JAY TAYLOR ON GOLD & THE MARKETThe chart of the S&P 500 illustrates how overvalued stocks continue to be compared to historical valuations. Historically, PE ratios above 15 were considered overvalued. Valuations seldom rose above 20, and at the bottom of bear markets, PE ratios traditionally fall to below 10 times. A decline in the S&P now based on current strong earnings would take the S&P 500 to a little over 500, or about 55% below current S&P 500 share prices.
In my 1999 interview with my good friend, institutional stockbroker, and economic historian Ian Gordon, he was adamant in stating that the establishment would not be able to inflate the equity markets back to their old highs. I suppose we can't rule out with complete certainty their inability to yet do so, but clearly it seems to me the energy required to drive this market to new highs simply isn't there, and what is amazing is the fact that it isn't there despite the greatest burst in money creation from thin air in history. Ian believed then and still believes as do I, that the enormous amount of debt in this 60- to 70-year Kondratieff cycle provides a drag against the system that forces it ultimately to deflate. The process of deflation is being fought tooth and nail by the Fed and by our government's monetarist and Keynesian policies. But they won't work because the laws of economics won't allow policy makers to repeal the natural laws of the markets. When assets become so ridiculously overvalued, as equities are now, investors who are in the best position to judge the value of their companies, such as those folks who run these businesses, will begin selling. Dictatorships (which is what we are quickly becoming) might in time force the rich not to sell, or tax them so high it isn't worth their time (think "Kerry for President"). But as long as markets are free, overvaluations can't happen forever.
Insider Sales Overwhelm Insider Purchases
My good friend Wistar Holt has been talking on a regular basis about the enormous disparity between insiders who are selling shares in the companies they manage and the number of shares that insiders are buying of the companies they work for. Wistar pointed me to the section in the Wall Street Journal in which these statistics are reported every day. Last week, starting Monday, I began to compile these numbers in an Excel spreadsheet, and the totals blew me away!
As reported by the Wall Street Journal, from June 17 through June 23, 2004 (five business days), insiders sold $909.7 million worth of their own stock. On the other hand, only $30.1 million was purchased. That calculates to $32.70 of insider sales for every $1 of insider purchases. One of the most notable insiders who sold this past week was Michael Dell. He took about $351 million off the table from the sale of shares of the company that bears his name and of which he is CEO. But there were other top executives from well-known firms like Microsoft, Oracle, Federated Department Stores, Capital One Financial, Harrah's Entertainment, MBNA Corp., Petco, dj Orthopedics, Ask Jeeves, and Staples, who took tens of millions of dollars out of the companies they run.
I want to be very clear that I do not blame these CEOs for taking money out of the companies they manage. I see nothing wrong with doing that. They accepted shares for compensation because they had the right to sell whenever they chose. That these extreme levels of compensation have become commonplace is not a symptom of capitalism but rather a symptom of fiat money, which has been a toxin injected into our capitalist system that is leading to its rapid demise and a demolition of competition. What we see in this market-topping process is how fiat money helps allocate the wealth to a privileged few, and clearly, Dell is displaying a pattern of lower lows and lower highs that has become so common in general in the equity markets.
What we are seeing here is a clear warning signal that the equity markets are running out of gas and that they are preparing for a terrible decline. But to keep enough "fuel" in the market, CNBC and other mainstream advocates have to keep talking up the markets to give time for the Michael Dells of this world to get out before the roof caves in. The pattern of lower lows and lower highs since the 2000 equity market peak is very clear from the charts above. Shorter term, we are seeing the same thing now in the bear market rally of 2004. And one chart that may be as important as any with respect to forecasting the U.S. economy is that of Wal-Mart. Look at how badly this chart is breaking down as it approaches the lows of this year. Remember, stocks discount the future, and this stock-which is perhaps the best proxy for the consumer-spending patterns of average Americans-is suggesting the consumer may be running out of gas.
Pinocchio's Nose Grows Ever Longer
Whenever I see Federal Reserve officials hit the airwaves, I think again of the cartoon characterization we showed a few weeks ago. Whenever Pinocchio told a lie, his nose got longer until he could no longer hide his lies. That, to me, is exactly what is taking place with our existing policy makers who have, through their monetary policies, obscured one market truth after another by printing monetary lies, which in fact is exactly what fiat money is-a lie! Fiat money has no value, therefore, it is by its very nature a falsehood. The banking system creates dollars by computer keystrokes and then wants us to believe they are worth something so we will be confident in receiving them for the goods we sell and the services we render. But behind those dollars are debts-debts that are growing and growing and growing.
