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Trading Lessons

The End of the Gold Bull Market

Commodities / Gold and Silver 2010 May 19, 2010 - 03:47 PM GMT

By: David_Galland

Commodities

Best Financial Markets Analysis ArticleDavid Galland, Managing Director of Casey Research, interviews... David Galland.

Q. With gold and gold stocks on a tear, does Casey Research still recommend holding 1/3 of a portfolio in cash?


A. The answer depends, of course, on what country you are currently sitting in. Were I sitting in the eurozone, I would have already moved much of my safe-harbor cash into the "resource" currencies such as Canada and Norway... i.e., countries that are rich in the natural resources that the world needs and will always need.

If my derrière were resting in a seat planted on U.S. soil, as it is, and I didn't plan on doing any significant overseas spending, then I would feel relatively comfortable - for the time being, with a larger than usual allocation to the dollar. But I would have been diversifying into the resource currencies as well.

Q. Hold the fort, dude - how can you write frequently about the demise of the dollar and yet be "relatively comfortable" holding the stuff?

A. In a nutshell, the monetary inflation, quantitative easing, and insane spending of the U.S. government, emulated by countries around the globe, have set the table for a large serving of currency depreciation down the road.

Once that depreciation begins to appear in the form of price appreciation, we'll look to trade our greenbacks for more in the way of tangibles - probably more gold... maybe real estate in a good location, location, location... maybe more silver... maybe deep-value energy stocks... maybe antiques... maybe some of all of the above.

For the time being - because price inflation is not out of control and yields are so low - there is little real carrying cost to holding a larger allocation to cash, and the flexibility and security of having cash is a big plus.

Q. What about gold and gold stocks today?

A. Gold is sound money. Always has been, probably always will be. In the sort of crisis now underway - a crisis that to no small extent is now focused on sovereign fiscal and monetary excesses - gold has a particularly important role in protecting wealth.

If you don't own it, start accumulating it, preferably on the inevitable dips. If you do own it, hold it and consider accumulating it up to somewhere between 20% and 30% of your portfolio, though the exact amount will depend on factors such as your cash flow needs, personal debt obligations, your age and work status, etc., that we can have no way of knowing.

One of the nuances in answering this question has to do with deciding what form of gold to own. While we like physical gold held in a safe place, you don't want to go overboard, because things can happen. For instance, robbery, or even a house fire that melts your wealth back into the dirt.

In addition, at some point the gold bull market will end, and when it does, the scramble to sell will likely overwhelm the coin dealers to the point where they literally take their phones off the hook. That creates the potential for big gaps down in the price between the time you decide to sell and are actually able to sell. Mind you, I don't see that being a concern anytime soon - but it's always worth keeping in the back of your mind.

There are a number of other bullion alternatives - a big positive being that many are easy to buy, hold, and sell - including allocated and unallocated gold accounts, electronic gold, gold ETFs, and so forth. Some are better than others - and all are worth understanding before making investments. Our Casey's Gold & Resource Report is a good source for this sort of info.

Generally our recommendation is to hold your gold in a variety of investment vehicles as that will mitigate the risks of having too many eggs in one basket.

Turning to gold stocks, savvy investors will already be well positioned in the best of the best. And will own many positions risk-free, having already recaptured their original investment. If that is the situation you are in, and you really understand the companies you are invested in, then at this point either hanging in for the big upside or trading the surges and dips makes sense. If you are new to the sector, I wouldn't chase the stocks just now - but rather put in stink bids - i.e., 10% to 20% below the current market, and look to get filled on a correction.

If you are new to the gold stocks, or risk-averse, then look to build a portfolio of large-cap gold stocks such as we cover in Casey's Gold & Resource Report. Those will attract a lot of attention from the public at large, and from institutions, as the bull market gathers steam.

If you have experience with gold stocks, and a higher tolerance for risk, then you may want to focus on the small-cap Canadian explorers and developers. Those juniors have amazing volatility and, when the news is good, the upside can be breathtaking.

Regardless of the approach you take, don't chase stocks as they move higher - but look to build your portfolio on dips over the next few months.

The idea is to get positioned before the underlying price of gold reaches a level where the public starts to come into the sector in a big way - at which point, if history is any guide, the early investors will make stunning returns.

Q. At what price do the gold stocks catch fire?

A. Some years ago, we had someone spend the better part of a week in a musty storage room full of old Canadian newspapers, paging through past issues and recording the price and volumes of the gold stocks during the last big run-up, in the 1970s. We then compared that data to the gold price in inflation-adjusted dollars in order to determine the price when the broader investment public began piling into the gold. The number worked out to about $1,250 per ounce in today's dollars. In other words, when gold decisively takes out $1,250 an ounce and holds above that level, if history is a guide, we may start seeing the average guy on the street - and the institutions - pile into the stocks.

