gold and the fear index

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    Midas Touch:
    James Turk believes today's gold price
    is cheap and can only go higher

    By Sandra Ward
    Barron's, October 2003

    These are glorious days in the north country of New
    Hampshire, which Turk, publisher of the Freemarket
    Gold and Money Report, calls home. Equally glorious
    has been the performance of gold since we last
    checked in with the longtime gold authority, who also
    happens to be founder of, a company
    intent on establishing the metal as the dominant
    currency in cross-border transactions. He correctly
    called gold's push higher last year and now sees the
    yellow metal reaching $400 an ounce by the end of
    this year. Why the bright prospects? Here's why.

    Barron's: You seem fairly confident that gold will
    continue to climb higher. What leads you to that

    Turk: One of my major contentions has been that
    you are better off holding gold than the Dow Industrials.
    That surely has been the case the past few years and
    that trend is only beginning. When we last spoke, I
    said gold was going to move to beyond $325 an ounce
    by the end of last year, and it did. That was very
    significant. It was as significant as gold tripling to more
    than $100 an ounce after President Nixon took the
    dollar off the gold standard in August 1971. What you
    have is a huge six-year base of accumulation.

    Q: Meaning?

    A: Gold has formed all the classical patterns, including
    a selling climax after the Bank of England announced
    in 1999 it would sell half its gold. Gold has been
    accumulated by so-called strong hands, and it is going
    to take much higher prices to shake that gold out of
    those strong hands. Looking at gold purely from a
    technical point of view, one has to be bullish.

    Q: What about the fundamentals?

    A: Gold is money. People move into gold and out of
    national currencies in response to financial uncertainty.
    There is a lot of financial uncertainty.

    Q: Is there, though? People are becoming more and
    more convinced we are in a recovery, and we've seen
    gold move lower on that. So, again, what fundamentals
    are in place for gold to continue higher?

    A: It is true there has been a lot of crosscurrents of
    opinion about whether this is a recovery, and whether it
    is a jobless recovery or not a jobless recovery, and gold
    has been buffeted as a result of these crosscurrents.
    But gold is going higher in the long term. It's important
    to look at things that impact the dollar because gold will
    respond to problems or perceived problems with regard
    to the future of any currency. Comments by various Fed
    governors talking about creating any amount of dollars
    necessary to get the economy jump-started is very
    scary because it suggests they will debase the dollar.

    In the past 12 months, we've created $600 billion of M3,
    the broadest measure of the money supply. It hasn't
    really produced much economic stimulus, but it has
    done a lot to debase the dollar, not only against gold,
    but also against the euro and some other major

    Then there's the increasing deficits of the federal
    government. Those deficits are going to have to be
    financed. Already, we are borrowing $2 billion a day
    from overseas sources. That implies more debasement
    of the dollar, because as you create more dollars by
    extending more credit and increasing the supply, there
    is an inherent loss of purchasing power.

    Finally, there is accelerating demand for gold worldwide.
    People are increasingly recognizing that gold is cheap.
    Changes occurring in China could be huge for gold. The
    Chinese are easing various laws prohibiting gold
    ownership, making it legal once again to own gold. Some
    also think that rather than revalue the yuan, the Chinese
    might enable the conversion of yuan into gold, so the
    Chinese can continue to accumulate gold for savings.

    Q: Gold has had a great run. Why do you think it is still

    A: Well, that's where my Fear Index comes in. The Fear
    Index is a very important indicator of which way the trend
    is going. When the Fear Index is rising, you want to be in
    gold and out of dollars and when it is falling you want to
    be in dollars and out of gold.

    I also use the index as a valuation model. Historically,
    when the Fear Index is less than 2.6 percent, gold is good
    value and should be accumulated. Right now, we are at
    1.12 percent, just a small bounce from the historic low of
    0.9 percent. On that basis, gold is very cheap.

    Everybody talks about the $850 an ounce level that gold hit
    in 1980, and here's gold today at $370 an ounce. If you
    adjust that $850 for inflation and debasement of the dollar
    over the past 23 years, it shows how cheap today's gold
    price is, even in nominal dollar terms. Adjusted for inflation,
    that $850 an ounce becomes something like $2,005. Even
    if you cut that in half and say $1,000 is too high, something
    over $500, $600, $800 an ounce would not be unreasonable.

