The past couple weeks have seen a
strong pullback in both commodity prices and stocks. Gold fell sharply off
its peak after soaring just past $1,900. Volatility in commodity, currency,
and equity markets has been very high recently, and these short-term price
movements have Wall Street pundits in an uproar.
As gold prices soared, many advisors
recommended investing in the yellow metal with appeals to the "bandwagon
effect". A rising price, they argued, indicated changing sentiment, and
thus future appreciation. For those who bought on this reasoning, a falling
price is a bad omen.
In addition, for a while, gold prices
were rising even as stock prices were falling. As a result, some investors
bought gold to hedge stock market risk. When gold eventually followed equity
prices lower, these trades were unwound.
But as my readers know, following the
crowd has never been the reason to buy gold. After all, that same logic would
have recommended buying a house in Phoenix five years ago. Since the
fundamentals still point to gold's long-term viability, our phones have been
ringing off the hook with customers smartly seeking to take advantage of the
dip.
UNCHANGING FUNDAMENTALS
It's important to understand the
fundamental reasons for owning gold, and those reasons have not changed. The
US government embarked on a decades-long spending spree of historic
proportions. To finance the resulting debt, the Federal Reserve is printing
money furiously. Because most every central bank governor appears
indoctrinated in the Keynesian economic philosophy, foreign central banks are
simultaneously printing euros, yen, francs, yuan,
and pounds to "keep up." Of course, this competitive devaluation
actually represents countries shooting themselves in the foot.
Don't expect any abrupt changes
either. The Fed's philosophy - a resolute faith in central planning and
debasement - has been unchanged since Paul Volcker stepped down as Chairman
in 1987.
Rather than considering any change of
direction, the Federal Reserve Board is likely asking itself: "Should we
print $50 billion or $500 billion in our next round of stimulus?"
"Can the ECB bailout Greece now or do we first need to bail out the ECB?"
"Should we call our money-printing'liquidity
assistance' or 'quantitative easing'?"Or
perhaps, "Do we have enough ink refills for all those printing
presses?"
You may think I'm joking, but this is
quite serious. While monetary policy was bad under Greenspan, Ben Bernanke
has literally instituted a revolutionary devaluation program for the dollar.
And gold is the only way to avoid his guillotine.
TRUE VALUE VS. SPOT PRICE
Let's remember that it is the
fundamental value of an asset which dictates its long-term market price. Yet
for some reason, many see this relationship backwards - they use the
short-term market price to extrapolate the fundamental value. Consider a car
on the dealer's lot: if the price of the car falls tomorrow, it becomes a
better deal. If the price rises tomorrow, the car has becomes less
attractive.
This principle is equally true in
long-term investments. I believe that gold's fundamental value is far higher
than $1,600, and far higher than $2,000. So, while it may be unsettling for
some of those who own gold to see steep short-term price declines, remember
to focus on the fundamental value of the asset, not the spot price on the
market today.
Has the fundamental value of gold
fallen in these past two weeks? Quite the opposite.
A DEBT-LADEN HOUSE OF CARDS
The Fed is still trying to find ways
to manipulate the bond market with the newly announced "Operation
Twist." This is yet another plan to suppress yields, encourage spending
(as if too little spending was America's problem), and paper-over the
untenable interest payments hanging over Washington. The manipulated US bond
market is perhaps the greatest bubble in existence. Further manipulation only
makes it more unstable in the long-term, and when that bubble bursts, gold
should skyrocket.
Meanwhile, the European debt crisis is
quickly spreading to Italy. On Sept. 28th, Italy was selling bonds
at yields twice as high as the previous sale at the beginning of the year.
The ECB may be able to keep Greece afloat, but Italy is the eurozone's third largest member. That's a load too heavy
for the ECB to bear.
This is especially true in the wake of
Moody's downgrade of two of the largest French banks - Societe
Generale and Credit Agricole.
As reported in the Wall Street Journal, "[Moody's] said its decision to
downgrade the banks included the assumption of debt restructuring that would
cost investors up to 60% on Greek sovereign debt, 50% on Portuguese and Irish
debts, 10% on Spanish debt and 7% on Italy's debt."
In other words, the Western financial
system is a debt-laden house of cards. This is the root of the current market
panic. But what's harder to explain is why investors are responding by
selling gold and buying dollars and euros. Then again, I was always told not
to look a gift horse in the mouth.
KEEP CALM AND CARRY ON
Do not get caught in the exuberance or
pessimism of short-term movements, even if they're sharp. Observe the
fundamentals - the events in Europe, the looming budget calamity in the US,
central bankers' steadfast strategy of debasement, and emerging markets'
continued diversification into precious metals. These are the main drivers
for gold's long-term appreciation.
To my readers who may have purchased
metals just before this pullback, your concern is understandable. But I
believe this bull market has a long way to run, and
the rise up ahead looks even steeper from these levels.
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