Phase Three

Gold primed to be ‘mania asset’
Gold is exhibiting all the classic signs of being in a structural bull market. On fears of inflation in early 2008, it rallied. Then, on fears of deflation in late 2008, it rallied again.

So does gold perform better during inflation or deflation?

In our view, that question is the wrong starting point. On the contrary, the rationale for owning gold, as it once again approaches the $1,000 an ounce level, is the prospect of mounting monetary disorder.

The US Federal Reserve, having flooded the market with liquidity by more than doubling its balance sheet in less than six months, may be unable or unwilling to withdraw it in time for fear of precipitating a secondary relapse in economic activity. Other central bankers will also face intense pressures to “support” their domestic economy by weakening the currency, leading to competitive currency devaluations.

The race to the bottom in fiat currencies has begun and hard assets, particularly gold and silver, should be the primary beneficiaries.

Gold is a prime candidate to become a “mania asset” once its demand becomes chiefly financially driven as opposed to jewellery and/or industrial demand driven where its upside could be capped by “sticker shock”.
http://www.ft.com/cms/s/0/eff64394-fdd7-11dd-932e-000077b07658.html?nclick_check=1

GOLD DEMAND PUSHES THROUGH $US100 BILLION BARRIER AS
INVESTORS TURN TO RECOGNISED STORE OF VALUE
[World Gold Council Report]
Sustained investor interest in gold over the course of 2008 against a backdrop of the worst year on record for global stock markets and many other asset classes, helped push dollar demand for the safe haven asset to $102bn, a 29% increase on year earlier levels. According to World Gold Council’s (“WGC”) Gold Demand Trends, identifiable gold demand in tonnage terms rose 4% on previous year levels to 3,659 tonnes.

As shares on stock markets around the world lost an estimated $14 trillion in value, identifiable investment demand for gold, which incorporates exchange traded funds (ETFs) and bars and coins, was 64% higher in 2008 than in 2007, equivalent to an additional inflow of $US15bn. Over the year as a whole, the gold price averaged $872, up 25% from $695 in 2007.

The most striking trend across the year was the reawakening of investor interest in the holding of physical gold. Demand for bars and coins rose 87% over the year with shortages reported across many parts of the globe.
http://media.ft.com/cms/0a5e5a50-fdb5-11dd-932e-000077b07658.pdf

In March 2007, Richard Russel a confessed "Gold Bug" discussed Gold and Bull Markets:

There are four kinds of gold or non-gold people (1) They know nothing about gold and never even think to ask. (2) They know a little about gold, but can't afford to buy any. (3) They trade small amounts of gold, but as soon as gold moves up or down 5 dollars or more, they sell it or are stopped out. (4) the so-called "gold bugs," the small minority who understand gold and money and adhere to a policy of accumulating gold.

The great majority of investors don't understand bull markets or the concept of the primary trend. When the primary trend of an item turns up -- whether it be stocks, commodities, agriculturals, precious metals -- we call that a bull market. There are small, medium and large bull markets. Once the primary trend of a category turns bullish, there's no way of knowing beforehand, how big the coming bull market is fated to be -- nor exactly what path the bull market will take.

We do know that in major bull markets there are psychological or sentiment phases. The first phase of a bull market is the accumulation phase. This is the early phase where informed investors accumulate an item because they know the item is underpriced or that the item is underused or simply not understood.

The second phase of a bull market, usually the longest phase, sees the professionals, the funds, the big money, the smartest of the public, taking positions in the item. The second phase tends to be characterized by many reactions, corrections, adverse news events that cause the public to dump the item.

The third phase of a bull market is the speculative phase, Here we see rising volume, the wholesale entrance of the public, accompanied by news and endless hype by the Wall Street "experts." People who wouldn't touch the item during the first and second phases, are now enthusiastic buyers. The third phase sees systematic distribution by the early first phase buyers. Third phase buying can easily turn to hysteria and madness. Towards the end of the third phase, we see hints of the beginning of the next primary bear market.

In The Beginning

Today's Bull Market in Gold began in 1999 with Gold at around $250. Left for dead, this "barbarous relic" began to gain attention as the Y2K fears swirled around the globe. Gold rose briefly over $300 as the turn of the century neared. After the 21st century arrived without incident or financial calamity, Gold drifted back down towards $250, and investors continued the Bull Market ride they were enjoying in the equity markets. Little did they know how close they were to the end of that ride.

