawing Rights (SDRs) from the IMF. When this failed, the U.S. gained support, in 1999, for the Central Bank Gold Agreement (CBGA) to coordinate the release of central bank gold onto the market.

Officially, at least, this was meant to prevent central banks from dumping gold. However, it is highly suspicious that these nominally independent central banks would take coordinated action to support the gold price. This is especially true given that they’ve spent the last forty years trying to do the opposite. In my opinion, it is much more likely that the CBGA was designed to covertly time purchases and sales to magnify gold’s price volatility, in order to dissuade investors from holding it over the long term.

I believe this intervention is the biggest factor currently distorting the gold market. But the precious metals investor should understand that central banks can only pressure the market, not dictate it. Gold will move up as the following dynamics unravel.

First, the dollar has benefited from its reserve status, which creates demand for dollars to complete various transactions. However, the conditions that put the dollar on the world monetary throne have already changed, and it’s just a matter of time before it is forced to abdicate. Just as French endured as the international diplomatic language long after France waned as a world power, so too is the dollar coasting upon its former glory. When the dollar loses its reserve status, demand for the greenback will evaporate.

Second, many holders of surplus currency have diversified massively into the euro. But the euro is a tower built on unlevel ground. Already it is showing cracks as Greece, Ireland, Spain, and Portugal exhibit signs of economic failure. What’s more, the EU is about to assume responsibility for basket-case Iceland. If the solvent states of the union succumb to pressure to bail out their weaker neighbors, the euro will lose all of its newfound credibility with investors.

Third, the U.S government has been successful in distorting the official inflation figures downward, reducing evidence of current inflation. Fortunately for the feds, people tend to think in ‘nominal’ rather than ‘real’ value terms. For example, investors still feel good buying stocks and bonds of American companies in U.S. dollars. They don’t realize that when measured in terms of gold, or real money, the S&P has lost some 20 percent over the past ten years. Over the same period, the U.S. dollar has lost over 280 percent!

Fourth (and perhaps least understood), the massive inflation already created by the Fed remains hidden within the banking system. As long as banks are able to lend directly to the Fed and Treasury at no risk, they have no incentive to circulate their new dollars. Only when the banks leverage up and lend to industry, or are forced to do so, will the prices for consumer goods skyrocket.

Finally, by changing accounting standards for the banks’ toxic assets and making self-congratulatory pronouncements, the government has created the impression that crisis has been averted and faith restored in paper currencies. This feeling of relief is flawed fundamentally. It will not be long before investors are brought to the devastating realization that true recovery from a credit boom requires tightening and recession - that Washington did not avert catastrophe, but ensured it.

As these dynamics unravel, the full consequences of U.S. profligacy will be felt around the world. The central bankers could sign any agreement they wish but it won’t stem the meteoric rise of gold. By then, investors will understand that those left holding dollars will be left holding the bill.

###

Dec 16, 2009

What happened in the gold market yesterday? The price of the yellow metal held steady.So what do you do? Is this the dip you should buy?

Well, as we keep saying…it depends. A few months ago, our view was simpler. We trusted gold because we didn’t trust central bankers. We still trust gold. And we still don’t trust central bankers. But now we see that the central bankers are even more unreliable than we imagined. They are diligently trying to do the wrong thing, as usual. But they’re not very good at it.

They increase the monetary base at central banks. But they can’t melt the huge overhang of cash and credit frozen in the system. A depression has iced over the economy. The feds turn on the pumps, but the liquidity freezes up. This cold snap could last a long time. In fact, with the feds blocking necessary adjustments, it could turn into an Ice Age. And there’s not much they can do about it - except make the situation worse.

Bond yields are already rising. There is a report of rising prices at the producer level. It wouldn’t take much to spook lenders and force the Fed to retreat…just as Greece did.

What’s more, there are two major trends underway. Neither has fully expressed itself. The bear market that began in 2007, for example, never took stock prices down to the levels you’d expect at a major bottom. Far from it. That means a major bottom is still ahead. We have had Crisis I. We will probably have Crisis II in 2010. It will make it easier for the feds to finance their deficits. But it will make it harder for the rest of the world to pay its debts.

On the other hand, the other major trend that has not fully expressed itself is the bull market in gold. When we were in the US last week we saw an ad encouraging people to sell gold “while prices are high.” People think the rise in gold is a fluke. But markets make opinions. At the top, they will believe that higher gold prices are permanent. Then, we will see ads encouraging consumers to buy gold before the price goes higher.

