Tuesday, November 17, 2009

How Much More Gloomy Can A Prediction Get?

How Much More Gloomy Can A Prediction Get?

A friend pointed me to this depressing prediction, based on how the price of gold has burst through the $1,100 per ounce ceiling:
For 18 months, the gold price had been in a trading range topping out around $1,000. It has now broken out decisively from that range. The opportunity for the world's central banks to change policy and affect the economic outcome has been lost. The world economy is now locked on to an undeviating track towards another train wreck.


With current Fed policy, gold is headed rapidly toward $2,000 per ounce, probably within six months. The forecasters who see such a price, but suggest it would take four to five years to get there, are ignoring history. Since gold was able to get from $185 to $850 in 18 months in 1978-80, there is no reason why it cannot get from $1,100 to $2,000 in six months now. What's more, although 1980's peak seemed madness at the time, and was equivalent to nearly $2,400 today, there is no reason why gold cannot go much higher if it is given another year or so to get there. The supply of gold from new mining is around 1 million ounces per year LESS than in 1980 and the supply of speculative capital that could flow into gold is many times greater. Hence, a $5,000 gold price is possible though not certain, if present monetary policy is continued or only modestly modified – and that price could be reached by the end of 2010.

As was demonstrated by the housing bubble of 2004-06, modest rises in interest rates are not sufficient to stop a bubble once it is well under way. Given the Fed's recent track record, it is most unlikely that we will get any more than modest and very reluctant interest-rate rises. Even if inflation is moving at a brisk pace by the latter part of next year, the price rises will be explained away, or possibly massaged out of the figures as happened in the early part of 2008. Hence the bubble will inexorably move to its denouement, at which point gold will probably be north of $3,000 an ounce and oil well north of $150 per barrel. Even though there will be no supply/demand reason why oil should get to those levels, and gold has almost no genuine demand at all, the weight of money behind those commodities in a speculative situation will push their prices inexorably upwards, beyond all reason until something intervenes to stop it.

At some point, probably before the end of 2010, the bubble will burst. The deflationary effect on the U.S. economy of $150 plus oil will overwhelm the modest forces of genuine economic expansion. The Treasury bond market will collapse, overwhelmed by the weight of deficit financing. Once again, the banking system will be in deep trouble. The industrial sector, beyond the largest and most liquid companies and the extractive industries, will in any case have remained in recession – it is notable that, in spite of the Fed's frenzy of activity, bank lending has fallen $600 billion in the last year. Unemployment, which will probably enter the second downturn at around current levels, will spike further upwards. The dollar will probably not collapse, but only because it will have been declining inexorably in the intervening year, to give a euro value of $2 and a yen value of 60 to 65 yen to the dollar.

And then it gets really bad. I have held off on buying bonds. Some friends are buying commodities--which really aren't an investment, but they can be a good hedge against inflation--and especially hyperinflation.

If the Democrats had an opposition party, there could be a very good opportunity for that opposition party to win decisive control of Congress next year. But there is no opposition party anymore. And even getting in control of Congress, isn't going to be able to clean up this mess as long as the Democrats control the White House. And that's assuming that this mythical opposition political party actually had the courage to do something.

Maybe it's time to stockpile canned food and ammunition.

UPDATE: A reader tells me that the $850 peak around 1980 didn't last very long--a day or two, before falling back. My recollection is that when my wife and I went out to buy wedding rings in early 1980, gold was at about $1000 an ounce, and our wedding rings are proportionately skinny as a direct result. I also notice that the "buy gold now!" advertising seems to be getting more intense--almost like someone wants to dump their inventory while the price is high. This is not at all what you would expect if there was a realistic chance of gold going a lot higher. On the other hand, the deficit is going to definitely cause inflation at some point.

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