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The Next Crisis

Monetary Digest, December 2000

The US is in its ninth year of economic expansion, which helped give rise to the greatest stock market in the history of the world. Never before have so many people made so much money with so little knowledge. Now, though, a myriad of technical indicators suggests that stocks have entered a primary bear market. As noted in the October Monetary Digest, there are some eerie similarities to the 1920’s stock market and economy. The big question today is, will Fed Chairman Alan Greenspan engineer a “soft landing,” or will this economic boom and history-making bull market end as did the Roaring Twenties with the infamous Crash of 1929?

The bulls are confident that Greenspan can bring about a soft landing, as in the economy losing steam but not turning recessionary (negative growth). Ironically, Greenspan’s solutions to other problems this decade could cause the worst economic and stock market crashes since 1929.

As the economy was coming out of its last recession in 1991, the S&L crisis lit up, threatening to torch the embryonic recovery. But, Greenspan inflated the money supply, and S&L depositors became bank customers. And, as the freshly-printed money then moved about the economy, much of it found its way to the stock market and helped prices climb higher.

Following the S&L crisis, things went well for years, then crises began appearing regularly. In 1997, the Asian crisis almost sank Indonesia, Thailand, South Korea, and other Pacific Rim economies. Now, this was a real crisis, one that threatened to engulf even mighty Japan if swift action were not taken. Because most of the troubled countries were exporters, it was necessary that the US remain a major importer. So, the Fed printed more money, and consumers continued buying.

The year 1998 saw two crises: the Russian banking collapse and Long-Term Credit Management’s failure. To quell concerns about the Russian crisis, Greenspan and the heads of European central banks proclaimed the Russian banking crisis “manageable.” And, so it was, but it required the printing of still more money, which again found its way to stocks, propelling stock prices to heights before unseen.

When LTCM’s failure threatened to destroy the US treasuries markets, the derivatives market, and a few major banks (in short, the world’s financial system), the Fed put together a midnight rescue. The financial markets were saved, and newly-created money moved about the economy. But, again, much of it found its way to the stock market, where prices climbed still higher.

Last year, the now nearly-forgotten Y2K crisis arose. To head off possible panic in case of computer failures, the Fed liquified the economy with money, much of which migrated to stocks, sending NASDAQ stocks to wildly unrealistic values. But, the public was told everything was okay, that it was the “new economy,” and that investors who were used to investing in steel mills and auto makers just couldn’t understand the new paradigm.

That was an accurate assessment because older investors had a very difficult time buying .com stocks. At last year’s annual meeting of Berkshire Hathaway, shareholders excoriated Warren Buffett for not buying technology stocks. With the NASDAQ now down 45% from this year’s high, it is doubtful shareholders will challenge Buffett’s decisions at the next meeting.

In 1996, when the Dow Industrials had just risen above 5,000, Alan Greenspan gave his famous warning about the “irrational exuberance” in the stock market. As it turned out, Greenspan hadn’t seen anything. From there, the Industrials climbed to an intra-day high of 11,908.50 on January 14, 2000. But, the NASDAQ, which had just cleared the 1,000 hurdle in 1996, hadn’t even given a hint of what was to come. On March 10, 2000, it hit an intra-day high of 5,132.52.

Investors who bought early made big money. Unfortunately, the stock market is a sum zero game, which means that one investor’s gain is another’s loss. (In theory, if prices never fall, the last guy in doesn’t lose. However, it does mean that for one investor to take his profits, another has to invest. So, when prices finally fall, one man’s gains become another’s losses.) Investors who are late to the game, and those who continue to put money into stocks, provide the profits for those who got in earlier. Finally, to take profits from rising stocks, one has to sell. With the public continuing to pour billions into mutual funds, it doesn’t appear that everyone’s gotten the message that the game is over and it’s time to go home. Through August, investors had poured $256 billion into equity mutual funds, versus $199 billion for all of last year. For those who doubt that stocks have topped, below is Richard Russell’s Top Out Parade.

