The Day the World Changed

The Impact 14 March 1968 had on Money, Gold, and Mining Shares

Part 2

Mark J. Lundeen

mlundeen2@mn.rr.com

Part 1 of this article will examine the significance of the London Gold Pool and the global monetary regime from the Bretton Wood’s Accords, to the present time. It also examines the shallowness of the digital financial archives. In the age of information, investors, economists and makers of “policy,” may not have the necessary information to properly examine our current age of inflation.

Part 2 of this article will examine the effects of monetary inflation on the seven decades of recorded price history found in the Barron’s Gold Mining Index (BGMI). Gold mining shares have proven to be a powerful indicator of future financial trends that everyone with money in the markets should be aware of.

Part 2

The Barron’s Gold Mining Index (BGMI) is a weekly data series that spans seven decades from 1939 to the present date. Upon careful examination of this record, the reaction of gold mining shares to war, political chaos, and currency inflation is quite different from what current expectations would have us believe.

This should not be surprising. Currently the widely followed XAU data set is the source data for most professional opinion on the gold mining industry. However, the XAU was first traded on 19 December 1983. This was three years after the October 1980 bull market top in the gold mining shares. So it is fair to say that the XAU is primarily a partial record of the post 1980 - 2001 gold share bear market.

The XAU is a modern index of gold mining shares that includes volume and open interest data. But like so much of today’s digital data, it is confined within the digital data bubble I noted in Part 1 of this article. To my knowledge, only the BGMI records seven decades of history for the gold mining shares.

An interesting point to know about the Barron’s Gold Stock Index is that it is the sole survivor, an antique remnant of the now long forgotten Barron’s Stock Averages. Barron’s published for 50 years (1939 to 1988), stock averages for over 20 industrial sectors. They provide a unique piece of history of the American stock market from a time when vacuum tubes were high tech to the era of computer microprocessors.

Except for their Barron’s Gold Stock Average, now called The Barron’s Gold Mining Index (BGMI), Barron’s discontinued their Barron’s Stock Averages in October 1988. The BGMI has been continuously published since before Hitler invaded Poland in 1939. The 67 years of data contained in the BGMI data set is the definitive source of information on gold mining shares price action under all economic circumstances.

Sorry to say that Barron’s allowed five decades of their publication’s recorded history for oil, textiles, steel, auto manufacturing and many other industries to fade into oblivion. Likewise, Dow Jones discontinued their excellent 20 Bond Average data just a few years ago. The DJ 20 Bond Average was an important historical bond data series for utility and industrial bonds that spanned 64 years from 1938 to 2002.

I believe these venerable, decades old market metrics based upon arithmetic averages were casualties of the digital information revolution. They must have seemed quaint to the vast majority of market watchers. These old “averages” were based upon a 19^th century method of using a simple average on share or bond prices to compute market measurements. Indexing market capitalization is the modern digital method, and I think a superior method. The new indexed measurements also come with open interest and volume figures, none of the antique averages did.

Most likely, the Barron’s Stock Averages and the Dow Jones 20 Bond Averages lost their following long before Barron’s and Dow Jones pulled the plug on Grandpa. But pull the plug they did and 50 years of market history was cast aside and forgotten.

The survival of the old Barron’s Gold Stock Average, the current Barron’s Gold Mining Index, says something of the attachment gold once had on people, such as the past editors of Barron’s. The demise of the Barron’s Stock Averages and the Dow Jones 20 Bond Averages also says something about Barron’s and Dow Jones too. Both publications are authoritative publications of record for financial statistics. I wish they would be more respectful of their decades long, and quaintly antiquated historic data series.

I would not be surprised to learn that currently only a hand full of people have been seriously tracking the BGMI for the past few years. I may be the first person to have made the effort in compiling the BGMI into a digital format. I hope this article attracts the serious attention that the BGMI rightfully deserves. To do this, the BGMI needs to be passed around.

As a service to the readers of this article, I am providing a link to Mr. Nick Laird’s Sharelynx webpage. Mr. Laird has many of the historical data series I have compiled, including the BGMI. People interested in gaining access to this body of historical weekly closing price data should go to the below webpage. For a very reasonable fee, MR. Laird will sell you data.

