US Currency in Circulation & Barron’s Gold Mining Index Part 3 of 3 (Continued)

Published: April 17, 2011

15 April 2010

This is the continuation of my Part 3 of 3 on Currency in Circulation series.

* * *

What drives the Barron’s Gold Mining Index (BGMI) up? The same force that drives it down: monetary inflation pumped in from the Federal Reserve, inflating a financial bubble somewhere in the economy. Initially, the Fed’s inflation flows into their targeted market: the real estate and/or the stock markets. Eventually a public mania develops as the bubble inflates to epic proportions, inspiring the general public to believe that everyone investing in the bubble is going to get rich! At first precious metals mining shares might rise slightly in sympathy, or actually decline as our “monetary policy makers” feed their latest bubble.

But inflationary bubbles don’t last forever. At some point in the cycle, the Fed’s “liquidity” stops flowing into the bubble, despite their best efforts to continue to inflate it. Eventually, the money the “policy makers” created to inflate the stock market begins retreating into the safety of precious metals, and the miners of precious metals. Rising consumer prices and falling financial asset valuations eventually create a panic in the economy, driving the BGMI to levels no one could have predicted a few years earlier. This has been the history of every Barron’s Gold Mining Index bull market since 1920, with the current bull market playing the part to perfection.

Here’s a chart of the Dow Jones Industrials, the BGMI & US Currency in Circulation (CinC). I’ve indexed the data to 1.00 = January 1920. Indexing data allows different data series to be displayed as a horse race, with the indexed 1.00 providing an honest starting line.

Since 1913, the Fed has been expanding the money supply (green plot). Nothing ever changes there. So, let’s look closely at the Dow Jones and the BGMI from 1982 to 2000, a period when the Fed’s inflationary dollars were freely flowing into financial assets such as stocks and bonds, as the BGMI deflated. But something changed since the year 2000. We know this because the BGMI bottomed in 2000, and began an 11 year bull market, a period of time that saw two major bear markets in the DJIA. For the third time since 1920, inflation is once again flowing into the BGMI, and just like in 1925 & 1957, a rising BGMI is a bad omen for the future of investments in financial assets.

One reason America is in so much trouble today is that we have been conditioned to rely on the advice of so called “financial industry investment experts” instead of analyzing the numbers and thinking for ourselves. These Wall Street shills currently have a poor opinion of gold mining shares. People idolize Warren Buffet, who sold off all his silver in 2006 at 1/7th of today’s price, and constantly goes on television saying how useless gold is. Since Jan 1, 2001 Buffet’s Berkshire A shares have returned 77%, while gold bullion has returned 424%, so Buffet is obviously no expert on gold.

The historical record shows that since 1920, the BGMI has outperformed the Dow Jones Industrials for years, or decades at a time:

1930-36
1965-80
2000-11

Sometimes the BGMI and Dow Jones trend together, but typically they are counter-cyclical to each other, as . As evident in my chart below, every gold-mining-share bull market has proved to be more profitable than the preceding bull market in financial assets. Currently, the 2000-11 bull market in the BGMI is a stealth bull market. Even after eleven years of solid gains, the financial media remains clueless of what is occurring to the valuations in the major gold mining companies. And financial advisors still feel some inexplicable obligation to warn wary investors away from large-cap gold and silver miners. I’m not aware of any other historical example where gold mining shares have seen a 590%, 10 year gain with little notice, or promotion by the financial industry. Gold, silver and mining shares received lots of attention in the 1970s, thirty years ago. But this is no reason to avoid gold stocks, as seeing significant gains in a widely ignored, and frequently denigrated stock sector is extremely bullish!

Long ago, inflation was measured by increases in the money supply. It has been known since John Law’s, Mississippi Scheme of the 18th Century that increases in the money supply (inflation) has effects on both asset valuations and consumer prices. But academics of the 20th century have been successful in confusing the public’s understanding of inflation. Those times when monetary inflation flowed into financial assets are now portrayed as “wealth creation,” and those times when monetary inflation flowed into consumer prices are blamed on the public’s “inflationary expectations.” Inflationary expectations arise when wage earners’ declining living standards forces the realization that the Consumer Price Index is a farce and they begin demanding wage increases greater than the US Department of Labor’s inflation calculations. Neither “wealth creation”, nor “inflationary expectations” are ever attributed to increases in the money supply by Keynesian economics.

I constructed the chart below using the same indexed weekly data seen in the chart above. However, this time the data for the BGMI (blue plot) and the DJIA (red plot) was divided by the CinC data (green plot). So the plots in the chart are ratios of the BGMI & DJIA to CinC, spanning the period from 1920 to 2011. Those times when the blue or red plots rest on the green 1.0 line, indicates those times when the value of the BGMI or the Dow Jones had inflated exactly as much as CinC since 1920.