  • Daily new highs on the NYSE topped out at 631 on October 3, 1997.
  • The advance-decline ratio for the NYSE topped out on April 3, 1998 at 13.00.
  • The Value Line (geometric) Average topped out on April 22, 1998 at 508.39.
  • The Morgan Stanley Cyclical Index (index of cyclical stocks) topped out on May 10, 1999 at 619.09.
  • The D-J Transportation Average topped out on May 12, 1999, at 3783.50.
  • The D-J Industrial Average topped out on Jan. 14, 2000 at 11722.98.
  • The Russell 2000 Average (lower priced stocks) topped out on March 9, 2000 at 606.12.
  • The NASDAQ Composite topped out on March 10, 2000 at 5048.62.
  • The Amex Index topped out March 23, 2000 at 1036.40.
  • The Wilshire 5000 topped out on March 24, 2000 at 14751.64.
  • The S&P topped out on March 24, 2000 at 1527.46.
  • The NYSE Composite Average (all NYSE stocks) may have topped out on Sept 1, 2000, at 677.58.
  • The NYSE Financial Average (banks, S&Ls, brokers, loan companies) topped out on Sept. 11, 2000 at 634.16.
  • The D-J Utility Average probably topped out on October 2 at 401.47.

As Greenspan inflated the money supply to head off the series of “crises,” the additional money not only drove stocks to extremes, it also distorted the business world’s perception of consumer demand. This means that consumer demand was artificially stimulated, but the business community made new investments as if it were solid and sustainable. World auto manufacturing capacity now far exceeds possible demand. A serious slowdown in car sales will probably result in many auto plants closing around the world.

In Austrian economic terms, malinvestments have been made and will have to be washed out as the financial markets return to normal. Although a washout in the auto industry could be devastating, the really big mess is in the telecommunications (telecom) industry and easily could result in the next crisis. This time, though, American banks will suffer. Again, we will see another Fed “rescue,” but this time it is likely to result in higher inflationary pressures.

One would think that with billions involved and with the decision makers being the most knowledgeable about telecoms, the right decisions would be made. But, the efforts of three satcoms (satellite communications telecoms) indicate just how difficult things can be.

Motorola led a consortium that invested nearly $7 billion in Iridium, a mobile phone-satellite system that was supposed to let users call from anywhere in the world. Iridium filed for bankruptcy nine months after opening for service. In the wake of the Iridium debacle, investors bailed out of London-based ICO, forcing it into bankruptcy. The third, Globalstar, is on wobbly legs. Loral, which built its 52 satellites, recently jumped ship. One analyst reckons that Globalstar needs 1.6 million users to survive. At last count, it had 13,000.

In May, ICO emerged from bankruptcy, thanks to a deal put together by mobile-phone visionary Craig McCaw. With an infusion $1.2 billion, plus $2.8 billion to come from McCaw and friends such as Bill Gates, the reinvigorated company plans to launch service in 2003. The company, now ICO-Teledesic, believes that by implementing the latest technology, which permits data transmission and “always on” Internet connections, it can earn a profit. Analysts see ICO-Teledesic facing two problems.

First, there are no standards by which to measure demand for such services. Motorola and Globalstar missed. Will ICO-Teledesic? Second, technology is advancing so rapidly that by 2003 the ICO-Teledesic approach may be obsolete. But, the money invested and lost by these three satcoms pales in comparison to that being bet by the general telecoms-and their banks. The Economist says it “may prove to be the biggest gamble in business history.”

Over the next three to four years, European telecoms will invest more than $300 billion in bringing together the two hottest technologies of the moment: the mobile phone and the Internet. The $300 billion will be split about evenly between paying governments for the G3 band spectrums and the cost of building new broadband networks.

Although telecom managers speak confidently of “knowing their business,” Investors are not so sure. Share prices in most big telecoms have tumbled as fears have grown and debts have mounted. Furthermore, the big players, Deutsche Telekom, France Telecom, and British Telecom, had their credit ratings down graded, with the threat of more to come. Their bonds are trading at far wider spreads than those of other corporate entities, more evidence of investor edginess.

The big question: will users want wireless Internet connections for their mobile phones? If so, at what price? Part of the drop in telecom share prices and widening spreads on their bonds came because of a weak consumer response to mobile Internet service that was released earlier this year. A mere two million frequent users log on, not the ten million expected. Nokia, the world’s largest mobile phone manufacturer, says the weak response was because of slow connection speeds and dull services, all of which will be corrected with the newest technology-so they hope.

