Speech given at Las Vegas Precious-Metals Conference, April 2003

by Bill Fleckenstein

I decided to set up a short-only fund in 1996 because I thought that things were headed in a very bad direction, though my timing was a little on the early side. My goal was to distance myself from the "speculative performance derby" and greed that was building, so that one day, I could return to the long side of the business with my credibility intact, which I still plan to do when I feel it's safe to be bullish on stocks. For those of you who care, I will start a mutual fund that will be open to everyone.


I thought I might state my prejudices at the outset. I believe that the mania for stocks and the revulsion against precious metals that we saw in the late 1990s were opposite manifestations of the same psychology. I believe that while that psychology has been dented, later this year it will be shattered, and stocks will sink as precious metals soar.


I believe that the stock market averages are headed much lower. I believe a dollar crisis lies in our future. I believe that the move that we will see for silver will dramatically outpace gold to the upside, though I own both, and I own a sizable position in Pan American Silver and one gold stock. However, I do not believe that a so-called plunge protection team actively manipulates the stock market. And I do not believe that gold is actively manipulated, as is suggested by many gold bulls.


Lastly, and most important, I believe that in a social democracy with a fiat currency (like ours), all roads ultimately lead to inflation. And in fact, that is the story of all paper currency regimes. They all collapse.


The biggest bubble in the history of the world that we recently experienced was powered by the most incompetent and irresponsible Fed in history, along with the public's willingness to suspend disbelief. It was a state of mind as much as anything else. Folks believed in the existence of a "new era," in a Greenspan put, and in retiring early, and rich.


Folks believed that the wonders of technology automatically meant that tech stocks were great investments. They even thought that two small pieces of paper were more valuable than one larger piece of paper, as they believed that stock splits meant stocks should go up -- though I don't suppose they expected to pay more for a pizza that was cut into eight slices than just four. In short, it was all about confidence and, ultimately, near-arrogance on the part of those involved.


In a period when an Internet "incubator" (whatever the hell that is) like Internet Capital Group could be valued at over $40 billion -- more valuable at the time than, say, Boeing -- and sported a valuation of approximately 150% of all the world's gold companies combined, is it any wonder that no one thought they needed to own gold?


Paper reigned supreme, as people were bursting with confidence. At the peak, Cisco claimed a valuation of over $500 billion. I saved a description from February 2000 by an analyst who followed Cisco and thought that within 18 months, it would be valued at a trillion dollars, never mind that its revenues were on track to be about $25 billion or $30 billion. Here was a company doing, in essence, about one-quarter of 1% of GDP that was deemed soon to be worth 10% of GDP. Those are just a couple of examples of hundreds that I could pick to illuminate the overconfidence of the public at that time.


I believe that as much as the mania for stocks was an expression of confidence in paper, the metals are just the opposite. They are an expression of a lack of confidence. I believe that given the pendulum's extreme swing to the side of confidence, it is now destined to travel back quite a ways in the other direction.


We all know that the government will cheat us over time, via inflation. We just don't know at what rate. While lots of intelligent people believe that deflation is right around the corner, this is not my belief (nor has it ever been). I believe that people have come to confuse declining asset markets with "deflation." Deflation, to me, means that the value of the dollar appreciates against a basket of goods and services.


A recession, coupled with a declining stock market and declining house prices, would be just typical consequences of what happens after a boom, much less the biggest speculative mania in history. I do not consider that to be deflation. So, I believe it's entirely consistent to expect a declining stock market and declining housing prices in the wake of a bubble, and higher inflation. That does not mean that inflation rates have to run at a high level initially. But over time, higher rates of inflation are what we should expect.


I believe we experienced deflation in the 1930s because we were still on the gold exchange standard, which was fairly rigorous, certainly compared to the confetti standard that we're on right now. As far as people asking, what about Japan, I don't believe Japan is a true social democracy. It may be moving in that direction, but when politicians there seek re-election, they don't tend to act in quite the same way as ours do.


And, I believe that the mindset existing in America is to never relive the Thirties again. I think that explains the statements we've seen from the central bank, in terms of Fed Governor Ben Bernanke talking about using the printing press to fight deflation, and FOMC secretary Vince Reinhart talking about buying Treasurys if asset markets don't respond in a way that the Fed likes. The Fed has basically said it will not accept "no inflation," and given its outstandingly consistent record of destroying the value of the currency over time, who wants to argue with it about that? However dangerous you may think the Fed has been historically, the Greenspan Fed takes that to an entirely different dimension.


Here, it might be useful to take a moment and review the history of the dollar. What I have prepared is a chart of the purchasing power of the dollar through something that we can all appreciate. I created it from data that the Hershey company gave me, after I asked them what a Hershey bar has cost since its introduction in 1908.


12:59 PM 3/29/2004

You have obviously noticed that from time to time, the price goes up and the amount of chocolate per bar changes. So what I have done is to take the price and turned it into the price of chocolate per ounce of a Hershey bar. What you can see here is that, surprise, surprise, the price of chocolate per ounce of a Hershey bar has risen over that period, and in fact is up about twelve-fold. Measured thusly, the dollar has lost 92% of its purchasing power.Interestingly enough, however, the value of Hershey's stock, since it came public in 1927, is up about 295-fold, with one share purchased at $39.58 now worth 180 shares at roughly $65 dollars. Even after adjusting for inflation, as I have calculated it, that's still a gain of 14 to 15 times in after-inflation terms. Obviously, Hershey's has been one of the rare, huge winners.


