Business As Usual?

An investment allocation to gold and gold shares makes sense only if one does not expect an imminent return to the investment world of the 1990’s. more stable and friendlier financial markets is a distant prospect at best.Author and MIT Professor Charles Kindleberger observes in Manias, Panics and Crashes (4^th edition-p 91) that “expectations in the real world may change slowly or rapidly, and different groups may wake up to the realization----sometimes at different rates and sometimes all at once---that the future will be different from the past.Three times in the last century, the DJII traded at a low single digit multiple of the price of gold (per ounce).

The investment mania of the 1990’s can be explained in part by Federal Reserve intervention in financial market busts starting in 1987 and continuing through the Asian meltdown, Russia, and LTCM.Bear markets that might have unfolded as early as 1987 were truncated by Fed intervention.Grant’s 1996 prophesy turned out to be a precise, if not exactly timely, warning of what would be the undoing of the 90’s mania. Bear markets are necessary, if unpleasant.An important ideological underpinning of the investment mania was the worldwide movement toward deregulated, unfettered capital markets.In a recent article (New Republic, Sept. 12, 2002), George Soros conveys a sense of the media and political environment that could lie ahead: “Misconceptions or flawed ideas are generally responsible, at least in part, for most boom/bust sequences.The current P/E on the S&P is 33.3x (trailing) and the dividend yield is 1.8%.The transformation from exuberance to stinginess occurs at the individual, institutional and social level.The narrowest spread since 1979 coincided with a twenty-year low in the price, the second half of 1999.

The shorthand history of the price of gold is the love or hatred of risk.© Sun Valley Gold LLC,

Just what will motivate investors to climb up the safety ladder to gold? Many would argue that investors have “forgotten” about gold because the modern financial system provides so many more sophisticated ways to deflect risk.Pay careful attention to yield spreads, the share prices of money center banks (particularly large derivative players such as JP Morgan Chase), the trade weighted dollar index (DXY), the share prices of housing related GSE’s (FNMA and Freddie Mac), the share prices of mortgage insurers such as MGIC, and the shape of the yield curve. Mortgage refinancing, the most important prop to economic activity during the last three years, could be the next source of concern for the financial markets.The possibility that mortgage refinance activity might sputter in the absence of renewed strength in capital spending seems quite plausible.A sharp fall in the dollar exchange rate, a sudden rise in interest rates, or an inverted yield curve are interrelated possibilities which would reduce the derivative positions of money center banks to financial market ground zero.Both the fundamentals and the supply and demand outlook for bonds appear dubious well before investors begin to sense that policy makers will cast aside their remaining shreds of integrity to deal with deflationary emergencies.These days, it is hard to identify whatever it is that represents business as usual.

John Hathaway