Although many people in the mobile phone industry are careful not to claim that handsets will replace PCs for surfing the Net, Nokia believes that its handsets could shoulder aside the personal computer to become the commonest way of connecting to the Internet. This is brash position, one that-if not correct-could cost Nokia and its banks dearly.

The industry hopes to exploit the uniqueness of mobile phones. Supposedly, mobile phones are always with consumers, and the telecoms will provide services based on knowing their clients, where they are, and what sort of information they want. Telecoms even have hopes of becoming surrogate banks, with customers use mobile phones as “electronic wallets.”

There are big problems with this vision. First, time- and location-specific services are likely to be low in value. Consumers are not likely to pay to be guided to a motel when a call on a cellular phone would provide the information. As for portfolio updates, they may be desirable when stocks are climbing, but when prices start falling, will users pay much for this service? The second relates to technology. The new G3 bands are not needed for the services touted, so why pay $150 billion for them?

There are limits on what consumers will pay for conveniences, and this will be especially true as the economy turns down. Telecoms-and their partners, the banks-have made a big bet, one that if lost could spell big problems for European and American banks. The Economist sees it as the next crisis, and it’s coming at a time when American banks are not prepared.

For the telecoms’ investments in G3 to pay, within seven or eight years the companies need to be earning at least half their revenues from transactions and from data traffic. Revenues from voice services are flat because of fierce competition. Will competition, or a lack of consumer interest, compound the telecoms’ problems?

Frankly, most investors would not suffer if the telecom industry’s new venture washed out, except that banks are on the hook right along with the telecoms. The telecoms borrowing and the banks lending are perfect examples of the types of malinvestments that arise during times when the money creators are loose with the purse strings. And, according to some bank analysts, signs have already emerged that American banks are headed for trouble.

“Bank of America has the potential to become too big to fail in the next recession,” says Charles Peabody, an analyst at Mitchell Securities. B of A is now the country’s largest bank, and Peabody talks about it failing. Actually, he likes very few bank stocks. Michael Mayo, of Credit Suisse First Boston, spurns them all. Not one bank does this analyst recommend. While these two analysts’ views may be extreme, regulators have been sounding warning bells for months.

The FDIC warns that banks are facing increased risks from real estate loans, mostly because of increasing volumes of construction and development loans and commercial real estate loans. Problems in the commercial real estate market contributed heavily to the banking crisis in the early 1990s and during the Asian crisis. The FDIC estimates that 9% of banks are “very vulnerable” to an economic downturn. The percentage of institutions that the agency considered very vulnerable between 1987 and 1995 never exceeded 5%.

David Gibbons, the man responsible for monitoring at US banks’ credit risks at the Office of the Comptroller of the Currency (OCC), thinks banks have been underestimating their risks. In fact, Mr. Gibbons has been sounding alarm bells for the past couple of years. Banks, on the other hand, are insistent they know what they are doing. Of course, the bankers are well aware that the US Treasury stands behind them, even if they make horrible lending decisions.

Even Fed Chairman Alan Greenspan has voiced worries about America’s banks. Apparently, investors have taken note. Bank stock prices have underperformed market averages over the last two years.

In June, Wachovia announced it would take a $200 million charge to cover loan losses. In July, Bank One disclosed losses totaling $1.9 billion; and, First Union lost $2.9 billion when it closed the Money Store, a lender for borrowers with poor credit histories. Since the economy is rolling along, it is not obvious why any of this is happening. Banks normally get into trouble in recessions. Perhaps it is because the economy is not as good as thought.

While deregulation has been the buzzword of the 1990s, it brought on new problems. With the rollback of the Glass-Steagall Act, commercial banks have jumped into the investment business and have started taking equity stakes in companies. Chase Manhattan is the biggest such investor. But, Bank of America, Fleet Boston Financial, First Union, BankOne, and Wells Fargo all have venture capital operations. In its latest results, Chase wrote down $563 million in its venture capital portfolio, and its stock plummeted.

