(May, 2004)
1987-STYLE DEATH FOR METALS?
Chris--Five minutes ago I finished reading the last Gold Stock Analyst report of which I am also a subscriber. They think the gold and silver bull market is over, and compare it to the 85/87 bull market. What do you think?
I have not read all the specifics of John Doody’s reasoning (BTW, I do regard him highly) on that, but he is not alone in this warning. Others have made the comparison between the 1985-1987 time period and the present, including Yours Truly on a few occasions.
Back then, a steady decline in the dollar led to a surge in long term interest rates. The dollar decline was bolstering most commodities, including gold and silver. The subsequent rise in long-term rates, though, started to hurt those areas. Finally, when the rise in market rates (which the Fed finally tried catching up to by raising the fed funds and discount rates) also undermined the stock market, the party for metals was over for a while. As the dollar rebounded and the stock market crash shook growth expectations, metals suffered a double-whammy that took a few years (and the onset of Gulf War Part One) to recover from.
One of my favorite old “props” from that time is this cover of the August 1-7, 1987 issue of The Economist. While not as high profile a magazine (especially in the U.S.) as a Business Week, it has a respectable following in the financial community.
A lot of people have said that once you see sensational headlines all pointing to one economic theory or bit of news, it’s time to think about switching gears. When Business Week, for example, talked of “The Death of Equities” on its cover in mid-1982, it was time for the long bull market in stocks to begin. The opposite has also been true at times.
By the time this issue of The Economist came out (and covers of many other magazines were talking of the same) we had not only had a couple years’ worth of a weakening dollar, rising commodities (including silver and gold) and inflation. We had also had many months’ worth of market rates rising (the 30-year Treasury peaked that month at around 10% after starting the year at 7%) and the Fed had already hiked rates a few times.
History can (and does) repeat itself in broad ways, but never exactly. This time around, it has been the dollar's rally, chiefly, that has hurt gold and silver again recently. For the recent peaks, though, to be the end of the metals bull market, I think we'll need to see the dollar continue to rally, as well as a significantly larger rise in interest rates. At the same time, though, we need to be cognizant of the possibility that a continued decline on Wall Street alone could also hurt metals’ prices. In short, as many people have warned recently, pretty much everything that rose on the back of the weakening dollar over the last year and a half is now suspect.
At the moment, there are a couple differences between 1987 and now where the metals are concerned. First, I don’t believe that either the markets or the Fed will take rates up as dramatically as they did in 1987. Among other things, there is not the foreign pressure against the Treasury market—at least not yet—that there was back then. Though Japan and China have both recently slowed their purchases of U.S. debt, there is no sign that they or anyone else is running for the hills.
Second, by late 1987 the dollar’s decline had become quite overdone, and had become unsettling to the markets. That is also not the case today. Sure, at its lows of a few months back, the Europeans were complaining a little. But everyone knows that the U.S. fiscal and trade imbalances that still exist mean that the dollar must go down further following this cyclical rally; and that will be tolerated as long as it is orderly. Thus, if and when we see this resumption of the dollar’s bear market, metals should at least be able to stabilize, if not run higher again.
I do tend to think that any opportunity in the near term to trade back into precious metals will be just that—a trading opportunity. Though I don’t go as far as John and a few others do in saying that the precious metals are toast indefinitely, I think we’re looking at, perhaps, several months where pretty much everything will tend to move “sideways” but with some dramatic swings, both up and down, along the way.
HOUSING CRASH AT HAND?
Hi Chris--I know this is a sales pitch, but I’ve attached a promotion I just received by e-mail calling for an imminent collapse of the housing market. Could the housing market bubble burst so soon and all in one massive pop? I know you disagree on rates going up significantly in the short term.
My home is under
massive construction in the hopes that the payoff will put us another
step ahead financially - but I can't sell for another year. Would hate
to think it's all over this week!! Any quick “housing bubble” and its
“end” insights?
The “pitch” you sent is one I've seen. As a general rule, these people are long on provocative or scary headlines, but have generally been short over the years on good investment advice. I am always entertained, though, by their stuff!