Of course, while interesting from an historical perspective, that analysis has no scientific basis. The key point, therefore, is that during the last big gold bull market the public wasn't involved in the gold stocks when they should have been - in the run-up phase - but rather only piled in after the price of gold bullion soared, relatively late in the bull market. So far, the average Joe and Jill are just not in this market. But they will be.

Q. How high do you think gold will rise?

A. At our recent Crisis & Opportunities Summit, an attendee asked how high we thought the dollar price of gold would reach in this bull market.

My response was that there really is no way of actually forecasting that number, for the simple reason that, in a fiat currency regime, the underlying unit of valuation is so intangible. Let's say you lived in Zimbabwe some years ago and owned an ounce of gold. One day your ounce might be worth 1,000 of the local currency units. A year later, it might be 1,000,000. Or even 10,000,000,000.

While the U.S. is no Zimbabwe - at least not yet - its currency is just as intangible, for the simple reason that the government can print the stuff pretty much at will. To say that gold will go to $5,000 in the current crisis is really just another way of saying that the dollar currency unit will fall by some significant degree. But, given the uncertainty in the economy and the unknown of what actions the government and the Fed might take next, we really can't know how much purchasing power the currency unit will lose in the months and years just ahead.

To date, the government has been extraordinarily - breathtakingly - willing to abuse the dollar. They have largely gotten away with it so far, but that certainly doesn't mean they will get away with it forever. When the time comes for the piper to be paid, we suspect he'll be paid pennies on the dollar... which could easily result in gold trading for $3,000, $5,000, $10,000 per ounce - but, who knows, maybe even $10,000,000,000.

The point is, given the choice between dollars and gold, you are far more likely to preserve your wealth over the duration of this crisis with gold.

Q. Is the gold bull market getting old? How much longer can it last?

A. Having been around and actively involved in hard assets - as the editor of "Gold Newsletter" and the conference director of the New Orleans Conference - during the last big gold bull, I hope I can provide some useful perspective.

For instance, I can well recall when, in late 1979, all of the many gurus of the day were predicting gold would keep going higher and higher still. Well, as we all know, it didn't.

What's interesting about this time around is that there is almost no scenario we can envision that is going to kick the legs out from under the gold market - at least not anytime soon. In contrast, in the late 1970s, the gold bulls coulda/shoulda seen that the Fed had a lot of room to act - i.e., by pushing up interest rates - in order to tackle the price inflation that was the key driving force in the soaring gold prices of the time.

Today, the situation is profoundly different. Starting with the fact that this is, at the core, a debt crisis. And the one thing you can't do in a debt crisis is to encourage interest rates to rise. Look no further than Greece for that lesson.

So, we have an unprecedented monetary inflation, truly out-of-control sovereign spending and debt, unprecedented levels of private debt, unprecedented trade deficits, a massively overbuilt and overpriced post-bubble real estate market, and, importantly, near historically low interest rates.

So, we have to ask ourselves - other than continuing to exercise its powers of fiat money creation - what ammunition does the government have at its disposal to address the structural problems of today's economy? And, of course, actually creating more money and more debt isn't addressing the structural problems, it is compounding them.

Of course, the government can default on their sovereign obligations - an option I think we'll see Greece and others of the PIIGS take, and probably fairly soon.

They can also continue to inflate, which we expect them all to do.

And they can... no, actually, I think that about sums it up: default or inflate. In either scenario, gold is going to be seen as the ultimate safe harbor.

Q. Won't the government see gold as a threat to its fiat currency and try to do something about it?

A. Of course, governments might try any number of stunts that could affect gold. For example, raising margin requirements to curb playing the markets with leverage, or even attempting outright confiscation.

All we can do is to monitor the situation closely and try to anticipate their next moves in order to get out of the way. A number of people I know have opened safety deposit accounts in other countries as one way to hedge their bets against confiscation. Others have bought numismatics - but be careful on that front, because that can increase illiquidity.

It is not out of the question, in my view, that before this is over, we could see a revaluation of gold in order to re-link the U.S. dollar to it - because sooner or later, as the crisis reaches its climax, something is going to replace the fiat currencies - but at this stage it's impossible to guess what that will look like. If we did see a return to a gold standard, then the government could actually be responsible for sending gold up by many multiples.

Back to the present, at this point I can't see anything that is going to derail this bull market - but I do see a whole lot of things with the potential to send it into the stratosphere.

Q. Thank you for your time.

A. My pleasure. Always happy to be of help.

Q. You're kind of strange, talking to yourself and everything. You know that, right?

A. Sometimes I wonder.

Europeans are starting to get the picture - many precious metals sellers in Europe are now finding themselves out of stock - but most Americans are still woefully clueless when it comes to the safe-haven value of gold. And timing can be most important. Read our FREE report How Do I Know When to Buy? Receive it here.

© 2010 Copyright Casey Research - All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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