THE GOLD GAME: SINGING A NEW TUNE.
The Gold Game: Singing a New Tune
By Don Luskin
Special to TheStreet.com
Originally posted at 8:31 AM ET 5/17/01 on RealMoney.com
I'm changing my tune.
It was great to call the April 4 bottom on the Nasdaq. But all the way up, I've
been saying it's just a bear-market rally. A great rally. A profitable rally. But
doomed.
By framing my predictions this way, have I tried to have it both ways? Maybe
I've set things up so that I can't be wrong. Or is it that I can't be right?
What I've been trying to convey is that we've
been fooled before in this awful bear market
-- I've been fooled before. I'm not willing to
say that a real bottom has been reached just
because the market has gone up or just
because the Fed has cut rates. The world isn't
that simple or that risk-less.
Catalyst for the Call
Now I'm just about ready to change my call that we're only in a
bear-market rally. And it's not just because of Wednesday's big move. In
fact, even after Wednesday's surge, the Nasdaq is still below the May 2
highs that I marked as the "bookend" of the move and the end of the rally.
Something else has happened that makes me think we might be seeing the
real thing. I've finally gotten the catalyst I've been looking for: a definitive
breakout in gold.
Yes, gold -- the monetary commodity that the great economist John
Maynard Keynes called a "barbaric relic."
On March 22, the very day the Dow bottomed at 9106, I wrote that we
would know when the bottom had arrived the same way we did in August
1982 -- the last time the stock market recovered from a deflationary spiral.
The "tell" would be that the price of gold would bottom out and begin to
rally. That's because gold is the most sensitive indicator of the market's
demands for liquidity. When gold starts to rise off its 22-year lows, the
markets are getting the liquidity they need and the deflationary spiral is
ending. As I put it on March 22, "The markets know more than the
economists. And when the Fed finally turns this deflation around, gold will
tell us."
Gold is telling us now. I reported March 26 that gold was establishing a
bottoming pattern and a mild uptrend. And I noted last week that gold had
broken out of its severe long-term downtrend. I was worried that last
week's breakout might just be a technical effect arising from the insolvency
of Australia's Centaur Mining and Exploration and that, when that
effect subsided and the Bank of England's bimonthly gold auction kicked
in, the breakout might prove to be illusory. But Wednesday's gold auction
went off without a hitch, and gold surged to new recovery highs.
If the gold market is right and the Fed's rate-cutting campaign creates
enough liquidity to end the deflationary spiral, then there are lots of
interesting consequences for stock investors.
What It All Means
First and foremost, it means that the Dow's March 22 bottom and the
Nasdaq's April 4 bottom were it. The bear market ended there. But don't
get cocky. We should still expect all of the normal ups and downs from the
stock markets, and we shouldn't kid ourselves about the markets' need to
digest the huge moves they've made in the past six weeks. At some point
-- probably soon -- the markets will correct, and that correction will end in
a secondary bottom higher than the March/April bottom. The trend that
can be projected from the March/April bottom across the coming
secondary bottom will define the new bull market.
Second, it means that we should expect some amount of inflation --
hopefully, just the right amount. When gold starts rising, it is a long-term
signal of incipient inflation, just as when it started falling four years ago it
was a warning of coming deflation. Don't let the pundits scare you about
this. We should welcome a certain amount of inflation: It is the corrective
against four years of deflation. We should expect to see it start appearing
first in basic commodities such as raw agricultural products. It may take
years to filter into the consumer price index in any noticeable way. There
are still four years of deflation that have to work through the economy's
complex price system first.
The best way to play even a small inflationary impulse is with gold stocks.
Wednesday, even against the backdrop of the Dow surpassing 11,000 and
the Nasdaq Composite doing even better, the best-performing index of all
was -- drum roll, please! -- the CBOE Gold Index. But it's not too late
by any means. We started positions Wednesday in Homestake Mining
(HM:NYSE - news) and Newmont Mining (NEM:NYSE - news).
These are two of the best-managed gold companies in the world. And their
balance sheets and hedge books are structured so that they are levered to
the price of gold: Their net asset values -- and presumably their stock
prices -- should move up and down in percentage terms more than the
price of gold itself.
Investing in gold stocks is an arcane art. If you're used to semiconductor
and optical-networking stocks, you're going to have to retrain your
intuitions a bit if you want to play to win in the gold game. Over the next
several days, I'll be writing more about that.
Don Luskin is president and CEO of MetaMarkets.com and a portfolio