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Gold 'Correction'?Chris Laird Short term gold to November 1, 2006 There has been quite some debate recently about a pending gold 'correction'. Since last week, gold corrected about $50. For some weeks, I have been predicting a drop in price below $600, and have been writing that the main cause will be a weakening commodity complex that will spill into gold. I present a thesis here that gold is not 'correcting'. Gold is reflecting an actual major macro economic change to recession in the US. The context of the term 'correction' in this present gold market is off base completely. The primary reason for a weakening commodity complex are two fold:
There is an article out by GMFS that also supports this view, but only as a caveat to their expectation that speculators are going to drive gold back up to $700. They apply a caveat that US economic weakening and subsequent commodity weakening will be gold bearish. Their assessment is for the investment side to reassert gold bullishness. My assessment is that the bearish caveat they suggest will actually be the reality. I will go into detail about this in a moment. http://www.thebulliondesk.com/content/reports/tbd/gfms/UP106_Investment.pdf I am a long term gold bull! I wish to point out that I am a gold bull. There has been some controversy about my recent short term gold bearish articles, which clearly anticipated gold's present $50 correction, in spite of the normally seasonal gold bullish forces that would be at hand at this time of year. However, just because I happened to have forecast every major gold drop this year (as I recall), that does not mean that I am not gold bullish. I simply see macroeconomic reasons for some gold weakness short and mid term. Longer term, over a year, I foresee gold to have to deal eventually with a longer term lack of confidence in the USD and in other fiat currencies such as the Yen. It is very hard to write about short term gold bearish events and forces, all the while to keep telling people that I'm gold bullish. However, if you were to look at all of the material in my public articles, and my newsletters, you will clearly find them dealing with shorter term scenarios and longer term scenarios. Sometimes they are both bullish, and sometimes I have some bearish short term views. Long term, I am completely bullish. Obviously, this is a very ambitious thing for any gold market analyst to do. To cover both short and longer term horizons. This is particularly true for gold because it reflects all aspects of economic and political activity, and is a central banker's reserve asset par excellence. This being the case, gold is both fascinating and highly complex. I have not been unwilling to make some predictions. At times this year, these predictions have been gold bearish. But -that is what the shorter term macro economic environment has been indicating. So, if the implications are short term bearish, then my public articles are also this way. This should not be interpreted to mean that I am gold bearish for a longer term. I personally have bought gold recently at 635 twice and 604. Before I get into this Nov 1 analysis, I want to point out that my position to my readers, both public and for the newsletter, has been to simply accumulate gold bullion and forget about it. This, even as gold has shown weakness for the last month or so. I have stated that even if gold were to drop $100 from 635 recently, to 535, it is still better to buy and hold bullion regardless of the shorter term price fluctuations. The reason is that I expect a USD crisis within 5 to 7 years hence, but not later than a generation from now, a real one, where gold will rise in value to astronomical levels, on the order of over $50,000 an ounce, should the USD really collapse. 5 years may seem a long time away, but it passes in a flash. Now is the time to accumulate precious metals bullion regardless of the present low prices, up or down a hundred bucks. I wish to point out some things about a pending USD collapse and what is typically expected. People are right that a USD collapse is inevitable. Where they are repeatedly missing the boat on this issue is in the timing. A major reason for this error is a lack of appreciation for the extent that foreign central banks will go to prevent large drops of the USD. A perfect example is the support Japan provided the USD in 2004 and 2005 particularly, where they almost single handedly stopped a rapidly falling USD in the late months of 2004 and early 2005. At that time, the USD was rapidly falling to close to 80 on the USDX. It was widely believed that the USD was right on the cusp of a USD crisis going into 2005. People of the caliber of Warren Buffet had taken huge USD bearish positions. In the case of Buffet, about a $20 billion position in foreign currencies for Berkshire. In the ensuing months, Japan and other central banks caused a rally in the USD in 2005, much to everyone's surprise, and to cause a $400 million dollar loss to Buffet. In short, the USD had a lot of support. People underestimated the extent to which central banks will go to defend the USD. This will also continue to be the situation in the near future. Therefore, predictions of a USD collapse happening in the next six months for example are highly premature. However, longer term, that is over one year for me, there is always a clear possibility of a USD crisis, and that is why I am so adamantly gold bullish, regardless of the price fluctuations in the mere hundreds of dollars an ounce price range we are in. In fact, I did a study on inflation adjusted gold and silver. The calculation dates the value of gold since 1983. The reason I chose 1983 was because that was when gold had stabilized in price to about $450 after the USD mini crisis that had led gold to the $870 level in the early 80's right after inflation had gotten out of control in the US. Volker had to raise US interest rates to the high teens to stop that rampaging inflation, and the USD gold price stabilized by 1983 to the 450 range. I then calculated inflation adjusted gold in USD from 1983 to 2006. That calculation indicated that gold priced in 1983 USD is really about $240 at 600 or so now. In other words, gold is really about $240 in 1983 USD. That is very much lower than the supposed price now of 600 or so. What does an inflation adjusted price of $240 now suggest for gold and the USD? It means that the markets have not yet priced in the real inflation of the USD into gold yet. Gold has not reflected the real inflation in these currencies yet. Not even close. Once again, if gold was reflecting the real inflation of world currencies, it would be three times the