Looking at the Dow Jones ratio to CinC (the best way to measure actual inflation adjusted gains and losses in the Dow), it becomes obvious that the only Dow Jones bull market of the past 90 years which delivered real gains for investors occurred during the 1920s. The Dow broke even with inflation (touching the 1.00 line below) for just two weeks in May of 1965, and even the Dow’s peak years of 2000 & 2007 failed to produce an inflation adjusted gain in constant 1920 dollars.

But since the US Government makes taxpayers compute their capital gains using nominal dollars, Uncle Sam taxes nominal gains from investments in the stock market; investments that actually produced inflationary losses for investors. But as is evident below, every BGMI bull market since 1920 has produced substantial inflation adjusted profits.

Let’s take a closer look at this chart, noting the three red triangles I placed just above the date line.

May 1925
Autumn 1957
April 2000

May 1925: The Federal Reserve and JP Morgan take inflationary actions that weaken the US dollar, in support of the British Pound, which was then having difficulty returning to the gold standard (see my first part of my part 3of3 in this series). As a result of these actions, a bull market is ignited in the American stock market, and the BGMI slowly increases in sympathy. An inflationary crisis strikes in October 1929 which forces the US Treasury to devalue the dollar from $20.67 to $35 per gold ounce in March 1934 (left red vertical line). The excess dollars created since 1925, flee the deflating financial markets and flow into the BGMI.

Autumn 1957: I could have also chosen the early 1950s, when the gap between paper and gold dollars began to increase, but I chose the autumn of 1957, when the run on the US gold reserves (the second gold run in 30 years) began in earnest.

Printing dollars in excess of gold reserves once again led to a bull market in the DJIA, but this time one that was greatly subdued in inflation adjusted terms. The inflation adjusted DJIA peaked in 1965 (see two charts above). But the irresponsible inflationary-monetary policy eventually led to the second US gold crisis of the 20th century (two charts up, right dashed red line), which ultimately led to the US Treasury taking the US dollar completely off the gold standard in August 1971. Look at the rising CinC plot (blue plot) in the chart above. From 1971 to the early 1980s, this monetary inflation not only drove up consumer prices and wages, but deflated the value of stocks and bonds, in both nominal and inflation adjusted terms. All bonds, including US Treasury Bonds earned the moniker “certificates of confiscation”. How could they not with:

soaring current bond yields,
collapsing bond prices
double digit, annual increases in consumer prices

Investing in fixed income will only come to tears when all this dominates the financial markets. But for the second time since 1920, the BGMI enjoyed a tremendous bull market from 1957 to 1980, thanks to the incompetence of the best and brightest on Wall Street, in Washington and in Academia.

April 2000: Market historians would have us believe that the Dow Jones has never seen a more impressive bull run than in the 18 year period from August 1982 to January 2000. But when the gains in the Dow Jones are adjusted for inflation (as measured by CinC, two charts up) it becomes evident that the inflation adjusted returns in the 1982-2000 Dow bull market were the worst of any bull since 1920. In May 1965, (for two weeks) the Dow managed to reach the Green inflationary break-even line. But the closest the 1982-00 Dow Jones “bull market” came to breaking even with inflation occurred in July 1999, when the inflation indexed Dow reached 0.87, a full 13% below its inflation breakeven point. The nominal Dow Jones Industrials Average may have continued increasing until January of 2000, but adjusted for inflation, the Dow Jones was increasing at a slower pace than Greenspan was increasing the number of dollars in circulation!

In January 2000 (a presidential election year), Doctor Greenspan’s bubble in the stock market popped, and as always, the good doctor was more than willing to flood the financial system with “LIQUIDITY.” But the flow of liquid cannot always be channeled to flow in the direction “policy” desires, but in September 1999, Washington was opened a wide new channel for Doctor Greenspan’s inflation to flow into, and did it ever! From the NY Times:

Fannie Mae Eases Credit To Aid Mortgage Lending

By STEVEN A. HOLMES
Published: September 30, 1999
“Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.”

- End NY Times Snippet-

Real estate valuations had been rising ever since 1982, but in September 1999, the Clinton administration opened a wide channel for Greenspan’s monetary inflation, this time to flood the single family mortgage market with 30 year, no money down credit. Ominously, seven months later the Barron’s Gold Mining Index reversed its 20 year decline, exactly as it had in 1925 & 1957, as the “policy makers” went to work devising ways of leveraging every square foot of private, residential property in the United States.

Looking back, the only Bull Market in stocks of the 20th century that produced actual gains above the rate of increase in CinC was the Roaring 20s bull market, the one bull market where investors could leverage their investment by 10:1.
That huge leverage was made possible by investors’ ability to tap the deep pockets of the new Federal Reserve system for margin loans. However, since 1929 investors have only been able to margin their stock investments by 2:1, and since 1929, bull markets in the DJIA have underperformed inflation.

