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Is This the Gold Buying Opportunity of a Lifetime?

October 22nd, 2008

By: Robert Perrego

Everyone has been saying how gold is going through the roof, right? All those predictions of massive inflation and that gold was the only safe place to hide. What happened you might ask? Why is it not working? Well, here is one answer and should it be right, this is the last best chance to catch the gold bus!

I am one of those that bet on gold and gold miners. How is it working out so far? Well, not so well. What am I doing? Buying more and this is why.

I saw the problem with the mortgages coming and the economy going south while inflation was being jacked higher by the retarded green-movement inspired ethanol subsidies and regulations that inflated the cost of food, the worldwide oil and commodity demand explosion caused by expanding populations and the entrance of the Chinese and Indian masses into the fast early economic growth stage while the worldwide printing presses were churning out more and more paper money. Does this make me a genius? No. Did this foresight even make me rich on this trade? No. What happens next and the important question is, 'What are you going to do now?' This is always the most important question a trader faces.

The mortgage mess did implode the financial system and the market crashed. The funny thing is that the dollar rallied, the market crashed and gold still did not break out as the inverse relationship to the dollar held it down like holding a beachball under water.

Lets start with the dollar. Gold and the dollar trade with a strong inverse relationship. This is because gold is a real asset in short supply that was the worlds first currency (and unfortunately I think someday it might be its last) and money. All currencies used to be backed by gold as a fiat currency for gold. That linkage was broken decades ago with the Bretton-Woods Agreement. Basically the more paper currency that you have in relation to something that people hold dear and real and difficult to get, the more paper money you have to trade to get it. Now lets say this 'it' is shiny, does not corrode or oxidize and is buried deep in the ground, and then throw on top of all this the fact that you can make things out of it that are pretty and helps a guy get the girl and people will start to value this 'it' a whole lot. Let's call this 'it' gold.

The dollar is the world's dominant currency. This is a result of the Marshall Plan that was launched after World War II when the United States provided Europe with a lot of dollars to rebuild. Europe's economic infrastructure was destroyed, as was Russia's and Japan's. The U.K. and France were a little less blown up but I think you get the idea. The only country with factories and productive assets that were not destroyed by the bombing and warring was the United States and thus the only unit of currency that had productive assets and value behind it was the dollar. With the Bretton-Woods Agreement the dollar became a fiat currency not tied to gold but tied to the economic productivity of that country. So enter stage right Mr. King Dollar.

The world has quite a few currencies from the pound to the yen to the euro to the Dollar. If you noticed I did not capiltalize all but the Dollar as the Dollar is still King. Oil and gold are traded in dollars and for good reason - the United States still has the most productive assets and the largest economy in the world and on top of that, for a long time we have been selling debt to all the other countries that print the other currencies.

Now this selling of debt gets people all very nervous, but in reality it was and is a sneak attack. Ask yourself how much the yen would be worth if all those Dollars the Japanese are holding were worth less? Ha ha - you got it. They hold all our debt and in a perverse manner their currency is reliant on our currency staying strong or the dollar assets they hold are worth less and they are not as rich and their currency is worth less. Also, should they start selling the dollar and it goes down, the dollars they still have are worth less. We have successfully co-opted the world into our own good fortune. Now use this same logic with the Chinese yuan, the euro and the Middle Eastern petrodollars. This is not even to mention all the lovely factories Toyota (TM) built in the United States but that is a whole different subject. We go broke - you go broke. Period! Have a nice day.

But I digress…

The tech/internet bubble and resulting market crash was solved by making credit and money easy. Interest rates were slashed and every clown in the country was given access to easy money through dubious mortgage lending and government policies. The natural human desire to keep up with the Joneses and the feeling that 'Hey, I was rich and now I am poor as that internet company I invested in that shipped fifty pound bags of dog food turned out to be a dud' turned the populace into greedy pigs wanting more. So what did all these newly awakened traders start doing? They started trading real estate saying 'They are not making any more land are they?' and 'Real estate never goes down.' Newsflash - sand found on beach - what goes up too fast must come down too fast.

