SCHMIDT’S GOLD THOUGHTS (20 April 2010):

One needs only read the story of Goldman Sachs’ creation of CDOs of dubious value to sell to one
client while allowing another to short them to understand why Gold has existed as an investment
down through the ages. We can not think of one story of kings in times long past that accepted CDOs
as payment for taxes. We now know why they usually demanded Gold, or other needed commodities.

Actually, the buyers of this dubious paper should not be suing Goldman Sachs. They should be suing
the universities from which they received their MBAs. The value of that education may be in
question. How could educated investment professionals purchase for their clients paper assets of
questionable value based simply on the advice of a firm’s traders and sales people?

$2,400 350%
$2,300 300%
$2,200
250%
$2,100
$2,000 200%

$1,900 150%
$1,800 100%
$1,700
50%
$1,600
$1,500 0%

$1,400 -50%
14.0109 15.0409 15.0709 13.1009 13.0110 12.0410
6 Month
$BILLIONS,
Annualized %
Left Axis
Change, Right

Speaking of players with dubious educations, let us consider the investment actions of the Federal
Reserve. In our first graph, above, the blue line is of Federal Reserve Bank Credit. It is the asset side
of the Federal Reserve’s balance sheet. From the early part of the graph to the high, the assets of the
Federal Reserve expanded by about $600 billion. If we were to back up further in time, we would
find that their asset purchases were far greater than that.

A worrisome part of this graph is the more recent experience. Federal Reserve is apparently trying
to withdraw some of that massive amount of liquidity that had been injected into U.S. financial
system. The worry to which we refer is the red line. It is the six-month rate of change in Federal
Reserve credit, annualized. We might refer to that as the rate of monetary liquification.

Rate of monetary liquification is again sitting on the zero line. That reality is making the dollar rarer
on a relative base. Given this restrictive and deflationary monetary policy, strength should be
expected in the value of the U.S. dollar. That should spill over into the Gold market causing $Gold
to continue to languish. Restrictive monetary policy is bullish for U.S. dollar and bearish for Gold.
However, that leads to some important questions. Will the Federal Reserve continue to withdraw
liquidity from U.S. financial system, sending U.S. back into recession? Or, will the Federal Reserve
now monetize the Obama Regime’s massive deficit? With the U.S. Federal deficit about $1.7 trillion
over the past year, debt monetization seems a good bet. Further, given that the U.S. election in
November is getting closer by each turn of the calendar, we would suggest that the Federal Reserve
will halt their deflationary policies soon.

That massive liquidity injection by the Federal Reserve did not translate into rapid monetary growth
in the U.S. as most of us expected. Rather, that liquidity went into the black hole of the mortgage
market. With mortgage monetization now fading as a policy goal at the Federal Reserve, the liquidity
being provided as part of the monetization of the Obama deficit is flowing to the remainder of the
system. The non mortgage sector is receiving what liquidity is being provided the system. The
transition away from a fixation on the mortgage sector is starting to influence U.S. monetary trends.

14% $1,200
12%
$1,050
10%
8% $900
6%
4% $750
2%
$600
0%
-2% $450
-4%
-6% $300
5.04 9.05 1.07 5.08 9.09

US
Inflationary 6 US$Gold, Monetary
Mos. Money Right Axis Buy Signals
Growth

In the above graph, the green line is the monthly average price of $Gold. It uses the right axis. Red
line is the inflationary component of U.S. money supply growth rate, M-2 NSA. That measure, which
is the annualized six month rate of change, uses the left axis.

Despite the massive injection of liquidity by the Federal Reserve, the inflationary component of U.S.
money supply growth plunged from more than 12% into negative territory. Much of the liquidity that
had been provided went into the abyss known as the mortgage market. In recent months, the
contraction of the U.S. money supply growth rate seems to have been reversed.

As has been marked on the graph with black triangles, this measure can be used to create buy signals
on $Gold. When the rate of change in the inflationary component of U.S. money supply growth turns
positive from a negative value, a buy signal is created. This is not a market timing indicator. It does
not mean the price of $Gold will go up tomorrow. It does mean that U.S. monetary conditions are
again returning to being a positive contributor to the price of Gold.
Before monetary factors can push $Gold higher, markets must digest both the volcano and Goldman
factors. Think of markets as a giant margin account, as it has been recently. Volcano and Goldman
event acts like any reduction in the equity of a margin account. On Friday, when Goldman Sachs
stock lost more than $10 billion of value, all markets went down as that slide was the equivalent of
a charge to the equity of the markets’ margin account.

Goldman Sacks may simply be a triggering event that converts one small market correction into a
swan much darker in color. Some selling, and perhaps even some margin calls, is likely in most of
the markets that rallied in past year. Included in that group of correcting markets should be financial
equities in particular, oil and Gold. Much of the buying in these groups was asset allocation driven
as equity rose in the markets’ margin account. The reversing of that activity is now more likely.

With $Gold having become over bought on fund buying, it is vulnerable to this margin induced
selling. What is likely to unfold is a Minor Wave C of Major Wave II for $Gold. A low, possibly
down to US$970, should develop by middle of Summer. Gold investors should be all over that low,
buying in size. From that point on the dollar will not be worth a Goldman as the Federal Reserve
must monetize both the Obama deficit and the nationalization of the U.S. health care system.

GOLD THOUGHTS come from Ned W. Schmidt,CFA,CEBS as part of a joyous mission to save
investors from the financial abyss of paper assets. He publishes The Value View Gold Report,
monthly, and Trading Thoughts, weekly. To receive these reports, go to
www.valueviewgoldreport.com