But don’t expect the top in gold any time soon. The major top in gold may have to wait for the major bottom in stocks. And the whole process could take many years.

So, relax. Sit back. Keep your seatbelt buckled. And enjoy the depression.
P.S. To get The Daily Reckoning sent directly to your inbox, sign up for our free email newsletter, or if you prefer to use RSS, subscribe to the Daily Reckoning RSS feed.

Editor’s Note: Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of the national best sellers Financial Reckoning Day: Surviving the Soft Depression of the 21st Century and Empire of Debt: The Rise of an Epic Financial Crisis.

GOLD AND THE DOLLAR

I won’t keep you in suspense as I am sure you all want to know about Gold and the Dollar. To be as succinct as possible, the Dollar may go up in the short run and its rally may even last a few weeks or even a month. Nevertheless it will only be a Dead Cat bounce: The US $ remains in a major BEAR Market and after listening to Bernanke’s latest speeches he will be in effect doing everything in his power to continue to weaken the dollar, as his focus is on the economy and jobs. Not exactly what the FED was originally set up to do: Maintain the Value and Stability of the Currency. But as far as the Dollar is concerned his and Geitner’s only policy is to simply try to talk it up. Believe or not the Government, the FED and the Treasury actually believe that they can INFLATE themselves out of their DEBT BUBBLE.

Exit Strategy: You got to be kidding. Each 1% increase in interest rates increase the Fed Debt by $250 Billion a year. And would trigger a Treasury Bond Collapse.

When it comes to GOLD, it is a completely different story. GOLD is in a Major Bull Market that has another 7 years minimum to run. GOLD has completed a perfect Elliott 5 Wave move when it hit $1227. However that 5 wave move was only Wave (3) of a larger degree WAVE (III) which after a Wave (4) correction, still has an even more explosive Wave (5) yet to go, to complete Wave (III)

The good news is that even that won’t be the end of the GOLDEN BULL. Then after a 2 or 3 year Diagonal Wave (IV) Consolidation (correction) we would then still have Wave (V) to look forward to complete this entire Bull Market in GOLD sometime in 2017 or so. Keep in mind that in the last 1971 - 1980 Golden Bull 66% of the entire move took place during the last 16 days: The result of a combination of GREED and FEAR. My long term target still stands at $6000: So Don’t Panic and just stay Tuned.

GOLD IN THE SHORT RUN

That explosive move into $1227 (pretty close to my year ago projection of $1250 by the end of 2009) was in itself an Elliot Wave 3ed Wave, with an EXTENSION in its 5th wave. All you Elliott Wavers should know that Extensions, always pull-back to the beginning of the extension and are then ALWAYS DOUBLY RETRACED, either forming the beginning of a sideways 4th Wave Diagonal Triangle or the beginning of the 5th wave. So what ever you do. DO NOT SELL YOUR CORE POSITIONS. Gold might pull back as much as 10% but not for long. HOLD ON TO YOUR CORE POSITIONS.

GOLD DOES WELL DURING PERIODS OF BOTH FEAR AND GREED AS WELL AS DURING RAPID INFLATION AND/OR DEFLATION.

JAPAN: A HISTORY LESSON

Heavy government stimulus spending and near-zero interest rates did little to end their “lost decade” (now quickly becoming 2 lost decades) of stagnation and mushrooming debt. More than a few economists and lawmakers are now joining me in warning that the U.S. is heading down that very same path. However, most economists and politicians who agree with me seem to ignore the basic Laws of Economics, arguing that the differences between the American and Japanese economies and business cultures make America less susceptible to a prolonged period of economic lethargy. While the debate rages, both sides agree that Japan’s painful experience offers the U.S. a lesson on how attempts at stimulus can go terribly wrong. More importantly, God’s Natural Laws of Economics always will out.

Japan’s bubble economy burst in 1990 and its tax, borrow and spend policies caused it to lapse into a lost decade. Struggling to regain its economic footing and manufacturing competitiveness, Japan is about to lose its standing as the world’s second-largest economy.

David Wyss, Chief Economist for Standard and Poor’s, warned that a “drawn-out period of economic stagnancy like Japan’s is a possibility”. Stock prices bottomed in Japan in 2003 but then hit an even lower low in 2008. Japan’s Nikkei Stock Index, now still stands about 80% lower than where it was 20 years ago. In the meantime, Japan has managed to amass a national debt that is nearly twice the size of its $5 trillion economy, the biggest deficit, percentage wise of any major economy and that all took place while running huge Balance of Trade Surpluses.