This positivity and group-think that real estate could not go down had the people dealing in it lose all trace of caution and voila! Another bubble!

How did we get out from under the rubble of the tech bubble crash? We made credit more available and printed money. How do you think we are going to get from under this one?

The United States Government just passed a $700 billion bailout plan. In actuality it was bigger, but what's another $150 billion? The European governments have done the same. Russia even pumped its petro-rubles into its fledgling stock market as it crashed day after day. All this means is there is a whole lot more fiat currency floating around representing a not as fast growing worldwide economy and still pretty much the same amount of gold.

The dollar has rallied as the market crashed as foreign investors took the Concorde flight to safety - the safest asset on the planet - United States Treasury Bonds. In order to do this first a foreign investor has to swap out of the currency they are holding into the dollars to buy the Treasuries. This drives up the demand for dollars and the dollar goes up relative to the currencies they are selling. You ask 'Why don't they just use the dollars they already have?' Well this is because these dollars are already invested in Treasuries and they want to buy more.

So the market has crashed and the dollar has run up. Now what?

That huge bailout bill money has not been pumped into the economy yet. From what I hear this will start happening this week. You getting wise yet? All that paper money the United States Government has been printing will start hitting the mainstream this week. The whole $700 billion won't be spent on Tuesday or Wednesday but it is starting. A huge amount of the credit default swaps on Lehman Brothers came due yesterday. Events like these, a lot of times, mark reversals in various markets. I believe this to be the beginning of the bottoming process in gold.

Over the past weeks we have seen every asset class drop but Treasuries and the dollar. Stocks plunged, commodities got taken apart and corporate bonds got smoked. What has been happening is a massive deleveraging (not a real word but it is now) across the financial markets. I just read that over 350 hedge funds have gone out of business recently. When the guys are at the door to repossess the office furniture (and in the markets this is called a 'margin call') you sell everything - your winners, your losers - everything. This deleveraging is what has caused what was supposed to be a big winner, gold, to decline.

So what we are looking for is when will all this deleveraging end. First of all, the government pumping those $700 billions in is a good start. The Lehman settlement event will also give the market a better grip on the size of that calamity and that means less uncertainity and the market hates uncertainity. Will this be enough to slow or stop the deleveraging? Also, if the stock markets start to look better around the world, the money that ran to the safety of Treasuries will reverse flow and start back into equities. If this selling of Treasuries also causes foreign investors to decrease their exposure to the dollar that means selling in the dollar and the dollar goes down and gold goes up.

What makes me right or wrong in this matter is whether or not the world experiences deflation or inflation now. I pick inflation. The financial price deflation has done damage across most all asset classes. For a decade now every country on the planet has been running its printing presses and the world's most voracious consumers (U.S.) have been taking on debt to buy things. The amount of paper/fiat currency has been growing at dangerous levels and I have faith that all the worldwide governments can do to get out from under this mess is to keep printing and spending.

No government wants a depression. During depressions citizens get pissed off and start thinking that whomever is running the goverment should not be. That reaction can be as extreme as a revolution or a voting revolution. Politicians certainly don't want that - they like to keep their jobs so they can take money from lobbyists. They will run the printing presses overtime and let the inflation genie out of the bag.

Throw on top of all this the possiblity of a socialist hitting the White House with an agenda of 'spreading the wealth around' and that means more inflation. 'Spreading the wealth around' has been an economic disaster throughout the annals of history as it diverts money from productive assets to non-productive assets. One has only to look at the productivity decline of the Venezeulan and Mexican oil industries to see the latest prime examples of this ill-guided policy.

I think gold is cheap here. I think the politicians are going to inflate the economy to get out from under this mess. I think inflation is going to ramp up from here and gold is going to be the next bubble.

Want to get in early on this ride or would you like to buy the top again?

We all love bubbles until they pop in our faces.

Seeking Alpha

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