Additionally, rumors circulate about losses at some banks (mainly investment banks) in high-yield junk bonds. The most talked-about are Morgan Stanley Dean Witter and Deutsche, but they maintain their losses are small. Yet, they are unlikely to be only ones to have suffered. Most banks in this market carry large positions, and the market, as well as falling sharply, has almost dried up: bids on many issues are almost impossible to come by. In other words, there’s no one to sell to, meaning the bonds are virtually worthless.

Defaults in bonds are already at their highest since the recession of the early 1990s, and the spread between junk bond yields and ten-year treasuries continues to widen. Considering that those who tapped the bond market are the more credit worthy borrowers, it seems reasonable that the loans on the books of the banks are worse than admitted.

A stock market crash or a long bear market would cause still more problems. For example, the mutual fund industry would cease to be as lucrative as it has been. Bond mutual funds, which has suffered huge redemptions because of a bear market in corporate bonds, are starting to hurt. And, the jittery market is causing headaches for banks with large overheads. Further, with the markets for initial public offerings and secondary offerings grinding to a halt, those lucrative fees have been lost.

Consumer loans, which should be big money makers during boom times, are already giving off alarms. Banks have had to write down a fair amount of lending on cars because banks were too optimistic about the residual value of the cars that backed the loans. Worse may come in other consumer areas.

Although sub-prime lending (the Money Store) has fallen off lately, banks still have on their books the loans they have already made. Then there is the credit card business. One analyst thinks that many consumers are using credit cards to maintain a standard of living they cannot afford. An economic downturn would prove devastating to banks in this lending arena.

Mortgages are another difficult area. Many banks have transferred credit card loans to home equity loans, which are tax-deductible for the borrower and offer collateral for the lenders. But, as with car loans, their attraction depends on property prices holding up and the economy continuing to thrive. If they do not, things might turn ugly. “Big banks seizing homes is not a pretty sight,” one analyst said.

In a recent report, a securities firm specializing in banks stocks found it “interesting that so many chief credit officers and other senior bankers have decided to retire or resign in recent months.” The implication seems to be: get out while the going is good.

In other areas, banks simply lent as if there were no tomorrow, either because they were about to do so, or because they felt that had to stop new entrants that were eating into their business. Rolling back Glass-Steagall was not wise because commercial banks carry the unwritten backing of the US Treasury, which tends to cause them lend more freely, and at a time when lending is getting riskier.

Corporate America is being downgraded by credit-rating agencies at a faster pace than anytime since the recession of the early 1990s. Companies are becoming ever more highly leveraged; that is, their debt/equity ratios are climbing. Last year, US non-financial firms issued some $535 billion of debt, mostly to buy other firms or their own equity. In net terms, US firms bought back shares for the sixth year in a row. Moody’s expects defaults on speculative-grade bonds to exceed 8% next year. In the first half of this year, nearly three times as many companies were downgraded as upgraded. Every sector seems to be getting hit, from textiles (Burlington Industries), to food (Dole), apparel (Levi’s, Tommy Hilfiger), cosmetics (Revlon), cars (Ford), and cinema operators (Carmike and United Artists).

As go the bond markets, so follow the banks, eventually. Borrowers’ problems show up in the bonds before banks because bond investors are hard-nosed. Bankers like to negotiate new deals instead of pulling the plug. The FDIC, for one, thinks that bond defaults are leading indicators of problems in the banking sector. Nonperforming loans have already started to climb, despite a supposedly robust economy. Perhaps it’s because the stronger borrowers went to the capital markets long ago, leaving the banks with sub-par clients.

Although the rate of bank lending has slowed since the heated pace of 1998 and 1999, it is still far above growth in GDP. This suggests that banks are taking more risk to generate the 15% or so in earnings-per-share growth that investors demand. One reason that bank lending grew rapidly after late 1998 is that the capital markets dried up for riskier borrowers. Construction lending has been growing at an annual rate of 20% or more since the second quarter of 1999. And, despite the experiences of First Union with its Money Store, sub-prime lending is still growing fast. KMV, a research firm, shows that this lending makes banks themselves more likely to default.

Some 60% of banks’ profits come from lending, and the quality of banks’ loan portfolios has been sharply reduced. The extent of the decline has been masked by a booming economy.

