Peter Grandich on Stocks, Gold, & Silver

Part - II

May 25, 1997


I pay very close attention to the Dow in terms of gold & silver. In 1980 about one ounce of gold would buy the whole Dow. In 1932 the low was about two to one, from 1885 forward until the 1920s bull market began, the ratio was roughly one to one as well. Now the Dow has topped in terms of gold, at about 20:1. At that level gold has lost 95% of its peak value against the Dow, which argues that the bear market in gold has nearly run its course. Technically, we have had a peak of the Dow in terms of gold & now it's up to the Dow to exceed that previous 20.61 ounce high to prove itself. Doesn't that suggest an epochal trend change away from paper assets back into physical assets?

I can see that down the road, but a few more things have to play out before the gold market can really strengthen.

Last year I didn't make myself very popular at gold shows because I was the lone bear. All that is changing, as I have documented in the past two months. The change in the stock market & the situation in the metals bode well for a major new leg up in physical bullion. For the first time in a long time, bullion may outperform gold stocks.

Last year people asked me how I could recommend selling gold above $375. Three things concerned me then, two of them still do.

There was an enormous option war going on, & both sides had set their positions accordingly. One camp was betting on a significant break below 370, while the other camp was betting on a break above 400. It was that war that locked gold for such a long time into that $370 - 400 trading range. As gold neared the support or resistance of one camp or the other, they would try to defend their levels. That's why gold fell so fast when it finally broke $370, because there was no physical support beneath it. But last year's undeniable key factor in the physical bullion market is about to change: world-wide physical demand. According to the World Gold Council, in 1996 investment demand (bar-hoarding) dropped to a ten-year low. With demand that low, you just can't expect a rip-roaring physical gold bullion market.

Maybe as early as this year,
but certainly in 1998, we
will see gold over $400

At the same time, central banks sales rose 44-45% in the second half of 1996. Don't forget, the stock market has also bewitched these 29-year-old central bankers. They see gold bullion on their balance sheets, wonder why they need it, & then opt to sell it to support their currency. These fellows haven't been around long enough to witness gold's historical value coming into play. They will learn their lesson.

Another big factor depressing gold has been gold loans. In 1990 there were only 29 banks that loaned 20 million ounces. By 1995 sixty-nine banks loaned eighty million ounces. The 1996 numbers aren't out, but some people at the World Gold Council estimate as many as 100 banks that loaned between 100 & 150 million ounces (Editor's note: That's equivalent to more than two years of Western World total production).

Now combine that growth in gold loans with producer forward sales. They are cutting off their own noses to spite their faces by selling gold forward to keep earnings constant. Companies used to build mines by borrowing money; now they borrow gold, sell it into the market to raise funds, & pay it back out of future production. On top of all these depressing factors, gold investment demand was falling. But that was last year. Looking past the next couple of months, am I bullish on gold? No doubt about it.

The options camp on gold's short side made their money & began to cover, sending gold higher in a short covering rally from $340 to $365. Inevitably, gold had to react back to test its lows. As we speak it looks like gold is passing that test, & we've had a great double bottom at $335 to $340. The stock market rolling over will lift gold technically, winning back investment demand. Once we pass that old high at $365, gold is off to the races. Maybe as early as this year, but certainly in 1998, we will see gold over $400. As the stock market rolls over, the real physical demand will reappear that we need to eat through this resistance between $415 & $425.

Adjusted for inflation,
gold now equals its $106
price back in the 1970s.

You expect a gold bull market by December 31, 1998? Yes, but I have no problem recommending gold right now. If you are not a trader looking for a quick buck, begin to accumulate physical gold bullion here. You ought to be moving money out of stocks & into physical bullion. I feel very strongly about that. You will both avoid losing money by exiting stocks, & make money buying gold from these levels. However, you won't get that instant gratification people have grown accustomed to in the stock market.

Adjusted for inflation, gold now equals its $106 price back in the '70s. That is a very bullish argument because no one can point to a single time in history where gold has not held its historical value. If gold is truly as cheap now as it was in the '70s & stocks are historically at their highest valuation, you don't have to be a gold bug to realize you are much safer going into gold. I have no doubt that I would be better off financially & mentally buying gold at $340 now than the Dow at 7000 or wherever it is.


What about the U.S. dollar? The dollar is in a final counter-trend bear market rally. I have been on the long side, I admit with some shame. The very long term chart shows that the dollar became so over-sold that it had to react upward. The appearance (but not the reality) is that politically & economically the U.S. is the best of all worlds, plus its rising interest rate trend suggests by default that the dollar is the place to be.

Unfortunately, the political environment will inevitably turn down. I think Clinton is toast. The Fed will tighten up to slow the economy, & could err on the side of tightness. Eventually that will cause a recession, & people will have to face the fundamental political & economic factors they refuse to face now. All of a sudden people will say, "Hey, what about gold? That usually works."

All in all, the bell has rung for stocks, & gold is bottoming. Financial assets, stocks & bonds, are topping, but that never becomes clear until till they are way past the turn. Only those who can recognize the turning process & attack it right, catch the bottom. If you don't want to catch the exact bottom, wait till gold breaks above $365. Then you can have real confidence that there gold's floor is so strong that no downside risk exists from that point. From there it will rise $100 to $200.


What about silver? Silver right now should be priced closer to $7-8. Only gold's lack-luster performance has prevented silver's truly bullish fundamentals from taking hold.

Silver has far more going for it. No central banks have huge silver holdings, so they can't become sellers, but so much privately held silver has come onto the market that it masks the true supply-demand scenario. True, new copper projects coming on stream will increase silver production, but that won't matter. The market is still trapped in the mentality that silver should have a fixed ratio to gold. If gold isn't rallying, silver can't go to $8. Since silver is such a thinly traded market, the average investor has stayed out, leaving just professional dealers. They're are not willing to let it trade outside what they see as a fixed relationship. When gold begins to advance, it would not surprise me for silver to outperform gold. [END]

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