    We are very, very close to breaking a 20-year downtrend
    line in the Fear Index going all the way back to the 1980
    highs, but we need the gold price around $400-$415 an
    ounce to do it. If that happens, the whole monetary and
    banking environment is going to shift, and we will enter a
    period like the 1970s, in which there will be increasing
    concern about the purchasing power of money and the
    banking system.

    Q: Because?

    A: It could be inflation. It could be banking problems. It
    could be currency wars. It could be capital controls to try
    to finance this deficit and keep it from spiraling out of
    control. It could be any one of a number of different events.
    We don't know why the market is shifting the way it is,
    but the Fear Index tells us the shift is occurring. At the
    top of my concerns, ever since the collapse of Long Term
    Capital Management, is the possibility of a derivatives
    blowup. I'm in complete agreement with Warren Buffett,
    who called derivatives "financial weapons of mass
    destruction." We haven't seen that mass destruction
    yet, but the potential is there.

    Q: Are you really concerned about inflation, given the
    Fed's stance?

    A: We shouldn't be focusing so much on the supply of
    dollars; we should be focusing more on the demand for
    dollars. Ever since the world was supposed to collapse at
    Y2K, the growth rate of M3 has been tracking lower and
    lower. Though the increase in the supply of dollars has
    been generally declining since those peaks, the dollar
    has been falling even more rapidly on the
    foreign-exchange market. That suggests there is too great
    a supply of dollars relative to demand or, conversely, that
    demand isn't growing fast enough to keep up with the
    increase in dollars.

    Q: This is October. Are you making any predictions?

    A: I've been in favor of holding gold and preserving
    purchasing power and buying stocks cheaper down the
    road. In gold terms, the stock market is going to continue
    to fall. At the peak, it took 1360 grams of gold to purchase
    the Dow Industrials. Today it takes 812. Historically, when
    it takes less than 100 grams to purchase the Dow, gold's
    purchasing power is at a high point. So we have got a long
    way to go down when you look at the stock market in gold

    Q: Do you see parallels to the '87 crash?

    A: I've been looking at that a lot. If there is a move out of
    dollars, people might sell stocks just to raise liquidity and
    convert their wealth back into their own home currency,
    which they may perceive to be safer. The bond market is
    more vulnerable than the stock market. The bond market
    has been propped up because the foreign central banks
    have been buying huge amounts of dollars. Those dollars
    are being recycled back into the bond market and
    government-paper market. I don't know how much longer
    that can be sustained without the dollar getting hit in a
    dramatic way in the foreign-exchange markets.

    The big swing down we saw a couple of months ago in the
    bond market was the first shot across the bow. Bond
    investors should be very wary here. Given all the selling
    pressure in bonds, we've been looking for a bounce, but
    so far the bounce has been very weak.

    Another interesting parallel is the early 1970s, when gold
    was at $35 an ounce and the Dow was about 800.
    Throughout most of the decade, the Dow traded between
    600 and 1000. Eventually, gold and the Dow crossed at the
    end of that decade at 800. Adjusting for 2003 dollars, and
    multiplying gold by a factor of 10 because it takes $1 to
    buy what 10 cents purchased then, you get gold at $350.
    If you take the 800 Dow level of 1971 and multiple it by
    10, you get 8000. If we repeat this, and that's what I'm
    expecting, the Dow will trade between 6,000 and 10,000
    for the next several years. And gold will move from $350
    an ounce up into the thousands. Gold could go from
    $350 to $8,000, which is no crazier than going from $35
    to $800.

    Q: But this isn't the '70s.

    A: That's what's worrisome. Back in the 1970s, we had
    an out. [Fed Chairman Paul] Volcker raised interest rates.
    He took government bonds up to 14-15 percent, the prime
    rate was 21 percent, and he saved the dollar. That is no
    longer an option. Can you imagine what this over-leveraged,
    over-indebted economy would do if interest rates even went
    up to half those levels, let alone a 21 percent prime rate?
    Or what the government deficit would do if interest rates
    rose 3 or 4 or 5 percent from current levels?