Additionally, banks themselves have become more leveraged (by taking on more debt compared with their equity), have lent to companies that, in turn, have also become more leveraged. At book value, the debt-to-equity ratio for non-financial companies has risen from 72% in 1997 to 83% this year.

A good example is the syndicated-loan market, where the proportion of so-called leveraged loans (bridge loans) has climbed rapidly. Regulators define such loans as those where the borrower has debt of three-and-a-half times equity or more. In 1993, some 7% of new syndicated loans were leveraged; by the first quarter of this year, the figure was a troubling 36%.

In early October, regulators released figures showing a sharp deterioration in the quality of syndicated loans. In total, loans that were, or might be problematic, came to some $100 billion. The worst of these so-called “classified” loans totaled some $63 billion, a 70% increase on the previous years (which itself saw a 70% rise from the year before).

All this is coming at a time when US banks’ reserves are at their lowest in 13 years. Worse, adjusted for the riskiness of the banks’ loans, the reserves-to-loan ratio is at its lowest in 50 years.

It is a truism that the worst loans are made at the best of times, and the economy is now in its 117th month of expansion. As long as the economy continues its record-breaking run, banks will probably only be bruised by bad loans, unless some telecoms go belly up. However, if defaults and bad loans are starting to show up with the most moderate of slowdowns, imagine what they would look like if the economy turned recessionary. Then, perhaps, Charles Peabody’s fears of bank failures would come true. If so, look for another government bailout, despite inflationary pressures.

In 1996, when Alan Greenspan warned of “irrational exuberance” in the stock market, he undoubtedly knew the problems ahead. Unfortunately, Greenspan had no alternatives, at least politically, other than to inflate the money supply to head off the crises. But, in doing so, he created conditions that distorted the financial markets and the business world’s perception of demand for its goods. Now, the piper has to be paid.

Few things, war the exception, stir interest in precious metals like the fears of bank failures. The above information was gleaned from eight issues of The Economist, one of the world’s esteemed business magazines. Over this year, The Economist has warned of banking troubles around the world, including France, Britain, even Turkey.

Further, The Economist repeatedly has noted that Japan, which has had financial and economic problems for ten years, has yet to convince the world that its banks are solvent, which is a problem perhaps much more ominous than US banks. Japanese banks count stock holdings as part of their reserves. Although Japan’s premier index, the Nikkei 225, rose strongly in 1999, alleviating some concerns about Japanese banks, since April the Nikkei 225 has steadily declined and now stands at just above the 14,000 mark. Some analysts calculate that below 14,000, many Japanese banks hold losing positions in stocks, pushing them close to insolvency.

Furthermore, loans are souring on the books of the banks. Bankruptcies and bad debts are expected to set records this year, and requests for debt waivers are rising, primarily in the problem-ridden construction sector. Next in line are the property, trading, chemicals, oil, and retail industries.

The problems in Japan are not restricted to the banks. Gross public debts top 110% of GDP. The government’s budget deficit is deep in the red and is expected to keep growing for at least a few more years. Consumer demand, which is three-fifths of the economy-is soft and looks to stay that way. Land prices continue their long, destructive slide, as do office rents. Urban land price declines are especially painful because banks rarely make provisions for loans backed by property. Recently, the bankruptcies of two big life insurance companies shocked the country. Chiyoda collapsed with $27 billion in debts, and Kyoei went under with liabilities of $41 billion.

Worldwide, huge problems are on the horizon. One wonders which will be the straw that breaks the camel’s back and sends the world’s markets into panic. Investors should prepare before the storms hit, which may be tornados and hurricanes, laying waste to all portfolios built on paper.

Historically, gold and silver have withstood all such onslaughts, and with such perilous times ahead, gold and silver should be much higher. So, gold below $300 and silver below $5 are gifts. Buy now, not after the storms hit.

Y2K Gold Eagles Sales Increase

The October Monetary Digest noted that 2000 was going to be a low mintage year for Gold Eagles. Although sales have increased, it looks like that it will be the lowest mintage year ever for 1-oz Gold Eagles. Below are the numbers posted on the US Mint’s Web site November 25, 2000.

