Friday, May 19, 2006


Correction Tests Metal Bulls

Forbes has the latest currency news. "The dollar rose against most major currencies Friday, rebounding from a slide that followed a drop in a widely watched barometer of U.S. economic activity. The euro fell to $1.2772 in late New York trading, well below the $1.2829 it bought in New York late Thursday. The British pound also slipped to $1.8780 from $1.8908."

"The dollar strengthened against the Japanese currency, climbing to 111.66 yen from 110.89 yen. The dollar bought 1.2259 Swiss francs, up from 1.2081 late Thursday, and 1.1197 Canadian dollars, down from 1.1206."

"Little new data was produced to move markets on Friday, but the dollar appeared to benefit from movements in other markets, according to Dan Katzive, a currency strategist at UBS AG."

"'The dollar's rally doesn't seem to be driven by any change in fundamentals,' he said. 'Rather, it seems caught up in the reduction of risk positions in other markets like metals and emerging markets. On the whole, the markets are still bearish on the dollar.'"

"Gold futures tumbled by more than $23 US an ounce Friday as the U.S. dollar gained strength against other major currencies and investors shifted assets out of the precious metal. The June futures contract for gold fell $23.40 to close at $657.50 US an ounce in New York trading. Just last week, gold was trading at a 26-year high of $732 US an ounce."

"On the TSX Friday, Barrick Gold shares dropped 12 cents to $34.09. Goldcorp fell $1.09 cents to $33.40. Despite the drop, many analysts remain bullish on bullion and are still forecasting the price will hit $800 US or higher by the end of the year."

"Commodity prices had their biggest weekly drop in more than 25 years, led by metals and grains, on speculation that higher interest rates will erode the appeal of copper, gold and silver as alternative investments. 'The speculators are piling out of the metals,' said James Vail, who manages $700 million in natural-resource stocks. 'There's been so much money made in this sector that people are trying to protect themselves. There was skepticism on the upside, and now there's panic on the downside.'"

"The Philadelphia Stock Exchange Gold & Silver Index of 16 companies, including Newmont Mining Corp., fell 12 percent for the week, the biggest drop since July 2002. Toronto-based Goldcorp Inc. led the declines, down 20 percent for the week, followed by New Orleans-based Freeport McMoRan Copper & Gold Inc., down 17 percent."

"Palladium fell about 6 percent, silver shed about 1.3 percent, and spot platinum also trekked south on liquidation in the metals complex and commodities generally. Silver prices also followed gold and fell to a three-week low of $12.11 an ounce, down 3.6 percent from $12.58/12.68 in the U.S. market. It was last quoted down 10 cents at $12.38/12.48."

"Palladium was the worst hit among the group, falling to a five-week low of $330. It last fetched $338/343 an ounce, versus $356/361 previously. Platinum dropped as low as $1,280 an ounce before marginally rising to $1,281/1,289, compared with $1,300/1,308 in New York. It had hit a record high of $1,336 this week."

"Platinum had not fallen as sharply as other precious metals because of positive market fundamentals, dealers said."

"After more than three months of a marathon run, the gold market took this week to finally begin a decent correction,' said Jon Nadler, analyst with bullion dealer Kitco. 'The market had obviously gotten ahead of itself and was overdue for a pullback of some magnitude,' he said."

"'It's a combination of options and technical-related selling. Potentially there is scope now for further pressure back even towards $600,' said James Moore, precious metals analyst at 'It's a short-term correction. We are still firmly in a bull trend as there are far too many factors supporting gold.'"

"Traders said large deficits in the U.S. economy, inflation concerns, the overall weak dollar sentiment, tension in the Middle East and a slow growth in mine production were expected to provide support to the market. South Africa, the world's biggest gold producer, saw output fall by 10.9 percent to 68 tonnes during the first quarter of 2006 from last year due to worker holidays and restructuring, the Chamber of Mines said."