Sharelynx’s data page

http://www.sharelynx.com/chartstemp/FreeCharts.php

Along with the above data on your computer, you will also need a reasonably priced subscription to Barron’s. Investing is like following a soap opera; you need to watch each episode or the ever changing plot will leave you behind. Barron’s will provide you with current weekly data needed to maintain your weekly data set. With all this, you can follow the markets like a serious student.

Barron’s subscriptions

https://services.wsj.com/Gryphon/jsp/retentionController.jsp?page=1012

The amazing statistical tables published each week in Barron’s have been a wonderful resource of hard statistical data for serious investors since 1921. Barron’s will mail its publication overseas to Asia, Europe and anywhere else. It is also available online on a subscription basis. Personally, I could not function without it.

I want to say that I have not in the past, do not now, or have any expectations that in the future I will be receiving financial payments from Mr. Laird, or Barron’s for any reason. Maintaining historical financial data is my hobby - providing a webpage for data hounds is a hobby for MR. Laird. Barron’s doesn’t even know I exist. No one is getting rich making this offer, except maybe you.

Now back to the Barron’s Gold Mining Index.

The next chart is a comparison between the BGMI and XAU. This is a chart containing every data point Barron’s has published on these two series from their first weekly published figures to the present. For your information, the XAU traded for about a year before being included as a statistic published in Barron’s. So the XAU as seen below is actually four years from the BGMI top of October 1980. As a record of the gold mining industry over time, we can see that the BGMI is far superior to the XAU.

The BGMI appears to have been in a persistent vegetative state from 1939 to 1963. As we will see below, hidden within this period (1939 – 63) is a record of great importance for insight on the US Dollar, gold and gold mining shares.

Why does this chart take on this appearance? It is solely due to the effects of monetary inflation on the paper US dollar’s value. Most market measurements valued in dollars, that spans this same period, have this appearance. The Dow Jones Industrial Average looks very similar. This annoying effect of inflation, makes analyzing one decade of a market to another very difficult. Inflation’s distortion to price valuations is another reason why historical data is not fully appreciated. As we can see in charting the 67 years of the BGMI, the first three decades contain no information in this chart. We really only see half of the whole picture.

The Federal Reserve’s chronic increases in the total volume of the reserve currency it manages, creates a base line shift in the fundamental values of the American market’s measurements over the decades. This gradual increase in the basic stock of money (CinC), has over time created distortions in relative price values from one decade to the next.

The first value listed for the BGMI was 48.75 in the 26-December-1938 issue of Barron’s. I will assume 750 as an average value for the BGMI from 1978 to present.

A 10% swing in the 1939 value of 48.75 produces a 4.87 point change. A 10% swing in my assumed 1978 to 2006 average of 750 produces a 75 point change. Both numbers are based upon a 10% swing in the BGMI. But the results of my assumed value is almost twice that of the total value of the 1939 listing of the BGMI.

Monetary inflation is why these decade long charts have assumed this appearance over time, just as monetary inflation has caused a huge loss in value of the paper US dollar over time.

Let us look at the BGMI from 1939 to the end of 1968, a span of time that includes the operation of the London Gold Pool (1960 to 14-March-1968). I have also included the plot for US Currency in Circulation (CinC), indexed to 1.00 = 26-Dec-1938. We can now easily see how many times the volume of paper US dollars in circulation increased over this same period.

Remember this chart the next time a financial expert expresses his opinion that gold mining shares are sensitive to massive inflation, wars and political upheaval.

Consider the following facts.

The darkest hours of World War II, for Britain and the United States (where these shares were traded), occurred from the very start of this chart until 24 June 1942. This period corresponds with Hitler’s obvious preparations to invade Poland to his actual invasion of the Soviet Union, 3.5 years later in June 1942.

In this 3.5 year period, the world’s political structure and economy was torn apart, while the US CinC doubled. Here is actual global chaos and massive inflation – yet the BGMI declined in value by more than -60%! This is not my opinion but an indisputable fact recorded in the BGMI.

