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Gold Bears Turn Up the Volume

Some people think that prices will stop rising when interest rates rise; they forget that interest rates can rise because prices do, not just because the Fed wants them to. Why wouldn't they forget... it's been two decades since a major dollar crisis?

I wrote that, then happened to run into the following quote from the Financial Post (a Canadian financial paper) Tuesday morning:

A report on gold by Raymond James states that the price of gold will resume "its long-term downward trend over the next few months." In a section headlined "Gold Bear Scenario," the report forecasts that an economic recovery that has taken a toehold in the United States will eventually translate into job creation. "As soon as the U.S. [Federal Reserve] is confident that the turnaround is indeed on solid ground, it will again revert to the use of interest-rate hikes as a bludgeon to reduce inflationary expectations," it states, adding "the price of gold will go down when interest-rate hikes appear on the horizon." - FP

Perfect. This confirms precisely that what ales the gold sector is the expected parade of bullish third quarter earnings news on Wall Street to confirm James' suspicions that the recovery is on track.

But the author fails to realize what the rise in inflation expectations means. It means the economic recovery isn't that real, and people increasingly know it. In other words, the moment the bludgeoning starts, so goes the recovery.

I have wondered if the Fed was ready for this course nonetheless. It's my job to wonder things like that. My position is that I doubt it is. However, I also doubt it will have a choice but to pursue it anyway some day. After all, bond yields have likely already bottomed. If that's true& if history is any guide, the Fed will inevitably follow.

In the spirit of the Fed it will convincingly build the case that interest rates are headed higher due to the improving prospects for real growth no doubt.

I'm not sure it can be seen fighting inflation expectations however. For, it has yet to acknowledge inflation, and moreover, perhaps as a consequence the markets have yet to as well.

But I'm certain that's a problem they can contend with later. Much later. I don't see it in their near term future.

The important thing will be to produce a picture where the economic recovery has its own momentum - no longer needing the incredible stimulus of recent years - such that equity valuations could withstand, and even cheer a tightening in monetary policy. Otherwise the dollar's toast.

This is not 1994. There is no one in the administration committed to balancing the budget. There are no hawks at the Fed brave enough to try and slow money growth in these delicate times. It is the aftermath of the most titanic stock market bubble in the world's history. And what are they doing about it? Everything that's wrong. Everything that led to the dislocations to begin with. And everything that will extend the bear market for years to come.

Thus it doesn't surprise us that your run of the mill blue chip analysts can't see the beginning of a secular bear market for the US dollar evolving right under their noses. It only confirms that sentiment has turned sharply bullish on the US economy, and that the bulls are in denial about the aforementioned facts.

What's more, they forget this stock market isn't up here only because earnings news is going to be good, but also because investors expected interest rates to stay low for a long time. As a result, the earnings recovery is all but fully discounted. Too bad higher rates aren't.

If inflation expectations are really on the rise, the S&P shouldn't be trading above 20 times backward or forward earnings. There's the first tsunami that's waiting in the wings. If interest rates are on the rise, this holds true as well. So how come no analyst takes into account the extent of the good news that has been factored, and the extent of it that is unsustainably induced inflation policy in their gold market forecasts?

Moreover, we disagree fully with the consensus bullish outlook for the US economy. Our position is that the recovery will fail on its own (in fact there is scant evidence it's even begun), but would certainly fail if the Fed tried to combat inflation expectations at this point.

Our view, furthermore, is that the upturns are cyclical (within the confines of a secular downturn), mostly sentiment driven, and will be short lived because interest rates will spike, not rise, on the first sign of something real. If the Fed decides it wants to bludgeon inflation expectations with rates rather than talk, it's going to have to raise rates sharply enough to support the US dollar in the subsequent falling stock market environment, and ballooning budget deficit.

Remember, the key here is not just that there is (or is going to be) a recovery, but to what extent is it real (or sustainable), and to what extent can it translate into US capital market out performance? The first question is important to equity valuation, the second is important to the US dollar outlook.

