Mark J. Lundeen
07 January 2011
* Author’s Note 07 Jan 2011: 10PM *
I’m starting with a late Friday addendum to my article below. I’m not going to do a rewrite to fit the following short comments into the body of the text, but I want to comment on Gold & Silver’s Bear’s Eye View Charts for the week. The talking-heads on CNBC, for the most, part were greatly concerned by the “crashing” price of gold this week. My Bear’s Eye View Chart (BEV), with its emphasis on all-time highs (BEV Zeros), and percentage declines from last all-time highs tells a completely different story.
Gold has declined less than 4% from its last BEV Zero (last all-time high), seen just this Monday.
Silver has fallen only 7.5% from its last 30 year high, also seen on Monday 03 Jan.
So far the action gold and silver saw this week is completely normal for a bull market and in no way deserves the hysterical comments expressed by so many TV “experts” in the gold markets. I’m not saying the closing prices for the week are the lows for the move, they could go much lower. I am saying that based on what we saw Friday 07 Jan, there is no logical basis to shout “crash” on TV unless you are attempting to start a selling stampede in the gold and silver markets. My investment tip for the week is: if after watching television you feel like selling your gold and silver: stop watching TV.
* End Gold & Silver BEV Comments / Start my latest article. *
For the past eleven years, the financial media has touted the virtues of Wall Street’s slowly aging soiled doves. Little is made of the major bull market in precious metals that’s been raging for the past ten years. Using the Dow Jones Industrials and the NASDAQ Composite as proxies for the stock market, and Barron’s Gold Mining Index (BGMI) & the XAU for precious metals miners, the chart below displays the profits investors have lost listening to the “advice” by the main-stream financial media for the past decade.
Gold, and the Gold Mining Indices have all gone on to new all-time highs since their 2008 credit-crisis plunge, with silver in striking range of its old 1980 high of $50. The Dow Jones Industrials has just last week exceeded its highs of 2000, but is still 18% below its highs of October 2007. The NASDAQ Composite has performed miserably since 2000. It’s currently 6% below its highs of October 2007, and 47% below its highs of March 2000. But the benchmarks of 2000 are getting stale. So let’s take a look at how the precious metals and a sample of major stock-market indexes have performed in 2010, relative to the highs and lows of 2007-09. Not surprisingly, silver leads the list from the lows of the credit crisis.
Relative Performance of Precious Metals and the Stock Market
from the Credit Crisis to End of 2010
DeclinesBounce Back from Credit Crisis LowsSilver 20.698.7930.91-57.51%251.65%* BGMI1,528.87464.111,624.69-69.64%250.07%* XAU206.3770.86226.58-65.66%219.76%NYSE Financial9,982.832,110.684,958.62-78.86%134.93%NASDAQ2,859.121,268.642,652.87-55.63%109.11%Gold1,003.20704.901,421.10-29.73%101.60%NYSE Comp10,311.614,226.317,964.02-59.01%88.44%Dow Jones INDU14,164.536,547.0511,577.51-53.78%76.84%* Based on Weekly Closing Prices, all Other Prices are Daily.
Precious Metals and Mining Shares (BGMI & XAU) Peaked in Late 1st Quarter of 2008, and Bottomed in December 2008. Stock Market Indexes Peaked in 4th Quarter 2007 and Bottomed in March 2009.
Graphic by Mark J. Lundeen
With the exemption of gold itself, precious metal assets have exceeded by a good measure, the returns seen in the stock market since their lows of 2008-09. In fact gold, silver and the BGMI & XAU have all exceeded their pre credit-crisis highs, while the major stock indexes in the table above have yet to do so. As we were reminded constantly by CNBC during the 1990s high-tech bull market, two bull-market hallmarks are upward momentum, and the ability to recover from declines. For the past decade, these hallmarks have taken on a golden aura.
Washington’s worst kept secret has been that the financial markets are supported by the Federal Reserve and the US Treasury, via their agents on Wall Street, with hundreds of billions of dollars of pure inflation. Yet with this gale-force wind to its back, the general stock market has been unable to outperform precious metal assets. This is an ill-omen for the stock market, and a huge plus for precious metals.