But what do you think would have happened to the value of the Dow Jones in its post 1929 bull markets, had the US Government launched a new “policy” to increase the nation’s wealth by directing the Federal Reserve to provide no-money-down, $250,000 loans backed by the full faith and credit of the US Government, to stock market investors? I suspect we would have seen an epic period of “growth” and “wealth creation”, with the gains in the Dow Jones rising far above inflation adjusted gains of 1929 – for a while. Using the model I’ve created, (next chart down) to match the inflationary gains made in 1929, the Dow today would have to increase to over 99,000.

But 1929 was an inflationary bull market, where investors were able to borrow $9 inflationary dollars for every $1 of their own they brought to the stock market. But how high would the Dow Jones have soared during the Greenspan Fed era, had “policy makers” given away no-money-down, free money to speculate in stocks as they did in real estate from 2000 to 2008? Much higher than the 4.0 line in the chart below!

But this is all hypothetical. What is real is that Congress created an inflationary credit system that pumped tens-of-trillions-of-dollars of inflation into real estate I-O-Us, that caused US real estate to become grossly over-valued. Compounding their error, Congress gave Wall Street, under the advice of Doctor Greenspan, the OK to create an unregulated, hundred-trillion dollar interest rate derivative market to hedge the certainty of mass-defaults in the sub-prime mortgage market. These dollars were created, and targeted at the American real estate market, and in the process creating a huge asset market for American single family mortgages. Today, these real estate assets do not trade in open market, as no one wants them, so they now sit like indigestible hairballs in the guts of the global financial system. Unfortunately these hairballs now constitute a significant percentage of the “assets” sitting on the world’s balance sheets.

One way or the other, the day is coming when these hairballs are going to pass from the financial system. Most of the dollars created by the Federal Reserve to finance Congress’s mortgage bubble, currently masquerading as assets, will eventually be written off as losses. Those interest bearing assets not written off will only find willing buyers if deeply discounted. This cleansing of the world’s balance sheets has yet to start. But when it finally does begin, no matter how high interest rates rise, no fixed income instrument will be able to compete for investment funds with the rapidly inflating BGMI.

This proved to be the case during the 1930s, when Dow Jones actually published a Defaulted Rail-Road 10-Bond Average, which proved to be no competition to Homestake Mining. In Wigmore’s: “The Crash and its Aftermath” tables A.7-11, listing Moody’s bond ratings for rail-road, utility, industrial, municipal and foreign bonds, we see the Great Depression had a way of reducing a Moody’s 1929 Aaa bond (best grade) into something completely different! So yes, interest rates in general didn’t increase drastically during the Great Depression, but most bond yields rose, and bond prices fell as credit conditions deteriorated.

There was no Great Depression from 1957 to 1980, but interest rates, both short and long term soared into double-digits territory, not so much from the bond market demanding a default premium (business was good), but on fears of inflationary increases in consumer prices.

From 1957-80, rising interest rates proved to be no barrier to rising gold, silver and mining share valuations when the smart money moved from financial assets into assets backed by precious metals. Interest rates were rising because bond prices were plunging as they sold off. From 1957 to 1980, the BGMI saw a gain of 3800% * ON * rising interest rates. The decline in gold shares didn’t really start until interest rates peaked in 1982, leading to a crash of 82% for the BGMI by the time it hit bottom in 2000.

Next time someone in the financial media suggests that rising interest rates are somehow going to dampen our current bull market in gold, silver and the mining shares, here’s something to consider: The BGMI went up in the 1930s because of default concerns in financial assets. From 1957-80, the BGMI increased by 38 times due to consumer price inflation, despite the steepest rise in interest rates in US history. But the current bull market in the BGMI has both credit default * AND *and inflating consumer prices (declining dollar) concerns driving it upwards.

Concerns of rising interest rates? I spit on them!

If past bull markets in the BGMI were proportional to the levels of monetary mayhem created by the US Government, and this appears to be the case, then this bull market in gold & silver mining shares should prove to be the most profitable since 1920. And the action in the junior miners and mineral exploration shares might just put the BGMI to shame!

Mark J. Lundeen
Marklundeen2@Comcast.net
15 April 2011

Article Title	Source	Last Comment Date
US Currency in Circulation & Barron’s Gold Mining Index Part 3 of 3 0 comments	Mark Lundeen	April 09, 2011
US Currency in Circulation & US Gold Reserves: Part 2 of 3 0 comments	Mark Lundeen	March 27, 2011
US Currency in Circulation & the Price of Gold & Silver: Part 1 of 3 0 comments	Mark Lundeen	March 14, 2011
Bear Market Race to the Bottom: Week 98 - Barron’s Gold Mining Index & the DJIA 0 comments	Mark Lundeen	August 29, 2009
Barron's Gold Mining Index Hits New All Time High 0 comments	Mark Lundeen	June 13, 2009

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US Currency in Circulation & Barron’s Gold Mining Index Part 3 of 3 (Continued)

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