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Slowly Unravelling!

Gwynne Dyer, a well known Canadian Geopolitical analyst, started off a recent commentary (Siege spells beginning of the end for US in Iraq, May 5, 2004, New Zealand Herald) quoting former US Ambassador to the United Nations Richard Holbrook on Iraq as "disintegration verging on collapse". Its appropriate following the events of April with the siege of Fallujah, the highest US death toll since the start of the war, the ongoing siege of Najaf, and the revelations of ongoing abuse, torture and murder at the infamous Abu Ghraib prison of Saddam Hussein and elsewhere.

A siege (Fallujah) that was ill considered because it was city of civilians and it would be impossible to identify the killers of the "contractors"; numerous unnecessary deaths not only amongst the US forces but especially in the Iraqi civilian population; a siege in Najaf against a junior Muslim cleric who has potential wider support if he is killed; and the scandal of the torture, abuse and murder (although not unusual or unique in times of warfare or even in peace time as what is unique is that it was revealed) are all signs of a slow unravelling of events in Iraq. Couple this with attacks in Saudi Arabia (and subsequent warnings of Westerners to get out of Saudi); attacks in Syria and Athens as well the ongoing "no solution" to the Israeli/Palestinian conflict, it is a clear demonstration that things are unravelling at a heightened pace on the geopolitical front.

What happens on the geopolitical front is important to investors in the Western world particularly North America even without a key election taking place in November. If things are deteriorating elsewhere, it will eventually wear on consumer and investor confidence. If consumer and investor confidence fails, a turn down in the economy and the stock market is not far behind. The stock market often starts falling before the negative events come completely into play. Recent retail sales in the US were lower than expected; Gas prices at the pump are at their highest levels ever in North America (although compared to Europe they are still a bargain); long term interest rates are rising and threaten the housing boom; and, with an unprecedented level of debt outstanding with consumers and corporations higher interest rates are potentially dangerous if accompanied with an economic slowdown.

Right now we have a most difficult situation going on. Interest rates have been maintained artificially low now for some time. Low interest rates are the major contributor to the debt bubble of consumer debt and mortgages, the revived stock market bubble and the housing bubble. The monetary authorities have maintained an easy money policy for years. The last slow down in money growth (M3) was in the early nineties. Since 1993/94 M3 has grown 114% from $4.2 trillion to over $9.0 trillion or roughly 11.4% per year. Consumer debt (mortgages and consumer credit) has grown even more from $4.2 trillion at the end of 1993 to over $9.4 trillion at the end of 2003 up 123% or 12.3% per year. Business debt is up only 100% growing from $3.7 trillion to $7.4 trillion in the same period.

Money supply growth actually retreated briefly for a few months in late 2003 but since the beginning of the year it has been rising once again at an 8.6% annual pace. But contrast the monetary and debt growth with economic growth that has only increased 69% (before factoring in inflation impact) since the end of 1993 ($6.7 trillion to $11.2 trillion) and you realize that without the massive monetary and debt growth not only would the stock market not have soared economic growth might have actually been negative.

Adding to the massive debt situation is the current account, trade and federal budget deficit that now combined is approaching $1 trillion annually. This deficit represents a massive transfer of wealth out of the US into the hands of foreigners who now own upwards of 50% of government debt. All of this leaves Alan Greenspan between a rock and hard place. Even a small hike in short term interest rates could quickly unravel the market. Yet the bond market falling in price (rising in yield) is doing it for him by pricing in anticipated interest rate hikes. What the bond market is saying is that there is problems here of debt and inflation (commodities, war, and economic growth) that is not being accounted for and as a result higher interest rates are needed.

The job numbers that came out today are adding fuel to the fire (238K versus expectation of 173K plus an upward revision of the previous month and a lowering of the unemployment from 5.7% to 5.6%). The bond market was, in reaction, to put it mildly, "trashed". And the stock market rather than reacting positively to the job numbers was down to mixed rather than experiencing a big up. Rising interest rates take precedence over rising job numbers. Speculation is now going around that while the Fed may not move in June it might be August although some are expecting that it could very well be June. In a highly leveraged economy even a small interest rate hike could tip things over not only cooling the stock market but ending the housing and consumer boom.

What always seems to be underreported is the record pace of bankruptcies, the record high level of credit card delinquencies and record high mortgage foreclosures to understand that while on the surface the increased jobs should be good news but rising interest rates in a highly leveraged economy could prove disastrous. Couple this with sharply rising gasoline prices and a consumer led slowdown could soon be in making which would in turn see the job numbers turn down as quickly as they turned up. Many of the jobs created are of the service variety or as some refer "McJobs" and therefore they could disappear as fast as they materialized.

So instead of a rosy picture as the jobs numbers would love to report what we are witnessing is we believe a slow unravelling not only the situation in Iraq but also the economy as interest rates rise. To finish off the turn around we would only need the US Dollar to resume its downtrend and for gold to turn around. Both we believe are on the cusp of that turnaround as our daily chart below shows of both gold and the US Dollar.

The US Dollar has rallied up to the 200 day moving average. Recently it broke down out of a small ascending wedge but could be forming a wider ascending wedge. This would be negative once we get a firm break of 89. We still have room to rise to just above 92 within the current triangle that is forming. The US Dollar remains well below its four year moving average, which is up near 104.50. That defines a major downtrend.

Gold has broken under its 200 day moving average but has solid support down to $370. We appear to be trying to finish off a C wave of an ABC corrective wave. Longer-term support remains down to $350 and again down to $310 neither of which we expect to see. A break above $390 would be positive and we would break out now above $407. Gold remains in a major bull market well above its 4-year MA near $310. Longer-term charts are still pointing to higher prices this year. We suspect that the current low is a cyclical 18-month low that was due between November 2003 and June 2004.

Our second chart is a weekly one of the S&P 500. Despite a very impressive year and half rally all we did was succeed in regaining to the four year moving average and an area of major resistance created by the rally out of the September 2001 lows. There is support at 1100 then down to 1050/1060. Ultimately we expect this down wave that is currently under way to reach as low as 960. This could happen rapidly by late June or early July.

Going forward not only does the situation in Iraq need ongoing monitoring but more importantly the growing situation in Saudi Arabia. Clearly the House of Saud is in trouble given attacks on the Saudi secret service and more recently the attacks on the joint US/Saudi Yanbu plant. The target here seems to be the price of oil and a spike could be coming if major oil fields are attacked. We have had ongoing long-term targets up near $55 that has not as yet been fulfilled. Curiously thousands of US troops are nearby in Kuwait and of course Iraq that could be redeployed quickly into Saudi Arabia if such an event took place. The US then would be in a position to control most of the major oil fields in the Middle East.

Rising interest rates, rising oil prices, global geopolitical uncertainty, economic uncertainty all of these are key reasons to continue to hold gold and look past the current gyrations to the downside. If we have a major concern going forward in the next several months it is that the slow unravelling we are currently witnessing turns into a rapid unravelling and a global financial crisis.

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