The problem “policy makers” always come to in an inflationary financial system, is that the flows of “liquidity” don’t always go where they desire it to go. In this case, the Fed’s “liquidity” isn’t puddling under the stock market as they would have it, raising valuations in stocks both large and small. But since 1913 this sometime happen, when the consequences of uncontrollable money flows benefits the commodity markets, and increases the price of consumer goods, not the valuations in financial assets.
Prices trends aren’t based on “monetary science”, as Doctor Bernanke would have us all believe, but on what fickled people do with the inflationary dollars Doc B creates with a few simple keystrokes on his computer. This is why investors, over time, have always had a love / hate relationship with their investments: because deep in the monetary water-table, “liquidity” is constantly flowing from one aquifer to another, turning once rock solid positions into quicksand, and trash into cash.
Gold mining shares were an excellent 20th century proxy for gold during a time when the price of gold was fixed by the US Government. That changed in 1968, when gold was finally allowed to float. Washington had no choice, as central banks were taking the Fed’s inflationary dollars, and returning them to the US Treasury, demanding gold for them at a $35 paper dollar to 1 ounce US Treasury gold rate.
The problem was that the Fed had created many more paper dollars than the US Treasury had gold to redeem them. With gold’s official price set by the 1945 Bretton Woods Monetary Accords of $35 paper dollars for each one ounce of gold held in deposit at the US Treasury, gold at $35 paper dollars became a legal fiction that could no longer be maintained in 1968.
Paper Dollar Inflation 1945 to 2011
US Dollars to One Ounce of US Gold
Event MilestoneYearDollars per One Ounce US Gold ReserveStart of Bretton Woods1945 $39.00 : 1Start of London Gold Pool1961 $64.97 : 1Kennedy Assassination1963 $81.42 : 1End of London Gold Pool1968 $135.01 : 1US Closed Gold Window1971 $198.82 : 1Barron’s 03 January 2011 Issue2011 $3761.60 : 1
The Bretton Wood’s Monetary Accords instituted a $35 Dollar an ounce Gold Standard. This Standard was to prevent the United States from Printing more than $35 Paper Dollars for Every Ounce of Gold it Held in the US Treasury. History shows that the US Never took the BWA’s $35 / 1 Ounce of Gold Standard Seriously. This is the Root Cause of today’s Current Debt Crises.
Graphic by Mark J Lundeen
A fact largely forgotten today, is that there was a run * on * the US Treasury’s gold reserves from 1958 to 71; and then a run * from * the US dollar into gold from 1971 to 1980. This is exactly what the smart money has been doing since 2001, running away from dollar assets, seeking safety in gold, silver and mining shares. The current trend of appreciating precious metals and mining shares will continue building momentum as the Federal Reserve, and US Treasury continues with their quantitative-easing program. This makes investing in gold, silver and mining shares possibly the safest, and highest returning investment opportunity investors in 2011 will see in their lifetime.
We can see the shifting flows of “liquidity” since January 1920 by plotting the weekly values of the:
the Barron’s Gold Mining Index (BGMI)
the Dow Jones Industrials (DJIA)
and Currency in Circulation (CinC)
Using the BGMI as a proxy for consumer prices, and the DJIA for a proxy of financial assets in the chart below, we get an excellent picture of these oscillations of “liquidity” flowing from financial assets into consumer prices, and then from consumer prices back into financial assets. Note how the creation of dollars (monetary inflation from the Federal Reserve) is the one constant in the economy. Where these inflationary dollars are flowing to, is clearly seen in the price action of the DJIA and the BGMI.
In the chart above, note how rising CinC, (the number of US paper dollars issued by the United States) drives the values of the DJIA and BGMI. The CinC plot reminds me of a moving average, where financial assets underperformed gold mining for decades. Sometimes the DJIA and the BGMI rise and fall together, but typically they have been counter-cyclical to each other for the past 90 years.