In November, the Mint sold only 30,500 1-oz Gold Eagles. If a comparable number are sold through December, then total mintage for the 1-oz Eagles could be 90,000, a very small number. When buying Gold Eagles through the end of the year, go with the Year 2000 coins, which now sell at the same price as older date coins. (Selling from Y2K buyers has subsided substantially.) Even 100,000, would be very low mintage for 1-oz coins. They could pick up collectors’ premiums in the years ahead.

Year 2000 Gold Eagles will probably be available through year end; however, in years past, the US Mint has run out during December as it converted to the next year’s production.

Silver Eagles

The US Mint reports having sold more than seven million 1-oz Silver Eagles through November 30, 2000. That’s double the numbers sold in 1996 and 1997. Yet, the uniqueness of the date 2000 could cause them to carry collectors’ premiums in future years. Silver Eagles sell at $1.65 over spot in Mint boxes of 500.

Putting Gold and Silver in Your IRA

In a few weeks, millions of Americans will start the annual ordeal of preparing their tax returns. Unfortunately, many taxpayers wait until just before the filing deadline to make their IRA investments. IRA investments should be given more consideration; they should be made when the opportunities are the best, not to meet a deadline.

Now is an excellent time to switch IRAs to gold and silver. Gold is within $20 of a 16-year low, and silver is trading at a three-year low. As the stock market continues to unwind and some of the economic and financial problems outlined in this Monetary Digest come to light, precious metals will do much better. To optimize profits, make the switch to gold and silver before they move higher. Over the next five years or so, gold and silver may perform as well as stocks have over the last five years.

CMI recommends American Church Trust (ACT), which offers a simple, inexpensive self-directed IRA that accepts gold and silver. Most IRA plans will not; it is highly unlikely your existing IRA will accept precious metals investments. ACT is regulated by the Texas Banking Commission and administrates more than 14,000 IRAs. CMI has worked with ACT for ten years; its personnel are professionals.

The metals put in IRAs with ACT are stored at HSBC’s depository in New York City. HSBC is one of the world’s largest banks; its depository is licensed and approved by all the major commodities and futures exchanges.

Establishing an IRA with ACT is easy. First, complete an application (which CMI can mail to you.) This sets up the account and authorizes the transfer of funds from your present IRA. (You do not have to move all your IRA investments to ACT.) This step requires the payment to ACT of $135, which takes care of the first year’s annual fee ($35), the first year’s storage ($60), and the initial transaction fee ($40). After that, ACT charges only 1/8 of 1% of the IRA asset value, with a minimum of $35 and a maximum of $150. HSBC’s annual storage fees are as follows: $1.00/$1,000 assets of gold or platinum and $3.00/$1,000 in silver, with a minimum of $60 and a maximum of $200.

After the account is funded, you direct CMI as to which metals you want. After the metals are delivered to HSBC’s depository for your account, ACT pays CMI, completing the transaction.

Gold items eligible for IRA investments include Gold Eagles and bullion coins and bars that are at least .999 fine. Eligible silver items include Silver Eagles and 999 fine bars and coins. For investors wanting gold, CMI recommends 1-oz Gold Dragons and Year 2000 1-oz Gold Eagles. Investors preferring silver should go with silver bullion. The premiums on Silver Eagles are too high compared with bullion.

Monetary Digest readers who would like to discuss ACT’s IRA program are encouraged to call CMI. And, we have information packets for those who would like to receive them.

Gold and the Dollar

The US trade deficit will reach 4.3% of GDP this year, and because the US been running a trade deficit for years, the percentage of US financial assets held abroad, $1.9 trillion or nearly 20% on a net basis of GDP, is the highest since the 1800s. The percentage of GDP that is internationally traded may be 20% to 25% of the total, suggesting a higher rate of borrowing and a lower degree of national solvency than is generally perceived. In other words, our chronic trade deficit is a crisis waiting to be recognized, which will be evidenced by a crash in the dollar.

According to a paper presented to the world’s central bankers at this year’s annual Jackson Hole Symposium, the risk of a dollar crash is significant. The study suggests that a sudden depreciation of 24%-40% could occur if foreigners moved quickly to exchange their dollars. The disproportionate ownership of the dollar is widespread throughout numerous asset classes, and selling by one could result in a crisis.

