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We have forecast gold prices for 2011 ranging from $1,300 to
$1,500 per ounce, with potential to reach $1,600 at some point during the
year given a strong tail wind. This is not significantly more aggressive than
our 2010 gold price forecast of $1,200 to $1,400 per ounce, with potential to
reach $1,500 by the end of 2010. We may be guilty of being guarded compared
to more extreme views of bursting commodity bubbles, or on the other hand,
“End of America” night terrors. For the most part, statistically
speaking, even in the days of black swans circling overhead, reversion to the
mean has a place, and pendulums pull toward the equilibrium. Our objective is
to help provide investors interested in gold and silver an opportunity to
hear a point of view, and to make decisions for themselves based on their
individual abilities and willingness to accept risk.
This review of our 2011 prognostication is for a variety of
reasons, most importantly to take a pre mid-year heads up and look around,
and this is typically the time of year for seasonal corrections. We will
comment on the current economic underpinning supporting the model for our
opinion. We will also take a larger view of the historical and philosophical
currents that suggest an irreversible tide lifting precious metal prices
higher in the years, if not decades, to come. We will also explore opposing
philosophical undercurrents of sovereign risk that may impact mining stocks
and owning physical gold and silver in different, unexpected ways. In the
meanwhile, with the Federal Reserve completing QE2, the dollar may again
strengthen, leading to lower interest rates and a correction in metal prices. A
concern for us is that this may occur at a time of year a compounding a
downward seasonal corrections.
The seasonal patterns for precious metal prices over the last
decade have been consistent. The investment world gets back from summer
vacation and the conference season starts up in September. In anticipation of
demand, gold fabricators in India, China and the Middle East ramp up for
religious holidays and the wedding season. Sniffs of increasing demand lead
to higher metal prices for physical gold and ETFs, as well as for exploration
and mining stocks. This upward volatility sustains the bulls until the
spring, when the tax man cometh and summer vacation plans become the focus,
and the precious metals and stocks correct. Nobody picks up the phone
until September. This is where we will soon be in this simplistic seasonal
perspective.
In recent years the pattern seems to have partially broken down
as metal prices corrected in the spring, but resumed an upward pattern
through the summer months. Apparently investors, for good reason since
2008, are cutting their vacations short and working through the summer. While
again it appears we are ripe for a correction (and we admit to being
dangerously optimistic at 52-week highs), we may see one, but it may be short
lived, as we remain comfortable with our original prediction for 2011.
An Economic Perspective: Broke and Broken
Irving Fisher’s money equation (MV = PQ) provides us the
best model to organize our thoughts. In simple form, the quantity of money
(M) times the velocity (V) of money as it moves through a fractional banking
system is equal to inflation (P) times total output (Q) or production of
goods and services. We believe gold and silver are a proxy for P, and
monetary impacts dominate expectations for price movements in our opinion.
Unquestionably, M is growing through stimulus spending and
quantitative easing (QE) programs of loose money policy to inject liquidity
and keep interest rates low. M is big and getting bigger. It is still hard to
perceive a situation where the Federal Reserve will be selling securities as
part of a tighter monetary policy. On the other hand, we seriously question
the health of the banking system to take risks; households, including the
seven million of unemployed since 2008 are still stretched, and corporations
and households have been deleveraging. As the economy has bottomed, the
“hoarding cash” may be reversing, leading to an increase in the
money supply (MV) as working households, the entitled class, and corporations
resume spending.
An increase in the money supply (MV) must balance with the other
side of the equation (PQ), prices and/or production of goods and services.
Even though the U.S. economy has bounced off the bottom, some economists are
now revising estimates downward for 2011, some below 2%. This would earn
a failing grade relative to any other period for the U.S. economy since the
1930s. With increasing legislative intrusion and government domination in the
medical, energy, finance, housing, and education industries creating even
greater uncertainly or inefficiency, real growth will stall, holding the
economy back from earlier high levels of performance.