The great Bull Market in equities began in the Spring of 1982, roughly two years after Gold peaked at $880 in a mania driven blow-off top. Gold had risen through the 70s from $35 an ounce to $880 after President Richard Nixon closed the "gold window" and effectively defaulted on the US Government's debt to the World. Closing this gold window ended the redemption of US Dollars by foreign nations for Gold at the US Treasury. The world was essentially full of "worthless Dollars" and rampant inflation ensued as the Fed continued printing more of them.

The Bull Market in Gold topped when new Fed Chairman, Paul Volcker, in 1979 stepped into the inflationary storm with massive rate hikes to knock the wind out of inflation. Interest rates peaked in the Fall of 1981 with the 10-year Treasury yielding 15.84%. This top in the bond markets, and the Reagan Revolution gave investors incentive to step back into the stock markets, and forsake Gold. Informed investors and contrarians began to "accumulate" stocks on the cheap. With the re-election Of President Reagan in the Fall of 1984, stocks became THE place to invest. Gold was kicked to the curb, and the "smart money" [the professional money mangers] swarmed into the equity markets.

The ensuing rally in equities soon morphed into the "Bull Market" that led investors to believe that stocks, like real estate, only go up. "This time was different." A mania in stocks ensued. By the Spring of 2000, the Bull Market in Stocks was 18 years old. There were few investors in stocks at this point that had ever experienced a Bear Market. When stocks peaked in the Spring of 2000, investors were too busy reveling in the New Century to notice the dangerous position they were in. "Irrational Exuberance" wasn't just an observation, it was a warning.

From Wikipedia:

"Irrational exuberance" is a phrase used by former Federal Reserve Board Chairman Alan Greenspan in a speech given at the American Enterprise Institute during the stock market boom of the 1990s. The phrase was interpreted by financial pundits as a typically cryptic warning that the market might be overvalued.

Greenspan's comment was made on December 5, 1996 (emphasis added in excerpt):

“ [...] Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade? [...] ”

Gold Wakes From The Dead

As the equity markets topped and rolled over in the Spring of 2000, fears of recession began to spread through the economy and Wall Street. As the equity market losses began to accelerate, White Knight Fed Chairman Alan Greenspan rushed to the rescue with interest rate cuts in the hopes of averting a "crash" in the markets prior to the Presidential elections coming up in the Fall. These interest rate cuts were largely ignored by the equity markets but made a huge impression on the currency markets. In September of 2000 the US Dollar peaked at its all-time high. 0.8228 versus the Euro. Gold Bugs across the globe took notice.

By the Spring of 2001, Gold prices had again bottomed at around $250. The Equity markets appeared in free fall, continued cuts in interest rates by the Fed were having little effect on stemming the bleeding on Wall Street, and the economy was rapidly slowing down. And then came the blow that kick started the heart of Gold. September 11, 2001.

911 was a national tragedy of epic proportions. Few recognized it as the knockout punch, the death blow, for the US Dollar that it was. Osama Bin Laden was, and is an evil man, but he wasn't stupid. He knew exactly what he was doing when he took down the Twin Towers of The World Trade Center. The Twin Towers were a symbol to the World of Western wealth. A wealth that revolved around the US Dollar, and the hegemony that came with it. He understood that the "real" strength of the US was it's control of the World's reserve currency, the US Dollar. Destroy the Dollar, and you could destroy the USA. There was not a military force on the planet that could challenge the US Military, but destroy the pillar of strength upon which it was built, and you could bring America to her knees. The War On Terror is less about fighting dirty men in robes standing in the shadows, and more about saving the US Dollar from certain death. Osama Bin Laden is not the enemy, The US Federal Reserve is. Bin Laden did little more than destroy the curtain the criminals at The US Federal Reserve have hidden behind since it's unconstitutional inception in 1913. The real enemy is sitting right there in Washington, DC. But that is a story for another day...

As the Financial Markets reopened following the 911 attack, Gold stirred to life. Prior to 911, with equity markets falling along with interest rates, contrarians and informed investors had begun taking an interest in Gold having noted an apparent top in the US Dollar. They had begun to accumulate Gold on the cheap in anticipation of further downside in both the equity markets and interest rates. A confirmed top in the Dollar could signal inflationary pressures down the road, and Gold seemed a logical hedge. The Twin Towers attacks in September 2001 had the effect of kicking the equity markets while they were down, and losses there accelerated quickly. The White Knight Fed Chairman Alan Greenspan, determined to stem the bleeding in the economy, and on Wall Street, began slashing interest rates, eventually lowering them to 1% by the Fall of 2002 from their highs above 6% in the Spring of 2000. Gold Bugs took notice and began to accelerate their purchase of Gold on the cheap. Gold slowly crept higher and was around $325 by the Fall of 2002.