The prevailing theory that the US$ was the reason for todays sell of doesn't seem right. It barely rose compared to the recent loses.

The idea of the Fed raising rates is also interesting. But what if the FF rate is increased to 6.5%? That's not high from a historical viewpoint.

It could be that statements from Fed people this week were intended to talk down gold. How likely is another 1 or 2% increase? At any rate, these episodes are interesting and I hope readers will post their thoughts on where we are headed this weekend.
remember, the currency markets are huge, especially compared to gold.
Relative Gold Bulls 2
Looks like I picked the wrong time to go long w/ 400oz. @ 678 !

I'm OK with though. In fact I'd love to see another correction like today come Monday and so I could buy 200 oz more.

If that's not balls tell me what is.
From The Daily Reckoning...

*** "In Gold We Trust," begins an op-ed in yesterday's Wall Street

"If none of the usual suspects is responsible for gold's sharp rise, what
is? We believe it represents an equally sharp decline in the confidence of
investors - large and small - in the likelihood that Washington will pay
back its mounting obligations in un-depreciated money. Throughout history,
and especially in wartime, governments have escaped from fiscal
over-commitments by letting their currencies depreciate. Ambitious
spending initiatives, threats of international conflict, and even
Washington's political unpopularity all contribute in the fear that this
is happening again now."

*** Yesterday, gold dropped to $680. Should you buy now? Or wait for
further correction?

There is no good answer. Yesterday, also, the Dow lost another 70 points.
The stock market seems to have topped out for this cycle. Your best
strategy is simple - continue executing the Trade of the Decade that we
have been following since 2001 - buy gold on dips; sell stocks on rallies.
Sometimes you'll get the timing right. Most often you won't, but at least
you'll be tracking the major trends, rather than fighting them.

"Bull markets and bear markets follow one another as surely as a person
in- and exhales," adds our old friend Doug Casey. "And, as with breathing,
the longer you hold your breath, the more urgent and powerful the
subsequent intake. Commodities in general, but precious metals in
particular, went through a deep bear market that lasted an entire
generation. Gold fell from over $800 in 1980 to $256 in 2001; silver from
$50 to $4. These are fantastically deep and prolonged bear markets. But
they were even worse than they seemed because the dollar was losing about
two-thirds of its value at the same time. For Americans to keep track of
value, over time, with dollars is as idiotic as for an Argentine to try to
do that with pesos.

"The financial crisis of the late 1970s drove the metals to those highs.
We're now looking at another crisis, one that will dwarf the turmoil of
the 1970s and likely bring on a depression worse than the 1930s. With so
much trouble just ahead, there's good reason to believe that the metals
will exceed their old highs - which, in today's dollars, means gold over
$2,000. Let me reiterate what I've said for years: This time, gold isn't
just going through the roof. It's going to the moon.

"Generally there are three stages to a bull market. The first is stealth,
when prices go up but nobody cares or even notices. With commodities, that
happened from about 2000 to 2003. Next is the 'Wall of Worry' stage.
People see that prices are rising, but expect them to fall back to the
bear market levels they'd gotten used to. People come up with all kinds of
reasons why they're overpriced. They are confused by the new reality, and
many 'old hands' and commodity producers take the opportunity to sell,
since they haven't seen good prices for years. This is the stage of the
market we're now in. Finally, there is the mania stage, when broad masses
of the public get involved. It's where the big profits - but also the big
risks - are. Personally, I'm more comfortable buying when everyone says
you're an idiot for doing so, or at least when they're skeptical. When
we're all hearing about what a great investment gold is, I'll be looking
for other opportunities. But my guess is that we won't really be there for
another year. And when it arrives, the mania should last for some time, as
it did most recently with the Internet stocks.

"While I was expecting to see a big surge - and went on record with that
expectation on March 22 when gold was trading at $550 - there's little
doubt that gold and silver may be getting ahead of themselves for the
short term. A market trend, even an unstoppable one - which is how I view
the current metals bull market - is still going to periodically correct.

