Believe It!

Jan.6, 2004
by Jim Puplava

An investor would be fortunate enough if he or she were to encounter one or two secular bull markets in their lifetime. Secular bull markets can last a long time and make investors a lot of money. If an investor can get onboard early enough and simply ride the bull, it is one of the few ways that real fortunes can be made.

New bull markets when they begin are seldom recognized. Emerging trends are difficult to discern when they begin because investor attention is still focused on the last trend not recognizing that the rules of the investment game have been altered. Supply and demand fundamentals alter and change investment markets, giving rise to new bull markets and bringing others to a close. The key is to recognize when one trend is coming to a close and another trend has emerged to take its place.

This is one of those times.

A new bull market has begun in commodities, especially gold and silver. This new bull market is a secular bull market and it coexists with a cyclical bull market in equities. It is one reason that it has gotten little attention and has gone unnoticed by the vast majority of investors. Most investors are playing the cyclical bull markets in equities believing that the good times of the 1990s have returned. Investing in commodities or commodity-like stocks is simply not on the radar screen of most investors. Everyone knows the price of the Dow or the NASDAQ, but few are even aware of what has happened to gold, silver, copper, nickel or lead. The old trend is still the most relevant trend for investors. Precious metals and precious metal equities remain ignored and under-owned.

Dow 1000 Gold $400 Syndrome

I mention the fact that precious metal equities remain under-owned because very few mutual funds or professional managers have significant ownership in the sector. Even those that do own it have traded in and out of the sector preferring to trade rather than invest. Many gold investors have done likewise trading in and out of the sector only to find themselves short when the metals take off. Today’s new bull market in silver and gold reminds me of the last bull market in gold that began in 1971. Back then like today gold and silver prices were rallying along with equities. The Dow fell sharply in 1969 and throughout the first half of 1970. After dropping 35% during the bear market of 69-70 the Dow went on to rally strongly until its peak in January of 1973.

After a 20% correction, the market went on to rally again before plunging in the last major bear market of the '70s.

The period between 1970 and 1973 was the era of the “Nifty Fifty,” the so-called can’t lose blue-chip stocks that could be bought at any price. The “Nifty Fifty’ stocks of that era are similar to today’s must-own tech stocks such as Intel, Cisco, Dell, AMD, Amazon and Yahoo.

While the Dow rallied in and out of cyclical bull and secular bear markets gold and silver prices began to take off at the same time as a result of the U.S. going off the Bretton Woods system. Gold and silver prices became deregulated and investor interest picked up in the metal. At first it was only the smart money and the insiders who were buying during the first phase of the rally which began in 1971. The first phase of the gold and silver bull market lasted until 1974. After reaching a nadir in December of 1974 the Dow would begin a new bull market phase that would take it back to the 1000 level again in 1976. During this same period that blue-chip stocks were rallying precious metals and precious metal equities went through a corrective phase, especially gold. Silver prices held up firmly during this period while gold lost 50% of it value.  

The pullback in gold and less so in silver was simply another period to accumulate as gold and silver consolidated their gains. The second phase of the bull market in gold and silver began in 1976 as the Dow peaked and another corrective phase in equities began. During the second phase of the bull market in gold and silver more professionals and institutions came into the market. During this period monetary conditions were ripe for fueling the second phase of the bull market in metals. Arthur Burns, Chairman of the Federal Open Market Committee (FOMC) from February 1970 until December 1977, began a grand experiment in attempting to control the rate of interest. Burns was part of a political and intellectual environment in Washington that believed in government control of the economy. Burn’s macro view of the economy was from a credit perspective. He believed that monetary policy worked its influence through the credit markets. However, he held a non-monetary view of inflation. Burns saw inflation from another perspective. His views were that inflation was caused by unions and monopoly pricing by large corporations. Even though he believed that a central bank could cause inflation by monetizing government deficits he never attributed the inflation of that era to that cause.

