Published November 17, 2011

What 2011 Gold Price Correction?

Dear Reader,

Communism screwed up the world. No, I'm not referring to the politics of the 20th century, but rather the reverberations still felt today – particularly in regard to rising commodity prices and oil. We often think about communism as a local intervention in the economies of Russia, China, and other places, but in reality, it was a worldwide market intervention.

Let me explain the problem by discussing economic theory in other examples. When a government artificially lowers prices, the wrong signal and incentives are sent to the market. College education is a good example at present in the US. The government provides relatively cheap state schools and makes education even more affordable with student loans. As a result, some people choose career paths that they otherwise might not. If each student had to pay $40K per year in tuition, I can guarantee that the number of art, sociology, and political science majors would fall through the floor. When tuition is a couple of hundred dollars at the community college or a couple of thousand at the state school, we can afford the luxury of more whimsical degrees with higher degrees of risk.

The same thing happens with interest rates. When the Fed artificially lowers interest rates, businesses begin projects that might not otherwise make sense. With piles of money flowing through the system thanks to the central bank, prosperity appears much greater than it really is. This illusion fools businesses into expanding, even though the total wealth of society has not increased. But when rates start to rise, AKA "the punch bowl is taken away," many of those businesses bust. In short, businesses formed under artificial incentives often can't stand up over the test of time.

So what does this have to do with communism? That unfortunate form of government suppressed the demand for all sorts of goods. While China and Russia were stuck in economic chaos, they curbed the economic potential of nearly a billion people who would have otherwise been producing wealth and consuming commodities to do so. What did that mean for us? Everything was much, much cheaper than it otherwise might have been – especially oil. Consider that just 30 years ago, oil was in the teens. Now, the new normal seems to be the $100 mark. Furthermore, China's presence is being felt everywhere in commodity markets from oil to copper to even gold.

Just like low interest rates encourage wasteful projects, the artificially low commodity prices – particularly oil – did the same thing. Just look at the auto-focused structure of American cities, which barely have any mass transport and where the suburbs are endless miles outside the city centers. Cities such as Los Angeles and Houston were not built with the assumption of $200 or higher oil prices. They were built on artificially lower demand for oil – a low demand created by communist-crippled economies elsewhere. Just like a real-estate investor leverages himself in hopes of a perpetually booming market, we have pushed our cities to the limit assuming an endless supply of cheap oil. In both cases, the interventions of world governments were pushing people in the wrong direction.

The high growth from emerging markets didn't happen merely by chance It's the catching up process of countries finally freed from communist regimes. If China had more economic freedom 50 years ago, I can guarantee that it wouldn't have today's astounding growth rates. It would have already become a modern economy decades ago. When the communist regimes ended, the event was like a bursting dam. Unfortunately for us, we had built a lot of infrastructure in the flood plains expecting that dam to hold forever.

Can you imagine a world where communism had never existed? We would have been faced with more realistic prices and assumptions about commodity supplies much earlier. If China started growing 70 years ago, I don't think that our cities would look the same way at all. Can you imagine if people back in 1946 started to be concerned about oil running out, rather than the past few decades? I can assure you that every US city would have had a decent mass-transit system, urban sprawl wouldn't be so large, and alternative energies would likely be decades ahead of their current progress.

Communism wasn't just an episode in history – it's something that continues to impact our daily lives, whether it's the location of one's house or the commute to work or prices at the store. Much like WWII gave us the baby-boomer generation (which could cause a fiscal crisis down the road), communism will continue to send rippling effects through the markets that will last for the rest of our lives.

Next, BIG GOLD editor Jeff Clark offers some reassurance to gold investors who might be worrying about the correction we saw earlier this year.

The 2011 Gold Price: What Correction?

By Jeff Clark, BIG GOLD

I've told more than one concerned investor that when the gold price falls, they should "come back in three months" and see if they're still worried. The idea is that the daily and monthly gyrations are nothing to fret over, that the price will recover and, in time, fetch new highs.