"Get used to it.

"That is especially true if you're an investor in the mining shares, which
is absolutely, without question, the right way to play this market. Buy on
dips (historically, we see buying opportunities in the summer months) and
don't be chased out of the market by volatility.

"When this thing does finally come to an end, the better-managed gold and
silver stocks will be trading for many multiples of what they trade for

"This trend is your friend...get comfortable with it."
I've been wondering when Robert Shiller would weigh in on commodities. Now he has:

"Robert Shiller, a Yale University economist and author of "Irrational Exuberance," thinks commodities markets resemble the technology-stock bubble of the 1990s.

"It's the same phenomenon," Shiller said. "When you have something that has glamour value, it opens up the possibility of a speculative bubble. You can't have a speculative bubble if there isn't a story."

And the world's largest copper producer warning about prices - that can't be good.

Companies that produce and use commodities are warning that prices eventually will drop.

"We live in very crazy days," said Juan Eduardo Herrera, vice president of strategy at Codelco, the biggest copper producer. "These prices are not here to stay, and nowadays they are causing more harm than good to everybody."

Schiller: "It's the same phenomenon," Shiller said. "When you have something that has glamour value, it opens up the possibility of a speculative bubble. You can't have a speculative bubble if there isn't a story."

On the other hand, you can't have a legitimate new market dynamic -- a rise, or fall in prices which vastly outweighs the typical moves of a market cycle -- without a story either. What so many analysts forget, is that legitimate market shifts do happen. Industries do rise (or plummet) in global importance. Just because something has attracted increased attention, doesn't mean its a bubble. In the 80's, software companies became the hottest thing since sliced bread -- almost overnight. No one ever called it a bubble, because they still are.
The software industry, soho? You couldn't pick a worse example to make your point. Maybe nobody called it a bubble in the 80's and that would be because there was no software bubble in the 80's - Microsoft and Oracle didn't even go public until the decade was more than half over. I work in the software industry and in 1999 I worked for a company (not a dot-com, a software company) with hugely negative earnings and less than $10m in annual revenue. In December of that year, we went public and shot up to $94/share on the first day of trading - around $2 billion in market cap. Here are some more software charts from the 90's:

BEA Systems
Agile Software

600oz's of gold??? You, sir, are a rich man!

john in va,

Stick around... I should present my case for depression & hyperinflation sometime this weekend. Lots to cover...
Maybe I didn't make my analogy clear: In the early 80's there *was* no Silicon Valley phenomenon, and then almost overnight, there was. An entire industry sprang up extremely rapidly, became the darlings of Wall Street, and today represents a significant portion of GNP and our balance of trade. Yes, if you look at equity valuations (your charts) -- they spiked around 2000 like everything else in the late nineties equity bubble -- and haven't done much since. But that's a micro-level metric compared to the existence vs. non-existence of a trillion dollar industry that sprang up in an extraordinarily short period of time.

(I used to own a private software development co, btw).

My point was really directed towards Schiller's comment that "When you have something that has glamour value, it opens up the possibility of a speculative bubble. You can't have a speculative bubble if there isn't a story". To which I say: that is only sometimes true. Contrary to some hard lessons learned in the dot-com years, paradigm-shifts really do happen, and actually many have happened in our own lifetimes. The "bubble" word seems to get tossed carelessly at every boom in financial markets. While many of those booms likely are bubbles, many represent true (and lasting) industrial and economic shifts.
I agree with you, soho, that paradigm shifts occur. The problem is that every time a bubble occurs, people attribute it to a paradigm shift. In the 20's it was believed that a new economic model had emerged and that the boom/bust cycle had been eradicated. In the 90's, people said it was a new paradigm and that traditional valuation metrics (like earnings) no longer mattered - it was all about clicks and eyeballs. And here's the save-for-posterity quote of the housing bubble:

last March a realtor told the N.Y. Times that "South Florida is working off of a totally new economic model than any of us have ever experienced in the past." The realtor also predicted that "a limited supply of land coupled with demand from baby boomers and foreigners would prolong the boom indefinitely."

