The US economy is headed for trouble. The housing market has seen sharp declines in prices and activity, manufacturing shows continued weakness and the US consumer is living a lifestyle that he cannot afford.
Paul Volker, the former Chairman of the Federal Reserve says he expects a financial crisis within the next two and a half years.
Total credit market debt (individual, business and government debt combined) as a percentage of GPD is now at its highest level ever in the US.
The last time it hit a peak: in 1929, just before the crash that lead to the Great Depression.
It is this rampant debt creation on the back of the lowest interest rates in 45 yeas that kept the US afloat after 9/11 and created a worldwide real estate and stock market boom. But, with rising interest rates and economic weakness, this boom is rapidly winding down, as the latest economic data shows.
One of the strengths of the capitalist system is that it is self-correcting. So when the US trade deficits started to accelerate, the US dollar should have fallen to act as a curb on US imports.
It didn't happen as Asian Central banks have supported the US $ in order to keep their currencies competitive to fuel exports. They have done this by buying record levels of US debt. The global funds flow into the US also helped create the Internet boom in equities in the late 1990s:
In Q3 2006, the US annualized trade deficit reached $ 874 billion or 6.6% of GDP.
With a savings rate that is now negative, the US must look to the 'kindness of strangers' to finance its deficits, absorbing 70% of global savings or US$ 3.5 billion per business day to meet its shortfall.
It is ironic that the world's reserve currency, the US dollar, has dropped 27% since 2001. The primary role of a reserve currency is to provide stability and preserve value!
It needs to drop by another 30-50% in order to bring the US trade deficit under control. But the dollar continues to hang on, though this is now set to change as these quotes from November show:
And in the chart of the US dollar index (USD Index), you can see the dollar beginning to break down (the blue line is the 200 moving average).
The US economy is headed for a recession and the US dollar is likely to fall in 2007. Are foreign investors likely to continue to invest, or even maintain existing US investments under this scenario?
This graph from Fortune magazine shows that housing has slowed dramatically, as measured by the National Association of Home Builders Index (NAHB Index). Historically, the stock market mirrors the housing market, with a one year lag. Since housing has plunged, the US stock market is potentially set for a sharp plunge in early 2007.
Out of the US and into the Euro and local markets. But what if the global dependency on the US consumer leads to a global recession? The US would have to dramatically raise interest rates or it would be unable to fund its budget and trade deficits.
This scenario has played out before:
In 1971, with increasing US trade deficits creating substantial pressure on the gold-backed US dollar, President Nixon de-linked gold and the US dollar.
The loss of faith in the US dollar then led to a massive flow of capital into gold, and the price per ounce of gold jumped from $ 35 in 1971 to $ 875 in 1980, a gain of about 2,400%. This was accompanied during the 1970s with low growth, high inflation, rising interest rates (peaking at 22%) and stagnant markets.
But in those days, the US was a net lender to the world. Today, it is the biggest debtor in the history of the planet. Rising interest rates in a heavily indebted economy may make things very painful indeed. This is why Paul Volker sees a crisis ahead.
Gold is the natural beneficiary of a decline in the US dollar, economic uncertainty and inflation or deflation as it is a store of wealth. Gold has risen from $ 256 in 2001 to $ 620 today, as the US $ has declined by 21% as they historically move in opposite directions in the long run. The Acamar Journal has been advocating that investors diversify away from the US dollar and into gold since April 2004, when gold was $ 325 per ounce. I believe that the price of gold will climb to at least its 1980 high in inflation adjusted dollars, which would be $ 2,176.
Since 2001, while gold has risen by about 188% when it had an interim peak at $ 730, the gold mining companies index (HUI) rose by 996% in the same period, showing that investing in gold mining companies provides substantial leverage to the rise in the price of gold.
Future declines in the US $ will cause sharp gains in the price of gold.
The total market capitalisation of gold mining companies is only about $ 150 billion. Compare that with total global stock market capitalisation of about $ 45 trillion. It will not take a lot of capital to come into the gold sector to make it soar in value.
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