The stall is reminiscent of getting in a car on a cold morning
and turning a key with a dead battery. The engine wants to turn over but it
just can’t. No matter how many times the key is turned (think QE1, QE2,
QE3…) the outcome is the same. Need a jump? Need a new
battery? (Progressives would say we need a new car, but you pay for
it.) If not, and you are lucky to be parked on a slope, maybe try
putting the car in first gear, let out the break, let gravity take over, and
then pop the clutch, give it some gas and recharge the battery. Maybe next
time we will learn to turn the lights off when we park. In much the same way,
while there are unused productive entrepreneurial forces ready to be
unleashed, until the brakes on the medical, energy, finance, housing, and
education industries are released, the economy will experience stagflation, and
prices (P), including precious metals, should move higher.
Reality Check: A Recovering Economy or Stagflation?
Increasing corporate profits and a revival in the stock market
may be less a sign of economic growth than of rising productivity, given high
unemployment and low interest rates pushing liquidity into higher risk assets
and commodities. Clearly, a lower employment base and growing population of
long-term unemployed suggests that the supply of labor exceeding demand has
driven private wages down and productivity up. One would anticipate that with
a reduced labor force, lower demand would reduce prices.
Certainly, inflation measured by the CPI is below 2%, which is
good news for the Federal Reserve as it provides cover for ongoing easy money
policies. The CPI reflects a broken banking system and a stagnant housing
industry, not the Wholesale Price Index, now at 5.8% which includes energy
and commodities. This in turn immediately impacts the needy, the young, and
those on a fixed income, and later, corporate productivity and earnings.
The current leadership in the Federal Reserve and the federal
government has a blind spot for the ravages of inflation and its destructive
redistribution of wealth from producers and savers to special interests and
consumers. The horror of inflation is that once inflation expectations
become ingrained in the supply chain, these inflationary expectations are not
cut out without significant pain. Even worse, the shock of inflation, when
institutionalized in corporate contracts, government salaries and benefits,
minimum wages or entitlements with cost-of-living-adjustments (COLA), are
like an electro shock therapy on the economy. When the CPI catches up with
the real world, and COLA kicks in, look out.
Historically, inflation breeds the most feared loss of liberties
following redistribution of wealth. The German economy grew in the 1930s,
after hyperinflation cleaned out the middle class, national socialists
squeezed unions to accept low wages by removing the politically incorrect.
This worked for the general population that enjoyed greater financial
stability or an improved standard of living. The new well-to-do turned a
blind eye to the ethics of this redistribution. Even today, blind eyes
won’t see the misfortune of others whenever a career or entitlement is
threatened. History has shown, in times of uncertainty, that individuals will
choose safety over freedom, effectively trading away personal risk with their
own professional and personal growth. They willingly justify trading away the
wealth of those they may never know, including future generations and
certainly the politically incorrect.
From an economic and political perspective, the Federal
Reserve’s only tool to attain its mandate to achieve both growth and
moderate unemployment is QE3 and then QE4, so long as the CPI suggests
inflation is absent. Public debate at the Federal Reserve suggests this
to be the course through 2011. There is not a chance that the political class
will reign in entitlements; certainly the entitled will not willingly abide
curtailment. Politically, things will be interesting, economically as
well, so inflation at this point appears unavoidable, which is good for gold
and silver, as paper assets devalue relative to tangible assets.
Frederic Bastiat and The Law
Frederic Bastiat wrote eloquently on the subject of life,
liberty and property in The Law, in the 1850s, coincidentally at the
same time Engels drafted the Principles of Communism, later to become
Marx’s Communist Manifesto. The simplicity in his arguments are
easily grasped and by plumbing the nature of human kind, his work remains a
classic, appearing as if it had been penned just yesterday. In brief, natural
law makes obvious these basic individual rights to life, liberty and
property. Simply, people are entitled to life, the ability to pursue life in
their interest, and to reap the outcome of their actions, both good and bad.
It follows that a just government would enact and enforce laws to protect
these rights of the individual from those that would seek to remove or
enslave that life and plunder property.
A government that takes these simple rights without consent, for
whatever good reason, commits legalized plunder and in fact is acting
unjustly. While many good reasons may exist for legal plunder, it does
not go well. Interestingly, Bastiat cited the differences of the American and
French Revolutions. He indicated that the American experience was a success
except for the use of tariffs, removing the liberty of free trade, and
obviously the institution of slavery, which requires no explanation. The
progressives of the French Revolution sought to build a new and just world,
making the individual subject to the new world based on the dictates of a
democratic legislature. In some bizarre instances, he cites statements by
enlightened leaders, to save lost individuals by executing them. Life,
liberty and property were subservient to the legislative elite’s
redistribution of justice.