Having said that, I do believe that housing prices will eventually peak and then soften. However, that will not necessarily start tomorrow simply because the Fed's Open Market Committee is meeting (as the headline implies.) And, yes, I am presently of the opinion that—though long-term rates will slowly ratchet upwards for a while—we aren't likely to see anything so dramatic right away as to kill the housing market.
Eventually, as Den Denning wrote in an item I added to my Other Experts page recently, housing will suffer. When it does, though, I think it will be just as much due to the growing squeeze on consumers apart from any rise in mortgage rates. By that, I mean a continuing weakening of the employment picture (both in numbers of decent jobs and stagnant wages) together with much higher costs for life’s everyday needs.
In short, I believe for the most part that the salad days for real estate are over. However, I see a very gradual erosion, where we even have one at all, rather than something sudden as these people are suggesting. Don’t forget that the Fed fully intends to keep money flowing like a river precisely to soften things such as this.
ASIA AND GOLD
I’m glad I’ve been a subscriber during the last several months, as you’ve “grounded” me a bit better in common sense where metals stocks are concerned. While I only owned Wheaton River where your picks were concerned (AMEX-WHT) and did sell it near the top, I had a basket of other stocks I lightened up in back in December and January. Thank you!
Now my question. I understand all the reasons why gold and now silver have plummeted, along with most such stocks. In the end, though, won’t Japan and China have something to say about gold—and push the price up? The bit by Gary North that you put on your web site (“From Rothschild to Wong” on the Other Experts page) I appreciated, and I think that says it all. Aren’t Asians accumulating all the gold the “west” is selling, and aren’t they getting ready to set up their own gold-backed currency? For us U.S. investors, doesn’t this all mean that the dollar-based price of gold HAS to go up?
I have a few points in attempting to answer your question:
First, I believe there has been sufficient evidence to show that private sector demand for gold in China has been rising. With that government in recent months having loosened its long restriction on the private ownership of gold—and given the increasing incomes and living standards for some of the population—this should continue.
In Japan, the recent weakening of the currency (now around 112 yen to the dollar as compared to a recent level of 103 or so) means that gold for the Japanese has not become as affordable in this recent plunge as it has for dollar-based investors. However, at some point I expect to see the yen strengthen further against the greenback; that will add momentum to yen-priced gold and, I think, invite some investment buying, especially if it turns out that the Nikkei’s recent rise is over for a while.
It’s a different matter to talk about “official sector” attitudes about gold, though. Though there has been a fair amount of noise about the subject, Japan has not made any public pronouncement yet that it was bolstering the gold portion of its foreign exchange reserves (recent articles have suggested that, as a percentage of Japan’s official reserves, gold is low and at some point might be bolstered.) As for China, information is tough to come by. However, there are many who believe—though nothing has been said publicly—that China is already bolstering the gold component of its own official reserves.
How this might eventually play into a “gold-backed” currency remains to be seen. I for one believe that at some point there will be some kind of “Asian bloc” currency similar to the euro. It will probably come about though (as I’ll be discussing in a future issue) after there has been much more pain inflicted on the region for being shackled so tightly to the U.S. economy/currency.
Any way you slice it, though, I do believe that Asian demand—whether from the public or governments—will be a major future “driver” of the gold price.
SHOULD I SELL POLYMET?
I am thrilled that PolyMet Mining has done so well, especially since I bought it (at 28 cents) right after you recommended it. Though you still characterize it as a buy, I’m wondering if you can give me some advice as to when to sell, since I have a large gain?
First, I always ask myself “Would I buy this stock today” in determining what posture to take. In spite of its run, I still think PolyMet is a compelling story, and very attractive at these levels as a speculative stock. Thus, my continuing “buy” posture.
Prudent portfolio management, however, could dictate things differently for you. First of all, in building and then managing a diversified portfolio, it’s generally a good rule of thumb to never have more than 5% of your portfolio in any one stock. This is especially true for those classified as speculative, as is PolyMet.
In addition, whenever you have any stock that moves up as strongly as has PolyMet, it’s advisable—unless you feel SO strongly that there’s some reason it will move much higher imminently—to take at least some money off the table after a big surge. In this case you could sell, for example, half your PolyMet and recover not only your original investment, but a decent profit. Then your remainder is the “house’s money.”
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