Trends in the markets can be intriguing to watch. Not more than three or four years ago, at the bottom of the resource cycle, books were written about how resources were never going to recover and how gold would only be worth $150 an ounce. Now, at the top of the cycle, everyone is forecasting gold to reach $1,000 an ounce.

Our research analysts point out that popular wisdom at peaks of fear or greed is normally wrong! Just as resources did not fall when predicted, they will not rise drastically, as experts are currently claiming.

Conventional investment theory states that gold is a way of protecting your portfolio against inflation. It is a safe haven in times of crisis and, because it is priced in dollars, can be a hedge against a fall in that currency. So why is the price of gold at its highest level in 25 years? Inflation across the world is low, the US dollar is stable and – the threat of terrorism and the Iraq war notwithstanding – the world is relatively secure both politically and economically.

To ensure that inflation doesn’t become problematic, the US FED (and other Central Banks) have been raising their intest rates gradually since mid-2004,
the classic sign of anti-inflation policy. As a result, the short-term rates have been rising faster than long, producing a flat yield curve. Note that an inverted yield curve is usually the prelude to a recession.

Is a recession the reason for gold to increase?
In every pre-recession period, recent buyers console themselves by saying: "Gold did not fall during the Great Depression. It went up." However, research indicates that this is not true. In the 1930s, the US was still on the gold standard internationally. By law, the US government bought gold from gold mines at $35/oz. Consequently the gold market had a legal basis, unlike today.

That policy ended on August 15, 1971, when Nixon unilaterally removed the US from the international gold standard. Therefore the experience of the Great Depression is economically irrelevant to today’s gold market. Central banks may buy gold, but are not compelled by law to do so. We can say with confidence that they will not buy
silver, which is no longer a money metal.

Gold fell in the 1974/75 recession. Then it rose in the inflation of the Carter era. It fell by 50 percent in the 1980/81 recession. It descended again in 2000 prior to the 2001 recession.

Our key point is that gold, as an inflation hedge when price inflation exceeds forecasts, should not be regarded as a universal solution to the gyrations of Central Banks’ monetary policy. It should not be considered a recession hedge but an asset that can be sold to raise funds in a crisis. Gold is sold in recessions because people want to raise cash. It is not under any safety umbrella.

A new era
A fresh generation of investors has arrived who have forgotten or never been part of the lessons of the last gold experience. They fail to fully understand why they bought gold in the first place.They just recognize that their investment’s market value has risen. Remember: Genius is a rising market. Investors currently buying gold are tempted to regard themselves as experts, and abandon their sound investment plans. They may start to open discount accounts and trade themselves into poverty! Does this strategy work? Ask those traders that got Nortelled.

If the economy enters a recession over the next 12 months, precious metals are unlikely to continue their upward move.The pressure on asset-holders to sell
in order to gain cash is always difficult for those who choose not to sell. They see the value of their holdings fall. Yet prices in general continue to rise.

The fall should not be comparable to what happened to gold and silver after January, 1980. That was a historically unique period in the post-World War II era. The rate of price inflation under President Carter soared. This, coupled with Nelson Bunker Hunt’s silver play, created panic in this market. After the Soviet Union invaded Afghanistan in December, 1979 the metals mania exploded for one month: January, 1980. It then declined overnight.

In a recession, asset values tend to fall as people become desperate for cash. Fear is a great motivator. And so are margin calls. The marginal sellers of assets are more active than the marginal buyers of assets.

Nevertheless, most recent first-time buyers of gold and silver often overlook the obvious: that the moves of both metals over the last four years are anomalies. There is low inflation, and foreign governments, especially the emerging markets India and China, have never been astute in their investment decisions regarding gold and the US dollar. They sold gold at the bottom, because it was not doing well, and they’re now buying gold at the top – the classic mistake of buying high and selling low.

So what should you do?
We have repeatedly emphasized that some basic principles apply to all successful investment portfolios:

1. Diversification of portfolio to reduce risk
2. Balance value and growth positions
3. Choose excellence in investment management
4. Winners take years to develop, so think long term

If you can discipline yourself to stay with these timeless principles over a long period of time, investing becomes much easier. For further information, do not hesitate to contact our office.

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