The truth is, the views of Raymond James' analyst(s) sent a surge of new confidence through my veins. For now I know what to pin gold's correction on: gold bears are expecting confirmation of their case in third quarter results.

Consequently, I don't have to worry whether it's acting on news we don't yet know.

Indeed, though I've been somewhat disappointed in the gold price action of late, it seems pretty clear that the landscape remains bullish for the precious metals.

Looking at the world through the technical microscope, we've got the dollar index making new five year lows, platinum prices making new 23 year highs, energy markets threatening to run at their all time highs, copper prices appear headed for the completion of a six year bottom, soybean and cotton prices are literally charging to new five year highs, and even cattle prices are making new 20-something year highs.

Granted not all commodities are on the move today.

However, enough are that the CRB is just about to make a new six year high itself, as if to confirm gold's first breakout attempt.

Moreover, commodities such as oil, gas, platinum, cocoa, livestock, and even the grains are already so obviously in a bull market it makes one wonder how the government comes up with its CPI figures in the very bleedin' first place.

The only commodities that look bearish on the long-term charts are sugar and orange juice.

Actually, OJ futures are getting thrashed. They're down some 30 percent this year, and plummeting towards a 20 year low (on a bearish surprise in the monthly USDA supply/demand report apparently). Bumper supplies from Brazil and weak retail demand were also cited by other sources.

The point is not simply to inform you on what's been going on in the commodities markets. The point is, aside from the OJ market, gold should be leading this parade!

Having said it, the fact is gold is leading so far if you accept the higher high in September as forecasting the current dollar weakness, and commodity revival.

Concluding Remarks
There are many factors at work in the global economy today. Many we're only just beginning to see, and many we'll never hope to see. The structure of the global bullion market is changing. India is moving fast to become an even bigger player in the official gold business. Officials there are lobbying for unrestricted import/export trade, and have launched futures and spot market facilities for gold, silver, and other commodities.

It's going to take a lot of work to determine what impact if any there will be on trade.

Meanwhile Russia has been entertaining the idea that it should price its oil exports in euros. I don't bring stuff like that up much because I see it as the kind of good news a dollar bear market produces - an opportunity to take profits if you're short, nothing more. It isn't the kind of development that determines major trends; it's just something that is sensible in the current environment for Russia to do.

But that's just my opinion.

News leaked out about a new Washington Agreement to be discussed by the brass in the spring of '04. The leakee was Buba (the Bundesbank) as usual in times like this.

The gist of the current conundrum is that gold has shaken out nicely, but also, trade seems to be keying off of the Dow (specifically its potential bullish impact on the dollar outlook) while the dollar itself is falling to new lows, as if there were a dichotomy. However, the new lows in the dollar along with the activity in other commodities simply represent an ongoing confirmation of gold's bull market, not a bifurcation in my opinion.

The noise will follow the trends.

The $370 level on gold has been tested three times over the past week, and bulls are beginning to nibble again, particularly in silver. Gold shares have fared better than I thought they would, so far.

It'll be less important to see how good the earnings and economic news is in coming weeks than how the broad market and gold will react to it. We can predict neither the news nor how the market will react to it. But we can draw conclusions by observing how it does.

We're looking for the dollar to bounce in coming days, but we're also looking for the broader stock market rally to peter out as investors sell the good news.

Ideally, I'd like to see gold prices take another run at $400 in the midst of that process - effectively forecasting another down turn in the Dow and US dollar. I'm not holding my breath (for the short run), but the challenge is to the gold bulls here.

All the pieces are in place. There is no reason we shouldn't lunge at new highs in coming weeks unless we're wrong to be bullish on gold in the first place.

The time has come, I believe, in the current phase of this bull market cycle, for gold to start outperforming our expectations rather than lagging them.

Last thought: what does it mean that four of the five highest priced Dow components are within the top seven best Dow performers over the past three months?

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