| |
|
Wall Street History
https://www.gofundme.com/s3h2w8
|
05/09/2003
Update: Gold
From time to time I like to deviate from the norm for this space
and supply you with a little update on gold, courtesy of my
friends at Van Eck Global. Back during my days in the mutual
fund industry, I worked closely with these fine folks and my
friends there have granted me permission to reprint some of the
thoughts from their portfolio management team.
Gold has been rallying again, recently, largely on continuing
weakness in the U.S. dollar, even as the Federal Reserve sends
out strong signals it is concerned with the prospects for deflation.
Counterintuitive, perhaps, but for more of an explanation we turn
to the guru of gold investing, John Van Eck, who issued the
following comments on May 1, 2003.
*For the record, I do NOT personally own any gold shares
myself at this time, nor am I going to purchase any in the
foreseeable future.
---
After the dollar price of gold peaked at $385 an ounce in
February, it began a correction which lasted until April 7 when
its price reached $321. Many investors unwound the risk-averse
and speculative positions they took before the Iraq war. At this
price it returned to the December breakout level from its six-year
“bottom.” It then began to strengthen and closed the month of
April at $339.10.
Gold-mining share prices broke above their twenty-one year bear
market trend last year as the general stock market and the U.S.
dollar declined. The Philadelphia Gold/Silver Stock Index
(XAU) climbed from 42 in October 2000 to 89 in May 2002, up
112%. It then began to consolidate this rapid move. After
reaching 62 in late March, it began to firm up and closed at 65.3
by the end of April.
Although there has been a short-term divergence in the price
performances of gold and gold mining shares, both have
established uptrends from the lows of February 2001 and
October 2000, respectively. Gold’s uptrend is approximately
14% annually, and the XAU’s uptrend is approximately 20%
annually. No one knows how long these trend rates will last, but,
in our view, both have begun new bull markets that will continue
for the foreseeable future. This update outlines some
macroeconomic reasons for this view.
---
Possibility of a Prolonged Low Growth Period:
A ‘Growth Recession’
Monetary Stimulation May Become Ineffective
After the stock market bubble burst in 2000, the Fed eased
monetary policy aggressively in order to avoid a recession.
During the past two years, it cut the fed funds target rate 5.25%
to below zero in real terms (ed. including the rate of inflation),
stimulating interest-sensitive borrowing and spending. The
political authorities hope for, and current market opinion expects,
a renewed cycle of business investment and debt expansion.
However, The World Bank in April stated, “A worrisome
characteristic of the current economic environment is that
macroeconomic policies may be running up against their limits.”
Credit expansion may gradually reach a “liquidity trap” and
become ineffective in stimulating borrowing, which could make
standard econometric model forecasts useless. Lower economic
growth may be inevitable in spite of equilibrium levels.
Remaining possible imbalances could include over-consumption,
over-capacity, low corporate profitability, excessive size of the
debt, record balance of payments deficits, and still relatively high
stock prices. Corporate profits may remain under competitive
pressures, and an upturn in investment demand may be delayed
longer than expected. Consumer demand may weaken.
Aggregate demand may remain less than potential. The rate of
growth of real disposable income may decline. Financial
problems may restrain spending and growth. The remaining
imbalances may inevitably contribute to an unintended period of
low growth until they are corrected. A low growth rate may be
under the rate needed to create enough jobs to match the growth
in the labor force; so unemployment may tend to rise. A period
of stagflation cannot be ruled out if low interest rates and rapid
liquidity creation result in higher inflationary expectations in the
future.
Weaker Consumer Demand: Vulnerability in the Housing
Market?
The growth rate of consumer spending and of household debt
formation may decline. Consumer demand has supported
economic growth, especially in the last two years. Consumption
has expanded from about 70% of GDP growth in the 1980s to
approximately 87% in 2002. The Fed’s relatively low interest
rates stimulated the growth of outstanding household debt which
has expanded from $1.4 trillion (72% of disposable income) at
the end of 1980 to $8.4 trillion (108% of disposable income) at
the end of 2002, up an average rate of 8.5% annually. Consumer
car and housing demand responded positively to recent low
interest rates. Median existing home prices have risen
approximately 38% in the last five years. Both regular mortgage
originations and refinancing of regular home mortgages made
all-time records in 2002, totaling over $4 trillion net of cash-outs,
possibly putting debt levels on depreciating assets into dangerous
territory and setting the stage for instability in the longer run.
Detailed IMF research shows that housing market busts regularly
follow booms of the scale recently experienced and have much
longer lasting negative effects on economic performance than
equity market downturns.
Federal Deficits May Prolong a Period of Low Growth
The Federal government’s budget surplus in fiscal 2001 slid into
a deficit of over 3% of GDP in fiscal 2002 and could approach
5% of GDP this year. State and local budgets also are incurring
huge deficits. Deficits normally add to aggregate demand in the
short-term, but they reduce the funds available for net domestic
investment and they may raise long-term interest rates. Thus,
they may raise the cost of capital and so limit growth. They and
“social” laws also may unintentionally tend to prevent a possibly
needed market adjustment of national labor compensation costs
to lower equilibrium levels and so to increase unemployment and
to decrease corporate profitability. These factors may tend to
delay renewed business expansion and to extend a period of sub-
par growth.
Summary
Interest in gold as an investment has slowly increased. If a
prolonged low growth period and its possible consequences of
increasing financial distress, bear markets and continuous
negative real yields materialize, investors could become more
risk-averse and seek to preserve their capital and to obtain a real
return. They could diversify more of their portfolios into cash
and gold as an alternative investment. Gold is a debt default
risk-free and currency devaluation risk-free monetary asset, and
has historically been a reliable long-term store of value in
periods of global monetary disorder. It has a low or negative
correlation with equity stock prices and so when added to an
investment portfolio could improve its performance.
Gold’s price may have renewed its historic long-term uptrend (as
fiat paper currencies were inevitably depreciated). If this trend is
accompanied by a “growth recession” and an increased
investment demand for gold, a rising price may offer gold-
oriented investors a real annual return. As gold prices rise and
investors gain confidence in gold’s uptrend, investment demand
could accelerate. Of course, gold’s price is volatile and erratic as
a result of shifts in short-term investor attitudes. Another
exponential upward move may eventually be under way, as
occurred in the 1970s.
---
Wall Street History will return next week.
Brian Trumbore
|
|
|
