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Gold Commentary - June 23, 2006


The 20% A Year Expectation

In a survey taken in May, "condo" owners in Los Angeles were polled. The question was: "What do you expect to be the annual increase in the value of your condo?". The answer was eerily familiar. 20% a year!.

Why eerily familiar? Because this was the precise answer that owners of stock portfolios were giving at the end of the 1990s to questions about their expecation of future annual increases on the stock market. That was six and a half years ago - and look at the actual result.

What do you think would have been the "consensus" from owners of Gold back in early 2001 (when Gold was languishing just above the $US 250 level) about their future expectation for Gold prices. Would ANY of them have answered 20% a year. Ironically, if they did they would have been very close to exactly right. Despite the recent severe correction, the $US 584.80 Gold price at present is only a few Dollars below what it would be if it had risen by 20% annually since it last traded in the $US 250s in April 2001. The actual price to achieve that 20% annual rise would be $622. Five weeks ago, Gold was $100 ABOVE that level.

When Gold hit its bull market high (spot future closing basis) of $US 721 on May 11, its price showed an annual rise of almost 25% a year for just over five years. Now, six weeks later and after what is almost universally perceived as a "severe" correction, that annual rise since 2001 has fallen to a little below the 20% level. That's what stock investors were expecting in 1999. They didn't get it. That's what LA condo owners are apparently expecting now. Are they likely to get it? We think not. Nobody expects annual returns like that except the arithmetically illiterate and/or those who are holding an asset at the apogee of a runaway bull market.

Part of the reason for Gold's acceleration from the low mid $US 500s to the low $US 700s between March and May this year is precisely the participation of the 20% per annum brigade. None of these people had any interest at all in Gold when it was doubling from $US 250 to $US 500 between early 2001 and late 2004, even though this did indeed represent an annual increase of almost precisely 20% a year. But when Gold (and silver) took off in March, they were all of a sudden noticed as what was the latest vehicle for the "get rich quick" mob.

Actually, that's not quite correct. When stock market investors were anticipating 20% a year increases in perpetuity at the end of the 1990s, they were indeed counting on getting wealthy. Six years and many TRILLIONS of debt later, the expectation has changed. Now, annual valuation increases of 10%-15%-20% or even more are required not to get rich, but merely to stay even or slightly ahead of the game. The cost of carrying debt has risen exponentially, as has the cost of trying to maintain the same "standard of living" which was taken for granted throughout the stock market boom of the 1990s and the subsequent real estate boom which has only shown unmistakeable signs of "popping" in the last few months - in the US anyway.

Most if not all of the 20% a year brigade have been badly financially wounded by the precious metals correction of the past five weeks. Those who understand the fundamental role of Gold as money and who have a clear-eyed view of the inevitable results of the financial profligacy of the past five decades have merely seen the annual increase in the Gold price retreat from the 25% level of mid May to the (just below) 20% level of the present.

All bull markets have surges and retreats. This Gold correction has been one of the retreats. Thus far, with support now having been found in the low $US 560s, the appreciation has merely reverted to the "norm" of the bull market so far. Between April 2001 and December 2005, the $US Gold price was going up at 20% a year. Right now, it is going up at about 18.5% a year. Yes, it has been a big correction from the May highs. But in the context of the bull market as a whole, it has merely been a reversion to the norm.

We think the message of the Los Angeles Condo owners poll should be pretty clear. But in case it isn't, remember what has happened to US stock markets in the six and a half years since investors were complacently expecting 20% a year "in perpetuity". Now, we've got the same thing in the US real estate market. If one didn't think the real estate bull's days were numbered before this, there can be no excuse for any doubt of that now.

When the US real estate market "goes", the US consumer will "go". When the US consumer "goes", the US economy will "go" - consumer spending making up 70-80% of it. When the US economy "goes", the US Dollar will "go". And when the US Dollar "goes" - so will Gold - in the opposite direction.

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©2006 The Privateer Market Letter

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