With commodities, the new paradigm is China. Just like we all predicted that Japan was going to swallow the globe in the 80s, now China is the unstoppable juggernaut that's going to consume the world's resources. The truth is, China's economy is a massive bubble. It is hugely dependent on U.S. consumer spending, which is dependent on home equity borrowing. Their banking system is immature and unstable (I read an estimate the other day that as many as 1/4 of all bank loans in China are non-performing), they have a huge RE bubble of their own, and there's all kinds of hot money flowing into questionable Chinese ventures in search of high returns.

There's nothing new under the sun with commodities. It's the same highly leveraged "speculative fury" that has wandered from stocks to real estate previously. Of course there's some underlying fundamental strength justifying an increase in prices - there always is, and that's exactly Shiller's point. Call it a paradigm shift if you like. My claim is that if it looks like a bubble, walks like a bubble, and quacks like a bubble... it's a bubble.
commodities are just coming off an all-time low just a few years ago, this thing has another 10 years or more to run. china isn't just going to stop industrializing. how can it be a bubble when hardly an new mines have been opened? when the public is not in? we just go new etfs. this thing has a long ways to go. we're only 5 years into it. china is the new paradigm, a long with India and the BRIC countries.

since we believe here in housing fundamentals and how they are in a bubble, where are the fundamentals that show commodoties are in a bubble? they certainly aren't there for gold and silver.
gtivbqdoesn't anyone remember the Plaza Accord? from the NYT editorial page.

Gambling on a Weaker Dollar
Published: May 20, 2006

For some time now, shortsighted lawmakers in Congress have been threatening China with tariffs for what they call its unfair currency practices. The Bush administration, to its credit, has generally resisted the protectionist rant, most notably by refusing to brand China a "currency manipulator" in an official report to Congress last week.

China responded to the administration's responsible policy and diplomatic courtesy this week when it loosened, a bit, the tether that binds the Chinese currency, the yuan, to the dollar. A stronger yuan implies a weaker dollar, as does the general strengthening so far this year of the euro and the yen. By making foreign goods sold here more expensive and American goods sold abroad cheaper, a weaker dollar would, in theory, eventually help reduce the United States' huge trade gap.

The problem is this: unless a falling dollar is paired with reductions in the federal budget deficit, it could do more harm than good by driving up interest rates, perhaps sharply. That's because the foreign investors who finance the administration's "borrow as you go" budget are likely to demand higher returns to invest in a depreciating dollar.

But if budget deficits declined over the long run, the government's reduced need to borrow would help keep interest rates low as the dollar depreciated. Then, after a lag, the falling dollar would shrink the trade deficit without risking big increases in interest rates in the process.

Unfortunately, the incessant tax cutting of the past five years precludes any serious attempt to reduce the budget deficit. So to keep interest rates in check as the dollar falls, the administration would have to persuade investors not to believe what they see: a dollar that is declining even as the United States does nothing to curb its borrowing.

That would be a difficult trick even for a Treasury Department that commanded respect. It will be especially difficult for Mr. Bush's Treasury team, which has suffered a diminution of esteem and credibility.

The Bush tax cuts also make it harder for Americans as a nation to bail themselves out of the trade deficit by saving more. Higher personal savings would allow the government to finance its budget deficit without outsized foreign borrowing — another safe route to a cheaper dollar and a smaller trade gap. But the Republicans who control Congress let a tax credit for low-income savers expire this year to free up room in the budget for nearly $70 billion in additional tax cuts for high-income Americans over the near term.

That tax cut bill, signed into law this week by President Bush, also commits an estimated $53 billion through the middle of the century to help those same high earners shift their existing savings into tax shelters. This adds not one cent of new savings and presages big deficits far into the future.