So the rising CinC green plot above not only explains why in 2011, gold no longer trades for $20.67 an ounce (as it did in 1920), but also why my little house, which cost $500 to build in 1910, saw a market valuation of $150,000 in 2007! There is no doubt about it, if investors don’t understand that price trends (both up & down) in the financial and commodity markets are driven by uncontrollable oscillations of inflation, flowing from the Federal Reserve, they cannot be successful in the markets over the longer term. As the current flow of inflation is away from financial assets (stocks and bonds), and towards commodities which includes gold & silver, we should all position our portfolios accordingly.
My next chart uses the same data as the chart above, but the plots are ratios using CinC as the divisor:
DJIA / CinC
BGMI / CinC
The plots below takes into consideration the effects of CinC inflation on market valuations. The Green line indicates when either the DJIA or the BGMI has been inflated as much as CinC itself, which in Barron’s 03 Jan 2011 issue is 219, meaning that there are 219, 2011 paper dollars in circulation for every 1 paper dollar circulating in 1920. The best way to understand the plots below are as follows:
Under the Green Line: Asset has returned an inflationary loss
At the Green Line: Asset broken even to its 1920 valuation
Above the Green Line: Asset has delivered a real inflation adjusted profit
Of course whether an investor makes a real inflation adjusted profit on these oscillations depends on when they take a position. Purchasing on a rising uptrend is the key. In 1982, investors in the DJIA (red plot) did see real gains in the Dow up to 2000. We know that as the DJIA’s red plot was rising slightly towards the CinC’s green 1920 break even line, even though the Dow failed to break above it. The red plot also tells us that even if in December 2010, when the DJIA finally exceeded its highs of 2000, investors in the large blue-chip stocks (as measured by the DJIA), actually took a 44% inflationary loss in purchasing power.
These are real losses. Look at the issue price of Barron’s and the cost of first class postage. In January 2000 an issue of Barron’s cost $3.50, and a first class stamp cost $0.33; today they’ll go for $5.00 and $0.44. These are price increases of 42.8% and 33.3% respectively. Rising prices for food, fuel, and yes gold, silver and mining shares have been largely unreported facts of life since the DJIA’s 2000 top. Doubt what you see below at your own peril.
So you see why I like using CinC as a deflator. CPI is just a bad joke government economists and statisticians play on the gullible American who actually watch CNBC with the volume turned up. Critically, until 2008, CinC went up in lockstep fashion with the Federal Reserves balance sheet. So CinC has actually tracked “monetary policy” since the late 1930s.
However after Doctor Bernanke’s QE1, the Earth no longer produces sufficient cotton to allow the BEP’s monetary printing presses to match the dollars gushing out by the trillions from the Doc’s hard drive. That’s a joke on my part – I hope. Still, the growing production of paper dollars spilling off the BEP’s printing presses is as good an inflation index as can be expected.
From a CinC perspective, the last Dow Jones Industrials’ bull market that produced real after-inflation returns was during the Roaring 20s. Since then, inflation has made non-sense of the dollar price of the DJIA. For example, using the actual price of the DJIA, it went from 92.92 on 28 April 1942 to 193.16 on 15 June 1948, a nice 100% gain; until you look at the DJIA in inflation adjusted terms. From a purchasing power perspective, the Dow actually declined from 0.33 on 28 April 1942 to 0.29 on 15 June 1948. An actual inflation adjusted loss of 13%.
But the IRS’s capital gains policy has always insisted that investors calculate their taxes with nominal dollars. For reasons that should be clear to you now, a dollar to Washington is no different in 2011 than it was in 1920. So since 1929, investors have frequently paid capital gains taxes on actual inflationary losses they’ve taken on their wealth. The reinvestment of dividends may have made a difference, but dividends are taxed as ordinary income, and the income tax laws are so complex, with so many different tax rates that change from year to year, sometimes up to 70% for wealthy individuals; that a simple model for a typical tax payer is impossible to derive. But with or without dividends, it’s fair to say that since 1937 the returns from investing in blue chip stocks have mostly failed to compensate investors for the inflationary losses resulting from the Federal Reserve’s “monetary policy.”