After June 1942, the issue of war turned favorable for the Allies, but CinC inflation roared ahead. Still, the BGMI would not return to its December 1938 high until 1961. That was over twenty years after 1938.

We don’t see the BGMI doing anything significant after World War II until 1961. During the 1950s, some Americans were building bomb shelters to prepare for the coming Soviet “atomic” attacks, and air raid sirens were installed in every major US city. The BGMI did not respond to this fear; however the Dow Jones Industrials were having a very nice bull market all during the 1950s. Current market logic expressed in the financial media would have these trends of the 1950s reversed.

CinC fell slightly between the inter-war period of December 1945 to June 1950. After the start of the Korean War in June 1950, CinC slowly started to pick up again. Let’s blame this slight inflation on the Korean War. Here is a second shooting war with more inflationary acceleration of CinC. Again, here was another shooting war that had no discernable effect on the BGMI in the above chart.

Everything changes with the Kennedy / Johnson presidencies. After the start of President Kennedy’s term of office, two things happened that the BGMI was very sensitive to.

1. CinC continued to noticeably increased, however now the US gold reserves noticeably decreased.

2. The London Gold Pool was formed.

The BGMI started to increase in value as the paper US dollars increased in numbers, and gold US dollar left the United States.

The world saw the creation of the London Gold Pool as the US Government’s rejection of the Bretton Woods Monetary Accords (BWA). Printing more paper US dollars than there were US gold dollars to back them would, by the laws of supply and demand, cause the price of gold to rise upwards in price from the official BWA’s price of $35 an ounce.

The London Gold Pool’s purpose was to pool the resources of US friendly central banks. Any time more buyers came into the London Gold Market than there were sellers, the pool would punish anyone who dared to purchase gold at a price above the official $35 dollars an ounce. Such purchasers would soon find that they would be met with massive selling of central bank gold. The London Gold Pool intended that over $35 an ounce gold purchases would be a losing proposition.

From the first day of The Pool’s operations, the world of money knew that the United States no longer intended to honor the Bretton Wood’s Accords. For reasons good or bad, printing paper US dollars in excess of its gold reserves was now the monetary policy of the United States. The world of money being realistic about such things, understood that the US would never again return to a limited paper currency.

The paper US dollar became a wasting asset. To see the truth of this, one only has to go to a library that offers news papers of the 1950-60s and compare the advertised prices then and what we pay for similar items today.

No doubt this increase in the BGMI was primarily from US investor demand. This was a time when American citizens needed a license to hold gold or face imprisonment, stiff financial penalties, or both. From 1933 to 1974, the shares in gold mining companies proved to be an effective American proxy for gold itself.

Note on the table below. I chose not to use the highest prices for gold and the BGMI of 1980. As 1980 was a period of extreme volatility in both gold and the gold stocks, it is pointless to pick a typical price. From the first week in January 1980, (the basis date for the values I used in my below table) gold was to rise $220 dollars in the next two weeks, and then fall $180 in the week after that. As $800 gold was but a fleeting moment in 1980, I thought it appropriate to use a 20 year period from the first week in 1960 to the first week in 1980 in the table below.

The BGMI record clearly shows that as long as the US could inflate CinC without having a corresponding decrease in the US Gold Reserves (1945-58), the BGMI was indifferent to CinC inflation. However, when the inflation in CinC finally resulted in calls from foreign central banks upon the US gold reserves (1958 to 1968), the BGMI entered a significant bull market.

It is most important to know that this 1968 BGMI bull market’s top occurred less than a week before the Bank of England’s announcement of its withdrawal from the London Gold Pool on 14 March 1968. The day the Bank of England withdrew from the London Gold Pool, was the day world changed. The following two charts are important in understanding the bullish price action of the gold shares in the 1960s.

Who today is aware that the 1960s was a golden decade for the gold mining shares? Gold stock investors from 1960 to 1968 saw gains of over 1,200% in eight years while gold itself was kept at $35 an ounce for the entire period!

Another important point for gold shares in the 1960’s, is that after the closing of the London Gold Pool, gold was allowed to be traded freely for prices over $35 dollars an ounce. The increase in gold prices triggered a BGMI crash of minus 60% over the next two years.