The Gold Bugs were relentless in the accumulation of their Precious Metal. As informed investors within the mainstream "investment community" joined them, Gold climbed towards $400. Between the Fall of 2002 and the Fall of 2004, Gold stealthily rose to peak at $450. The Gold bugs were ecstatic. They had watched from the sidelines as their Precious Metal rose in price by 80%, and nobody seemed to notice.

By the Fall of 2004, the equity markets had rallied from the 2002 lows, the economy had shaken off the throws of a "mild" recession, and the White Knight Fed Chairman Alan Greenspan began to observe an addiction to the punch he had spiked with 1% interest rates two years earlier. He decided to raise them. The Dollar quickly began to rise, and Gold was put in check at $450. The equity markets stumbled a bit at first, but then decided to move forward, they were "printing money on Wall Street". America was in the throes of a "housing boom", new highs in equities were just around the corner!

2005 arrived with Gold prices firm between $415 and $460. Gold prices remained steady in that range thru the first three quarters of the year despite a 15% rise in the US Dollar. Gold Bugs and their growing cadre of informed investors continued to accumulate their Precious Metal. It did not go unnoticed by these savvy investors that as the US Dollar rose and currencies around the globe fell, the price of Gold rose dramatically in a number of foreign currencies, breaking out to new highs in many of the major ones. In 2005, the price of Gold rose 35% in Euro, and 36% in Yen. Gold was sending an important message to investors around the globe. Few were listening.

By the Fall of 2005, fears of a resumption of the bear market in equities, a slide in the US dollar, and a credit squeeze that could deflate the world economy began to sprout. In the US, a slowdown in housing was just beginning to materialize, and the pace of consumer spending was being called into question. The week of September 11, 2005, almost four years to the day of the Twin Towers attack, Gold closed above its 2004 high at $460.40. The talk of "credit derivatives" was beginning to appear in the financial media:

Dealers Vow to Enforce Tougher Rules in CDS Market
Thursday, September 15, 2005
NEW YORK -- Fourteen credit derivative dealers met with the New York Federal Reserve Bank on Thursday and vowed to police the booming market themselves to keep regulators from doing it, a meeting participant said.

At issue were lags in the processing of trades and delays in informing involved parties when contracts change hands, which regulators believe has the potential to throw the market into confusion if it comes under stress.

Delays in processing trades could lead to disputes over payments in the event of a default, as well as confusion over the amount of exposure banks have to counterparties.

The Fed is concerned that delays in communicating to involved parties when contracts change hands could spill into systemic problems in the global financial system."

Industry participants outlined a number of concrete steps," to address the back office issues, the Fed said after the meeting. "The Federal Reserve and other members of the supervisory community will continue to monitor developments in this market very closely."

Then in the week of November 27, 2005, Gold crossed the Rubicon, and closed above $500 for the first time in 24 years. In the span of just 90 days, the price of gold had increased 25%, from around $440 to $550. In contrast, it had taken three years from its bear market low in 1999 for gold to sustain a 25% rise. The shrinkage of time from three years to 90 days to muster a 25% move signified that the gold market was evolving. The end of Phase One of this secular Bull Market in Gold had arrived at this time.

Phase Two in the Gold Market wasted little time getting started. By the Spring of 2006, Gold prices had rocketed above $700, peaking at $730 the week of May 7, 2006. By this time the Fed was getting serious about raising interest rates to support the floundering US Dollar. Between March 28 and June 29, 2006, the Fed raised interest rates 75 basis points to 6.25% and threatened to raise them further. Gold was, technically, significantly overbought at this point in time, and the first major correction in Gold's Bull Market occurred. This correction in price was most unwelcome by the now fast growing Gold community, and confirmed that Gold had indeed entered Phase Two of it's secular Bull market.

Massive corrections and high volatility in the Gold Market followed for the next 18 months as the Fed held interest rates steady at 6.25%. Gold traded in a wide range between $550 and $650 for the balance of 2006. But then, late in February 2007, a major turning point in the financial markets arrived. The US Housing market topped out. News of a top in the Housing market sent fear rippling up and down Wall Street. Gold broke from it's seemingly endless trading range and began trading in a higher and tighter trading range between $650 and $700. Gold Bugs again stepped forward in anticipation of a reawakening of the now slumber Gold Market Bull. A new accumulation of Gold was begun by the ever growing Gold Community.