Burn’s view of inflation was constantly in a state of flux. He went along with President Nixon’s wage and price controls because he believed that unions and corporations were the cause of inflation. He attributed inflation to special causes such as a spike in oil prices or in food prices due to a bad harvest. He saw them all as one time events. As government deficits began to increase in size once the U.S. no longer backed its currency with gold Burns attributed inflation to government deficits. He never saw inflation in terms of the polices of the central bank. It therefore became difficult to correct inflationary increases as long as the chief source of inflation, monetary policy was expansive. It would not be until the reign of Paul Volcker in 1979 that Federal Reserve polices would switch from expansionary to contraction. Under Volcker's reign the Fed began to take charge of monetary policy and control the supply of money and credit in the financial system. Volcker recognized that too much money growth and too much credit growth were the harbinger of greater rates of inflation. The beginning of Volcker's reign was the beginning of the end of the great bull market in commodities.

However, long before Volcker took control of the Fed all of the pieces of the puzzle were in place for a great bull market in “things”. Monetary and fiscal policies were expansionary and they became a primary driver of the new bull market. Supply and demand fundamentals were also in place with a growing world population, the end of America’s energy independence as the U.S. went from an exporter to an importer of oil, the deregulation of the gold markets and geo-political risks- the Yom Kippur War in 73, Nixon’s resignation, the capture of the American Embassy and hostages in Iran.

During the great monetary expansion of the 1970s money went into tangible assets as investors sought a refuge from a depreciating U.S. dollar. Decades later under the expansionary policies of the Greenspan Fed money went into paper assets. Greenspan like Burns did not recognize monetary policy as the primary source of inflation. Greenspan has always been fond of quoting productivity miracles and rising U.S. financial markets as a sign of America’s industrial enterprise. It has never occurred to Greenspan that too much credit and money growths were responsible for America’s equity bubble. Yet no other Fed chairman has acted with such recklessness in fostering a monetary and credit bubble of biblical proportions.

This new bull market in gold and silver has no greater friend than Mr. Greenspan. Mr. Greenspan's penchant for fighting every financial crisis and every recession with more money and credit are creating the ideal monetary conditions for a major bull market in the precious metals. His expansionary monetary policies know no equal. The only equivalent would be the expansionary polices of John Law’s Mississippi scheme in 18th century France. The expansion of the money supply under the Greenspan Fed has been greater than Mr. Greenspan’s entire predecessor’s combined. Government fiscal polices are also expansionary as the U.S. budget deficits grows to record levels, now estimated to be close to 5% of GDP. At the same time the U.S. trade deficit is headed higher with the trade deficit hitting 5-6 % of GDP. That is putting a lot of U.S. dollars in foreign hands much of which is currently being disposed of which is why the dollar is falling to new depths.

The point to understand here is that the U.S. debt figures are too large and unpayable. The only way out for government is to inflate its way out. The current debt on America’s balance sheet is over $34 trillion. There is another $44 trillion that is unfunded primarily Social Security and Medicare which is growing at $1.6 trillion a year. There is no way that these debts can be repaid honestly. Instead with debt levels this large the only solution politicians will use is a monetary one, which means eventually hyperinflation. The stage for hyperinflation is in place with growing trade and budget deficits. In addition to large country debts the nation’s citizens and corporations have also been going on a debt binge borrowing and spending their way into oblivion. Consumer debt hit a record $1.98 trillion in October, 2003. That figure according to the Federal Reserve translates into $18,700 per U.S. household excluding mortgages. Add mortgages into the equation and the figures become unfathomable.

As Bill Gross recently penned last month “when too much debt infects the heart of capitalism you either default or inflate it away and the latter is by far the easiest (although not necessarily the wisest) policy." As mentioned previously in past essays the stage is set on the monetary front for higher rates of inflation. One of this year’s big surprises for the financial markets is going to be higher rates of inflation. If they measure it properly the true inflation rate is already in the high single digits. The first major pillar of this new bull market in precious metals is a monetary one and monetary conditions are now primed for higher precious metals prices.

