TURNING POINT?
by Michael J. Kosares
USAGOLD-Centennial Precious Metals, Inc.
June 4, 2007

In this issue we resurrect the old Nuggets format to accommodate several analysts who surfaced last week to say that we may have reached a turning point in the gold market. If last week's lows hold, the corrective process took all of a 6% bite out of the price. The charts continue to display a bullish pattern of rising lows and strong buying on the dips. What's more, we are back within roughly $20 of the interim highs. Perhaps commodities analyst Dan Norcini said it best: "All in all, this week will sure go a long way to soothing the hearts of weary gold bulls who will probably be seen walking around town with a much lighter step than they possessed last weekend. All of you guys on the window ledges can come in now." As we have said all along, these corrections have proven to be little more than solid buying opportunities for shrewd gold buyers looking to add weight to the asset preservation side of the investment portfolio.

Nuggets

James Grant gets to the heart of the matter: Why Kuwait dropped the dollar peg

Concerns about international inflation seem to have invaded the mainstream press. Lately, quite a few articles have surfaced pointing to the potentiality for rapid money supply growth translating to not only inflation in the United States but contemporaneously on a global basis. James Grant [Grant's Interest Rate Observer], who is one of the more learned gold spokesmen, has written a compelling and pleasantly brief portrayal of the problem for the Financial Times which we have linked below. Grant starts with the problem Kuwait experienced via its dollar peg and what it is doing to counter it. He then goes on to explain what the US overproduction of dollars means for other countries. In the end, as we have suggested repeatedly here, it really boils down to the possibility of global inflation and a consequent global rise in gold demand for the long term.

Here's a neat summary from Mr. Grant article, "Kuwait split raises questions over longevity of the dollar":

"Hard-working Asians (and oil-blessed Arabs) consume much less than they produce. Americans, on the other hand, produce much less than they consume. But the savers and spenders do have something in common. The workers are happy to receive dollars, and the consumers are more than happy to print them. Unlike the solidus, a greenback has no intrinsic value. It is faith-based. Here is a new idea in the world. Certainly, the unsystematic world monetary system is a new arrangement. Up until 1971, the dollar was collateralized by gold. If you were a central bank, $35 would get you an ounce on demand. The system gave good, durable service until the US started to run out of bullion. On August 15 1971, the dollar became uncollateralised. Exchange rates started to float - or to sink or be pegged. Governments made it up as they went along."

Spain the next Argentina?

Spain is selling off its foreign reserves -- gold, U.S. treasuries, British gilts, baby, bath water -- anything they can get their hands on. The Banco de Espana, reports London's Daily Telegraph, refuses to comment on the wholesale liquidation which, as of this writing includes 80 tonnes of gold. This kind of news, to those of us who have seen this sort of thing previously in places like Argentina, Thailand and Indonesia, will not be taken it lightly. These are the activities that usually come just before the banks close down, stock markets collapse and the populace ends up taking a major financial hit.

Needless to say, all of this argues for gold ownership but few in Spain at this point foresee a problem. All -- with the economy seemingly perking along and the real estate expansion still in progress -- still seems to be as it should be. The bright lights, however, could be blinding investors as to what's ahead. "The current account," says Spanish economist Alberto Mattelan, "is completely out of control. We [Spain] have the worst deficit in our history and worse than any other country in the western world. It has not yet become a 'street concern', but I can assure you that it is of great concern to us economists. This will turn bad over the next 18 months."

Implications for the European Union: Taking this a step further, Tim Congdon, a name familiar to those who read these pages [America's Deficit, the Dollar & Gold, USAGOLD Gilded Opinion, one of Britain's "wise men" advisors to the government on economic policy] points out that Spain's problems raise some interesting issues for the European Union. In essence, since there is no federal government in Europe, the possibilities for a bailout are minimal. In other words, if there is a real banking crisis, there is no one to guarantee bank deposits, or save the Spanish stock market, unless the European Union somehow recalibrates itself to deal with it. As such, the International Monetary Fund has warned in the past that the EMU is exposed to "systemic financial risk." Add to this a descent in housing prices from lofty highs and you have ingredients for a full blown financial crisis in Spain sometime soon with consequent effects on the rest of Europe and beyond.

European Central Bank puts gold sales on hold through September

The recent sharp upward correction in the gold price can be traced directly to the European Central Bank's announcement this past Thursday that it would not be selling any more gold through September. Demand had already been on the rise as the price dropped over the past 30 days, and the ECB announcement simply added fuel to the fire. The refinery, MKS Finance SA in Switzerland, reports in a Bloomberg article that buyers must line up in a "queue" to get the metal because of ramping demand in India and other parts of Asia. Throughout this period we have been advising our clients that the recent downtrend would be a good time to purchase gold due to the fact that the announced sales would be confined within the 500-tonne annual sales limitation of the European Central Bank Gold Agreement. In other words, the sales for the most part have already been factored into the gold price. We have been suggesting there could be a slingshot effect and that is exactly what happened late last week. Recent activity proves once again (as we have been saying all along), "In this bull market, it pays to buy the dips."

Dan Norcini, who does a good job analyzing Comex stats and calling the trends at JS Mineset, had this to say about last week's gold market action:

"Gold looks to have put in a bottom here with today's strong performance. That ECB news is going to have some strong reverberations going forward as it will serve to embolden the bulls. What is also very encouraging is to see the gold holdings in the Streetracks ETF rise nearly 5 tons yesterday. If the gold disgorging has ceased in there, the market will also gain further confidence that the worst is behind us for gold and will come to the view that the low $650 region is the new and higher level of major support. When you toss in what seems to be shaping up as a stellar performance for the HUI today, gold has a type of Trifecta going for it right now. Solid technical charts, increase in the ETF gold holdings and a massive upside weekly reversal in the HUI. All in all, this week will sure go a long way to soothing the hearts of weary gold bulls who will probably be seen walking around town with a much lighter step than they possessed last weekend."

