Global Watch - The Gold Forecaster
Would I buy gold at these levels?

Julian D.W. Phillips
Oct 18, 2005

Excerpts from the "Global Watch - The Gold Forecaster."

That was the week that was
Gold did so well this week, rising to hit over €400 at its peak and over $480 at its peak in the U.S. currency. But then the inevitable question had to be asked, would I buy gold at these levels? On a straight run up such as we've just seen, way down from below $450, it would take a brave man to buy it without a consolidation before it assaulted the $500 level. Then good sense kicked in, taking it back down to $466. Right now it is trying to recover over $470. Funds wisely took good profits after a good run and calmed a market worried that they were too top heavy for the good of the market. We expect the consolidation to continue until it has gathered sufficient confidence that it is going to stay at these levels and has the strength to overcome $500. Before that it should see lower levels, but not significantly lower in our opinion. It is all a matter of perception. It's reaching this level was expected and was accompanied all the way up by physical demand from the Middle to the Far East, with India standing back a little, despite the festival season. As you know, the Indians don't chase prices, but wait until they are sure it has laid a foundation price. It is a quicker process in festival season, but still has to be done. So here we are, in a consolidation phase for a while. But the news out there is such that gold is receiving more and more interest and it will continue to grow alongside growing uncertainty and trepidation at the future of inflation, the state of the U.S. economy and increasing structural global pressures. These are sufficiently strong fundamentals to keep this gold market in a bull phase for years to come, not just months.

Please note the progress gold made in the €. From €316 earlier this year to cross €400. This is denotes not just a price rise of 20% inside a year, which is not so dramatic, but it represents the transition of gold from a "barberous relic" to a "currency shadowing the €" to a separate "currency" as an alternative to paper currency. Psychologically this is a major evolution of gold back to a position it has not held for 20 years.

In the $, gold is doing the same but not nearly as spectacularly. Bear in mind many observers still see gold moving inversely to the $. Not that many observers recognise the extent of the evolution, to our surprise. But it has happened. Indeed, U.S. Investors will continue to believe that gold inversely reflects the state of the U.S. economy and the $. It is our belief that this is a consideration as it reflects part of the path of the global economy, but in itself it is a major factor primarily in the minds of U.S. Investors. By the same token the € price of gold is a growing factor in the minds of European Investors, as the Rupee price of gold is in the minds of the Indian Investors, the Rand price of gold is in the minds of the South African Gold Producers.......

Central Bank Gold Sales
With the gold price hitting $480, we saw little evidence of Central Bank Gold Sales, unless they too are selling on Technical signals, at $480. If they are, we do not accept that they are trying to knock the price down. It makes far more sense that they are maximising prices, in an effort to justify these sales. One can only imagine the conversations amongst those they report to, when they explain the gold sales policy. It must be getting more and more difficult to explain them in terms of good investment criteria. After all since the gold agreement started on the 27th September and the gold price has risen with spectacular force!

The U.S. Economy!
Bad news came this week, confirming the uncertain future. Inflation is taking off and with a dash of speed. Interest rates will continue to rise for as long as a healthy economic picture in the States can bear it. What is a healthy economic climate? In terms of rising interest rates, it is not one that is moving into a recession [two consecutive quarters of a declining economy] not lower growth. If growth is present, the economy is healthy. If the economy is not declining it is still a healthy economy. We have been sensitised to think that if growth alone is declining there is a major problem, but that is not so.

When we turn to exchange rates or to the gold price, the picture changes. An exchange rate either declines or rises in today's world. There once was a time when exchange rates almost did not move, but that was in the days of yesteryear, long since evaporated into history. But here again we can have a structural crisis, without it being expressed in an exchange rate as this week's news highlighted: -

We are now used to heavy trade deficits in the U.S.A. and the $ has not collapsed despite most competent observers saying it should and it will. But then comes the Capital account with often more $ flowing back into the States and not exiting the $, so the pressure on the exchange rate disappears, we might think. But far from it! The $ exiting the States go into the hands of other countries, who only leave them in the $ because they also have bills to pay in the $ and may need the $ in times of difficulty. All well and good one may say, but these countries like the States don't have friends, they have interests and if friendship and interests clash, friends go. With so many $ being around, any loss of buying power either in the States [inflation] or internationally through a falling exchange rate clashes with the interests of these $ holders.