A weakening dollar, on top of intractable budget deficits and a chronic savings shortfall, is a recipe for recession. The question now is whether the country will change direction in time. The portents are not good.
Anyone expecting politicians to "do the right thing" is delusional, which is high on my hit parade of reasons why we're headed for a depression.

You know, World War I was universally known as "The Great War" until World War II came along. Guess the name "The Great Depression" is living on borrowed time.
China's not the new paradigm, john_law; China is the new bubble economy.

And the problems, like everything in China, are mind-bogglingly huge. At their heart is a dysfunctional, corrupt and virtually bankrupt financial system. PricewaterhouseCoopers estimates the country's banks have racked up as much as US$800 billion in bad loans, mostly doled out to weak state-owned enterprises that churn out cheap, inferior products in a thinly veiled effort to keep millions employed in the absence of a social safety net.

The government in Beijing has tried to clean up the banks' books and present a semblance of financial order by offloading US$325 billion in bad debt to state-run asset management companies. But, like the banks, these groups are headed by Communist party officials, and they've shown little interest in disposing of the loans. Instead, they prefer to swap the bad assets among themselves at inflated prices financed by central bank loans. Reminiscent of Japan's failure to settle ailing accounts in the 1990s, the Chinese asset managers have dumped less than a third of their bad debts since 1999, collecting just 20 cents on the dollar.

While all that debt languishes in murky obscurity, a new crop is being groomed. The government, anxious to lure more foreign investment and bulk up production capacity, has been on a frenetic building spree -- investing in high-speed railways, power generation and state-of the-art airports. New steel mills, concrete plants and aluminum smelters have sprouted up like weeds, while five-star hotels gather dust in provincial backwaters alongside deserted golf courses.

The level of capital investment, equivalent to half of China's gross domestic product, is not only highly inefficient, but unprecedented, says DeWoskin. "No other economy in the world has reinvested in the economy to such a degree. It's a situation that is fundamentally not sustainable." In addition to some US$500 billion in bad loans generated as of 2003, as much as another US$300 billion is in the pipeline, says Mike Harris, a partner at PwC in Beijing. "It's pretty frightening if you think about it."

So far, Beijing has solved its problems by throwing more money at them. Flush with a whopping US$711 billion in foreign currency reserves, the government recently spent US$60 billion bailing out three of the country's biggest banks, and is expected to put up another US$15 billion to revive the moribund stock market, among the world's worst performing exchanges and currently limping along at an eight-year low. More money is expected to flow to dozens of brokerages teetering on the edge of insolvency after dabbling in shady financing schemes.

We all know the situation with the US dollar and have purchased PMs or
PM stocks. What we fail to realize is that the US is still the most stable country in the world and it is hard for old money to abandon our currency completely. It will take some time or a large event before the mass exodus occurs.
It will take some time or a large event before the mass exodus occurs.

Agree completely. That's why PMs are ultimately going much higher.
(China's not the new paradigm, john_law; China is the new bubble economy.)

china just isn't going to stop industrializing, nor the whole BRIC area. that doesn't mean that commodities won't fall. it also doesn't mean they are a bubble. where are the fundamentals of a commodity bubble? it doesn't show up in the real gold or silver price. it doesn't show up in the dow/gold or dow/silver ratio. sure some commodities may be overvalued, but they're probably closer to 87(for stocks) than 80(for metals). if they were a bubble, that implies the end of a long bull market. this thing just got started around 2000. the public isn't in on this. how many people do you think hold futures accounts and own zinc? how many own the gold ETF? my take is the smart money is only just now getting in.
china just isn't going to stop industrializing, nor the whole BRIC area.

john, that doesn't refute the bubble assertion. There's still a market for tulips, people still buy stocks on the NASDAQ, and builders are going to continue building homes. A bubble doesn't completely destroy a market, or the economic activity associated with it.

where are the fundamentals of a commodity bubble? it doesn't show up in the real gold or silver price.

