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Why Iím Taking Profits In Gold Now

FORECASTS & TRENDS E-LETTER
Gary D. Halbert
October 23, 2007

IN THIS ISSUE:

1.   My History With Precious Metals

2.   The Precious Metals Crash Of January 1980

3.   Why I’m Selling My Gold Coins Now

4.   I’m Not Bearish On Gold

5.   Pros And Cons Of Investing In Gold

6.  Gold Exchange Traded Funds Revisited

Introduction

As discussed last week, the response to our recent Reader Survey was much larger than we expected, and we received tons of comments and suggestions.  Interestingly, many of you asked me to write about precious metals from time to time.  The timing was excellent, since I sold most of my gold coins last week when gold prices topped $760.

The last time I made a sizable investment in gold coins was back in 1998 and 1999 when gold was around $300 per ounce. At that time, I purchased a large number of uncirculated American Gold Eagle coins.  I also bought several bags of circulated silver coins, also known as “junk silver.”  I have been sitting on them ever since, until now.

Obviously, gold and silver prices have risen substantially since 1998/99, especially in the last two years, and most especially in the last three months as prices spiked higher.  Many analysts believe precious metals prices will rise much more in the months and years to come.  There are plenty of predictions of $1,000 gold, and maybe they’re right.  But in the pages that follow, I will tell you why I sold all but my core holdings of precious metals now.  I’ll also tell you a little about my history with precious metals.  I think you will find it an interesting discussion.

We will also revisit the subject of exchange traded funds in gold.  There are currently two gold ETFs, and they have become a very popular way to participate in the movements in gold prices without having to own the physical metal.

My History With Precious Metals

After getting my Masters degree in 1975, I went to work for Continental Grain Company, one of the largest grain and agribusiness companies in the world.  After less than a year, I became a broker in the company’s commodities futures division in their Dallas branch office.  Specifically, I was what was called a “hedging broker.”

In a relatively short period of time, I developed a large clientele which consisted mainly of grain elevators, commercial feedlots, cotton gins and many large farmers.  Most of my clients were located in Texas, Oklahoma, Louisiana and Arkansas.  My clients were not in the futures markets to speculate; rather, they used the futures markets to “hedge” the value of their inventories of whatever commodities they dealt in or produced so as to protect their profit margins. 

I actually taught most of them how to do it.  In 1977, I wrote a manual entitled “Hedging – Can You Afford Not To?” which explained in layman terms how the complicated process of hedging in the futures markets works.  With all of these clients, I quickly became one of the largest producers in the company by the ripe old age of 25 or 26.

What does this have to do with precious metals, you’re probably asking.  I’m getting there.  It was also in 1977 that I was introduced to The Bank Credit Analyst.  At that time, BCA was predicting that inflation was going to get out of control, and that precious metals prices, and tangible assets in general, were going to go through the roof in the next few years.

Of course, I was writing about BCA’s forecasts in my newsletter, even back in those days, and most of my clients agreed that inflation was going to be a big problem in the next few years.  They wanted to know how they could make money from this trend.  I had always urged my clients not to speculate in futures on the commodities they dealt in or produced.  But in this case, we were talking about precious metals futures – gold, silver, platinum, etc.

In 1978, most of my clients loaded up on gold and silver futures at a time when gold was below $200 and silver was below $6.  As most of us remember, inflation ran rampant in the last few years of the 1970s, and precious metals prices soared just as BCA had predicted.  By late 1979, gold had reached $650, and silver had soared above $30. 

My clients were making a killing, and I was a hero.  As noted above, I had a lot of clients, and with all the market positions we had on - hedge positions and speculative positions - my daily printout of all accounts and all positions stretched the entire length of our large office suite.

But BCA Killed The Party In Late 1979 

You may recall that Paul Volcker became Fed chairman in August of 1979, with a mandate to get inflation under control.  Initially, there was a widespread consensus that Volcker was not going to take any significant actions to bring down inflation, what with Jimmy Carter in the White House.  However, by late 1979, BCA thought otherwise.