Unsurprisingly when one really considers what has happened since the creation of the Federal Reserve in 1913, the Barron’s Gold Mining Index has frequently proven to be a superior investment to the Dow Jones Industrials for the past 91 years. This is a historical fact recorded with ink on paper, on the pages of dusty old news papers from many decades ago. That this is not widely known says a lot about the ship-shod research produced by Wall Street analysts, and targeted at retail investors from financial news sources such as CNBC. We should expect our current cycle of rising consumer-prices and deflating financial assets, will once again drive the BGMI high above the CinC’s 1920 break-even line sometime in the not too distant future, and stay there for quite some time.
I’m going to close this article with a look at how a broad range of stock groups from the Dow Jones Total Market Groups (DJTMG), various commodity prices, and monetary & inflation indices have performed in 2010. I took this Data from Barron’s first and last issues of 2010. Here is the color key:
DJTMG ———————————————: Yellow & Grey
Metals and Miners ——————————–: Black
Major Stock Market Indices ———————: Green
Inflation and Washington’s Disinformation —: Red
Strangely, aluminum mining is last on the list. I don’t know why, or care.
Investment returns for 2010
From Barron’s First and Last Issue of 2010
Category% Chg1CLOTHING FABRICS122.08%
51GAS UTIL16.94%2SILVER One Ounce73.64%
52CONSUMER NON CYCLS IDX16.63%3CASINOS71.55%
53ENERGY IDX16.48%4AUTOMOBILE MANUF64.02%
54INSUR PROP & CAS16.36%5AUTOMOBILE PARTS56.18%
56POLLUTION CONTROL15.77%7NON-FERROUS MINING47.12%
57RETAIL BROADLINE15.25%8RECREATIONAL PRODUCTS38.94%
60NATL DEBT14.61%11RETAIL SPECIALTY32.83%
64OIL DRILLING14.04%15XAU (Precious Metals)31.51%
65RUSSELL 100013.79%16BGMI (Precious Metals)30.83%
69MARINE XPORT12.14%20OFFICE EQUIPMENT29.13%
70TECHNOLOGY IDX11.80%21BASIC MATERIALS IDX28.42%
72FOOD RETAILERS11.47%23CRB INDEX27.60%
73SOFTWARE11.42%24DJ PRECIOUS METALS MN27.46%
74DJIA10.98%25COPPER One Pound27.25%
75PHONE COMPANIES10.88%26HEAVY CONST27.25%
76TELECOMMS IDX10.71%27RUSSELL 200026.15%
77RETAIL DRUG BASED10.55%28AIR FREIGHT25.21%
82BIOTECH8.48%33GOLD One Ounce24.81%
84DJ BOND INDEX7.77%35INSURANCE LIFE24.41%
85PAPER PRODUCTS6.28%36WIRELESS PHONES24.28%
87MEDICAL SUPPLIES5.43%38INSURANCE FULL LINE23.67%
88UTILITIES IDX3.61%39INDUSTRIALS IDX23.64%
89HEALTH CARE IDX3.21%40DIGITAL HARDWARE23.11%
90COSMETICS2.85%41CONSUMER CYCLICAL IDX22.48%
91ADV MEDICAL DEVICES2.31%42RETAIL APPAREL21.67%
93COMMUNICATION TECH1.91%44AEROSPACE & DEFENSE20.35%
97HOME CONSTRUCTION0.14%48HOUSE PRDS DUR18.77%
98CONSUMER SERVICES0.01%49WATER UTIL18.28%
100ALUMINUM MINING-3.74%2010 was a Good Year for Investors. It was hard finding an Investment that didn’t return an above Inflation Profit. But as a Class, Metals and Mining were at the Top of this List!
Graphic by Mark J. Lundeen
If my standard for real above inflation gains is for appreciation higher than that of CinC, (item #86 in the table), 2010 was a generous year for the 87 items that gained more than CinC. But I do note that metal prices and mining shares (black items), with the exemption of aluminum, are all in the top 1/3 in the table above. I expect these same investments in metals and mining will do even better in 2011, but I don’t care to risk my reputation saying something positive for the financials and high-tech issues.
Mark J. Lundeen
07 January 2011