This seems confusing, but there is logic to it. I promise, by the end of this article all will be explained and understood.

The next chart is a side by side comparison of the US gold reserves with the BGMI from December 1938 to January 1970. The two vertical dashed lines mark the start of the run on US gold and the withdrawal of the Bank of England from the London Gold Pool. There can be no doubt why the 1958-68 BGMI bull market occurred. It was the gold share’s reaction to the run on US gold and the existence of the London Gold Pool.

Please note that the Vietnam War was concurrent with, but not a factor of this bull market in the BGMI. As in the case with World War II, the Korean War, and the Cold War that created constant US domestic fears of Soviet atomic attack upon the civilian population of the United States, the Vietnam War was an incidental non-factor to the BGMI price action from 1960 to 1973. (See the below chart)

As you can see above, the 1960’s BGMI bull market coincided with the London Gold Pool, * not * the Vietnam War. Without a doubt, for the first three decades in the history of the BGMI, (1939-68) a period that involved the US in World War II, The Korean War, the Cold War and The Vietnam War, the BGMI’s primary trend was completely indifferent to American’s involvement in armed conflict.

If foreign armed conflicts produced no reaction to the BGMI, what about American domestic upheavals? The 1960’s racial problems occurred during the 1958 to March 1968 BGMI bull market, however Martin Luther King was assassinated on 04-April-1968, three weeks after the closing of the London Gold Pool. The BGMI was to crash by -60% in the next two years as the radical “Black Power” movement grew in influence.

The anti-war riots and political upheavals peaked in the United States, and elsewhere, after the closing of the Gold Pool and the market top in the BGMI. The BGMI collapsed 60% during the anti-war chaos of the next two years. In light of this data, on what basis can anyone claim that the gold mining shares are sensitive to war, social unrest, or persistent American public fears of sudden death from domestic or international terror?

The XAU is silent upon these years. One must wait some time before the digital XAU will be traded.

Considering the gold mining shares market of today, and seeing that the start of the current bull run of the BGMI closely matches that of the September 11, 2001 (9/11) World Trade Center Terror Attack, can we assume that the US’s involvement in Iraq is somehow buttressing the BGMI extremely strong performance since 9/11? Many experts’ considered opinion may say that this is so, but to assume this one must be unaware of the 67 years of BGMI history.

The Iraqi conflict is into its third year of combat operations. Of the four major wars the US has been involved in since 1939, the Iraqi conflict has seen the fewest human causalities to US troops abroad. To date, there have been negligible consequences on the home front when compared to the other three major wars. World War II and Vietnam were traumatic events to the American public. The Iraqi War, up to this point in time, has not been.

By the end of the current bull market in the BGMI, it will be very clear that the factor supporting its bullish primary trend will be monetary inflation and nothing else.

For the rest of this article, I will be examining the effects of monetary inflation on the BGMI. I have found that monetary inflation not only caused the past bull markets in the BGMI but have also caused the BGMI to crash as much as minus 82% in value. All other factors are moot.

These wild volatile swings in the value of the BGMI are a source of constant frustration to mining share investors. But if one steps back, and views the BGMI as a single part of the whole, we can see that the BGMI is also a barometer predicting where the inflationary flows of Federal Reserve liquidity are going to: financial assets or real assets.

But first I must explain my below “Bear’s Eye View” or “BEV chart.” With the BEV Chart, I will make my case that for 67 years, both bullish and bearish primary trends in the BGMI were solely the results of US created monetary inflation, and nothing else matters.

In the BEV chart below, I have marked the three gold share bull markets by placing them between the orange, green and blue vertical lines. The bear markets are found in between the different color vertical lines.

Here is the unaltered BGMI chart from the published values for a comparison. Note the details given in the above BEV chart for the 1939-63 period of the BGMI

Both the above charts used the identical BGMI data. However, the BEV chart allowed us to strip way the distortions on market valuations caused by decades of inflation. I have a lengthy explanation on this technique in another article I wrote called: “119 Years of Dow Jones Bear Markets.” A Google search will make it available to you, but it is simple enough to explain it in the few paragraphs below.