What do you mean by "the fundamentals of a commodity bubble? That sounds like an oxymoron. I can't get anyone to show me a method for calculating the valuation of gold and silver. No one ever says, "Based on the XYZ ratio, gold should be priced at $X." It's always vague stuff about coming depressions (with apologies to tj), dollar decimation, Weimar-like hyperinflation, China consuming everything, Iran nukefest, etc. Sure, you can count those as generic "fundamentals", but if you can't attach a dollar value to it, how do you separate the fundamental value from the speculative premium? With real estate, we can look at price:rent. With stocks, price/earnings, PEG, ROE, etc. What are the fundamental metrics that you use to calculate the fair value for gold? Merrill compares the spot price to the futures price and concludes that commodities are 50% overpriced due to speculation.

my take is the smart money is only just now getting in.

This smart money is getting out:

BCA Research of Montreal said the "dramatic run-up in commodity prices has turbocharged the Standard & Poor's materials sector."

BCA has tracked selling by corporate insiders in materials companies. "Corporate sellers are out in droves," said BCA analysts. "They are unloading shares at a frantic pace."

No apologies necessary, I haven't made my case yet. That case will not be vague, and won't be based on any "expert" opinions.

BTW, I generally avoid "quote" battles, since you can always find someone out there with respectable credentials to support *any* position. Did you know a survey of economists in 2000 showed almost unanimous belief in the "new economy" and continued market gains?

p.s.: My dad had a favorite (albeit rude) line: "Opinions are like assholes; everyone's got one and they all smell!".
50% overvalued only 5 years in? I think not.

you can calulate if gold and silver are good investments by tracking the dow/gold and dow/silver ratios. supply and demand. the fact that we just went through a 20 year bear market in commodity prices. is 5 years a bubble? those are the fundamentals. most commodities are still well below their inflation-adjusted highs. if gold were $2000 an ounce and silver $150 an ounce, you'd have a point. not until then though will I think it's a bubble.

insiders in the materials sector are probably selling because they've spent most of their career in a falling commodities prices era. they don't believe. only now have pension funds gotten into commodities.

just look at the chart from marc faber's article. commodities just made an almost ALL-TIME bottom. you don't cure underinvestment in a few years. this is going to take a decade or more.

"Even if we assume that the long-term commodity price cycle did turn up in 2001, we should also be prepared to occasionally see 50% declines in the prices of individual commodities within a long-term up-cycle."

Booming Commodity Prices, but…

when oil is $175, gold is $2500, silver at $125 and the dow/gold ratio is under 5, then I'll join you in calling a bubble. today, the grains are still at very depressed prices.

for instance. today the dow/gold ratio is at 17, the two highs in the dow/gold ratio, besides the last high in 1999, were at 18 in 1929 and 28 in 1966.

another good example:

commodities all-time low
here is a great chart that shows stocks and commodities switching places for about 18 years.

Stocks vs. commodities 1871-2004
Interesting article on attempting to value PMs...

Why the Global Financial System is About to Collapse
john, that's an interesting chart, and I'm not being dismissive, but it's not a valuation model. It just shows a correlation between two things. What is the fundamental analysis that you use to arrive at a fair market value?

"Even if we assume that the long-term commodity price cycle did turn up in 2001, we should also be prepared to occasionally see 50% declines in the prices of individual commodities within a long-term up-cycle."

I wouldn't necessarily disagree with this. A bubble can exist within a long-term uptrend. For example, I expect housing prices to correct significantly over the next few years and then begin to rise again, like they did following the bubble of the late 80s. Likewise, I expect the long-term direction of commodities to be up, for the same fundamental reasons that you, tj, and others have cited. I just believe that the market has gotten way ahead of itself.
I don't know how those research people or people like david morgan get their price targets. I guess you could do a historic average of the dow/gold ratio or whatnot. you'd have to see if mines are being opened, what supply is in stockpiles and so forth.
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