In summary, a new bull market in metals is now in place as shown in the charts of the HUI and the XAU below. The reasons are summarized below:

supply/demand imbalances which have created bullion deficit
large U.S. current account deficits
breakdown of the monetary system and the drop in the dollar
distrust in paper assets and their substitutes
depression and war

All of these elements are now in place, which is why gold is in a new bull market. Let's review a few basic principles:

Principle 2: Gold and Silver are Money

I have written extensively on these subjects in my Storm Series and Storm Watch Updates, so I won’t elaborate any further other than to point out that gold and silver are money. When paper assets start breaking down or are depreciated, gold resumes its historical role as money. Fiat currencies or freely floating currencies are inherently unstable. There is nothing backing them and governments can freely print as much of them as they will. Fiat currencies have a poor record of maintaining their value. Eventually paper money systems break down and governments turn back to some form of a gold-backed currency. It is the only way to bring stability to a monetary system.

Principle 2: Supply and Demand

In addition to gold and silver acting as the only form of real money, we are also dealing with major supply and demand deficits. Both gold and silver have been running supply deficits for over a decade. Readers of my articles may be familiar with the charts of gold and silver deficits as well as drawdowns of above-ground stockpiles. I have featured in previous articles, but I believe they are important enough to show them again. My reason for showing them is that you cannot run supply deficits of any commodity forever. Eventually you run into shortages and higher prices. Wall Street and the financial press would have you believe that deficits and lower prices are the natural state of affairs for gold and silver and will always remain so. In other words, prices will always remain low and mining companies will continue to produce these metals at a loss. Does this make economic sense? Why would you go into the mining business or stay in the mining business, if you could not earn a profit? In fact, because of the bear market in gold and silver, many companies have gone out of business or have been taken over by larger companies. These actions have not increased supply.

Courtesy of Sharefin

Principle 3: The Boom in The Developing World

Today leading mining companies acknowledge that the production of gold and silver will decline over the next decade. Lower prices have discouraged new exploration even while worldwide demand has expanded. Outside western industrial nations, investments in gold and silver are much more important to lesser developed nations. The developing world, which does not have established financial markets gold and silver, are the preferred investments of choice. As Asia becomes a center of economic power in this century and in this decade in particular, investments in gold and silver will become more important. There are already movements in Asia and in the Middle East to go to gold-backed currencies. Gold and silver are slowly transitioning back to their historical role as money. This is an important point to remember as you view the deterioration of paper assets over this coming decade. With these facts in mind and in reference to the charts above, it is clearly established that gold and silver are in a new bull market.

How to Participate in This New Bull Market

As to how to play this new bull market, which is only in its formative phase, I recommend a buy-and-accumulate strategy. When a bull market is in its formative stages, before institutions or the general public comes in, your best strategy is to buy and accumulate. Think back to the early days of the technology boom of the 1990s. you would have made more money and increased your net worth substantially by buying Cisco, Dell, Intel, Microsoft, Amazon, Yahoo and AOL then trading in and out of them.

Trading in and out of stocks can be quite costly during the beginning stages of a bull market. You can outsmart yourself. I know of many newsletter writers and advisors in the gold camp who sold out of their positions in late summer when gold and silver prices tested the upper limits of their trading range. Gold and silver prices have been within a narrow trading range over the last decade with gold at $400 and silver at $5. Every time prices approached long-term resistance levels, the smart money commercials would go short, the momentum crowd would exit and the price of precious metals and precious metal equities would decline. It seemed like the smart thing to do was to trade out of bullion and precious metal equities. It worked like a charm and with a great deal of regularity and certainty.

Hold On For The Rise of Your Life

But new bull markets have a way of confounding the experts. Old chart patterns change. Resistance levels are taken out, new support levels are drawn on the charts, and you start to see higher highs and higher lows. That is the most telegraphic sign that you are in a new bull market. In the early stages, you want to be a buyer and accumulator of bullion and precious metal equities. In the early stages of a bull market you buy on the dips and hold. Don’t trade out of your position. Why? Because when you least expect it, the bull will roar and charge upward to higher levels. As Richard Russell is fond of saying, a new bull market will try to throw investors off every chance it can. Russell recommends putting a third of your portfolio in bullion and stocks and then holding on for the rise of your life. I couldn’t agree more. Trading in and out of stocks or bullion at this point can be quite costly.