The U.S. National Debt of $12 trillion, by contrast is only now fast approaching the size of the overall economy ($13.6 trillion). As staggering as that is, the ratio is half that of Japan’s, but for how much longer? Our own government projects that our deficit will grow to (an understated) $21 trillion within the next 10 years and that is assuming a return to 4% average, annual real growth rates. Yet we all know how understated government projected deficits are and how over stated real growth rates are. Despite early signs of recovery and a strong (in nominal terms only) U.S. stock market rally, fears persist that the failure to generate new jobs could drag the economy back into recession or result in a protracted Japan-like period of poor economic and stock market performance.

“It seems to me we are following along the exact same path that the Japanese took in their `lost decade’ — of running up huge government debts, raising taxes and restricting economic growth.” I to have made similar observations as Wyss who has drawn comparisons between the stock market today and the 1930’s. A furious rally following the crash of 1929 carried prices to within 18% of the pre-crash peak and investors were relieved that the worst was over for the economy and stocks - only it wasn’t. Economic conditions had deteriorated and would continue to slide due to the heavy anti-business rhetoric and policies of the NEW DEAL (sound familiar) stocks then embarked on another leg down, losing an astounding 80%.

Most of the Wall Street Investors as well as the Government have a tendency to dismiss the 1929-32 climactic decline as irrational and see the current advance as the real deal and therefore a 1930’s phenomenon that will not be repeated. They completely disregard the numerous economic imbalances that must be corrected and that this will be a sufficient drag on growth to produce “seven lean years” for corporate PROFITS and the stock market returns.

Major imbalances are unlikely to be quick or easy to work through. For example, we must eventually consume less, pay down debt, save more and encourage private capital Investment. That is the only way to readjust Global trade imbalances.

NOTE: Even J. M. Keynes recognized and warned against the anti-Business anti-Capitalist Rhetoric as the major cause of the extended Depression. Read More…

We got the heavy reaction in gold that we had been expecting for some days on Friday. The problem is that we also got a big important breakout in the dollar, which we had acknowledged as a significant possibility for some time. This is not good news for commodities and not good news for the stockmarket either as it signifies the onset of a flight to cash such as we witnessed last year.

What was really odd about yesterday was that we saw a big dollar breakout, but Treasuries fell heavily. We are now believed to be on the verge of another massive deflationary downwave, similar to last year, but worse. However, this time it is very possible that while we will see a flight to cash, we will not witness a stampede into Treasuries, or at least not on anywhere near the same scale. So what is going on here? - what are the principal underlying dynamics? Anyone who has had the misfortune to watch a nuke exploding, misfortune because you get irradiated, knows that first you see a very bright flash, then there is a period of tranquillity as the flash dies down and the mushroom cloud starts to rise, before the shockwave hits, when things get pretty rough to say the least.

Youv’e seen the flash - now get ready for the shockwave…

What happened in Dubai just over a week ago was the bright flash, and the media have used the intervening period before the shockwave hits to reassure everyone that everything is going to be just fine - “You just relax, nothing will come of it, it’s only $60 billion down the drain or whatever - have a cup of tea”. The trouble is that it’s not $60 billion at all - the reality is that this is a default on a massively larger scale. Dubai was a vast sinkhole into which western banks and governments unquestioningly poured not just billions but trillions of dollars which was then leveraged enormously by means of derivatives enabling Dubai to build itself up into a latter day Rome, with a level of opulence and extravagence that would have made Caesar green with envy.

When people think of Dubai the things that come to mind are the massively extravagent 7-star hotels, the towering record breaking skyscraper, palm-shaped island resort complexes etc and forests of new office buildings and apartments etc. What the vast majority don’t realize is that the stupendous leverage afforded by derivatives has in addition enabled Dubai to create an immense global empire of businesses, most of the elements of which are broke, having racked up staggering levels of debt. Dubai is the nexus of the derivatives pyramid and it is flat, stony broke. Where did all the money come from to pay for all these things? - why from taxpayers and pension fund contributors the world over of course, but especially in the US, with Wall St acting as a giant conduit sluicing a torrent of cash into Dubai. The interesting thing is that there was never any accountability - countries and companies vied with each other for the privelege of pumping money into the exalted kingdom, seduced by its supposedly limitless oil wealth, and requesting or requiring guarantees was regarded as impolite. Now that Dubai is broke, the Dubai government has suddenly distanced itself from Dubai World, and the attitude towards the Western banks and governments who have poured trillions into Dubai is “Tough luck - you lose, suckers”. What this means is that trillions of dollars which are now counted as assets on the balance sheets of banks worldwide and especially in the US are actually liabilities. So what do you think is going to happen to the stock prices of these banks - and stockmarkets generally, when the world wakes up and acknowledges this reality - when the shockwave hits?? Small wonder that the charts for Goldman Sachs and J P Morgan look very like the market charts before the ‘87 crash, but that was “small potatoes” compared to what is coming down the pipe this time. Read More…