Gross foreign ownership of US assets now measures over $6.4 trillion (66% of GDP). Foreigners own a record 38% of the US treasury market, and 44%, excluding Federal Reserve holdings. They own a record 20% of the US corporate bond market and 8% of the US equity market. A change of sentiment on the dollar would collapse these markets.

The integration of the world’s financial markets has caused capital flows that now dwarf currencies that once were principals players in the world markets, namely the d-mark and the Swiss franc. It seems as if it has come down to the dollar or nothing at all, except gold, which stands to become the protest vote on the monetary ballot, the equivalent of “none of the above.”

The epic strength of the dollar is no longer something to celebrate. Oil is the best example of the damage a strong dollar can do. Oil is priced in dollars. At $35, oil is three times what it was two years ago. Add in the strength of the dollar, which means allow for the weaknesses of other currencies, and other nations are paying dearly for oil.

Additionally, the weakness of the euro has created sufficient discomfort to trigger a round of concerted efforts to prop up the euro. The interdependence of world economies and financial markets means that the dollar cannot be isolated or insulated. Whenever the foreign exchange markets force the hand of central bankers, there is reason for us to cheer because interventions rarely work in the long term. Interventions are more signs of the severity of the problem than a solution.

Perhaps the euro will be viable, but there is no precedent for a successful multinational currency. It was the prospect of the euro in large part that led European central bankers to view their reserve assets, especially gold, as redundant. It is possible that the euro will turn out to be a fiasco, notwithstanding the current rescue effort.

The European central bank is issuing euros at growth rates of 10% annually and nearly 20% in recent months. These are banana republic growth rates and may help explain the market’s aversion to the euro. An eventual abandonment of the euro would be bullish for gold and possibly bearish for the dollar. A demise of the euro would certainly cause central bankers to reassess their attitudes toward gold. But, the demise of the euro is not the only potential source of renewed investment interest for gold.

Banking derivatives have to give bankers restless nights. The potential miscalculations in the gold market are minuscule compared to the bets placed on the foreign exchange and interest rate markets. According to the BIS, total derivatives on interest rates and currencies measure in the hundreds of trillions; consequently such huge investments in those areas mean under investment in the commodity sector, which will lead to shortages and spiraling prices in certain commodities. What is happening in oil could be the future for other basic resources. The rise in commodity prices over the past year has not been a fluke.

Furthermore, excessive investment in the high tech and telecommunications sectors will lead to banking and bad loan problems reminiscent of tanker loans, S&L defaults, real estate, and other similar misadventures. And, the doctrine of just-in-time inventory management has resulted in a run down of critical stocks of basic materials. Supply shocks will evoke consumer responses similar to that recently witnessed in Europe during the protests over high energy prices. If the markets lose their confidence in deliverability, there could be a secular swing toward restocking and hoarding.

Recent acquisitions of behemoth financial institutions by their foreign counterparts are another sign of a market peak for financial assets, and a recession would undoubtedly trigger renewed monetary ease, including lower interest rates and more rapid money growth. The dollar is potentially vulnerable on these and many other fronts. The inflation news cannot remain rosy forever. BLS reports on the CPI and PPI are already viewed with suspicion.

The dollar is high because of a successful and widespread campaign across several fronts and the confluence of external events that included: implementation of hedonic pricing methodology to BLS statistics; widespread financial market reforms that encouraged banking industry consolidation and the emergence of financial institutions of unprecedented scale; removal of trade barriers; curtailment of longer term treasury debt maturities; endless spin on a strong dollar; making sure gold did not establish an uptrend; the demise of the Soviet empire; and, the strong fiscal position of the US.

These developments interacted with the markets in a way that reinforced the dollar’s strength and undermined gold. However, these measures and/or events, like the Clinton administration, will soon be history, and we may have reached the limits of the desirability of a strong dollar based on the extreme position of our trade balance and foreign asset ownership. The euro intervention is a tip off that there is sufficient disquiet in the public and private sector that a change is in the wind.