Shortly after Volcker took over at the Fed, he talked about implementing a new monetary policy.  Rather than targeting interest rates, as had been done for years, he was going to target the growth in the money supply.  Volcker believed that if he squeezed the money supply, interest rates would rise and eventually choke off inflation.  And he basically said he didn’t care how high interest rates had to go to get the job done.

As noted above, few believed Mr. Volcker’s words.  But BCA did.  In their November and December 1979 monthly reports, the BCA editors made it very clear that they believed Volcker was dead serious.  They warned in chilling terms (at least for me) how they believed interest rates were going to soar, and how that could lead to a serious recession.

Most importantly they adamantly advised readers to liquidate all positions in precious metals, tangible assets and other inflation hedges immediately.

I was stunned to say the least!  My clients and I were having so much fun, after all.  And we were all very convinced that inflation would not be brought under control.  I anguished for several days about what to do.  My clients certainly didn’t want to get out of their inflation hedges.  But in the end, I decided to take BCA’s advice, as much as I hated to.  By the end of December 1979, I had sold out every single position in gold and silver for every client but one.  That one client got so mad at me he transferred his account to another brokerage firm.

When I liquidated all of these large positions, gold was in the area of $650, and silver was around $35.  Well, gold went on to soar to near $850 and silver to $50.  I didn’t look so smart then, but no one complained that we got out a little early, especially after what happened in January 1980 – but I’m getting ahead of myself.

My branch manager was thrilled because of the huge volume of commissions this unloading of metals positions generated.  A couple of days after the liquidation was done, my manager came into my office and asked, “When are you going to buy it all back?”  I replied, “We’re not, we’re done.”  He was shocked, once he realized I was serious.

In the ensuing days, the manager talked to me on several occasions, trying his best to get me to put all my clients back in these trades. I refused, even though the precious metals were still exploding on the upside.  Growing weary of his efforts to get me to put my clients back in the market, I finally responded with something like the following (paraphrasing):

Look, this has been an historic run in the precious metals, which aren’t even my area of specialty; thanks to BCA, we got to ride most of this huge move; we made a lot of money for my clients and for the company, and you and me.  We’re done.

When I first got in to the commodities business, I heard an old saying that always made sense to me: ‘There’s some for the bulls, some for the bears, but there’s none for the hogs’.  What a great saying!  I repeated it to my commission-hungry manager, and he never asked me again.  Good thing.

The Precious Metals Crash Of January 1980

After soaring to all-time record highs of $850 in gold and $50 in silver, the precious metals markets collapsed in the last half of January 1980.  You may recall that the Hunt brothers of Dallas had driven the price of silver through the roof.  But as silver futures prices were exploding to $50 per ounce, the New York Comex Exchange arbitrarily raised the margin requirement to hold futures contracts in silver. That signaled the peak.

Silver futures plunged from $50 to below $17 in less than a month!  Silver futures were locked “limit down” for 21 consecutive days, meaning that no one could unload their positions.  A move from $50 to $17 was a $33 swing, and on a 5,000-ounce silver futures contract, that move represented a $165,000 loss in value.  Margin calls were huge, and several large brokerage firms were rumored to be in trouble.

At the same time, gold collapsed from around $850 to below $500 in less than a month.  Gold was also limit down for a couple of weeks.  To this day, that was the single most violent move in commodities that I have ever seen.  Many speculators were wiped out. Fortunately, I got all of my clients out a month earlier.  Talk about dodging a bullet!  Perhaps this helps explain why I have valued BCA’s opinions for all these years.

Why I’m Taking Profits On My Gold Coins Now

As you probably know, precious metals prices have been on a tear for the last couple of years, and especially in the last few months.  Gold has risen from below $450 in late 2005 to above $760 as this is written.  Silver prices have soared from around $7 to above $14 per ounce in the last two years, although prices are slightly below $14 as this is written.

Gold prices 

On Wednesday of last week, I decided to take profits on all but my core holdings of gold coins.  For better or worse, I called the coin dealer I use (Camino Coin) and locked in the price on my Gold Eagles when spot gold was around $760.  Gold prices have dropped back a bit since then, but it will not surprise me if gold prices continue to move higher for a while longer.

