The Michael Fuljenz Metals Market Report: September 2011, Week 3 Edition

Gold slipped below $1800 once again this morning (Monday), based on a stronger dollar. Two-thirds ($18) of gold's $27 decline (as of noon, EDT) is due to a stronger dollar. But the dollar is not really "strong" these days. It's simply "less weak" than the euro, which is struggling with a more immediate currency crisis than the dollar. Last week, both Italy and Spain had to offer more than 5% on their bonds (vs. 2% in America) to attract buyers for euro debt. Also, Moody's downgraded two large French banks, Credit Agricole and Societe Generale, while putting France's largest bank, BNP Paribas, on review for a downgrade.

• Gold 52 weeks ago (September 20, 2010): $1279.25
• Gold's average price during 2011: $1524.78
• Gold's London Low for 2011: $1316.00 on January 28
• Gold's London High for 2011: $1896.50 on September 5

Last Week In Metals: Gold slipped below $1800 but then rallied strongly. Stocks had their first good week in almost two months.

U.S. Inflation is Rising while the Economy Cools
That's 1970s-Style "Stagflation" All Over Again

The classic recipe for a rising gold price is the combination of inflation and stagnation - the dreaded "stagflation" of the 1970s. Last week brought us a potent combination of both elements: The Consumer Price Index (CPI) rose 0.4% in August (a 5% annual rate), with energy costs rising 1.2% (15.4% a year).

In the past 12 months, the CPI is up 3.8%, but wages (for those who still have a job!) are up just 2%, so inflation-adjusted ("real") take-home is off 1.8%. That explains why August retail sales were flat and July's retail sales were up just 0.3%. In fact, the Census Bureau told us last week that household income, adjusted for inflation, is back to 1996 levels! The result is the same kind of stagflation that made stocks and the dollar fall in the 1970s, giving gold its rightful place as the #1 investment for the decade.

Politically, the current administration feels a lot like the Carter years of 1977-1980, filled with economic "malaise" and a President who seems at a loss on how to resurrect the economy. Like Carter, President Obama is focused on economic fine-tuning. He seems to think that a series of clever centrally-planned solutions will add up to a recovery, when the truth is that the private sector can create jobs best when government restrictions are reliable and reasonable.

Gold could be on the cusp of a "Carter moment" in late 2011, capped by a huge 1979-style gold rally.

Beyond Each Day's Wild Price Swings, Gold Fundamentals Remain Strong

On the supply side, it is still very hard to find and extract new gold. "New" supply often has to come from grandma's old jewelry, sold at a sacrificial price to hotel buyers, pawn shops and other market vultures. Gold mining companies can't bring a lot of new mines to market, even at $1800 gold prices. Many gold mines are located within poor countries led by dictators known as "kleptocrats" (they steal their nation's resources, often by nationalizing the gold mines, and then "personalizing" the nationalization by shipping the gold off to their personal Swiss bank account). That's one reason why so many gold mining stocks have not yet followed gold bullion's price rise, but the demand side provides us with a constant floor under gold's price, since nature made gold scarce and trees (for printing paper money) far more abundant.

On the demand side, rich and middle-class investors around the world keep buying gold as their safe haven in times of inflation, paper currency debasement, low-yield U.S. Treasury bonds and flat-or-falling stock markets. In addition, gold holds special attraction for governments wishing to fill their foreign exchange coffers with something more reliable than paper money. Mexico, Russia, Thailand and South Korea have all bought gold for their central banks this year. With 100 days to go in 2011, governments have already almost tripled their net gold purchases over 2010, which was the first year since 1987 in which central banks became net buyers of gold. Earlier this month, Venezuela and Bolivia both said they are either buying or taking possession of more gold. Venezuela's Hugo Chavez recently said he is taking all his country's gold out of London and the U.S. and bringing it home.

China - the Government and the People - Still Love Gold

Since the 1980s, over 300 million Chinese have emerged from absolute poverty to the middle class, while many in China's middle class have become rich, due to the new "capitalism with Chinese characteristics" allowed by the nominally-Communist Chinese leaders. China's investors are still buying gold, despite the high price, while the government said they would begin to "liquidate" their dollars in favor of gold.

China owns far more foreign exchange (and U.S. Treasury debt) than any other country. U.S. debt makes up over half of China's $3 trillion in reserves. Due to their large and rising trade surplus, we get China's manufactured goods and they get our dollars. This trade has not pleased China lately: They underwrite our deficits in a depreciating paper currency, so they have turned more toward other currencies and gold.

Earlier this year, a Chinese central bank official, Li Daokui, said: "The incremental parts of our foreign reserve holdings should be invested in physical assets… Once the U.S. Treasury market stabilizes we can liquidate more of our holdings of Treasuries." In former times, China describes dollar sales as an attempt to "diversify," but this is believed to be the first time China has used the world "liquidate" for U.S. debt.

China is not obligated to tell the world it is buying gold. They have likely been purchasing gold secretly! If they made a big announcement about gold vs. the dollar, they could send gold prices too high, too fast, destroying their plan to accumulate as many tons of gold as they can at reasonable prices (under $2,000).

Australia's New Bullion Exchange

Australia is second (behind China) in gold production. In order to market their gold directly, Australia has opened a new physical bullion exchange (spot market) for gold, silver and platinum, launching October 4, selling bullion directly to investors. As we've seen in the case of exchange-traded funds (ETFs) in the U.S., whenever a country makes gold buying easier, more previously first-time buyers will gobble at gold.

European Distrust Crisis Sparks Run on Banks

One effect of the financial crisis is that depositors have been pulling their money out of banks in Europe. Savers and money funds have been spooked by the debt crisis and seek safe havens. Retail and institutional deposits at Greek banks dropped 19% over the past year, while deposits at Irish lenders plunged nearly 40% in 18 months. At the same time, EU banks are lending less among themselves. US money-market funds have cut their investment exposure in German, French, and Spanish banks.

"All of this is symptomatic of a lot of fear in the European financial sector," said Kash Mansori, senior economist at Experis Finance in Charlotte, North Carolina, which advises U.S. and European companies. "It shows that even European banks don't trust each other anymore, so they're taking their money out of the EU system. It's similar to the distrust that happened worldwide in 2008." This highlights again why governments are buying far more gold in 2011 than they did in 2010!

Why Many Gold Coin Prices Rose While Gold Prices Declined

Since the bull markets of the 1970s, I have watched gold coin prices, at some point in time, outperform gold bullion prices. With the exception of a period when many Indian gold coins rose dramatically during 2005 to 2007, that has typically not happened in the 21st century. Of course gold stocks were often bought in hopes of multiplying gold's gains, but that hasn't been the case like in the past, either.

Europeans Line Up to Buy Gold

In the past few months, however, there has been a relative shortage of many rare gold coins dealers need for customers. The dealers I trade with have noted that they have been selling far more gold coins than they have been buying. Buying gold coins out of Europe has slowed to a trickle and Europeans are often lined up to buy gold coins, not sell. This has continued into the fall, a rare occurrence. Dealers' inventories were already reduced, since many banks have reduced loans to dealers by up to 30%, regardless of collateral, after the financial banking crisis of 2008. This has caused many dealers to carry less inventory to meet rising demand, pushing up prices for many rare gold coins.

As you may notice, many dealers are buying more ads to take advantage of increased customer interest. This results in increased demand for a decreasing supply. That is the formula for rising gold coin prices.

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