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Gold
and silver are headed higher propelled by a powerful bull trend. Gold is
climbing on its way to new multiyear highs, buoyed by massive government
intervention in the capital markets. We will see gold exceed its 2011 highs
this year. Silver will also soar to new highs.
What
is behind this bullish prediction? Can we pinpoint the cause and effect
relationship to the rise in the precious metals? Is now the time to buy gold
and silver?
The
answers to these questions come with a firm understanding of the dynamics of
the business cycle, and the power of market trends. As we know from Mises and
Hayek, interest rates have a profound effect on capital investment. Left to
the free market, interest rates are determined by the supply of credit (a
proxy for the savings rate) and investors’ willingness to risk placing
capital in the market (a proxy of the return on capital). And as we know from
Adam Smith, because investors act in their own self-interest, capital is
allocated in free markets very efficiently. Investors tend to put more
capital in “winners” and are quick to cut the losses in
“losers”.
But
if free markets are so efficient, how can there be downturns in the economy,
ranging from recession to depression? The cause of most economic downturns
has been manipulation in the markets, typically by government agencies that
seek to “manage” one or more segments of the economy by controlling
interest rates, prices or both. Governments use coercion under the color of
law to achieve their ends. Government intervention distorts natural interest
rates and spoils price discovery, which leads to malinvestment
and market bubbles. Downturns and displacement occur when economic bubbles
burst.
The
Federal Reserve has been one of the chief market manipulators. By setting
interest rates and controlling the availability of credit and money, the Fed
distorts the natural demand for money and credit, which obscures purposeful
capital investment and contaminates prices for labor and commodities, often
with disastrous results. When the Fed feeds artificial credit into the
economy by lowering interest rates, it spurs investments in projects that
eventually fail. The high-tech and dot com and housing manias all were fueled
by decades of easy Fed money and credit. In each case these artificially
induced booms collapsed with massive loss of wealth and devastation of the
general economy.
The
data support the theory of cause and effect. The dot come run up coincided
with a money supply run up which began in 1995. The money supply slightly
flattened in 1996 and then zoomed up again in 1997, peaking at a 15% increase
in January of 1999. The rate of increase began to fall precipitously
thereafter, which popped the dot com bubble. The housing bubble, created by
easy money and social engineering in the 1990’s popped in 2007,
creating the Great Recession. The Fed and the Treasury added an unprecedented
$2.3 Trillion to the money supply in 2008-2010 in the name of economic
stimulus. The Fed’s MZM money supply measured $907 Billion in 1980 and
is reported to be $10.8 Trillion as of this month. The MZM does not reflect
the $16 Trillion in bailout loans the Fed provided to large US banks in
2008-2011. There is no doubt that judgments of investors and entrepreneurs
are distorted by massive injections of money and credit by the Federal
Reserve.
 
So
what does easy money and credit from the central bank have to do with the
price of gold? Well, every Dollar the central bank creates out of thin air
debases the value of Dollars already in circulation. That is the nature of
fiat currency. Because gold is priced in Dollars, it takes more Dollars to
buy the same amount of gold with every new weaker paper Dollar printed. We
have seen the price of gold climb along with the money supply, accelerating
its climb in 2002 coincident with the fall in the Dollar.
We
are now seeing technical breakouts in gold and silver. Last week, gold broke
out of a bullish head-and-shoulders pattern dating back to November 2011. The
price target from this pattern is just over $2000/oz. Silver followed last
week, with a breakout from its own bullish head-and-shoulders pattern
indicating a return to its September 2011 highs.
The
trend in precious metals is up from here. Now is the time to buy gold, silver
and selected gold and silver stocks.
Investors
from around the world benefit from timely market analysis on gold and silver
and portfolio recommendations contained in The Gold Speculator investment
newsletter, which is based on the principles of free markets, private
property, sound money and Austrian School economics.
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