So why did I decide to sell last week?  To begin with, I have been thinking about selling for a couple of months now, what with the sharp rise in gold prices just since August.  Most analysts believe that precious metals prices are soaring due to expectations for a significant rise in inflation.  Oil prices are at all-time record highs, and precious metals often track the price of oil to some extent.  As noted above, there are analysts who now predict that gold will hit $1,000 per ounce on this move, and maybe they will be correct.

However, as I have discussed in recent E-Letters, the latest inflation numbers have been tame, even as oil prices have soared to record highs near $90 per barrel at one point last week.  The Consumer Price Index (including food and energy) rose only 0.3% in September and was down 0.1% in August.  For the last 12 months, the CPI is up 2.8%, and the trend is down.  The “core” CPI is up only 2.1% over the last 12 months.  That is hardly runaway inflation.

Meanwhile, BCA has maintained for several months that US inflation will surprise on the downside over the next year or so.  What with the US and global economies slowing down, BCA expects the core rate of inflation to remain tame, or actually decline, in the months ahead.  In a Special report issued last week, BCA had the following to say about inflation:

“The cyclical tendency of the world economy is leaning toward disinflation or deflation, not inflation.  The reason is simple” The bursting of the U.S. real estate bubble is a deflationary shock whose disinflationary impact will continue to be felt in the global economy… This is because asset price deflation often precedes a period of economic weakness, which in turn restrains the business sector’s pricing power.

In short, BCA expects overall inflation to surprise on the downside over the next year, despite soaring oil prices and the increases in food prices.

The tame inflation rates over the last few months are, in part, what led the Fed to cut interest rates on September 18, and it may do so again on October 31.  I don’t think the Fed would be cutting rates if it believed that inflation is going to be a problem in the near-term.

I’m Not Bearish On Gold

For the gold bulls in our E-Letter audience, please note that my selling of my gold coins does not mean that I am bearish on gold, although I do believe it is overbought in the near-term.  In fact, the long-term supply/demand fundamentals still look quite encouraging.  Demand continues to rise, especially from China, and there have not been any major new discoveries of gold in the last couple of years.

There are a number of other factors that have the potential to impact the price of gold in the future.  I have discussed these factors in previous E-Letters, and have updated them below as they are just as relevant to the future price of gold as they were back then:

1.  Gold is a good store of value during times of uncertainty, and there is definitely no shortage of uncertainty in the world today.  In fact, you could call gold the “currency of global uncertainty,” in that, as a general rule, the greater the geopolitical tensions, the more investors tend to buy gold.

2.  Gold is considered by many to be a hedge against inflation.  I noted above that BCA does not feel that inflation will be a factor in the short-term.  However, that doesn’t mean that inflation will never again be an issue.  As Baby Boomers retire and the government is forced to borrow to fund Medicare and Social Security, both interest rates and inflation have the potential to rise in the long-term. 

3.  Although I do not believe that gold reacts to supply and demand in exactly the same way that many other commodities do (see #4 below for more about this), you cannot discount the fact that exploration was down during the period of low gold prices and gold mining companies have had to play catch-up in the last few years, and this has helped push up the price of gold.

4.  As I have written before, another reason why gold does not always react to supply and demand forces the same way that many other commodities do is because gold has a hybrid nature.  While it is a commodity used by many industries, it is also a currency maintained in large reserves by many countries, central banks and individual investors.  As a result, the price of gold is often dictated more by its relative value to currencies rather than on a strict supply/demand basis.

Accordingly, the slide in the value of the US dollar over the last few years has been bullish for the price of gold.  If the US dollar experiences a continued decline, this might provide additional upside potential for gold prices.

Obviously, these are not all of the reasons to be bullish on gold, but they are some of the major factors that I keep on my radar screen in relation to the yellow metal, in addition to the supply/demand fundamentals.  The point is that there are several factors that are favorable for a continued increase in the price of gold.  But you never know.  What is clear is that gold prices are at a 28-year high, despite the fact that the US and global economies are slowing down. 

Reasons To Be Cautious

Just as there are reasons to be bullish about the price of gold, there are equally valid reasons to be cautious about running headlong into a major gold investment at this point in time.