That advice has worked every time gold underwent any significant correction (except in late 2008, when one had to take a longer view than three months). Here's proof.

I've traded emails regularly with Brent Johnson ever since meeting him at an investor event I spoke at a couple years ago. He's the managing director of Baker Avenue Asset Management, a wealth management firm with over $700 million in assets. He forwarded some charts he'd prepared for his clients that put gold's September decline into perspective; it's a good visualization of my standing advice to worriers.

The following charts document corrections in the gold price of 8% or more – first measured with daily prices, then monthly, quarterly, and finally annually. See if this doesn't put things into perspective.

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While the gold price has had plenty of big corrections since late 2001, they're not so concerning when viewed beyond a day-to-day basis. In fact, if one resists checking the gold price except once a quarter, one might wonder what all the fuss with price declines is about.

You'll also notice that the September decline, when measured monthly, was our second biggest in the current bull market (and third when calculated daily). This suggests to me that unless we have another 2008-style meltdown in all markets, the low for this correction is in.

That's not to say the price couldn't fall from current levels, of course, nor that the market couldn't get more volatile. It's simply a reminder that when viewed on any long-term basis, corrections are nothing but one step down before the next two steps up. It tells us to keep the big picture in mind.

It also implies that pullbacks represent buying opportunities. It demonstrates that one could buy any 8% drop with a high degree of confidence. Keep that in mind the next time gold pulls back.

Until the fundamental factors driving gold shift dramatically – something that would require most of them to completely reverse direction – I suggest deleting any worries about price fluctuations from your psyche.

And if you're still a tad uneasy about today's gold price, well, let's talk next February.

[The current issue of BIG GOLD lists the top stocks to buy in our portfolio, ones we're convinced are destined for much higher stock prices before this bull market is over. Get their names, along with our new Bullion Buyers Kit, with a risk-free trial here.]

Additional Links and Reads

Legg Mason's Miller to Exit Main Fund (Bloomberg)

For those who haven't heard of Bill Miller, he's a legend in the mutual-fund world. He beat the S&P 500 for 15 years in a row, until being severely derailed by the 2008 crash. However, his fund has underperformed the market for the past four out of five years. As a result, Miller is retiring from his once-famous fund. So, what happened? Essentially, Bill is an expert at bull markets. When the sun is shining, one couldn't be in a better fund. However, he apparently has absolutely zero grasp of markets in a slump. He kept making bullish bets expecting yet more sunshine and roses ahead. Unfortunately for him, this optimistic scenario never materialized. The crisis claims another optimist.

As New Graduates Return to Nest, Economy Also Feels the Pain (New York Times)

This article notes the return of many college graduates to their parents' homes. I've covered this topic before and don't want to beat it to death, but there's something interesting to note in this article. The piece complains about 20-somethings staying at home and not spending money. The unemployed are living at home as an obvious consequence of lacking employment, but others are just saving money. This New York Times bemoans this lack of spending.

However, is this really such a bad thing? What's so wrong with building a safety net for oneself or amassing capital prior to going out on one's own? Nobody wants to live with one's parents, but let's not pretend that there's any great virtue in living paycheck to paycheck. If young people are saving money, that's a good thing; they'll need it in the rough years ahead. A return to thrift is an encouraging sign for US spending habits. Perhaps our future growth will come from real savings rather than debt this time around. As long as these kids don't plan on mooching off their parents forever, then I don't see this as such a horrible thing.

Top Favorite Stock Holdings of Congress (The Big Picture)

This article details the top stock holdings of members of Congress. For a detailed look at the total values and the Congresspeople with the greatest holdings, check out link above. Here's the top 10 list.

  1. General Electric
  2. Proctor & Gamble
  3. Bank of America
  4. Microsoft
  5. Cisco
  6. Pfizer
  7. Intel
  8. Wells Fargo
  9. At&T
  10. Exxon Mobil

That's it for today. David Galland should be writing tomorrow. Thank you for reading and subscribing to Casey Daily Dispatch.

Vedran Vuk
Casey Daily Dispatch Editor