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Is the Rally Really Over for Precious Metals?

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The first part is, but there are no clear signs that the whole rally is over at this point.

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Prime Minister Gordon Brown, who will face a tough battle in the upcoming election, has two nicknames in the British press -- "Golden Brown" and "Goldfinger Brown."

Since anything pertaining to gold is of interest to me, I looked into why the Prime Minister has such monikers. Does he perhaps have a Midas touch?

It turns out that quite the opposite is true.

Brown, who took over from Tony Blair in 2007, acquired the ironic nicknames about 11 years ago when, against the advice of leading bankers, he sold off about 60% of Britain's centuries-old gold reserves. The timing of the sales, from 1999-2002, was "impeccable." In his role as Chancellor of the Exchequer he sold 400 tons at rock-bottom prices. He got an average price of $275 an ounce, raising $3.496 billion. (British gold traders have dubbed the 20-year low the "Brown Bottom.") Since the unfortunate sale, gold prices have more than quadrupled to $1,159 an ounce.

There is a lesson to be learned here both for nations and for individual investors -- hold on to your physical gold and don't worry too much about governments selling or "dumping" gold when its price gets very high -- history suggests that governments aren't the best traders and don't necessarily sell at the top.

With only 310.3 tons of gold left in its Central Bank holdings, Great Britain, once an empire that ruled half the world, ranks number 16 on the list of gold-holding nations, just below Venezuela and just above Lebanon.

There is further irony in the fact that it was Britain that had led the way in establishing a gold standard when Sir Isaac Newton, as warden of the Royal Mint, linked the value of raw gold to the value of money back in 1717. The 1844 Bank Charter Act formalized the gold standard, the Bank of England's promise that every note could be redeemed for its value in gold. The gold standard lasted until Britain was forced to abandon it during World War I. Churchill returned to the standard in 1925 but it was again abandoned in 1931.

Newspaper accounts in the British press estimate that Brown's gold sale cost the British taxpayer about 6 billion pounds.

The gold sale has become a campaign issue and already posters have appeared of a smiling Brown with the accompanying text: "I lost 6 billion pounds selling off Britain's gold. Vote for Me."

According to British newspaper reports, the proceeds from the gold sale were invested in dollars (40%), euros (40%), and in the yen (20%). It's safe to say that the revenues generated from the fiat currencies don't come close to the spectacular four-fold increase in the value of gold since the sale.

In May of 1999, when Brown announced his plans to sell the gold, the price had stagnated for much of the decade in a secular bear market. British gold simply sat in the vaults gleaming prettily but earning no interest. Some had perceived it as a capital wasteland, an anachronistic relic. Apparently, Brown wanted assets that would generate interest payments. He ignored gold's habit of retaining its intrinsic value over the long term.

"Golden Brown" was wrong to dump gold in favor of paper currencies. Gold's breakout against the world's primary paper currencies underscores gold's growing allure as a store of value against further currency debasement caused by profligate government spending. It appears that gold is reassuming its role as an alternative currency unencumbered by the political liabilities of fiat money.

Therefore, the long-term bullish fundamentals are still in place despite the fact that governments still own a substantial amount of gold -- they are not super-traders, who are likely to sell everything at the top, thus pushing prices lower. Still, fundamentals are responsible for where markets go in the long term (years), not where they may go in the short and medium term (days, months). Therefore, let's focus on the charts and see what they tell us at the moment.

In the following part of this essay, I'll focus on the situation in the mining stocks, as it seems that there are several voices saying that the rally in gold stocks is over and they are likely to decline from here -- I respectfully disagree.


Source: StockCharts.com

In Are Precious Metals Likely to Plunge?, I said that though sharply moving higher recently, the HUI Index appears to be ready to pause, especially, as the multi-month support level has been touched. Consequently, the current pause is something natural, not necessarily a signal of a coming plunge. One of the questions at this point is: Are prices likely to move much lower?
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No positions in stocks mentioned.
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