The French Revolution succeeded in eventually delivering up a
strong central government to Napoleon, which was both good and bad.
Interestingly, on his death bed Napoleon lamented that his officers had
wished he had been a “Washington.” To the contrary, the United
States at the time was a loose connection of states with a weak federal
government. Alexis de Tocqueville noted in his travels that America enjoyed a
mediocre level of wealth, with an industrious people, few poor and few rich.
Like Bastiat he noted the yet unresolved evil of slavery. This issue was
central to the Civil War, which started 150 years ago this last week. It is
forgotten to many, but the sin of slavery is still visited on future
generations. Clearly, universal agreement on the injustice of slavery
undergirds and supports Bastiat’s assertion for an individual’s
rights to life, liberty and property. Beyond the Civil War, capitalism itself
has been characterized as a similar failure, and redistribution, even with
inflation plundering the saver and the productive, is considered to be deemed
fair by an elite legislature.
Bolivia, Sovereign Risk and The Law
Bolivia is one of the author’s favorite places (second is
Halifax, Nova Scotia) to have visited as an analyst. The people work hard in
a protein and oxygen-deprived environment helped along by chewing coca
leaves. The Spanish spoken is as pure as it was 500 years when silver
from Bolivia financed the empire. The remoteness of the area has kept it from
much economic development from those early years through today. Bolivia is
rapidly catching up with modern mining law, international finance and law.
Expectations for its success are not strong, but it is building a track
record with companies following earlier privatization of government owned
mining companies.
A combination of events recently increased the volatility of
exploration and producing mining companies in Bolivia. Labor unions
appear increasingly unsatisfied with pay increases and are applying pressure
on the government. This contributed to comments by Bolivian leadership for
revisiting lease agreements with mining companies and the Corporation of
Mining of Bolivia (Comibol) dating back to the mid-1990s. Broad comments,
combined with unsettled revisions to Bolivian Mining law scheduled for
completion in the coming months, and investors concerns dating back to the
government’s earlier handling of foreign interests in the oil and gas
industry, kept investors on edge.
Through the week, certain companies received assurances through
public statements by Bolivian authorities that they were not under review.
The Minister of Mining and Metallurgy made a statement that the only
companies under evaluation were those with “mines that belonged to the
state in the past” and those formally requested by workers. The role of
workers in the determination by the state seems in conflict with the rule of
law. Interestingly, these comments were made at about the same time as
statements by the Bolivian Vice Minister of Mining, supporting the importance
of foreign investment to one of his country’s most important industries.
Clearly Bolivia is at a crossroads in redressing its past as it seeks to
capitalize on its national wealth. Decisions impending on its review of past
contracts are expected by May 1, 2011, with further revisions to its mining
law in the months ahead. Bastiat’s understanding of The Law now
moves from theory to reality.
Sovereign Monetary Risk and The Law
Bastiat has argued that a just government would protect the
natural right for an individual’s rights to life, liberty and
property. By extension this would include ownership of shares of a
corporation lawfully operating for the benefit of its customers and
investors. While we wait to see how Bolivia advances in its
understanding of The Law, other examples in South America provide highly
visible examples of both good and bad. In our opinion, investors have
been quick in their judgment of Bolivia, which may not have been earned. We
believe there is an exceptional opportunity for Bolivia to stake out its
position; we should know soon, but the decision is its own.
Sovereign risk is always an issue. Concerns in areas of high
reputation including Australia, Canada, Mexico and the United States are not
beyond an occasional stumble. One need not look past the condition of
drilling in the Gulf of Mexico to fear an arbitrary, cautious or vindictive
bureaucracy. This may include the expectation for the soundness of a currency
by savers and producers. This would include the risk of the devaluation of
the U.S. dollar when the world is depending on the U.S. for a currency that
is a trusted store of value. Regardless of a springtime correction, gold
remains insurance against monetary sovereign risk.
Author in La Paz, Bolivia
Mike Niehuser
Beacon Rock Research.com
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