What a Strange September It’s Been

Closing in on $1,300

Gold prices are at new highs. Last week’s bump pushed the price of our favorite metal close to the $1,300 level. Gold and silver have outperformed nearly every asset class this past year. Yet, in the grand scheme of things, maybe 5% of investors have gold in their portfolios. If gold were to enter into a super bull market, the price could double literally overnight. Think of it like this: A few years ago no one really paid attention to the price of oil. It dropped to as low as $10 per barrel. Steadily it moved up to around $30 and stayed there for a while. That was a move of 200%. As we neared the mid 2000s, the price of oil started to move higher, first because of demand and then because of speculation. During the demand phase, the price of oil jumped to $50. Then, during the speculation phase it moved to $150 per barrel.

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Right now we are in the demand phase for gold, with prices moving up steadily. We have not hit the speculative phase yet. If that were to happen, the price could easily top $2,000 or $3,000 per ounce as individual investors pile into an already seemingly crowded trade. Gold unlike oil is a very tight market with very limited supplies. If you are inclined to bet on the upward movement in gold prices, you are likely to see a similar, maybe higher move in the price of silver, which has the added benefit of being an industrial commodity. At $2,000 per ounce, gold would still not be any higher, adjusted for inflation, than it was in 1981. The case for buying and owning gold is still compelling.

The shares of gold miners may represent the ultimate bargain however. As I wrote last week, the price of gold has meant nothing for the miners. They are still lagging the move in metal significantly. If the miners were truly matching the price of the commodity in terms of performance, each one should be trading at twice their prices today. But, they are trading at levels lower than when gold was at $900 per ounce. Again, our favorite miner is GoldCorp (GG-NYSE), which is up about 5% this week alone.

The Mean Season Approaches

The next month and a half will prove to be quite exciting for the market, and likely very volatile. It is earnings season again, and after a slowdown in the economy over the past two quarters, it could be painful for many companies. Last week Adobe Systems, a tech darling announced numbers just shy of the Street’s expectations, with slightly lower guidance for the year ahead. The shares were slammed by 20% in one trading session. This is a trend that will continue in the weeks ahead. Investors are unforgiving right now and companies that miss will be whacked mercilessly. Be sure that your portfolio is adequately protected through the use of tight stop-losses or through put protection by buying short term put options against the share you own.

Additionally, we are in the thick of the mid-term election season and it is getting quite testy out there. The political situation in the US could turn 180 degrees in November and that could have a major impact on the market. The market hates uncertainty and while not pleased with the Democrat plan to allow taxes rates to revert to levels prior to the Bush tax cuts, it is a known event. If the Republicans gain control of the House and/or the Senate, the political climate will change significantly.

Neither party is in a position to do anything but spend more money. That is a given. Stimulus whether through direct government spending or through an extension of tax cuts will result in continued increases in the deficit. The given is that the US dollar will likely remain weak. If the Republicans win, and deficit cutting is the platform they run on, then the market could be in for a short term shock as the only way to cut the deficit would be to tighten government spending, which has been the major contributor to economic growth this past year. At this point, it’s a toss up. Once again, it would be wise to have some hedges in your portfolio or outright short term puts just in case the markets react negatively to the outcome in November. If there is one certainty in this morass of uncertainty, it is this: Today’s market does not move in baby steps anymore. It reacts to news and it reacts violently and if you are not prepared either on the long or the short side, you will be sorry.

Don’t Fight the Fed – Part II

The recent market breakout has come as quite a surprise. The jury is still out about how long it will last, or whether this is what we call a “fake-out”. The Federal Reserve is doing all it can to flood the market with liquidity. That liquidity will find its way into the market as investors are being forced into equities for lack of return elsewhere. Cheap currencies also make for bullish market action, and the US Dollar is not showing any signs of getting expensive anytime soon.

Low interest rate bearing currencies enable investors to put on what is called a “carry trade” where an investor borrows in one currency which sports a low cost of borrowing, say the US Dollar and invests the proceeds in a higher interest rate currency like the Aussie Dollar or Brazilian Real. Using leverage, and the assumption that the weaker currency will not strengthen, can result in huge gains for the investor. The carry trade is also a signal that the market players are re-risking their portfolios, which is bullish for equities.

The Fed’s latest minutes are quite telling. They report lower than expected growth going forward and low to non-existent inflation. This flies in the face of conventional wisdom that printing gobs of cash is not inflationary. Commodity prices are saying the exact opposite. Being denominated in dollars, many commodities are at or near new highs. What the Fed is not saying and what explains the movement in commodity prices is this: Inflation is subdued in the short-term because people are unwilling to spend and unemployment and tight credit are squeezing consumers. In this type of environment it is tough to raise prices at the retail level. However, the commodities markets are saying that prices will rise and rise sharply in the future. It is commodities future prices that are soaring. So, for this moment in time we can have a dichotomy – low inflation today but much higher inflation to come. Each dollar that the Fed prints through its easy money policy will have the effect of incrementally boosting inflation in the future…unless the laws of Economics have been repealed.

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Best regards,

Kevin Raymond

One Response

  1. Dillanger

    I am forever indebted to you for this information.


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