With the Gold market hitting the point of recognition, and Silver soon to follow, investors should now spend their energy focusing on the companies. In fact, that is why we started a newsletter dedicated to tracking as many of the companies and as frequently as possible. This weeks issue, updated nearly 55 gold and silver stocks. The majority of those stocks look like they can gain a bit more before they run into resistance.

Looking at the gold stocks by themselves is not a good way to judge their true value. In order to value a market or asset in a world with 0% interest rates and rampant inflationary policy, one must compare it with other asset classes and markets. The gold stocks as evidenced by the GDM, XAU and HUI indices are closing in on their 2008 highs. Does that mean they are expensive?

In our opinion, the gold stocks won’t truly be expensive until they are hitting repeated all time highs against other stock groups. Below we compare the GDM index of gold stocks to commodity stocks, emerging markets, world stocks and the Nasdaq. As you can see, the gold stocks aren’t even close to 15-20 year highs when valued against these various stock groups.

Why is this important? Look at these ratios carefully. They tell us that money is only starting to flow from common stocks to gold stocks. When gold stocks have been hitting major highs against these stock groups, for more than a year, then we will know that a bubble is in the early stages.

Next we show our proprietary junior gold index divided against Gold. The JRGold/Gold ratio fell about 71%. The ratio has only recovered 40% of that loss. Keep in mind our various Gold ratio charts in updates past. Those charts have indicated improving margins for gold companies. In other words, while the seniors and intermediates are capturing some leverage, the juniors have only captured a fraction of it.

This is the most interesting chart. One can see that the HUI index has outperformed our JR index since 2004. However, that looks to be coming to an end. Look for the junior golds to strongly outperform the unhedged larger gold stocks.

The shape of our Junior Gold index looks very similar to the HUI. In particular, we are referring to the 2008 crash and 2009 recovery. The index is about 12% from the 2007-2008 highs. The index is composed of 20 stocks, most of which have a market cap from $200-$500 million.

On November 19, we added one stock from the index to our recommended list (which includes silver stocks). The company has ample cash, and the potential for two producing mines in the next 18-24 months. At the time, it was trading at near $20/oz of gold in the ground. We wrote: “At present, we like the valuation and we like the technicals. With $1000 a floor for Gold, its only a matter of time before stocks like these catch a bid.” Since then, the stock rose as high as 60%. It is currently up 36%. Most important, we highlighted the stock when risk was low.

Adam Hamilton     December 4, 2009

Gold’s performance over the past month has truly been epic.  Since late October, it has soared 18.2% higher.  Over a 21-trading-day span, no fewer than 16 days achieved closes at new nominal all-time-record highs!  Even the perpetual gold disdain from Wall Street and the financial media is fading.

With gold surging so rapidly and relentlessly, growing numbers of investors and speculators are wondering if we are now entering the long-awaited Stage Three gold bull.  Over 5 years ago, when gold was trading at $400, I wrote an essay describing the evolution of a secular gold bull through 3 distinct stages.

Stage One stealthily emerges out of a secular-bear low when everyone loathes gold.  In response to a devaluation in the dominant currency, this metal starts quietly creeping higher.  Stage One in today’s bull began in April 2001 and ran for over 4 years.  It was marked by modest yet consistent gains in gold.

Once global investors figure out that gold is moving up on its own supply-and-demand-driven fundamental merits, Stage Two dawns.  More and more investors “discover” gold and deploy increasing amounts of capital in it.  Today’s bull transitioned into Stage Two shortly after euro gold broke decisively above €350 in June 2005.

A gold breakout in a secondary currency may not sound like much, but it was a game-changing event that finally convinced global investors that the young gold bull was the real deal.  Before that to everyone but Americans (who see gold through a dollar-centric lens), gold’s strength was perceived as nothing more than the other side of the dollar-bear coin.  They thought gold was only rising because the dollar was falling.

