September 17, 2010

Here’s the news of the week – and how we see it here at McAlvany Wealth Management:

1. Golden Reflections for the Weekend:
The quote of the week has to be Sir Alan Greenspan offering this reflection to the Council on Foreign Relations on September 15th: “Fiat money has no place to go but gold.” Gold is at new highs and breaking out – in spite of the fact that we expected a soft correction based on technical issues, which for several weeks have been issuing caution signals.

We’ve been cautiously optimistic as the price has moved higher, but cautious all the same with volume statistics remaining lackluster. That did in fact change for the better throughout the week. The engine is now firing on all cylinders. We watch now and await Fed comments on September 21st to determine either a longer period of consolidation, or an immediate move to higher numbers.

In the broader picture, we remain in a structural, or what some would call secular, bull market in gold. The move to higher prices in coming months should bring us to between $1350 and $1650 an ounce. Most of the significant price increases over the last decade have been between 25% and 35% if on the weak side, and 45% to 75% if extraordinarily strong. While we are interested in the most recent $120 rise, it represents only a 10% move off of $1160. The $1350 number is quite conservative. $1650 represents a 42% rise, which in dollar terms is very impressive but is far less than in other strong periods within this ten-year saga. Still, I’m not sure you’ll mind that.

Much of our discussion in the office of late has revolved around leveraged purchasing power. This is a concept that redefines the word leverage, and should be taken to mean an exponential increase in purchasing power. By having exposure to gold in one form or another in our current economic context, there is a benefit from the appreciation in the commodity price. There is also a benefit from not being subjected to a compression or even collapse in stock values. The double benefit is thus obvious when a portfolio expands while other assets contract, opening the door for a move from inflated assets into deflated assets.

Not only were the 1932, 1949, and 1982 periods tough for equity investors as the market reached its nadir, but those periods of time were equally and inversely beneficial for the hard-asset investor. Transitions in those very challenging times represented generational wealth-creating opportunities not rivaled since. We endeavor for our clients to benefit both from the current trends and the transitions that lie ahead.

2. All Quiet on the Western Front – ahead of the Fed: The week started with a roar and ended with a whimper as the advance in assets (almost across the board) came to an eerie halt Friday afternoon – possibly in advance of the next FOMC meeting on September 21st. The promise of Fed QE II or something to that effect has helped to “float all boats” in the marketplace. Stocks have breached their higher moving averages, bonds have rallied smartly, and commodities are firm.

Gold and silver were especially strong, breaking out and into to what appears to be the beginning of a strong run for both. Oddly enough, reports this week and last of either a worsening or mixed economy are only compounding the issue, promoting self-reinforcing market dynamics.

Still, we do not believe that the recent success in stocks suggests the return of improved economic fundamentals. Instead, it reflects a strong fear of the Fed and the damage they can do in the short run to anyone betting against them. In the long run however, we would like to make it clear: Fed intervention in these markets is the actual cause of their decline, through a systematic devaluation of the dollar and the resulting inflation that ensues.

Some markets may have territory to give up in the following weeks, as this phenomenon is slowly factored in again. In addition, there may be a little “buy the rumor, sell the news” at work, since the Fed may not be willing to give as much liquidity as the markets have come to expect – for political or strategic reasons. Whatever the outcome, the metals and other tangibles will be the only markets that deserve (in our opinion) to hold their ground following next week’s FOMC meeting.

As we have mentioned before, either more or less action by the Fed won’t stop the natural corrective forces of the markets; their involvement serves only to delay the inevitable. At some point in the not too distant future, the markets will figure out that the Fed is in fact irrelevant and force some violent adjustments (i.e., in the bond market), which should usher in the next stage of this commodities bull.

Have a wonderful weekend.

David Burgess
VP Investment Management

David McAlvany
President and CEO