The real clues to the outlook for gold lie in the market for the US dollar. The Clinton administration’s strong dollar campaign has enjoyed wild success, creating an insatiable appetite for the paper. But, this success is a principal reason for the dollar’s present vulnerability. When foreign holders of US assets begin to suffer buyers’ remorse and realize that the strong dollar has gone too far, the dollar will decline and gold will rise. The fundamentals supporting such a change have been in place for some time, and the prospects for a change are promising.


For years, CMI has taken the position that silver will perform better than gold during the ensuing precious metals bull market. In a rising market, silver enjoys a higher percentage gain; in a bear market, it falls further. In short, silver is more volatile than gold.

For example, in the early 1970s, silver was $2 but reached $50 in 1980, a twenty-five times move. During the same time, gold climbed from $120 to $850 for a seven-fold move. Even if gold’s starting point had been $75, it would have had only an eleven-times move.

Another example: In 1992-1993, gold traded many months in the $340-$370 range, while silver was $3.50-$3.70. Today, silver (at $4.70) is up 27%-34% while gold (at $270) is down 22%-27%. And, the bull market has not yet started. When it does, silver should again do better than gold.

Since 1991, silver has been running a production deficit, which means that production (plus salvage) fails to meet industrial demand. This year’s industrial deficit has been estimated to be 100 million ounces. Add silver used for coinage, and the deficit swells to nearly 120 million ounces.

Many precious metals investors avoid silver because they consider it an industrial metal and fear that a recession will curtail demand. While it is true that a recession would reduce industrial demand, there are two other points to consider. First, a recession would cause a big shift in investor sentiment, resulting in pessimism and anxiety, which would send investors looking for the safety of silver (and gold.) This would go a long way toward offsetting reduced industrial demand.

Second, a recession would result in reduced silver production, perhaps widening the production deficit. Nearly 75% of newly-mined silver comes as a by-product of other metals. Lead-zinc mining generates about 37% of all silver mined, and copper about 22%. A recession would lessen the need for lead, zinc, and copper, thereby reducing the amount of silver coming out of the ground.

Finally, it should be noted that more people have used silver for money than have gold. In at least seventeen languages, the words for silver and money are the same. When times get tough, more investors will buy silver than gold. Investors who can handle silver’s bulk and weight should make it a substantial part of their precious metals portfolios. This is especially true for investors putting precious metals in their IRAs.


Silver still holds the greatest upside potential of the precious metals. It simply moves higher on a percentage basis in bull markets-and falls further in a bear market. Yet, investors unable, or not wanting to, handle silver’s weight and bulk should not hesitate to buy gold. Below $300, it is a gift. There will come a time when many investors bemoan not having invested at these levels. This will be especially true for those sticking with stocks when there are so many indicators that a primary bear market in stocks has begun.

Investors should avoid platinum at these levels, where it holds as much downside risk as upside potential. Gold and silver, on the other hand, have very little downside risk.


CMI recommends circulated 90% coins because they normally pick up premiums in a rising market. Presently, they are selling near spot.

One-hundred ounce bars are a convenient way to invest in silver, but rarely do their premiums increase. One ounce rounds are ideal for investors who want the flexibility rounds offer. Right now, both 100-oz bars and 1-oz are selling below the cost of production, but a few cents above spot.


Australia’s 1-oz Gold Dragons are absolutely the best buy in gold coins. By law, the Perth Mint can produce no more than 30,000, and it is likely that the number sold will be much less than 30,000. Gold Dragons are priced only a few dollars more than other bullion coins. CMI believes that the uniqueness of the Year of the Dragon falling on the year 2000 will cause Gold Dragons coin to achieve high premiums over the next couple of years.

It is highly likely that 2000 will be the lowest mintage year ever for 1-oz Gold Eagles. With the huge number of collectors interested in American gold coins, these coins could also pick up premiums over the next couple of years. If you don’t go with Dragons, then Gold Eagles should be your choice of gold bullion coins.


Despite a recent report by CPM Group that supply/demand fundamentals could move platinum prices higher, CMI does not recommend platinum at these levels. Although there is a growing demand for platinum in meeting environmental goals, the big consumer of platinum is the Japanese jewelry market. And, the demand for platinum jewelry is increasing in the US. However, if Japan’s problems compound, and the US economy turns recessionary, both jewelry demand and industrial demand would be curtailed. Platinum is risky at current levels.