I believe this has been one of the mistakes made by gold bugs and the gold and silver camp. They were watching the old charts too closely. When prices rose along with equities and the dollar this summer, they were taken by surprise. As prices in bullion hit historical resistance levels and as commercial short positions increased, they traded out of their positions and sold a substantial position. This was the message that I came back with from the November San Francisco Gold Show. I was simply amazed by the number of newsletter writers, gold company execs, and to my surprise many investors who had turned decisively bearish or cautious at the time. I was also struck by an article I read by Mark Hulbert of the Hulbert Digest that said that only 34 percent of the gold newsletter writers were bullish at that time. Since that time, that figure has dropped even further to 11%. I believe that many of these people were watching the old charts too closely. As silver moved over $5 and gold approached $400, they were thinking back to February of last year when a severe correction took place. In addition gold and silver remained strong and rose along with a dollar and equity rally. The metals weren’t acting like they were supposed to act when the dollar goes up or when equities rise metals do the opposite. However in the early stages of a new bull market, metals and precious metal stocks can rise simultaneously as they did during 1971-73.

This Bull Market in Metals is Just Beginning... BELIEVE IT!

This is where I believe we are today. As Eric King and I wrote in “To the Moon, Alice!” we are going higher, much higher than anybody can possibly believe. This new bull market in metals is just in its formative stage. At this point you want to hold on to your positions and accumulate more shares and bullion on any setbacks. Trying to trade your way in and out of this new bull market can be detrimental to our financial health. Most of the wealthiest people I have met in the investment world have not been traders. They were INVESTORS. Unless you are absolutely confident that you can trade in and out of this market, always buying in at the bottom and always getting out at the tops, you will find it more profitable to hold your positions and adding to them on the dips.

It's time you became a believing investor.

Today's Markets

U.S. stock prices closed higher today as investors became more bullish that economic growth and higher corporate earnings will help to send stock prices higher this year. The Dow gained 134 points or 1.3% with 28 out of the Dow 30 stocks rising. The tech-laden NASDAQ rose 41 points to close at a new two-year high. The S&P 500 climbed 14 points for a gain of 1.24%.

Market volume on the NYSE rose to 1.56 billion shares and 2.3 billion on the NASDAQ. Breath was positive by 22-10 on the Big Board and by 21-10 on the NASDAQ.

The U.S. dollar slumped to new lows as gold and silver prices went through the roof. Gold rose $8.70 or 2.1 percent. Silver prices jumped $.28 to close at $6.245.

Jim Puplava
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Technical Review
by Eric King

About the only time I can remember having a disagreement with Jim Puplava was right before the gold show in San Francisco at the end of last year. Jim was getting cautious on the mining sector and I (being the contrarian that I am) was trying to explain to Jim that everyone everywhere I looked was bearish and selling their gold and silver stocks. Well, the disagreement became quite heated. Jim pulled into his garage and we ended the conversation and that was that. Later on that evening after dinner, Jim called me and we had a much better conversation. I explained to him that there was too much pessimism out there and as far as I was concerned, we were heading much higher. 

A few days later when we talked, Jim said he had received a prominent metals newsletter which was very bearish and Jim began to shift over into the bullish camp. The story doesn't end there however as we agreed to go the gold show in San Francisco. For some reason Jim wanted to arrive a day early to see who was there setting up their booths. I reluctantly agreed as we were driving together and he was my ride (beggars can't be choosers). A funny thing happened when we first started to walk around and see who was setting up booths.  I overheard a gentleman in front of us say he had just sold all of his gold. I turned to Jim and he couldn't believe it when I shared this information with him. We then bumped into several other bearish industry people. Jim was quickly getting the concept that folks were just plain bearish into the advance of gold and silver and gold and silver stocks.