In a nutshell, I passed each of my 3,503 weekly BGMI data points (67 years of data) through a screen using the following formula:

(BGMI / Last BGMI All Time High) - 1

Here are the actual Excel formulas used in my spread sheet for the first data point (26 December 1938) and the last (13 February 2006) used to construct the above BEV chart.

=CZ1009/MAX(CZ$1009:CZ1009)-1

=CZ4512/MAX(CZ$1009:CZ4512)-1

I first wrote the first formula, and then note how I placed a “$” between the “cz” and the “1009” in the =MAX() formula. This makes the first week in the range an absolute reference that does not change as I copy this formula down the next 3502 rows on my spread sheet. I can now copy the formula down from 26 December 1938 to 13 February 2006 in a few seconds.

The BEV formula converts each numeric value in a data series into percentages within a strict range. No percentage will result in more than zero% or less than minus 100%.

Each new all time high is converted into a zero percentage value. Any number that is not a new all time high is converted into the negative percentage from the last new all-time high of the given range.

Let’s break down the BEV formula used on the 13 February 2006 BGMI value to its particular components.

1). [cz4512] = BGMI of 973.12 recorded in Barron’s 13 February 2006 issue

2). [max(cz$1009:cz4512)] = the range of values, (3503 weekly published values of the BGMI from 23 December 1938 to 13 February 2006) used in locating the BGMI’s latest all time high. For 13 February 2006’s BEV charted value, the latest all time high is the BGMI value of 1,285.16 from the 13 October 1980 issue of Barron’s. That was 1,322 weeks, or over 25 years ago.

Anytime the BGMI produces a new all time high, this formula divides this new all-time high by itself, and when any number is divided by itself, a positive value of 1.00 results. This step removes the distortion produced by monetary inflation.

Think of the value of 10 as our last all time high. This formula would divide this latest all time high (10) by itself. 10/10 = 1.00 or in percentage terms 100%.

Any number that is not a new all-time high (less than 10) is made to divide itself by the last all-time high (10) in the given range. This produces a positive percentage * of * this number from the last all-time high. Think of our last all-time high of 10 and our new value of 7. Dividing 7/10 = .7, or in percentage terms 70% of 100% as that is what 7 is, 70% * of * 10. We continue with our numbers 7 & 10 below in #3).

3). [-1] = Subtracting -1 from every data point converts each new all-time highs from 1 to zero, or in percentage term 100% becomes 0.00%. This step prevents any number in the given range to exceed zero or 0.00% in percentage terms. It also renders all other values that are not a new all-time high, into a negative percentage value * from * its latest all-time high.

Using our numbers of 7 & 10 we found that 7/10 = .7. We then subtract -1 from .7, or (.7 – 1.00 = -.3). In percentage terms, -.3 = -30%. So, if our last all-time high was 10, but this week we have only 7, we know that the market fell -30%. * from * the last all time high.

The logic behind the BEV chart is to convert all new all-time high values into zero percentage values and all other values into a negative percentage value from their last all-time high.

It is very important to know that except when values become new all-time highs, manipulating data with this formula does not alter the chart appearance or percentage moves seen on a BEV chart.

A comparison of the BEV chart and the usual chart of the BGMI shows that the chart plot from 20 October 1980 (the week after the last all-time high) to 13 February 2006 are identical to each other. Importantly, the same is true with the period of time from 26 December 1938 to 21 Aug 1961. However in my first chart, this period of time is the area I identified as the “persistent vegetative state” and appears as a straight line. The BEV chart reveals all the details in this very important period of time, and on a scale that can be compared to any other period on the BEV chart.

Over the decades, this formula would treat an inflated series of data’s 100,000 exactly the same as it treated the original 10. So with a Bear’s Eye View or BEV chart, we can now see the extremes in valuations, from decade to decade charted together in a manner that provides the insight of the market between the all-time highs. Or in other words, we can see the bear markets side by side. That is why I named this chart, the “Bear’s Eye View” because that is what your looking at - the bear market drops and the bullish reversals off the bear market lows between the new all-time highs.

The two charts do complement each other. Together they allow us to the price action during the entire 67 years history of the gold mining shares. But the BEV chart actually provides the most detailed account of the 67 year history of the BGMI.