In the mania, all stocks were expected to eventually do as well "over time," as people were blinded by long-term returns of stocks like Hershey's -- though they were more interested in stocks like chocolate.com -- and completely oblivious to the risks. But folks were also completely oblivious to the number-one financial risk that we all face as investors/citizens, and that is inflation. In that regard, I consider the Fed to be public enemy number one.


Not only did guys like Greenspan, McDonough and McTeer help the Fed power the mania by making up new-era rationalizations for it, since the market peaked in March 2000, they have fomented another bubble, this one in housing prices. This has enabled consumers to continue to live beyond their means, thereby making the ultimate adjustment more protracted. Rather than taking the bubble as a warning sign and urging folks get their financial house in order, the Fed has given folks the shovel, via the housing bubble, to dig themselves deeper and deeper in the hole.


It's sort of like lending money to somebody who had a margin call, rather than making him meet the margin call, and then lowering margin requirements as well, so he can buy more. That is, in essence, what has occurred in the housing market, as many people have increased their mortgages as housing prices have gone up.


Further, we have put ourselves in a position of being completely at the mercy of foreigners. Thanks to our trade deficit, we are dependent on foreigners to be willing to accumulate an additional $1.5 billion every single day, just to keep the dollar where it is.


This period that we have experienced since the market peak has really been a period about denial, and it's gone on longer than I would have guessed possible. But it is what it is. Initially, folks were in denial about the fact that stocks had peaked and that we were in a bear market. Then, all of our economic and stock-market problems were blindly pinned on the attacks of September 11, even though that wasn't the market or the economy's problem. And now, all the problems of the last six months have been pinned on Iraq.


Thus far, Greenspan and the Fed have basically been issued a pass after going 0 for 12 on the rate-cut front. Folks still have faith in the Fed, I believe, because the housing bubble has kept the consumer feeling more or less OK, even as people lose their jobs or know someone close to them who has lost his job.


However, I believe that later this year, people will finally be forced to realize that our problems are a result of the mania, and are long-lived. That psychological readjustment will come about when the economy and the stock market don't come back (excluding some minor postwar relief bounce).


Along with that realization, folks will start to contemplate what happened in the Thirties, even though things are different now, especially in terms of our currency regime. They will contemplate what's gone on in Tokyo for the last 12 years, where now 60% of the stocks on the Tokyo Stock Exchange sell below book value, contrasted to the three-times book value that stocks sell for here.


I think that at some point, the exact moment being unknowable, folks will recognize that the Fed has ruined the financial system, the Fed is powerless to stop the bear market, and the Fed is powerless to fix an economic bust precipitated by the misallocation of capital that occurred in the mania.


That realization, I believe, will cause folks to lose confidence, and that loss of confidence will set off an avalanche in stock prices, forcing them to be valued as the fractional shares of businesses that they are, instead of the conceptual fantasy lottery tickets that they have become. I believe that this loss of confidence, both here and worldwide, will also cause the dollar to be reappraised as the piece of confetti that it has become.


Now, I don't say any of this because I want it to happen. I say this because to me, it was preordained by the policies that precipitated the bubble and the policies that have gone on since the bubble. I don't root for any of this to occur, but I fear it will occur. My choice is to be prepared, and to do the best I can in that environment.


Unfortunately, when it comes to looking at other currencies, the euro and the yen are not a whole lot better than the dollar. I sort of view each of them versus the dollar as a one-eyed man in the land of the blind. Not too interesting, just slightly better alternatives. However, all of this is very bullish for the only currency that has been in existence for 5,000 years, that cannot be printed, and is no one else's liability i.e. gold. I would like to be clear that when I say gold, I also mean silver in the same breath, as I stated at the outset. Just as buying stocks until your hands bled was a state of mind of supreme confidence in the mania, owning precious metals is, to repeat, the expression of the lack of confidence in the monetary authorities, an oxymoron if there ever was one.


I believe that investor demand, the lack of which has been responsible for holding back the metals, will finally manifest itself as this year unfolds and the problems that I have articulated become clearer to people. Greenspan, in particular, has painted himself into a corner, at last, by blaming all of our current problems on "geopolitical uncertainties" surrounding the Iraq war. This is why I feel that we have a potential catalyst to cause people to re-evaluate their thinking. When the alleviation of those geopolitical concerns fails to ignite the economy and the stock market, the game will be up, and the race to protect oneself will be on.


I have no clue as to the precise timing of this scenario, since a lot depends on the length and potency of the relief rally in stocks and the economy. However, the relief rally in the dollar has been especially pitiful. Basically, the euro traded from $1.10 to $1.06 in three days, so we had a mild 5% correction, after a nearly 25% move in the euro. And of course, the euro is now back over $1.10.


This suggests to me that the dollar is on borrowed time, and trouble is coming, sooner rather than later. It also means to me that the price of gold has seen its lows. And, while the tsunami of investment demand that I envision may still be months away, I believe the surprises will now all be on the upside for gold.


I would just like to close by leaving you with one of my opening thoughts: In a social democracy with a fiat currency, all roads ultimately lead to inflation.