The Unbelieving Gold Camp

Fast forward to the ride home from the gold show and I could clearly see I had created a monster. Jim was far more bullish than I was (if that's possible) and he had me convinced we were on to something. Jim was instantly buying right out of the gate after the gold show and the HUI was up 5 straight days. This was too easy. I began to believe that at some point the gold camp would surely join us in our bullish euphoria and we would have to become cautious. Well, here we are many weeks down the road and most all of stocks I watch are hitting brand new 52-week highs. The HUI is a stone's throw away from a new all-time high and what does Mark Hulbert report? More pessimism now with only 11.6% exposure by the gold camp at this point. This is one of the lowest readings ever in his 23 years of tracking the gold camp.

Taking all of this information in, I thought I would try to give folks some visuals of what a mania is really about and hopefully give people a feel for why it is a mistake, as Richard Russell correctly points out, to try to trade in and out of a secular bull market.

I liken the secular bull market and coming consolidation phase or as I call it the "PAC-MAN PHASE" in the mining shares to what the networking sector experienced from 1990 to 2000. It was an unbelievable mania, so let's take a look at some interesting charts.

Let's start off with a look at 3COM:

During the period from 1990 to 1996, 3COM vaulted from a split-adjusted price of around 20 cents/share to roughly $16.00/share, a staggering 80-fold increase! Money flows were extremely strong and will be shown with many of the charts.

CSCO exploded from a split-adjusted price of 5 cents/share to roughly $7.50, an amazing 150-fold increase! Tremendous money flows are also shown on the chart.

Well something had to be done, the networkers as a group were on fire, so somebody had the bright idea to create the NWX (AMEX Networking Index). As you can see, even though some of these stocks already had astronomical moves by the time the NWX was created in 1996, the party continued and roared from a level of around 200 to roughly 1200. Altogether that's one hell of a mania!

Now let's take a look at some more of the astronomical gains investors enjoyed during the mania:

The public bought in, sending money flows skyrocketing as shown on the CSCO chart. Now that's a mania, going from 5 cents/share in 1990 to over $80/share in 2000!

The following chart shows NT (Nortel Networks) went to incredible levels as well.

Look at this nice 3 1/2 year run by LU (Lucent Technologies). Ah, the money flows!

The NWX during the Lucent run:

Gold and Silver's New Bull Market

I hope folks are getting it from the above charts. This gold and silver mania is in its infancy as Russell says and has a long way to go.

Let's take a look at the HUI as of the close today 1/5/2004. Many in the gold camp are talking about the fact that the HUI is extended above its 200-day moving average. Today the HUI sits at roughly 256, while the 200-day moving average sits at roughly 180. So the HUI is roughly 42% above its moving average.

Yes it is extended, but let's take a trip back to the beginning of the summer of 2002. The HUI's 200-day moving average was roughly 155 on 6/4/2002, while the 200-day moving average on the HUI was roughly 82 at the time. So the HUI was trading 89% above its moving average!

So if the HUI were to simply equal what it accomplished back in the beginning of summer of 2002, it would be trading today at slightly above 340!!! Will the HUI get to 340 on this leg? Who knows? I am simply pointing out that yes, things are extended, but it is possible the HUI can get a hell of a lot more extended before this leg is over.

What should investors get from all of this? I don't know. Everybody's brain works differently. But hopefully it opened up some minds of folks who are bearish or constantly trading themselves out of this secular bull market and looking for the pullback that never seems to come. Smart money is accumulating on pullbacks in gold and silver stocks as the weak hands are shaken out of what in all probability will be a very, very long secular bull market in gold and silver shares.

Russell summed up the situation succinctly in his daily commentary today:

"A good day all around for the precious metals and the precious metals stocks. All the experts continue to predict a correction. Is there any such thing as an 'expert?' Meanwhile, the public is oblivious of the metals. Pretty fascinating situation. I bought more PDG and NEM today." -- Richard Russell, January 5, 2004 

Subscribers to Richard Russell should already be positioned long gold and silver and long gold and silver stocks at much lower prices. Their job is to hold on and not get bucked off the bull too early. If you are not a Russell subscriber, then sign up. The $250 will be some of the best money you'll ever spend. Russell has been studying the markets for almost half a century and is a living legend. Go to www.dowtheoryletters.com to subscribe. Think of it as a New Year's resolution.

Believe it. Live long and prosper.

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