When will a gold position double in value?
"Last year saw the most severe bear-market decline since 1931. The instant reaction is to be bullish after such a decline, but the situation is more complex. The watershed events of 2007 and '08 lead to a different world in many ways. The household sector is traumatized by a 20% drop in net worth, as the worst year prior to this saw a loss of just 5%. The corporate sector is traumatized by a slump in earnings, and refinancing problems. Thus, everyone will turn more cautious, not just for 12 months but several years. Deleveraging is a structural process, not a short-term process.
Fiscal policy and other interventions may stabilize the economy later in the year and into 2010, but economic growth will be anemic and disappointingly low once things start to improve. Less leverage means lower growth, lower profit margins, a lower return on equity, lower valuations and such. But the market is slow at pricing that in. During the energy crisis of the 1970s, it took the market six years to stop extrapolating 6% annual growth and get in line with reality.
We are still in a secular bear market that started in 2000 in the industrialized economies. It has several more years to run. This is a transition year after the first slump, and we will see some corrections to the upside.
We've just seen one.
Zulauf: The current rally will peter out sometime in the first quarter. It's the Obama hope rally. Obama is dangerous for the market in the sense that expectations that he can change the world are too high. He is a charismatic person, but a charismatic person with no track record. Eventually the market will grow disappointed that he can't change things as quickly and to the degree people hope.
The market will have a setback after this rally ends, with the next rally starting sometime in the second quarter. It will be more powerful and a bit more sustainable because some of the economic numbers will show positive momentum, and it will start from a new low. But you can't buy and hold equities for the long term. Investors will turn away from equities. They are fed up with negative returns over 10 years. In that period, as I said earlier today, risk was high and perceived risk was low. Now risk will be low, due in part to support from the world's central banks. But investors will perceive risk as high, and price financial assets accordingly.
Witmer: They already have.
Zulauf: In a few years' time there will be some fantastic long-term buying opportunities, but we aren't there yet. The Standard & Poor's 500 easily could fall into the 400 to 600 range over 2010-'11, after a bounce that takes it to 1,050 or so. But the upside is limited because the fundamentals aren't there.
Gabelli: So it's up 10% and down 50%.
Falling oil prices are central to what has happened in the markets, if not the economy. You're a commodities man in some ways. Where do you think oil is headed?
Zulauf: The price of oil has tumbled much more than I expected. I thought it might be cut in half in this cycle, which would have meant a price of around $75 a barrel, not $35-$40. Oil will bump along around $40 for a while, with rallies up to $70 or so. It will build a range for some years, until demand and supply get back into balance. So far, producers are behind in adjusting production to weak demand. Buy oil for a trade but not for an investment. Lower oil prices are one of the big pluses in the economic equation, because consumers will pay less for gasoline and fuel.
Is OPEC pretty much out of the picture?
Zulauf: It is cutting back. There was a struggle within OPEC [the Organization of Petroleum Exporting Countries]. The Russians didn't behave as the Saudis wanted. The Iranians didn't behave as the Saudis wanted. Now the Saudis are playing hardball with other OPEC members. But OPEC, as announced, will cut production. It isn't interested in having oil prices get too low or too high. It thinks a price of $60 a barrel or so is reasonable.
Gross: We always root for lower oil prices because they restore consumer purchasing power. But cheap oil also impacts oil-producing nations and the global economy.
Zulauf: It plays havoc with their budgets. The boom in the Middle East is over. Government finances in the region will go into deficit. These are not politically stable countries. A large part of the population in the region is dependent on government finances. A drop in oil prices could further destabilize the Middle East.
Cohen: Is there a policing mechanism to make sure OPEC members cut production? So far, it hasn't worked.
Zulauf: Swing producers like the Saudis can cut back as they bring other OPEC producers in line. But it takes time to cut production by three million or four million barrels.
Faber: Some people say they have to cut by seven million barrels.
Gabelli: Either way you have a demand problem, even as oil companies have invested in new production. Petrobras [ Petroleo Brasileiro ] has spent hugely on its new field off Brazil.
Zulauf: At current oil prices, you can forget it. A lot of projects around the world have been postponed or canceled altogether, and that's true in all commodities markets, including metals.
Gross: Does extracting oil from tar sands make economic sense, with oil at $45?
Zulauf: You need a price of $60. Getting back to equities, dividends will be cut in the next few years, but dividend yields will be higher than today, despite the cuts.
Zulauf: Investors should keep their powder dry. Sit in fixed income. Buy five-year investment-grade corporate bonds in less-risky industries that service daily necessities, such as telecoms, oil and food, and blend them with medium-term government bonds. Check company balance sheets. I wouldn't buy long-term government bonds, except maybe German bonds. My one recommendation for the longer term is physical gold. Consider the basic set-up: World economies are so weak that we are seeing government stimulation of historic proportions. At first this is deflationary, but it will become inflationary. Gold is the only currency that won't get devalued. It will be revalued.
If the Fed's liabilities had to be covered in gold, it would sell for more than $6,000 an ounce. We aren't going back to the gold standard, but the markets won't trust the central banks anymore. Gold is in a very slow bull market. The year-end price has been higher each year since 2001. The gold market could have a shakeout in the next six months, and the price could fall back to $700 an ounce or below from today's $850. But two years from now it will be a lot higher. It is one of the few commodities that held up during the forced liquidation of almost everything else. We have talked about the risk of currency devaluation. If you were a citizen of Iceland and your currency went down by 50%, consider how gold performed in your currency. Gold functions as a protection against your central bank doing stupid things.
Schafer: Did gold hold up because it wasn't a part of leveraged structures?
Zulauf: To some degree. You don't own it in a leveraged way. It was helped by the forced liquidation of other things. There was some forced liquidation of Comex futures contracts, but at the same time there was a massive move into physical gold. Gold will stay in a bull market. It can't be manipulated like a currency you can keep printing.
What about central-bank sales of gold?
Zulauf: You can sell it, but unlike a currency, you can't make it out of thin air. You have to dig hard to get it out of the ground, and there is a limited quantity available. Historically, jewelry accounted for about 70% of the demand for gold. That will decline as hoarding increases.
Gross: How many years will it take for gold to double?
Zulauf: Two, but don't blame me if it takes three. If you're a little more adventurous, you can buy gold stocks, but put the core of your holding in physical gold. Gold-mining stocks have underperformed physical gold for more than a year, due to rising production costs."