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Global Macro Roundtable

The following is an excerpt from our GMR #7 of 07 August.

Gold Observations

Currently I have a schizophrenic view on gold - it can be summed up into two scenarios of which both I find highly plausible given the charts and the current market psychology. Each scenario has its merit.

  • Scenario 1: Gold Stocks Dither & Wilt

In this scenario, the consolidation that has taken place in the gold stocks since March 2006 continues where the stocks were last at their strongest. Since then the red downward trending line has meant that the bullion price remains stronger, relatively, than gold equities. With the broader world markets in a subprime scare and the markets falling, this brings a SERIOUS downdraft as resource / materials related equities are much more volatile than Blue Chips or whatever à DOW down 5%, HUI down 9% these last few weeks ! (recently HUI @ 372 x .91 = 338 : Friday closing)

Likewise, with the "steam" running out of a long run in the commodity sector at this cyclical moment, it would seem gold and silver equities are struggling even as base metal equities have been doing better.

To compound this scenario, as has been talked about in previous letters, with the opening up of new commodity ETF and bullion-proxy products, these vehicles present the investor with diverse methods for investing in gold and silver. As the investments inflows into this sector are by definition finite, they are distributed over more instruments - pure equity plays combined with a) consolidation (M&A activity) in the gold/silver sector; b) a large percentage increase in the sector over the last 5 years is resulting in fewer and fewer "bargains". Thus the previous leverage in owning paper gold seems to be diminishing. Likewise, with some investors wanting real gold and not paper, plenty of investment inflows are certainly to have taken place in the straight bullion or bullion-proxy products. The red line continues its downtrend looking for a bottom (red circle would, in my opinion, be a good area to buy into). On this longer term weekly chart, this area of -80 has been a winner these last 3 years - see blue rise.

Again, as stated above, if consumers / investors are confronted with the thunderclouds of losses on existing paper investments + home value losses + higher mortgage payments + higher food and energy prices + markets re-pricing risk forcing the broader markets to slow or go lower THEN I see little chance of "poor old gold equities" making a strong counter-offensive ; much to the contrary, they would likely suffer more.

BUT, we still have scenario 2.

  • Scenario 2: Gold Stocks Rocket Higher

What if everything (world stock markets) just starts to crumble, albeit slowly, AND the energy market has an "event" (geopolitical or weather) of some sort AND the US Fed starts to soften its interest rate stance in the wake of plausible US economic slowdown ... AND God help us all, the Fed decides to cut interest rates AND Trichet at the ECB keeps his promise of a rate hike upcoming in September. All of these things are very REAL and partly in the pipeline. There will be hell to pay somewhere - likely the US Dollar. The Euro may start to gather strength along with other currencies and the world will see Bernanke as "just another Greenspan" - crank up the USD printing press. The 80 level on the USD Index would break immediately, I conjecture. Confidence will be lost and, as outlined above, the commodity producers will need to re-adjust their pricing levels across the board.

Panic stricken, gold may once again be an option of favour to the world investment community. Please note, I'm just "thinking out loud" - to find a plausible case for gold in the immediate context. Bonds would falter as well. What else? Gold often performs much better in a restricted liquidity environment - which is happening now - because risk is reduced and owning gold has little risk. With Yen Carry Trade possibly drying up and risk premiums going higher, investment managers might feel a bit more safe owning some gold bullion than junk bonds.

Where the hell are we right now in these scenarios? I believe we are straddling both - sorry for the pat answer, but that's how I see it and that is exactly how the markets are reacting. Gold is edging higher but not rocketing and nobody knows where the junk debt floor is so gold equities are "hanging on" right now with the broad markets... waiting for some sort of daylight and news.

In looking at the chart below, previous action has been interesting in the longer term weekly chart. Previous rebounds up from -50 level were than hammered back down to -80 levels setting up excellent BUY signals. BUT that was during an interest rate period which is different than is now unfolding going forward, i.e. slower rate rises. Rates have been heading higher and inflation increasing - both gold positive. I cannot say whether the last blue box can be reached or not, only to say that within this scenario it seems unlikely. If anything, under this backdrop gold should be rebounding off the -50 level and last week that started with a rise of $12 for the week.

Until we hit a ratio on the HUI/GOLD of 0.54 and break above the red downtrending resistance line and/or a strong price breakout above $685 (latest high) or better yet, above the May $690 level, (see below) I will remain unconvinced of imminent gold strength right at this moment.

To note, I have recently read multiple gold forecasts of year end prices around $740/oz. from various market "gurus" who are NOT from the gold-cheerleading crowd. From the gold-cheerleading crowd we continue to get the forecasts - since 2003 - of $850, $1000 and $1300 and it is going to happen NOW, is their call. That may very well happen - but right now I'm more concerned as to what happens between now and then.

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