Rising interest rates should lower the value of these surpluses in the States as the prices of the liquid assets into which they are parked, drops. But the Treasuries into which they have been placed have not seen this change because the demand for Treasuries has been so great that we find short term rates rising to meet the long term rate, so flattening the yield curve. But as we are beginning to see now the Treasury yields rising and the prices of the Treasuries falling, the value of these holdings is now falling. So what does a surplus holder do? He is at the mercy of the Fed on this one unless he keeps the demand for Treasuries at a persistently high level, so defeating rising short-term interest rates.

Will $ surplus holders cut and run? Will they switch out of the $ to go elsewhere to earn more income on their surpluses [the reason given by gold selling Central Banks for selling gold]. The limitations of the foreign exchanges of the world militate against this, leaving such $ holders captive. That is until the prospects of others switching out of the $, or oil prices being priced in the €. Should either of these two phenomena happen, then we will see the foreign exchange version of a stampede, one such as Refco clients could not match.

But most commentators will state blithely, that this will not happen. We disagree. It has happened and it can happen again. The prospects for the oil price, the transfer of wealth to the East and the steady debilitation through the Trade deficit is bringing the cliff edge for the $, closer and closer by the day. "So far so good" is the story to date, but fewer and fewer senior men doubt that that day is on its way. Here are the words of one man in a position of responsibility:

"Inflation in an underlying sense is not high now, but there is a risk that it could go higher, and that's what we are particularly focused on,'' Fed Governor Donald Kohn. ``Energy prices might affect underlying inflation by affecting expectations about future inflation".

The U.S. Trade Deficit
The Trade deficit rose to $59 billion, about $1.1 billion more than the previous month, reported the Commerce Department. We had forecast a potential Trade deficit of $720 billion for the year and we may well not be far out, a level way above last year's imbalance of $617.6 billion. Whilst U.S. exports in August rose 1.7% to a record level of $108.18 billion [the rise primarily due to commercial aircraft sales that will not be repeated in September]. That was overwhelmed by a 12.2% leap in crude oil imports, to a record $17.16 billion. Total petroleum imports, which includes refined products, also set a record at $22.6 billion in August. Some may well say, not as bad as it could have been, but the important feature of the Trade Deficit is the likelihood that it will continue at unacceptable levels for the foreseeable future, abrasively undermining confidence in U.S. money. With the $ being the global reserve currency still, persistently excessive U.S. Trade deficits bodes ill for the stability of global international Trade. But again it is unlikely to be visible, until we go off the cliff edge.

Contributing to the deficit, but lowering inflation by way of lower U.S. prices on imported goods, the month's deficit with China was $18.5 billion, driven by record imports, particularly Chinese clothing and textiles. The deficit with China is 28% ahead of last year's pace when it hit $162 billion, then the highest level ever with any country. So looking internally U.S. inflation, whilst rising, was not as high as it could have been. Cheap Chinese imports also contributed to wage rise restraints, also holding back inflation.

Is there nowhere else to go? After all, selling the $, means buying another currency. The Euro the Yen, the Swiss Franc seem to be alternatives, but are they large and sound enough to provide an alternative to the 68% of global Trade the $ does? It will take a heavily destabilised world for a move away from the $ and we certainly are not there, yet. But are we beginning to head that way? The gold price says, yes we are. These are early days for gold in such a scene. If we are headed that way, expect the gold price to rise massively into a $-four figure number or higher!

Oct 17, 2005
Julian D.W. Phillips

321gold Inc