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December 21, 2007

Boom or Bust?
by Puru Saxena

The global economy seems to be slowing down after the massive expansion which has taken place since 2002. Moreover, the recent rout in the equity and credit markets is yet again prompting several prominent analysts to claim that a catastrophic depression lies somewhere ahead. The doom-mongers are back in fashion again; pointing towards high debt levels, US housing recession and the eventual failure of the monetary system when making their dire economic forecasts.

According to this bearish camp, American debt levels are unsustainable, foreigners are on the verge of dumping their US Dollar assets and the world's reserve currency is about to disappear from the face of this planet. Furthermore, this gloomy bunch is expecting a gut-wrenching decline in US equity and property prices.

So, are the pessimists correct in their assessment or will the US economy continue to muddle through over the coming months while nominal asset-prices move sideways in a ranging pattern? In my view, given the high monetary inflation taking place worldwide, the further scope for aggressive rate cuts by the Federal Reserve and the gigantic pools of money with the Sovereign Wealth Funds, the latter outcome looks more likely. Whilst I am of the opinion that the ongoing credit crisis and the housing recession will continue for the foreseeable future, I expect central-bank sponsored reflation to work yet again. In this modern era of endless money-creation, I anticipate that asset-prices will bounce back sooner rather than later.

After parabolic upward moves in the past few years, the majority of the base metals are currently undergoing a medium-term correction as the market discounts a growth slowdown in the US. With the exception of tin, all the other metals (copper, zinc, nickel and lead) seem to be caught in sharp medium-term pullbacks.

Recently, I have come across a number of reports by various analysts who are claiming that the bull-market in base-metals is now over. I beg to differ with this opinion and feel that we are witnessing a classic and violent correction within the ongoing bull-market rather than a full-blown bear-market.

As far as I am aware, the demand for base-metals will increase for several years as China followed by India continue to improve their infrastructure and build massive highways, airports, seaports, buildings and so forth. Moreover, the Middle-East is also undergoing a boom due to record-high oil and many oil-producing nations are also improving their infrastructure whilst the going is still good. Under the scenario that the price of oil stays high for many years, these nations in the Middle-East will continue to consume more metals for the foreseeable future.

On the supply side, escalating costs and environmental issues are making it very hard for new mining projects to come online and this should further eliminate fresh supplies in the future. Whilst this development is a disaster for the relevant mining companies (as gold company - Novagold recently realised), it is great news for the base-metals bull-market.

The barometer of global economic activity, Dr. Copper, has fallen sharply in the past month (Figure 1) and I suspect it may be about to commence a rally in anticipation of further interest-rate cuts by the Federal Reserve. The recent decline in the price of copper looks like an ongoing consolidation during the long-term bull-market. Once the credit crisis subsides, the price of copper is likely to stage an impressive rally.

Figure 1: Copper correction almost complete?

Source: David Fuller, Fullermoney

Finally, over in the precious metals arena, both gold and silver are holding up reasonably well after some impressive gains. In my view, precious metals are simply consolidating before launching higher in the weeks ahead. I have little doubt in my mind that the Federal Reserve will slash its interest-rate in the next meeting and this should act as a catalyst for yet another rally in gold and silver.

Both gold and silver have recently broken out from large multi-month consolidations and this usually marks the beginning of an explosive move. So, I would suggest that you consider adding to your positions in this sector as I anticipate a strong rally over the coming months. Personally, I prefer to invest in precious metals via the producing-companies as they provide better leverage than physical bullion. So far in the bull-market, mining shares have outperformed bullion and this should continue in the future. Therefore, depending on your risk appetite, you can consider investing in top-quality gold/silver producers or physical bullion or a combination of both.

As long as the central banks continue to destroy the purchasing power of their currencies via inflation and as long as confidence in the financial system remains low, both gold and silver are likely to provide a safe haven for your hard earned capital.

Puru Saxena publishes Money Matters, a monthly economic report, which highlights extraordinary investment opportunities in all major markets. In addition to the monthly report, subscribers also receive "Weekly Updates" covering the recent market action. Money Matters is available by subscription from www.purusaxena.com.

Puru Saxena
www.purusaxena.com

An investment adviser based in Hong Kong, he is a regular guest on CNBC, BBC, Bloomberg, NDTV Profit and writes for several newspapers and financial journals.