December 4, 2006 – This is the time of the year that I dust-off my crystal ball in order to look at the year ahead. I will share with you what I expect to be the good and bad news for 2007. But before I do that, I would like to first revisit what I said to expect for this year.
Even though there are still four more weeks before year-end, there is I think enough ‘water under the bridge’ to make some basic conclusions. So here is, so to speak, my report card, and while I won”t give myself an A, I think I have earned a B+.
I made my forecasts a year ago, and just the day before gold had closed above $500 for the first time in more than two decades. Silver was also rising, closing at $8.54. You may recall that there was a chorus of naysayers who said that gold’s advance would be stopped at $500, just like it had so many times before. I took the opposite point of view. My conclusion was that these new highs marked the continuation of the bullish uptrend in the precious metals, already several years old.
Those new highs in gold and silver also made clear to me that the factors driving gold higher were still very much in place. Importantly, those same factors remain very much in place, and will therefore continue to drive both of the precious metals higher in the year ahead. It is therefore worth repeating some of them here (the direct quotes are taken from my article, “Coming in 2006 – Gold’s New Record High” published December 5, 2005).
(1) “Inflationary pressures are growing“, and “Inflation is going to worsen in the year ahead. There is a lot of inflation ‘in the pipeline’ yet to be reflected in the CPI.” Even by the federal government”s own measure (i.e., CPI, which in my view significantly understates the true rate of inflation), the inflation rate has moved out of the Federal Reserve”s ‘comfort zone’, highlighting the importance of this growing problem.
(2) “Today’s huge trade deficits are unsustainable“, and “The present international monetary system is broken.” The trade deficits have worsened in the past year, with the consequence that gold has risen 24.7% year-to-date and the US Dollar Index during this period has fallen 9.5%.
(3) “The growing federal budget deficit has to be financed, which cheapens the dollar.” That observation was spot-on, and the continuing reckless spending by the federal government makes the dollar increasingly vulnerable to a banana-republic style currency bust. As one wag recently commented, to say that the federal government is spending money like drunken sailors is an insult to drunken sailors – and besides, drunken sailors spend their own money!
(4) “There has been growing uncertainty about the outlook for the dollar…which is now being heightened because new incoming Fed chairman Bernanke is new and unproven.” Not much new to add here, but based on his first year’s performance, expect Bernanke to go down in history as the Federal Reserve’s worst chairman, even worse than William Miller, who unleashed during the Carter era the most horrific part of the 1970’s inflation.
Clearly, the above factors present a large part of the bearish outlook for the dollar and the bullish picture for gold. And here was the key part of my forecast for 2006:
“I expect that gold will follow recent experience, and appreciate, say, 15% at a minimum. If we end this year at $520, then my minimum upside target next year for gold would be about $600. Note, however, that I say “minimum”, for the reason that I am actually expecting a lot more from gold in 2006. We should be looking for gold to set a new record high next year. Though gold briefly traded at $850 for a nanosecond on January 21st, 1980, it closed that day at $825.50, which to this day stands as gold’s record high close. My target for 2006 is $900.”
So in summary, I got the trend right, but my upside target was not reached. So I think a B+ is a reasonable grade. I hope to do better than that in 2007. In this regard, here”s what I am looking for in the year ahead.
I’ll start with the bad news. The US in 2007 will move closer to implementing – and perhaps even impose – capital controls. These will restrict your freedom to do what you want with your money. In particular, they may prevent you from getting your money outside of the US by restricting the conversion of dollars into foreign currencies, and perhaps even prevent you from buying gold and silver outside the US.
I have been talking about capital controls for some time, but haven’t specifically forecast when they would be implemented. That time is near. It’s near enough to begin worrying about it.
It’s really anybody”s guess as to what the capital controls will look like, but a recent article in London’s Daily Telegraph provides an insightful clue. While acknowledging that “currency controls” would be the “nuclear option”, the article says that “Brussels may lawfully freeze capital flows in and out of the EU, and within it, and that this could be done by a “qualified majority” of EU finance ministers.” It goes on to say that this authority is already in place in Europe and was granted “to enable Europe to stem the rise of the euro if the dollar goes into free fall, the underlying argument being that Washington should not be allowed [to] export the consequences of its own reckless spending policies through a “beggar-thy-neighbour” devaluation. The idea was to stop money coming in, though it could equally be used to stop money leaving.”
