Being Street Smart 9/24/5

BEING STREET SMART
___________________


Sy Harding

GOLD IS FOLLOWING ITS TRADITIONS! September 23, 2005.

Gold has a centuries-old history of providing protection for asset values in
times of rising inflation. What does that mean?

An old-time observation put it this way; that through many centuries the
price of an ounce of gold remained roughly equal to the average price of a
man’s suit. That is, long ago when a man’s suit cost $20, gold was $20 an
ounce. By the time inflation had the average price of a man’s suit up to
$200, the value of an ounce of gold was $200, and so on. As inflation
constantly eroded the value of paper money, requiring more dollars, or yen,
or whatever, to buy a suit (or a loaf of bread), the value of one ounce of
gold kept pace with inflation, one ounce of gold always able to buy a man’s
suit.

Gold’s tendency to rise in value when inflation is eroding the buying power
of paper money has never been more clear than over the last 30 years.
In the 1970s inflation soared out of control. As measured by the Consumer
Price Index, inflation was growing at only a 5% annual rate in 1970, only
somewhat above a normal pace. Prices then began to rise out of control, and
by 1980 inflation was growing at a horrible 13.5% a year. The catalyst had
been the Arab Oil Embargo in 1973, which started energy costs rising
sharply, followed by corporations passing their rising costs along to
consumers.

Gold, with its history of holding its value in times of rising inflation,
also soared. Gold was $70 an ounce in 1972, and by 1980 had soared to an all
time record high of $850 an ounce.

Then the aggressive rate hikes by the Federal Reserve in the late 1970s
(which had the Fed Funds rate as high as 17.6% by 1980), finally began to
work to bring inflation under control.

As the rate of inflation then began to decline, the price of gold also began
to drop. Inflation then entered a long-term downtrend, as did the price of
gold. A few years ago, in 2000, the rate of inflation was down to 3.5%, and
the price of gold was down to $250 an ounce. Both had been in a 20-year
decline.

However, in the year 2000 major shifts again took place in a number of
areas. The stock market, which had been the main beneficiary of declining
inflation and declining interest rates (which are good for the economy and
good for corporate earnings), had been in a long secular bull market since
1982. By 2000 it had become overvalued, and topped out into the severe
2000-2002 bear market. It was pushed along toward topping out by the Federal
Reserve, which had begun to raise interest rates again in 1999 to slow down
the over-heated economy.

And inflation, particularly as measured the CRB Index of Commodity
Inflation, began to rise. And yes, gold’s 20-year long bear market ended as
gold prices began to rise.

It was a couple of years before it was clear that the rise in the price of
gold was not just another of its frequent bear market rallies, but was
indeed a major trend reversal into a new gold bull market.
Since 2000, the stock market suffered through the 2000-2002 bear market, and
then enjoyed the new bull market that began from the low in 2002.
However, inflation has continued to rise, and sure enough the price of gold
has also continued to rise. This year, from its level of $411 an ounce in
February, gold had risen to $433 an ounce by the end of August. Then the
Katrina disaster hit and gold spiked up dramatically, and continued to do so
this week as hurricane Rita entered the picture. Gold bullion reached an
18-year high on Wednesday of $475 an ounce, before pulling back to end the
week at $463.

Gold, that long-time predictor of inflationary trends, is telling us that
inflationary pressures have been underway since 2001, but that Katrina and
Rita will add to those pressures by raising energy, food, and
transportations costs even higher.

I just wish the current situation didn’t so closely resemble the 1970’s,
that most recent period of sharply rising inflation and serious problems for
the economy and stock market.

However, as many of you will remember, the problems in the 1970s began in
1973 with the Arab Oil Embargo and sharply higher oil and energy costs. The
Fed then, as now, was also raising interest rates to try to ward off
inflation, and as now, it continued to do so, more concerned with inflation
than the threat that high energy costs, inflation, and higher interest
rates, would cause an economic slowdown. There was even a similarity in the
political picture, as the president’s support in the polls plummeted (in
1973 it was as a result of the growing Watergate scandal).
Let’s hope the bulls will be right, that this time is different.
Meanwhile, as in the 1970s, a portion of portfolios in gold is not a bad
idea.


Sy Harding is president of Asset Management Research Corp., DeLand, FL,
publisher of The Street Smart Report Online at www.streetsmartreport.com and
author of 1999’s Riding The Bear ­ How To Prosper In the Coming Bear Market.