And because debts are growing so much more rapidly than income, total debt is in fact the obnoxious truth or the "nose of Pinocchio" that Fed policy is trying to hide. The problem is that as they attempt to decrease the nose (debt) by creating more money, they only cause it to increase because debt is the raw material from which money is manufactured in a fiat currency system. And debt is growing so much more rapidly than income, which means that at some point as this trend continues, indebtedness will reach a threshold of lethality, at which point macro economic insolvency will result. And so, the following observation, which my good friend Wistar Holt sent to me a couple weeks ago, is apropos:
"Hey Jay, "It is amazing to watch Greenspan and other Fed members in action lately. While talking out of both sides of their mouths in merely a 48-hour period, several Fed members (Greenspan, Poole, Kohn) stated just prior to or on 6/14, that monetary policy will be more aggressive than the market is expecting, due to inflationary concerns. This drove bond yields and the dollar straight north. Then in Greenspan's testimony yesterday, he reversed his position and claimed that inflation was not a problem (after all), driving bond rates and the dollar south. Looks today like the market doesn't believe them, as bond yields and the dollar reverse (again) and head higher. "What is becoming obvious is that the Federal Reserve is attempting to manage the markets on a 24-hour basis. When inflation rises they talk tough. However, as bonds react and yields climb significantly, they retract their statements and say as Lyle Gramley (former Fed member) said on CNBC this morning, "I think the bond market overreacted to the Fed's inflation concerns." "As a side note, some hedge funds may anticipate some of this ridiculous volatility correctly and make money. However, my assumption is that most are "a day late and a dollar short," as the derivative market is suffering a serious bout of whiplash!" Regards, Wistar of Holt & Shapard Capital Management, LLC; 212 N. Kingshighway Blvd., Suite 1027, St. Louis, MO 63108, 314-367-6300/877-367-6300; www.holtshapard.com.
GOLD
The closing price of gold in New York on June 25, 2004, was $402.10.
Average Gold Price for month of June 2004 so far = $391.49.
Rolling 20-month average = $370.88.
Rolling 40-month average = $330.49.
As can be seen from the above chart, gold remains comfortably above its longer term (20-month and 40-month) moving averages. As such I remain convinced the gold bull market remains in place. Of course the price could turn down tomorrow and in short order the chart above could turn negative. But due to fundamental factors, not the least of which is the annual deficit of gold production to meet demand, and a growing recognition among policy makers from outside of the U.S. and England (which two countries together currently control the world's monetary system) that the dollar is living on borrowed time as the world's reserve currency, gold is I believe poised to rise to a level that will ultimately be quoted in 4 digits rather than 3, as John Hathaway insists. Timing is a much harder question, and I am not going to try to play that game. Better to pick the primary long-term trends so that we take our positions early when the markets in question are undervalued. Gold is a hugely undervalued monetary asset now at a time when politicians around the world are debasing their units of currency like never before in the history of mankind. Never in my life (I'm 57) have I lived through a time that is as bullish for gold as now. And remember, I lived through and invested in gold stocks as a young man during the 1970s.
You can play the gold markets shorter term if you like. I do like to read the ideas of some shorter-term technical players. I like to quote my friend Trader Roger Wiegand. In fact, I'm posting some of his most recent thoughts below. But most people do not do well with trading. They are better off simply (actually, it's not so simple) placing themselves on the right side of the market and staying there for the longer term. So that will continue to be the focus of this letter. Are we still in a gold bull market? That is the question I ask myself every day. If the answer is yes, then we are going to keep looking for ways to profit from a rising gold price, mostly by seeking out good gold stocks to buy.
Three Reasons Gold Has Been Weak
Richard Russell frequently contends that gold's weakness may be due to deflationary forces. My good friend Bill Murphy believes, with mighty good reason, that gold weakness is caused by policy maker manipulation. Also, a service that I have begun subscribing to, provided by institutional market analyst Bob Hoye, suggests that policy makers are only able to manipulate the gold price downward at the same time that they expand financial bubbles. Mr. Hoye, who like me is a deflationist, believes that gold has begun its rise of the past 3+ years now because of the beginning of the deflation of the stock market bubble. Furthermore, Bob believes that gold's rise will really get underway when the bond market and the dollar both rise dramatically-in other words, as the forces of deflation cause the U.S. currency to gain value, and as a flight for dollar liquidity leads to stashing dollars under mattresses, and as an income-short public begins panic-buying of U.S. Treasuries to secure SOME income.
What do I think about these views? Actually, I think I agree with all three of them. I agree with Richard Russell that there are very powerful deflationary forces now that are keeping a whole range of prices from rising and that those forces may be leading to a dampening effect on the price of gold. That is because the masses of investors think of gold as just another commodity and not as monetary metal that will inevitably be reverted to again when the existing dangerous international flirtation with fiat money implodes into a deflationary collapse. At this time, to most Americans at least, the notion of deflation leading to a need to own gold is nothing more than an irrelevant and far out-of-touch academic question. Only when deflationary instability leads to defaulting banks, which in turn cause citizens to demand actual paper money or gold or silver, will these folks begin to understand that gold and silver are money. At this point in time the notion that gold and silver are money is incredible because only those of us folks "from the hills" think that way. Sophisticated and well-educated folks know that isn't true.