Stage Two can run for many years, it is the longest phase of a gold bull’s lifespan by far.  It persists for so long due to the way bull markets affect investor psychology.  Early on in a bull, few investors believe it is real so little capital chases it.  But as a price powers higher, more and more investors start to believe which gradually yet relentlessly increases capital inflows.  This drives prices even higher, forming a virtuous circle that attracts in even more investors.  All this takes a long time.

Some bulls end at Stage Two, but the truly great ones ultimately transition into Stage Three.  Lasting less than a year, this is the terminal phase of a secular bull.  After professional investors are already fully deployed in gold, the general public soon grows enamored with it and wants in at any price.  The resulting massive influx of capital drives a popular speculative mania and its resulting parabolic blowoff.

Think of the NASDAQ tech-stock mania in early 2000.  Tech stocks were all over the mainstream news, and everyone wanted in no matter how little capital they had.  People were mortgaging their houses to buy speculative tech stocks trading at hundreds of times earnings.  Conversations everywhere in all walks of life eagerly discussed the tech-stock boom.  There is nothing else like a Stage Three speculative mania, they are impossible to miss.

So much capital flooding in so fast drives vertical price gains, a parabolic ascent.  The last Stage Three gold parabola unfolded over several months climaxing in January 1980 at $850 (just under $2400 in today’s dollars).  That event was blisteringly fast, gone in the blink of an eye.  Over the final 10 trading days leading to the end of its bull, gold soared 34.1%.  Over the final 20 trading days, it was up 80.3%.  And over the final 30, just 6 short weeks, it nearly doubled with a 95.9% gain!

Now despite November 2009 being exciting, it was nothing remotely like a Stage Three blowoff top.  At best over the past month, gold’s gains over any 10-trading-day, 20d, or 30d span ran 8.8%, 15.7%, and 15.1%.  These are obviously a far cry from the last Stage Three climax’s 34%, 80%, and 96%.  So there is no doubt at all that we have not witnessed anything Stage-Three-like in the recent exceptional gold strength.

But even though gold clearly hasn’t entered Stage Three, could it be on the cusp of rocketing parabolic as many analysts assert today?  The only honest answer is sure, of course it could.  Anything can happen in the markets, and none of us mere mortals can see the future.  It is even the right time of the year, a seasonally-strong period for gold that also happens to coincide with the last Stage Three climax from November 1979 through January 1980.

Nevertheless, for a variety of reasons I am almost certain our current gold bull is nowhere close to Stage Three yet.  Gold isn’t going parabolic anytime soon, so if you are planning on retiring in early 2010 from the next few months’ gold gains I suspect you’ll be sorely disappointed.  As any student of the markets who has studied history and psychology can tell you, today’s conditions are all wrong for Stage Three dawning.

Think of bull markets as popularity contests.  The higher prices go, the more popular those assets get.  And the more popular the bull gets, the more investors deploy more capital to chase the gains.  Stage Two chronicles this journey from relative obscurity among investors to widespread adoration.  This long stage lasts until professional investors are fully invested.  Has this happened yet with gold?  No way.

There are many ways to illustrate this truth.  In the new December issue of our Zeal Intelligence monthly newsletter, I outlined a couple key ones.  Despite the GLD gold ETF’s huge success in enticing stock-market capital into gold, stock investors are still incredibly underinvested.  At the end of November, the market capitalization of GLD only ran about 0.4% of the combined market cap of the elite S&P 500 stocks.

Are stock investors fully invested in gold yet at an allocation of under a half percent? At today’s levels they have barely even started deploying in gold!  I don’t know if “fully invested” in this bull will ultimately cap out at 5%, 10%, or even 20%, but it is certainly not going to be 0.4%.  Central banks are also big gold investors, and the growing Eastern CBs are woefully underinvested in gold.  The top 5 Asian CBs in terms of gold holdings now have an average of just 3.5% of their foreign-exchange reserves in gold.

Is this fully-invested?  Certainly not.  For comparison the top 5 Western CBs have an average of 64.8% of their forex reserves in gold bullion today!  Given the Eastern CBs’ undiversified heavy exposure to the ailing US dollar, which has been in a brutal secular bear since July 2001, it is impossible to imagine them not wanting to sell more dollars and buy more gold.  Like American stock investors, Asia has barely even started investing in gold.

How can Stage Two transition into Stage Three when the only investors with heavy gold exposure today remain a relatively small fraction of contrarians?  It can’t.  Stage Two will not reach maturity until large professional investors all over the world have great-enough allocations in gold to consider themselves fully invested.  I suspect it will be many years yet before professionals reach this milestone. Read More…