In July of 2007, news broke that two hedge funds at Bear Stearns were on the verge of collapse. Both had investments in the subprime housing markets. Rumors that the two hedge funds mothership, Bear Stearns may be in financial trouble if these two hedge funds are allowed to fold. The market senses the fear, and so does the Federal Reserve. Our new Fed Chairman, Ben Bernanke, is quick to slash interest rates with a major mid-term election coming up in the Fall. On August 17, 2007, the Fed slashes interest rates by 50 basis points to 5.75%. The US Dollar immediately turns lower. Two weeks later, Gold roars through $700 like a hot knife through butter and sets its sights on the 1980 high. Phase Two of the secular Bull Market in Gold is progressing just as it should. The few industry professionals not already in Gold, quickly jump on board the train leaving the station.

As the balance of 2007, unfolded the Fed was forced to cut interest rates three more times as the credit derivatives that had given them cause for "concern" just two years prior were now beginning to explode up and down Wall Street. The US Dollar was in free fall and a panic was developing. Gold was riding that panic higher and higher. Gold broke $800 quickly in late October, pausing briefly to enjoy the Holidays before reaching new all-time highs as 2008 arrived.

Continuing to cut interest rates 50 and 75 basis points at a time, the Fed became desperate to halt a blossoming credit crisis threatening to put the world's credit markets in lock down. Gold responded by tacking on another $150 and reached $1034 on March 17, 2008. With a major milestone now toppled Gold looked poised to "go to the moon".

The US Government had other ideas. On March 18, the Fed announced the collapse and subsequent takeover of Bear Stearns by JP Morgan with financial backing by the Fed itself. A coincident interest rate cut by the Fed of "only" 75 basis points appeared to "spook" the rampaging Bull Market in Gold. Prices fell immediately, and continued falling...for weeks. Phase Two of the secular Bull market in Gold looked like a bust. But that's what phase two is supposed to look like. The Bull is going to do everything it can to throw you from it's back, never to return.

Speculators were crushed in the violent correction that followed the March 2008 top in Gold. Each new rally in Gold in response to a deterioration of the global financial markets was squashed. Belief in the Gold Bull was being called into question by even the most die hard of Gold Bugs. Phase two of a Bull Market is both volatile and frustrating. Only the strong survive.

Finally, in October 2008, after a $350 haircut, Gold prices bottomed. A second chance for those believers in Gold's Bull Market was at hand. Phase Two was offering a "golden" opportunity to purchase Gold at prices not seen since Phase Two of the Gold Bull Market took off in earnest in the Fall of 2007. If you missed the train ride to $1000 before, here was your chance to buy tickets at a sharp discount. Interest rates had been slashed to 1.25% by the Fed, it was obvious there was nowhere to go but up for Gold.

In December of 2008, the Fed slashed interest rates one last time putting them effectively at ZERO. In doing so the Fed committed to holding rates there far into the future, and were seeking alternative ways to unlock the credit log jam paralyzing the World's financial system. They even suggested buying the Treasury's debt to fund the growing national debt and raise the cash to prop up the nations now insolvent banks.

Since that major low in Gold prices in October at $680, Gold has steadily climbed a growing wall of worry on Wall Street and at central banks around the World. The financial system is in peril and people are beginning to question the value of the World's fiat currencies. On Friday, March 20, Gold surpassed $1000 for ONLY the second time in history. Phase Two in the ongoing secular Bull market in Gold is living up to it's potential...and nearing it's end.

Phase Three is waiting in the wings. Numerous "news" reports covering the "experts" predictions on where the price of Gold may be going are one sign. Rising volume in Gold "products" is another. Every day it seems we are treated to a "new high" in gold holdings in the Gold ETF [GLD]. Volumes are rising in the Gold share indexes. Yet few people actually own, or have exposure to Gold in their investment portfolios. Phase Three will be here soon enough. Knocking down Gold's 2007 high of 1034 should open that door, and close the door on Phase Two. Phase Three is where the real money in Gold will be made as Gold finally makes it's way to the Moon.

1999 - 2005 Phase One

2005 - 2009 Phase Two

2009 - ? Phase Three