So initially, when everything under the sun has to be liquidated in a mad scramble for fiat money cash to be used to meet exploding debt-servicing requirements, and/or dramatically rising energy costs, or whatever life's essentials may be, gold may in fact decline in value as well. For example, out of ignorance most Americans do not think of the gold in their jewelry as being money, though some other cultures do in fact buy "monetary jewelry." When push comes to shove, I would expect most ignorant Americans will sell their gold jewelry to pay the gas or electric bill or to make a mortgage payment rather than face insolvency. But that will change when people begin to demand asset money like gold or silver, or gold-and silver-backed money for normal everyday commerce. At that time, there will be a dramatic rise in the value of gold and silver, at least vis-à-vis everything else. With that, I think Richard Russell agrees.
What about the notion that the gold price is weak because it is being manipulated? Yes, of course gold is manipulated. Everyone other than compete idiots or self-delusional stock market bulls know that is true. Even Alan Greenspan admitted gold is manipulated when he said in 1998 that, "Central banks stand ready to lease gold in increasing quantities should the price begin to rise." And in 1966, Mr. Greenspan also acknowledged that government hates gold and will do all it can to destroy gold because it gets in the way of government's pernicious growth by retarding the creation of money from thin air. So Greenspan and Lawrence Summers and all the policy makers know that gold has to be capped if at all possible for them to romp and roam around their kingdom, robbing the masses with fiat money. And so they do. Yes! Yes! Yes! Everyone with an open mind who has honestly examined the evidence at hand knows that the gold price is rigged and manipulated by the policy makers; yet, there are large numbers of intelligent people who are blinded by their allegiance and dependence on the existing fraudulent system that is designed to rob average folks who work hard and play by the rules. For example, one person who was interviewed in the pages of this newsletter and who once worked for Bob Rubin can't allow himself to see how the gold markets are rigged.
But for goodness sake! Even Oleg Mozhaiskov, the deputy chairman of the Russian central bank, believes GATA is right in its allegations that the gold price is rigged. Do I believe gold is rigged? YES! YES! YES! BELIEVE IT! BANK ON IT! BUY GOLD BECAUSE OF IT! Yes, and not only does the deputy chairman of the Russian central bank believe gold is rigged, but you have to think a couple of judges in the U.S. who have examined two lawsuits believe it, too. The first is the judge in the Blanchard case who has refused to allow JPMorgan and Blanchard to manipulate their way out of anti-gold manipulation charges. This case is supposedly going to trial later this year and it is now in the discovery phase. The other is Judge Lindsay, who was in charge of Reginald Howe's lawsuit against the Fed and U.S. Treasury and all the major bullion banks as well as the BIS. If Judge Lindsay thought that Reggie's charges were bogus, he would have said so rather than applying a Boston Federal court.
But do you believe the authorities are limited in their ability to manipulate the gold price? Do I believe that? You bet I do! And here I think Bob Hoye is most likely right in suggesting a relationship between deflation and rising gold prices. Hoye talks about how major financial asset bubble deflations are followed by rising gold prices. He suggests that the inability to continue pushing the price of gold down below its low of $255 was a result of the beginning stages of a massive deflation. In this sense he is in agreement with Ian Gordon, who believes the start of the Kondratieff winter occurred with the top in the stock market in March of 2000. Despite massive infusion of new money, what we are seeing is big money coming out of the equity phase before the ultimate decline. Clearly in this election year, Greenspan is pumping money into the system so that housing and stocks remain in a huge bubble. When both of those asset bubbles pop, gold will have its day in spades. I'm not looking forward to that because a collapsing stock market and U.S. economy will not be a pleasant experience. But for those who own gold, it is likely to be less unpleasant than for those who have not put some of their savings into the yellow metal bullion or gold shares.
Actually, Hoye's view is not contradictory with my view and the view of Bill Murphy and other GATA folks that the suppression of the price of gold during the Clinton years was a means by which the bubble was enlarged. We know from the Gibson's Paradox paper co-authored by Lawrence Summers that he knew the gold price had to be capped if real interest rates declined. Otherwise the currency would tank vis-à-vis gold and the great expansion of the second half of the 1990s could not have taken place. And real interest rates did of course decline sharply during the Clinton years despite massive printing of money to bail out Mexico, Russia, LTCM, Asia, and Y2K.
However, as any engineer will tell you, all bubbles have their limits. The equity bubble was popped, and other problems began to arise. It is in fact well-documented that gold and stock prices are negatively correlated over time. And if you believe, as I do, that we have only seen the very earliest decline in equity prices, then for that reason alone it makes sense to expect much higher gold prices. Of course Mr. Greenspan has been printing money like mad in an effort to overcome the forces of deflation. This will, in the longer term, prove to be an exercise of futility because as I point out weekly, debt is the raw material from which fiat money is manufactured, and debt is growing at a faster and faster pace while income grows at best at a 3% or 4% clip over time.
June 28, 2004
Jay Taylor, Editor of J Taylor's Gold & Technology Stocks