1.  As noted above, gold prices in the US have tripled since the low around $255 in 1999, including periods of time when prices moved virtually straight up.  The spike up in prices since late August has sent gold prices from $650 to $760.  That suggests to me that the market is ripe for a pullback at any time.  Furthermore, gold has heavy overhead resistance (a technical term for selling pressure) from $750 to the all-time high around $850. 

However, there have also been significant pullbacks in the price of gold, such as in 2006, and that’s another negative.  Gold prices typically fall off a cliff after a sharp run-up, rather than gently trending downward.  This extreme volatility can be disconcerting to many investors.

2.  Most analysts believe that the US dollar will continue to fall for at least another year.  That may well be true, but keep in mind that the dollar is already down apprx. 20%.  If for any reason the dollar stabilizes, or begins to rise, that could take a lot of the wind out of gold’s sails.

3.  Another thing to keep in mind is that the run-up in gold prices prior to late 2005 was largely a US phenomenon.  If you look at gold prices in Euros, you will see that gold prices in that currency were generally flat during much of the big rise in US gold prices prior to that time because the Euro has strengthened relative to the dollar.  So, the relative value of gold as an investment sometimes depends in part on what kind of money you have in your pocket.

More recently, however, it is important to note that gold has experienced a bull market even in other international currencies.  Click on this LINK to see a chart of gold prices in various currencies since 2003.

4.  Contrary Opinion.  More often than not, I am a contrarian, meaning that I don’t like to buy when everyone else is buying (or short when everyone else is shorting).  Right now, the bullish consensus on gold is very high, as evidenced by the stampede into the new gold ETFs over the last couple of years (more on this below).

5.  As prices have continued to rise, gold producers have begun to ramp-up production.  As noted above, they may be playing catch-up at present, but at some point increased supplies may adversely affect gold prices.  It is also important to note that most of the gold that has ever been mined continues to exist.  As prices rise, some of this gold will find its way to the markets.  I’m sure you’ve seen the TV commercials for companies that will buy your gold watches, rings, etc.  If enough of this “scrap” gold makes its way to the markets, it could help hold down the price.

6.  As I have written in recent weeks, the US economy is clearly slowing down, and the odds of a recession have increased.  The global economy is slowing down as well.  Historically, weakening economies lead to decreased demand for gold and other metals.

As the above pros and cons illustrate, there are many reasons to invest or not invest in gold.  For those of you who do want to include gold as a part of your overall diversified portfolio, the question then becomes how to make the purchase.

Gold Exchange Traded Funds Revisited

As I discussed earlier, there are various obstacles to owning physical metals. Obviously, there is the storage issue – you must have a safe place to hold your precious metals, and this can be expensive.  There is also the issue of insurance, which is not cheap.  Then there is the shipping issue, unless you trade with a local dealer, which frequently will not have the best prices.  Typically, you will need to ship your coins or bullion via registered mail, which I found has gone up substantially in the last 10 years.

I know there are some of you who will prefer to keep your gold in a safe deposit box at the bank.  For others, however, there are relatively new gold Exchange Traded Funds (ETFs) that address many of the disadvantages of buying, storing and selling physical gold.  If you want to participate in the movements in gold prices, I think ETFs are a good way to do it.

In late 2004, I discussed at length the then new gold exchange traded fund (ETF), StreetTracks Gold Trust (NYSE: GLD).  Since then, we have seen the introduction of the iShares Comex Gold Trust (ASE: IAU), which is also an ETF.  These funds have become very popular for those who wish to participate in movements in the gold market, either long or short.

There are advantages and disadvantages to trading these ETFs in gold.  One of the most obvious advantages of the gold ETFs is that they solve the shipping, insurance and storage problems associated with investments in physical gold bullion or coins.  Some of the other advantages of this new way to own gold are as follows:

1. Dealer markup is no longer a problem, in that there is no spread between bid and ask prices.  There may be transaction costs associated with purchasing and selling these ETFs, but there is no premium to be paid.

2.  The gold ETFs are listed on the New York Stock Exchange and the American Stock Exchange, so they are liquid and can be bought or sold any time the market is open and trading.  In addition, the gold ETFs may be “shorted” if an investor believes the price of gold will fall.

