A response to Blanchard's gold bullion report

We have been asked by some of our subscribers to give an opinion of the recently released report on gold bullion by the Blanchard Economic Research Unit of the precious metals sales firm Blanchard (New Orleans, LA). This report was published, among other venues, on Gold-Eagle. Ordinarily, we do not read economic-related reports since the focus of our work is technical and not fundamental, but we were given a tip by respected sources that this controversial report is must-reading for the gold investor.

The 7-page report is entitled, "The Fed Funds Rate, Stocks, Bond and Gold Bullion." It is available for viewing from the following Internet link: http://www.economicresearich.net/bulletin35.html. We will not cover every detail of the report, only the conclusions, so we leave it up to subscribers to read this report when time permits. The report was very well written and the arguments were crafted masterfully, the facts are compelling and the thesis is very persuasive right up until the end. The analytical eye discovers by the end of the report just where this economic thesis is heading - it is a critical appraisal for investment grade coins at the expense of going bearish on gold bullion.

The first five pages of this report basically builds a strong case that interest rates, which are currently at multi-year lows, are due for a rise and that such a rise, aside from hurting bond investors, could shock both the stock market and the economy. The report quotes a number of respected sources and makes a powerful argument that Fed Funds interest rates will indeed see a rise beginning sometime this year. Considering interest rates are at extreme lows and can't really fall much further without a correction, they'll get no argument here. So far, so good.

Then Blanchard throws a curve ball of sorts when addressing the state of the market for gold bullion. One would think that a firm whose business is selling gold and silver would be perennial bulls on the yellow metal, but not so in this case. In an extremely odd and unprecedented sales strategy, the country's most famous gold coin firm did an about-face last year and published an extremely controversial sales piece (in book form) titled "Gold Bullion: Caught in a Bear Trap." This followed a period of undeterred optimism on gold's prospects for higher prices, an outlook which reached its apogee with the Y2K non-crisis. Ironically, Blanchard's change of opinion in the desirability of gold as an investment coincided almost precisely with the orthodox bottom in the long-term gold bear market. Blanchard went bearish on gold in wave 2 of gold's emerging bull market. There are typically five waves in any rising Elliott Wave price progression, and according to Elliot Wave expert Robert Prechter in his seminal work "The Elliott Wave Principle," the second wave of a 5-wave bull market is typically when bearish sentiment is at its highest even though the trend has turned up. In true Elliott Wave fashion, Blanchard has conformed to this scenario).

Blanchard proceeds to make the case that the "price of gold respond[s] to increases in the Fed Funds rates by stopping in its tracks." The report also quotes two university economics professors who wrote a study entitled, "Gold Price Targeting By the Fed." The report claims that the Fed responds to a 10% increase in the price of gold by raising short-term interest rates (the federal funds rate) within the 52 week horizon until the rising gold price is stopped in its tracks. Blanchard conducted its own independent study to verify the conclusions of the university study and found that "during the four periods from 1985 to 2001 in which the Fed raised the Federal Funds Rate, the price of gold declined each and every time."

The clincher to Blanchard's argument is found in the following statement on page 6: "The problem is, one of the traditional diversification vehicles, gold bullion, is unlikely to perform well in the face of a rising Federal Funds Rate. In fact, a strong case can be made that, in view of the evidence over the past 17 years, it is very nearly impossible for the price of gold to increase during any period in which the Fed Funds Rate is climbing." To put it simply, Blanchard is arguing that gold prices won't rise as long as interest rates are rising, and that the Fed can control the price of gold simply by tweaking interest rates. This represents a huge departure from classical thinking on the interest rate/POG relationship since Austrian Economics teaches that gold prices are the ultimate barometer of inflation/deflation, not interest rates. True, interest rates are highly sensitive to inflationary/deflationary pressures in the economy, much more so that other financial instruments. But gold is the quintessential economic barometer in the classical/historical view and no amount of interest rate manipulation can ultimate contain gold prices, either to the upside or the downside.

To buy into Blanchard's line of thinking, we would have to throw out the better part of 150 years of economic history in this country and focus exclusively on the past 17 years (which is apparently what Blanchard would have us do since they refer only to the period 1985-2002). This is nothing less than economic tunnel vision, and like driving a car, investing with tunnel vision can have disastrous consequences. What about the late 1970s, when interest rates and the price of gold rose in tandem?

Blanchard wraps up its analysis by stating, "The evidence overwhelmingly shows that gold bullion is not positioned to be of help to investors." The report then adds, "one investment area has in fact performed very well over this same period of uncertainty in the U.S. and world economies and financial markets: the market for Mint State U.S. Gold Coins." Blanchard concludes its report by stating, "Right now, [the best] form of gold ownership is clearly Mint State Gold."

In our opinion, this is not the best of advice. Allow us to say that we have nothing against Blanchard and have found them to be a reputable and established gold coin firm with high standards. Our problem is when a highly esteemed sales firm decides to go into the business of telling its customers (existing and potential) not only WHAT to buy, but WHEN to buy it! This should be left to the financial forecasters and professional investment advisors. Blanchard's job is to sell the customer what he or she wants (presumably gold coins, whether bullion or numismatic), not give them timing and investment advice that may or may not be in their best interest as investors. In our opinion, this sales strategy can only backfire on Blanchard when their forecast for a gold "bear trap" fails to materialize.

One final potential pitfall in the Blanchard report is their heavy touting of mint state rare collector coins. In our opinion, this is not the best time to heavily commit to collector coins since the market for collectibles hasn't finished bottoming, and also since collectibles tend to follow the broad trend during deflation (down). Since K-wave deflation is still underway and is not scheduled to end until sometime in the middle of this decade, collectibles for the most part (in our opinion) should be avoided. Actually, Blanchard would have done better to recommend gold bullion as a financial hedge and investment and avoid spotlighting numismatics for the time being.

While we agree with Blanchard's conclusions regarding stocks, bonds and interest rates, we cannot agree or endorse their conclusions regarding the state of the gold bullion market or that of investment grade coins. We leave it to the reader's discretion as to what types of coins to include in a well-diversified investment portfolio, but it surely should include some form of gold bullion coin.

Clif Droke is the editor of the weekly Bear Market Report, a combined forecast and analysis of U.S. stocks and indices and international precious metals stocks, and is the author of numerous books on trading and technical analysis (most recently Gann Simplified, published by Traders Library). For a FREE COPY of the Bear Market Report send e-mail to:[email protected] or write: The Bear Market Report, Clif Droke, P.O. Box 3401, Topsail Beach, N.C. 28445-9831.