Market Watch - July 2005
The
bull market died after reaching a high of 11,722 in January of 2000.
Now, 5 years later, the market hovers around 10,500, prices that
were first obtained in 1998. There is little hope the market will
substantially improve over the next several years.
Question: The above sounds like a typical Market Watch market summary –
a variation of the same forecast and summary that Market Watch has
published for years. Why so gloomy?
Answer: 10,500 on the Dow is not gloom and doom – it’s almost
10 times greater than the market was 20 years ago. Investors who’ve
been in the market all along have done very nicely. After a prolonged
increase in stock prices, there is always a period of time when
the market must correct itself in order to return to prices where
stocks are again a value. That is the period of adjustment in which
the market is currently mired.
Question: How long will this last?
Answer: While it is impossible to predict, adjustment periods last until
inflated prices have been deflated. The more the Fed creates money
out of nowhere, with no backing but “the full faith and credit
of the Federal Reserve System”, the more likely the market
will obtain ridiculously high levels. If cheap money is available,
the public will spend, as we have seen the last several years. Money
will be spent upon consumer goods, stocks and bonds, real estate
and all sorts of intangible items, all of which creates a “bubble”
in values. “Bubble prices” (unrealistically high prices
where opportunities to make money on an investment over the next
several years are limited) sometimes take a long time to readjust.
We’re an impatient society, and we expect values to be available
now. There have been significant adjustments toward reasonable values
the last five years. However, the market has a long ways to go in
order to readjust to average long term values. While it’s
purely a guess, it appears, based upon the last five years, that
this adjustment period will consume at least another three to six
years, if not longer.
Question: What does an investor do with their cash?
Answer: Three things:
1. Be happy you have cash. Cash is king.
2. Make sure you invest so that your principal is not at risk.
3. Invest only in income producing, “A” rated, stocks
and bonds.
Question: Is there an investment with, perhaps, a greater potential to increase
in value?
Answer: Yes, gold and silver. Both appear to be substantially undervalued.
Question: Gold is said to be an ancient relic, part of the past, and not to
be considered an investment. Besides, gold and silver are heavy,
hard to store and pay no dividends. Aren’t those adequate
reasons to avoid gold and silver as an investment?
Answer: That’s certainly the conventional wisdom. However, if one
thinks like the “crowd”, one will be limited to investing
in an idea after those investors who commit their money ahead of
the curve. If we think like the “thundering herd”, our
upside potential will be limited. Gold and silver have been money
for thousands of years. They have survived all sorts of government
monetary schemes and all sorts of paper money that have been created
over the centuries.
If one held a dollars worth of gold from, say, 1930, that “gold
dollar” would now purchase $22.50 worth of goods today. A
paper dollar from 1930, however, could now purchase only 5 cents
worth of goods today. The truth is that the dollar is fast becoming
a relic itself. All great civilizations have suffered through this
pattern, and all have eventually returned to a commodity standard
of money like gold and silver.
Question: What prices can gold obtain?
Answer: That’s an impossible question to pinpoint, but we can look
at some clues to future values. In the 1940s, you could convert
every dollar of the U. S. money supply into gold at a ratio of 1
to 1. Now, however, the U. S. money supply (M-3) divided by our
8,200 tonnes of U. S. monetary gold would make each $450 ounce of
gold equal to about $35,000 an ounce. Put another way, that 1930
$1.00 gold coin would now be priced at $1,750 in today’s currency.
Gold “experts” believe gold will obtain a value of at
least $1,500 to $3,000 an ounce in the next five to ten years.
Question: Wow! How is that possible?
Answer: The public has been completely duped by our politicians. In the
1940s, the U. S. owned 60% of the world’s monetary gold, or
36,000 tonnes. Much of that was sold by the Fed to “stabilize”
the dollar (keep it from precipitous drops in value). Today, our
8,200 tonnes of gold represents 25% of the world’s monetary
gold stock. Silver is actually cheaper than gold from an historical
point of view, but both, mathematically, have tremendous upside
potential. And, they will both go up dramatically in value. But
nobody knows when. An old Wall Street saying is, “don’t
tell me something is going up in value – tell me when it’s
going to go up!”
Question: Doesn’t the stability and credibility of a currency reflect
upon an economy, and, if so, isn’t the U. S. looking rather
weak right now?
Answer: A currency’s stability is a significant measure of the power
and viability of an economy. One might think that the depreciation
in the value and the purchasing power of the dollar signals further
deterioration of our economy. However, the Euro and the Yen, the
other two world reserve currencies, are also troubled. (A reserve
currency is accepted as legal tender to settle international obligations.)
The Yen is anchored by an economy whose values are deflating. The
Euro is anchored by a combination of countries with no constitution
and no set of laws that can give the Euro further credibility. All
three major currencies are backed by paper. In the long run, all
paper currencies fail.
Question: Is the U. S. in a state of failure?
Answer: No. On his way back to France on the ship ‘Victory’
after the Revolutionary War, General LaFayette wrote: “The
happiness of America is intimately connected with the happiness
of all mankind. She will become the safe and respected asylum of
virtue, integrity, toleration, equality, and tranquil happiness.”
Upon reflection, there’s a lot of truth to what LaFayette
said.
Are we a country driven by it’s own economy, or are we a country
driving the world’s economy? It would appear we’re more
the latter than the former: the dollar represents 70% of the world’s
reserve currencies, and the U. S. economy is 30% of the world’s
GDP. The U. S. economy literally drives the other economies of the
world.
America has been considered a safe haven for investments over the
years. We still are. The Constitution and the U. S. body of laws
contribute to our image as a safe haven. Our geography also helps
with the world’s two largest oceans surrounding our landmass.
A 292 ship navy with fourteen fleets, each of which has more fire
power than all but a few countries in the world, insure our present
security and our world image of safety and security for investments.
Conclusion
While our country isn’t in a state of failure, we do have
severe economic problems emanating from prior excesses. It will
take more time for our markets to become stable again.
In the meantime it’s important to invest carefully, and conservatively,
because everything except gold and silver is overpriced.
Rule number one of investing is “don’t lose capital”.
Since these markets are still overpriced, with many structural economic
problems yet to be worked out, putting capital at risk in this climate
bears a greater probability of losing money than the potential that
exists to make money.
Caveat Emptor!
George W. Rauch
July, 2005