    We have a $7 trillion debt. Standard intervention weapons
    aren't going to work. The normal weapon would be to raise
    rates, and I don't see that as an option. We might have to
    resort to nonstandard weapons like capital controls such
    as were implemented in the 1960s, but they might be more
    draconian than the ones implemented then. In the early
    '60s we had the "Interest Equalization Tax," which was
    intended to keep dollars from flowing overseas. It was a
    fairly mild capital control, but relative to the time it was
    quite a controversial issue.

    Q: So you're still a fan of gold stocks?

    A: Yes, but I would stay away from the stocks of companies
    that hedge, the stocks that sell future production. Look at
    Barrick Gold, which hedges, and Newmont Mining, which
    doesn't. The stocks used to trade one-to-one, and Newmont
    is now nearly $20 higher than Barrick. That outperformance
    suggests to me that the market rewards stocks that don't
    hedge. Additionally, there is a lot of complexity and risk
    added to a mining company when you have a hedge book.
    My preference is to avoid the risk and go for the simple

    Q: Why is Barrick still hedging? I thought they recognized
    it was a problem.

    A: Barrick and J.P. Morgan Chase have been sued by
    Blanchard and Co., a dealer in physical gold, under the
    Sherman Antitrust Act, alleging that Barrick and Morgan
    were conspiring to fix the gold price by keeping it lower and
    enabling Barrick to take advantage of the low price to buy
    mines on the cheap. Whether there is any truth to that, the
    courts will decide. But it may be why Barrick is sticking to
    its hedge position. But another reason is that its hedge
    position is so huge, at 15 million ounces, that there is no
    practical way you can go into the market and cover 15
    million ounces without causing the gold price to
    skyrocket. I think they've locked themselves into a box.

    Q: What's the impact on the gold market if Blanchard wins?

    A: Extremely profound because it would suggest the gold
    price has been low because of price fixing and not because
    of its own merits or demerits. By way of disclosure, I should
    note I've had some discussions with the Blanchard attorneys
    as a potential expert witness should the case go to trial.

    Q: What else should people look for in choosing gold stocks?

    A: How much leverage a company has to the gold price. The
    high-cost producers have more leverage than the low-cost

    Q: Who fits that bill?

    A: Durban Roodepoort Deep, a South African company that I
    recommended last year.

    Q: That hasn't performed well.

    A: It is down. Durban Deep got hurt when the rand strengthened
    against the U.S. dollar. Though the dollar price of gold was going
    up, the rand price was going down and they had a significant
    cost squeeze and their earnings were hit because of the impact
    of declining margins on their cash flow. Agnico-Eagle Mines, a
    Canadian mining company, is another I recommended that didn't
    do well, either. It faced currency pressures, as well as a rock fall.

    Q: A what?

    A: A mine collapse. It set back production for two quarters. They
    had significantly reduced production and it created a lot of
    uncertainty as to whether they were going to have extra costs
    associated with re-establishing the operations on the mine.

    Q: But you're sticking with them?

    A: Yes. They both have good management and good mines.
    Durban has rationalized part of its South African operations to
    reduce its costs. If I'm right about gold going higher, these
    stocks will do well, particularly Durban, because of their
    leverage to the gold price. Durban's leverage, however, makes
    it a more risky bet.

    Q: Where will gold be by year end?

    A: I've been predicting it is going to be $430 by
    September-October, and that is looking less and less likely.
    I'll stick my neck out and say we'll take out $400 before the
    end of the year.

    Q: What else do you like here?

    A: Newmont is still one of my top choices. Newmont has
    gone from strength to strength, and it is clearly the gold
    stock everybody wants to own.

    Q: Isn't that just because it's got the biggest market cap?

    A: Some things feed upon themselves. Its big market cap
    enables it to do things others can't. But President Pierre
    Lassonde has laid out a good strategy for the company.
    They've positioned themselves globally with a diversified
    asset base and a great operating team. I also still like
    Harmony Gold, which I mentioned last year. It's a South
    African company with good leverage to the gold price.

    Q: How about something new?

    A: Another major blue chip is Gold Fields, also based in
    South Africa. It has a no-hedging policy and not only does
    it have good mines in South Africa, but it has got a good
    mine in Ghana. Ian Cockerill, who is the CEO, has done
    a great job since taking control a couple of years ago.

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