The whole article (which can be found at the following link – www.telegraph.co.uk – is worth reading. The really interesting question is why would the EU want to stop money from leaving?
Simple. If capital controls may be imposed in the US, they would come with compliance from other countries, particularly Europe and Japan, which would impose controls complementary to those implemented in the US. In other words, though the above quote implies that the EU would pursue its own interests, the reality is that all central banks are still tied at the hip. Therefore, it is more likely that the US and the EU (with Japan as well) would pursue a common agenda. Namely, they would drop the value of all fiat currencies more or less in concert so that they all end up losing purchasing power against gold and other tangible assets, but more importantly, these currencies would drop in unison against the Chinese yuan. In this way the yuan’s exchange rate would rise, in theory reducing its trade surplus. Further, it seems probable that the EU may justify taking this dire step toward capital controls on the spurious grounds that they need to prevent their monetary union from unraveling.
Europe already has the authority for controls, as does the US through dictatorial decrees that are called “Executive Orders”, that are issued by the president without due regard to the law-making process set forth in the Constitution. I don’t know about Japan, but we can assume that they would do whatever the US asks. Will these controls be imposed in 2007?
Obviously, I don’t have the answer to that question. No one can know the future. But we should assume the worst because the writing is on the wall, which should be of concern to everyone who believes in free markets.
It also raises the question of what we can do to protect ourselves, but there are no easy answers. I think the best answer is to do what I have been saying all along. Get your money out of the dollar and even out of the US in order to obtain some international diversification. Buy metals and foreign stocks, particularly foreign mining stocks. And buy them through non-US companies/brokers. You should even consider buying your US mining stocks through foreign brokers on overseas exchanges. Foreign owners of US mining stocks will I expect be treated differently (they will receive a hands-off approach) than their US counterparts, which could be subject to a windfall profits tax or other unfriendly measures.
In short, when these controls are imposed, we will face a big shock. The industrial economies of the West will take a huge step toward command economies, like that which prevailed in the Soviet Union or like those in the US and the UK during World War II. It means more government regulation, which will further impede economic activity. This touches upon the other piece of bad news I expect for 2007.
Even without the imposition of capital controls, the US economy is headed for a severe slowdown and recession. Housing and the US auto industry are the obvious weak spots. An economic adjustment will come regardless of whether or not capital controls are imposed because the assumption of new debt and the creation of financial derivatives have been so excessive. In other words, capital controls will only make the economic situation that much worse.
In short, it is a bleak outlook. The dollar is headed lower but attempts will be made to prevent it from falling off the table by some type of capital control(s). And regardless what happens to the dollar, the US economy will weaken, and only be made worse if capital controls are imposed. So that’s the bad news, and the good news is really not that good.
It is that gold will soar in 2007, but as I explain in the following article, it is more accurate to say that the dollar is collapsing, rather than gold is rising, which means this news is not really that good. Gold”s purchasing power in the main always remains unchanged, except that labor is being devalued. Dollar-based labor (i.e., people who earn dollar-based income) is being debased as the dollar is being debased. In short, dollar-based earners are becoming poorer in real purchasing power terms, so a soaring gold price is a mixed blessing. And it is a soaring gold price that I am expecting.
My initial target for 2007 is $900, which I expect to see in the first quarter. Thereafter, gold will head toward 4-digits, and I consider a 4-digit gold price to be at least a 50% probability in 2007 and an 80% probability by June 30, 2008.
Two other forecasts for 2007 are that silver will climb faster than gold (i.e., their ratio will continue to fall). Their ratio will probably drop below 30, meaning it will take less than 30 ounces of silver to buy one ounce of gold. A $900 gold price and 30-to-1 ratio means I am expecting silver to reach $30 in 2007.
Also, the XAU Index of gold mining stocks will appreciate faster than gold itself. My minimum target for the XAU Index is 220, approximately a 50% gain from current levels. If gold achieves a 4-digit price, then the XAU could touch 300, a double from current levels.
In summary, 2007 will be a good year for precious metals, and for people who are prepared for a collapse in the dollar. And the best way to prepare for a collapse is to own gold and silver.