Now back to the BGMI using the BEV chart. With amazing detail, we see two significant bull markets in the BGMI (1958-68 & 1970-80) each lasting ten years.

The 1958-68 BGMI bull was a lamb from a petting zoo. Here was a bull market in gold shares where money was easily made. Thanks to the BEV charts unique characteristics, we can see that the biggest correction in the 1960-68 market was about minus 30%. The BGMI also made reasonable sized moves, both up and down and went to its new all time highs with baby steps. Nothing extreme, just slow, sure and profitable trending price action in the BGMI for ten years that returned 1,292% from start to finish.

The 1970-80 BGMI bull was named “el Diablo” and el Diablo hated all the world, gold bugs especially. Rarely did el Diablo make new all time highs, but went ballistic when he did and then crashed down on people’s positions by -40%, -50% even -68% before going ballistic, (again) into a new all-time high.

After el Diablo’s final all-time high in October 1980, how could you tell that it was over? By 1980, gold stock investors were conditioned to expect over -50% crashes in valuations as normal market corrections. What a horrible market to have money in. the 1970 – 80 bull market was a market that killed off many believers in gold before it peaked, and then kept all too many people hanging on for the next decade or more.

From start to finish the 1970-80 BGMI returned 1,336%, if you had the guts to go toe to toe with el Diablo, and knew when to get the hell out of Dodge City. Most people didn’t. Heaven help the fools who bought gold stocks on margin with this bull running around.

Now consider the differences between these two bull markets in the BGMI. Most likely many of the same companies included in the BGMI in 1960 were still present in 1980. The ending of the 1960’s bull market was only two years distance from the start of the 1970-80 bull market. How had the world changed between 1968 and 1970?

The logical dividing point in the BGMI series is the termination of the London Gold Pool on 14 March 1968, which as you remember marked the top in the 1958 to 1968 BGMI bull market. Below is another BEV chart of the BGMI that marks the termination of the London Gold Pool. Without doubt, something happened to the gold mining share market after the termination of the London Gold Pool. Where there was once peace and quiet, there was now extreme volatility of a psychotic nature.

I believe this increase in volatility in the BGMI is due to the world’s concern of the stability of the US dollar after 14 March 1968. From 1950 to the closing of the gold pool, The Federal Reserve, US Congress, President and US Treasury have proven their ability to brush aside any fiduciary responsibility in their management of the world’s reserve currency.

After the gold pool broke up, people with real wealth, who truly understood the implications of having their fortunes defined in terms of an unconvertible reserve currency, must have always kept an eye on the dollar exit.

For the first time since 1789, no one, including the US Government knew what an American dollar meant anymore, or if the United States would really get away with decoupling the paper US dollar with its gold reserves. I think that is what we are seeing with the BGMI after 14 March 1968 - the international fear of what might happen to the world’s reserve currency.

The “policy makers” denied the world a stable reserve

currency. Why would the increase in volatility of a leveraged gold derivative not be something to be expected?

Remember this; gold for thousands of years has always been either money or a money substitute. This makes gold mining a perpetual put option on the full faith and credit backing the paper US dollar.

After the ending of the Gold Pool, there were times when the world fell in love with the US dollar. Double digit annual gains can do that, for awhile. But the post London Gold Pool extremes in volatility we see in the BGMI tells me that there was never a marriage contract, or even a good faith understanding between great wealth and the US dollar after 14 March 1968.

The world was a happier place when a non-inflated 4% return from a savings account in a bank was the reasonable expectation on a paper US dollar investment. For the general peace and quiet of the world, it is best if the “policy makers” do nothing to create the conditions where gold stocks become an attractive investment. It is very disconcerting to see the strong appreciation in the BGMI since its lows in November of 2006.

With this in mind, I believe that the BGMI is much more than just an index of actively traded gold shares. It is also the continuous weekly report card on the management of the paper US dollar for the past 67 years from 1939 to 2006. After 14 March 1968, the paper US dollar, all too often found getting a gentleman’s “C” a difficult thing to achieve.