3.  In the past, many institutional investors were precluded from owning gold because of the costs related to buying, selling, and storing the physical gold.  The gold ETFs allow these investors to have an undivided interest in gold, but without all the hassles.

4.  Gold mining stocks, a popular way to play the gold market, are often significantly overvalued or undervalued, relative to the price of gold for various reasons, and are typically extremely volatile.  Because the gold ETFs closely track the price of gold, they have become a popular alternative to gold mining stocks.

Unfortunately, there are still some disadvantages to investing in these gold ETFs.  Perhaps the most obvious is that it is not physical gold.   For those investors who want to own gold as a store of value in case of emergency, having an undivided interest in gold sitting in a London or Nova Scotia vault will provide little or no comfort.  Those investors who want to run their fingers through their gold hoard will still have to buy physical gold, and deal with the storage, shipping and other hassles involved.

Other disadvantages of the new gold ETFs are:

1.  As I have written a number of times, the price of gold is very volatile and can move suddenly and without warning.  The gold ETFs do not change this characteristic of gold, but at least they offer a way to quickly trade out of a gold position without the hassles of selling physical coins or bars – on the days the markets are open, of course.

2.  The success of the gold ETFs likely contributed to the rise in gold prices over the last few years.  As large sums of money have flowed into these gold funds, the ETFs have had to buy more and more physical gold on the open market.  This buying almost certainly contributed to the upward pressure on the price of gold, and may continue to do so as long as the demand for these ETFs continues to grow.

Of course, the reverse will also be true whenever gold prices start to decline and investors start to sell their shares in these gold ETFs.  In that case, the funds will have to sell physical gold on the open market, and this could exacerbate price declines.

3.  While shares in the gold ETFs are considered to be securities, the IRS classifies these shares as “collectibles” for tax purposes.  This means that long-term gains will be taxed at a higher 28% rate reserved for collectibles, rather than the 15% rate for other types of investments.

The points above do not represent a complete discussion of the advantages and disadvantages of gold ETFs.  Be sure to read the prospectus carefully before you invest.  However, the gold ETFs can be a good way to participate in the price movements in gold without having to own physical precious metals.

Other ways to deal in precious metals are e-gold.com and e-bullion.com.  Both of these are electronic Internet currency facilitators backed by gold or other precious metals.  E-gold Ltd., a Nevis corporation, states that it is:

“100% backed at all times by gold bullion in allocated storage. Other e-metals are also issued:  e-silver is 100% backed by silver, e-platinum is 100% backed by platinum, and e-palladium is 100% backed by palladium.  e-gold is integrated into an account based payment system that empowers people to use gold as money.  Specifically, the e-gold payment system enables people to Spend specified weights of gold to other e-gold accounts.  Only the ownership changes - the gold in the treasury grade vault stays put.”

Apparently, e-gold and e-bullion have become popular as a form of international payment, as well as an investment medium.  How popular, I don’t know.  I must emphasize that I have never used e-gold or e-bullion, so I cannot recommend these services. 

Conclusions

There is an old saying in the commodities markets that “the solution to high prices is high prices.”  This probably sounds strange but generally speaking, when commodities prices rise significantly, production increases and demand decreases.  This combination usually results in lower prices at some point. 

While I don’t profess to know what gold prices will do in either the short-term or the long-term, I simply decided to take some profits on my gold investment, based largely on how much prices have increased over the last two years, and especially in the last few months.  So it will not surprise me if we see a pullback in gold prices just ahead.

And finally, while I have sold my speculative position in physical gold, I still maintain my core holdings in precious metals, and I still have exposure to gold via our futures funds and certain of our Absolute Return Portfolios.

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES

US soldier speaks of the good things happening in Baghdad.
http://article.nationalreview.com/print/?q=OGRlOTA5ZTJmZTYyZGRjMTI3MzFmYTdiMmNiYTQ2NmM

A good review of the top Republican candidates.
http://article.nationalreview.com/?q=ZjhjMDNjMDk5MGRjZGYxOTY4ZTI4ZTcyNjA3NzQ3ODk=&w=MQ

Hillary is the GOP’s dream (I’m not so sure)
http://www.latimes.com/news/opinion/la-oe-goldberg23oct23,0,3831108.column?coll=la-opinion-center


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Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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