Julian Phillips on China's gold diversification

"Will [China] invest in gold? We believe they will, but the sheer size of their reserves makes it impossible for them to go into the open market to buy gold, after all a tonne of gold only cost $20 million, 50 tonnes a $billion. What will be easy for them to do is to buy gold for their reserves via the purchase of local production, now around 250 tonnes a year [a mere $5 billion], but this will be paid for with Yuan. The Chinese want to keep the surplus away from the Chinese economy and avoid increasing the inflationary printing of money, so they will be cautious when going this. Such caution will, of course, be tempered by a continuous expansion of the local money supply to accommodate the larger economy and its consequential demand for more money. So the purchase of local gold is certainly on the table of choices in front of the Bank of China. A more appropriate way to ensure that there is gold in China is to expand the size of the local Chinese gold market through the widening of the gold market and direct encouragement to the Chinese citizens to buy gold and we believe they want to do this. After all the holding of gold by its citizens, still leaves that gold within its reach."

Editor's Note: When you think about it, China's removing 250 tonnes from the already tight supply/demand equation by itself is no small matter.

Some interesting observations of who owns the gold and why from Antal Fekete

"The last time in history when huge quantities of gold were going into hiding occurred during the twilight of the Roman Empire. It was an ominous portent of bad tidings. People were withdrawing gold coins from circulation. They declined to spend them hoping that saner and safer times would come. As a rule people do not spend their gold coins unless they see that they will be able to get them back on the same terms. As saner and safer times did never come, these ancient hoards were forgotten and remained buried in the ground throughout the Dark Ages. Present day archeologists still keep finding them fifteen hundred years later. . .

The present episode of gold vanishing into private hoards is no less ominous than the previous one that was followed by the collapse of the Roman Empire, and the lights going out in the civilized world.

As this 'agonizing reappraisal' shows, the days of the dollar are numbered. Whether it be a large number or small, the coming Dark Age looms large on the horizon."

Editor's Note: I have written Dr. Fekete on the sections in his essay where he refers to "gold income" inquiring whether he means the imputed income that comes from gold rising as currencies depreciate, or some other form of income (like that which comes from a gold deposit with a bullion bank.) His answer I am sure will be of interest to advanced readers of these pages and I will publish his response at a later date.

Swiss Novartis fund buying metals

Swiss portfolio managers have long advised diversification into gold and other precious metals. Now the Swiss-based pharmaceuticals giant -- Novartis -- announces that it intends to invest 4% of its nearly $11.5 billion pension fund in gold, silver, platinum and palladium. As inflation continues to heat up globally, the strategy to diversify into something of real value is likely to gain new and unexpected buyers of gold and the other metals.

What do you do when the inflation rate hits 3714%?

The New York Times ran an editorial over the Memorial Day weekend on the devastating hyperinflation in Zimbabwe where the annual inflation rate recently hit 3714%. According to the article by Bill Marsh, if the current rate of growth holds, inflation could hit 410,000% annually. There is a lesson here to be learned by savers, particularly savers who neglect to fortify their portfolios with gold. "Savings and pensions have been devastated, " writes Marsh. "With interest rates officially a few hundred percent, but far outpaced by inflation, the actual rate of interest amounts to minus 3500%. Nest eggs, where they existed, have disappeared."

To most of us, facing a hyperinflation on the scale Zimbabwe suffers seems a bit far-fetched. However, we should keep in mind that inflation on any scale has a corrosive effect on the portfolio -- even double digit inflation can be devastating when yields run in the mid single digits. Beyond that, as the Zimbabwe experience shows, things can get quickly out of control once faith is lost in a currency and a government finds itself backed to the wall.

Zimbabwe's problems began a decade ago when land reform drove productive farmers off their land. Following this, Zimbabwe began printing money to repay loans to the International Monetary Fund. Things got progressively worse until they ran out of control. One 70-year old Zimbabwean is quoted in the article saying, "I shall have to work until the day I drop." One cannot help but consider where that same individual might have stood had he put even a small amount of his savings into gold coins and bullion.

The real cause of the housing slump

Adrian van Eck puts an interesting spin on the subprime mortgage/housing downturn problem. He says that the "house flippers" are the real culprits. "A significant number of the affected flippers," says van Eck, "were men and women who had a connection to the real estate industry, either as Realtors or as bankers acting on their own account. That is so because they were intimately aware of how fast housing prices had been rising, and with their contacts they were able to arrange financing with little or no money down." Now he says this group is "stuck" because builders are cutting prices to unload unwanted inventory, thus driving down new home prices across the boards, and the Fed is out to "punish the speculators" Brings to mind the day-traders who quit their day jobs and mortgaged their homes to speculate in the stock market. In the end, they too ended up losing their shirts.

Keep an eye on the upcoming G-8 conference in Germany which could prove to be a contentious affair -- on ALL sides and in a myriad of international relationships. The chilling television coverage of the street riots could be matched by equally chilling meetings between G-8 members faced with a range of pressing issues and competing interests including the battle over the climate and the on-going economic/currency wars. As much might be gleaned from what's not reported as what is. I would be hard pressed to remember a time when the G-8 nations were more at odds than they are now. The various investment markets could be rattled . . . . . . . . . . . . . . Happy Trails, my friends. More in a few weeks. MK

© 2007 Michael J. Kosares
USAGOLD / Centennial Precious Metals, Inc.
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