The post London Gold Pool dollar is backed by debt, and debt can be understood either as an asset or a liability. Looking at our present period, previous to November 2000, (the bottom in the 1980 – 2000 BGMI bear market) Wealth chose to view the US dollar as a desirable asset to be held. It was dollars, not gold which one needed to buy semiconductor and software stocks during the 1990s.

After November 2000, almost a year before 9/11, wealth’s opinion of the dollar shifted to view it as an increasingly questionable liability to be sold in due course. Why hold on to inflating dollars when double digit dollar gains on the NASDAQ are no longer to be found. No one is running from the dollar, but the extreme strength in the post November 2000 BGMI is strongly suggesting that knowledgeable people are walking briskly from it.

The following comparison between the Dow Jones Industrial Averages (DJIA) and the BGMI BEV charts are interesting.

- The fall of the BGMI from 1980 to 2000 was as deep as the fall in the Dow Jones Industrial Average (DJIA) from 1929 to 1932.

- The DJIA had a gap of 25 years between its new all time highs (1929 to 1954). It appears likely that the BGMI will make a new all time high in 2006. That would make a gap of 26 years between the BGMI new all time highs from 1980 to 2006.

- The DJIA took 3 years to fall to its bottom (1929 to 1932) and 22 years, from that bottom to reach a new all time high (1932 to 1954). The BGMI took 20 years to reach its bottom (1980 to 2000) and 6 years to reach a new all time high, (2000 to 2006). This assumes that it does in fact reach a new all time high sometime in 2006. That is why I placed a “?” in the table, because as of February 2006 it has not done so yet, but I am hopeful!

Looking at the BEV charts of the DJIA and the BGMI, it seems that the BGMI from 1980-2006 is replaying, in reverse, the DJIA 1929-1954 BEV chart. That seems very positive for gold mining stocks, but very bad for the dollar.

Here is a table for the bull and bear markets of 67 years for BGMI current to the 13 February 2006 issue of Barron’s (*).

So what are we to make of all this? The BGMI seems to be indifferent to war and social unrest at all times. There are frequent incidences when the BGMI has * decreased * significantly during long periods of massive monetary inflation. Remember, the BGMI went down 65% during its 1939-42 bear market when CinC inflation was at its most intense in the 20^th century and while a world war waged on! The BGMI performed in very similar manner after the post London Gold Pool era from 1968 to 1971. In the Age of Greenspan we saw CinC increase by a whopping 538% while the BGMI crashed -82%!

Is this confusing? Then step back and consider the following.

The actual key in understand the BGMI is inflation, but not as you currently understand inflation’s effects on the BGMI. We must look at inflation’s effect upon all asset classes to understand the historical action of the BGMI. When we do, we see that monetary inflation flows from one asset class to another from one period of time to another. One asset class’ inflationary gains are another’s asset class deflationary losses.

Realizing this truth, you must understand that gold mining companies are only one asset class, of many, that is fed from, or denied the flows from the wellhead of inflation. The flow of inflation-funding from one asset class to another is dictated by the fads and fashions of any current investment environment.

Here is the key to understanding the BGMI’s 67 years of history. Since 1950, it has been a fact of life that the Federal Reserve has been creating inflation flows into the economy. That these inflationary flows have not always flowed into gold mining shares is also a fact of life.

So the current assumption of most people that inflation is at all times beneficial to the gold mining shares is wrong. There are 67 years of BGMI and monetary inflation history that shows this is not so. The above data proves that inflation drives the BGMI up 1,200% and then drives the BGMI down -60% or more as the Federal Reserve’s endless flows of liquidity move the from one asset class and then on to another.

Ultimately, the “policy makers” have little control directing where their rivers of “liquidity” will go. That sometimes their inflation flows where they desire it to is just dumb luck. If this were not so, there would have been no need for the London Gold Pool in the 1960s, or the current Gold Cartel with its OTC derivatives market with a notional value of hundreds of trillions of dollars.

Arthur Burns of the 1970s created annual double digit CPI gains. In fact Burns did nothing different than what Alan Greenspan did in the 1990s when Greenspan created annual double digit increases in the financial markets. They both greatly increased the stock of paper US dollars in circulation. However, the Burns’ inflation flowed into bread and butter items and so was blamed for the double digit inflation of the 1970s. Alan Greenspan’s inflation flowed into financial asset items like high tech stocks and housing, so he is credited for creating great bull markets. The only differences between these two historic Inflationists, is just dumb luck. To believe any different is just plain dumb.

Both were only reckless Inflationists who danced with Madam Dumb Luck. Dumb luck for Burns caused people to hate him, dumb luck for Greenspan made people love him. I don’t think dumb luck will treat our new Fed Head kindly.

When a previous hot sector starts to deflate, an increase in liquidity is likely to flow away from this now deflating asset. New liquidity wants to flow on to other assets that are more reasonably valued, and so more easily to benefit from inflation.

The psychology of inflation investment is momentum investing with leverage. New liquidity seeks out inflating asset prices and then jumps onboard. One opens a margin account in 1993 and pays 6% on borrowed funds to purchase shares of Microsoft and Intel. All during the 1990s, both companies almost guaranteed an annual return much greater than 6%. Software and semiconductors increased by factors of 40 and 60 times from January 1989 until 2000. On margin, using inflation, the returns on the past high tech bull market were fantastic!

Buying the deflating gold shares in the 1990s with inflation via a margin account was a losing proposition. Still it could be done if one didn’t mind paying 6% on borrowed funds and having to cover the constant margin calls on assets that were deflating at a double digit rate.

The flows of inflation came from the Federal Reserve, but the decision of where this inflationary money was to flow into was made by the millions of people who used the inflationary money, not a few “policy makers.”

I suspect that our new Federal Reserve Chairman Ben Bernanke will receive an education when the housing market and NYSE share prices start to deflate again. This is especially so with the housing bubble. Housing is so heavily leveraged with interest only, no down payment mortgages supported with the collateral of unaffordable houses. How are home prices to rise from current levels when the “policy makers” are counting on nearly bankrupt people to take on ever greater levels in unsupportable debt to make the new purchases in housing? Every time I see a massive layoff of employees by a major employer I think of all the mortgages with no paycheck to finance them.

Bernanke may think that dropping money from helicopters will prevent deflating values in housing and blue chip stocks; but I believe that anyone finding the free money would be wise enough to take the free hundred dollar bills and buy gold, silver and natural resource stocks. Time will prove which of us is correct.

I want you to think of the following analogy when you look at my BEV chart of the BGMI. If the world’s economy is a high-pressure boiler, and Federal Reserve’s CinC inflation the coal that fires the boiler, my BEV chart of the BGMI is the pressure gauge’s indication of wealthy people’s * acceptance * of the ever inflating US dollar supply from 1939 to present.

Here is how to read the pressure gauge called the BGMI:

BGMI Trending Down – the world’s economy, and wealthy people are accepting US CinC inflation. Financial assets are benefiting from inflationary flows. Microsoft, Intel and real estate up - and the BGMI down by significant margins.

BGMI Trending Up – the world’s economy; and wealthy people are resisting US CinC inflation. Real Assets are benefiting from inflationary flows and will outperform financial assets by significant margins.

So we must understand that since 1939, there has always been inflation, but inflation has not always benefited the valuation of gold mining shares. Inflation can benefit the valuation of tech stocks and single-family homes also. Every asset class, in its turn, partakes in an intoxicating drinking binge of monetary liquidity from the Federal Reserve, and then experiences the inevitable and painful detoxification process of deflation.

It is no more complicated than that. Looking at the BGMI from November 2000 to February 2006, inflationary momentum is quickly building in the BGMI. The next decade will be the gold bugs’ turn to enjoy monetary inflation.

A chart like the current BGMI’s is like waving a red flag in front of old el Diablo. One good correction in the BGMI before going on to new highs and the motley crew of momentum investors will flood into gold mining shares as they did in the software and semiconductor in the 1990s. Warning to margin investors in gold stocks - the road ahead can be expected to be rocky.

Real things like commodities, but not real estate, are now due to get a full measure of the Fed liquidity, while the 1990s glamour investments are going to take the cure in the decade to come.

Mark J. Lundeen

mlundeen2@mn.rr.com