present prices in Yen, Euro, and USD at least. Why has this come about? Why has gold not yet reflected all the excess fiat creation over and above real GDP growth since 1983? One major reason is the willingness of US trading partner central banks to buttress the USD. They do this by buying US treasuries, and manipulating the Forex markets. Japan has unilaterally supported the USD every time the Yen/USD drops to 110 or so. In other words, for a USD crisis to really happen, the Yen would also have to collapse for example. Every major US trading partner is in the same situation. This year, when the USD was falling rapidly in the Spring, even the EU stated they intend to support the USD if necessary, and the USD stabilized soon after. The only way a USD crisis can happen in the next year or two is if central banks of US trading partners collectively abandon the USD. That will not happen until the US consumer has nothing left to spend... And that day is rapidly approaching. But, by Dec of 2006? Not likely. In fact, I am coming to believe that we are on the verge of another rally in the USD of approximately 10 points on the USDX over the next 6 months. Reasons? Coming stock and financial market drops, to include commodities and possibly gold. Also general recessionary expectations. There will be flight to safety in a big way, and that is Yen, Euro and USD bullish. I have not completely convinced myself that a 10 point rise in the USDX is definitely going to happen, but I suspect it will. In a few months I will have a better picture of this likelihood. The US has been calling for a drop in the Chinese RMB/Yuan. They are likely to get something they don't expect- from merely macroeconomic reasons. This is because China will not fare well at all in a coming serious US economic recession! It is entirely possible that the RMB/Yuan will in fact drop in value! So then, where does this discussion so far take us for gold in the next two months? Let's take a look at the major macro economic factors:
What will speculators do right now? All of this leads to what will speculators do now. If, in fact, my analysis of a pending US recession and its effect on stocks and commodities is correct, then speculators will actually short gold and commodities. That actual event happened this last week already. If a consensus forms in the investment community that gold will not rise well above $600 in the next weeks, they will conclude a real short term commodity and gold market is in play, and short gold. If this happens, gold can actually go back below $500 by Dec, and be right back where it was in Dec 2005! I will be looking for gold to go well over $640 soon to see if this will not happen. I expect gold will not achieve $640, and if it gets close, to see a set of massive gold sell offs to 550 and eventually to 500 by Dec, if gold does not exceed $640 soon. I expect that the reason gold will not achieve $640 is because there is already a consensus by large fund investors and speculators that gold is weak and they want to get out. They will sell into any gold rallies in the coming weeks. Gold as economic indicator This all would make sense if gold is actually a supreme economic indicator. If there is a big US recession now just beginning or about to begin, gold will reflect the deflationary forces of this, and anticipate it by up to 6 months. I believe this is happening now. The speculator activity is merely the active hand, but the macro economy tending to recession is actually the driving force on gold. Speculators are merely seeing a profit opportunity. And right now, they are about to form a consensus that it is time to short commodities and gold. Please don't interpret this analysis to mean that I am gold bearish long term because I am not... These are short and mid term views of mine. Long term, that is over a period of several years, I foresee gold to rocket up. Hence my bullion centric gold preference. Obviously, stocks are more volatile than gold, and bullion is safer if there is a gold 'correction'. Gold correction? This gets to something that is repeatedly discussed about the present gold market, ie that gold is 'correcting'. The fact is, gold is reacting to a major change in the macro economic environment, and is not correcting -it is acting fundamentally as money, and is anticipating a severe US recession. The only way gold could be said to be 'correcting' would be if the world macro economic situation was actually similar to 2005 and early 2006. The fact is gold rose in those time periods, but in an entirely different macro economic environment! The present macro situation is definitely recessionary. Gold is now reacting fundamentally to that, and not what was happening in 2005/ early 2006! This present gold drop is not a correction! Let me clarify something. If gold rises with speculators and investors anticipating large rises in price, that is an 'investment' view. A 'correction' is appropriate in this situation. But if gold is reacting to macroeconomic expectations of a severe recession, then it is reacting as money, and that reaction has nothing to do with the meaning people give to 'corrections' in investment markets. Therefore, any logic of 'corrections' actually does not apply right now to the gold market. Prudent Squirrel Newsletter sample I conclude this article with a sample of my latest Prudent Squirrel newsletter of last Sunday. I am doing this because, I write so many public articles, that people think they are getting most of what I have to say. That is not correct. If you like my analysis, you will see that the newsletter has lots and lots more of my views on the ever changing gold markets. One comment: I have some charts in this NL but I generally do not use them much. 59th edition of the The Big Gold Picture Major change trend in world economy - recession in US Gold writers not in tune, US recession already in genesis? Commodities bull long in the tooth? USD strengthening? Gold writers not in tune Recently, I have written several newsletters and several public articles about how a coming US recession will be commodity and somewhat gold bearish. This caused some prominent gold writers to comment on the idea. I'm going to give you all a couple of links seeing the reaction these articles generated... When I started writing those articles, I knew that going against the grain of gold bugs and some gold writers- having to disagree with most of them- can be a little hectic for the writer - me. It is not easy to see macro trends that are temporarily counter to a gold bull, and sometimes I feel like a point man who is the first to get shot at, or, like I'm having to cut a new trail through the jungle, with vicious vines with thorns whipping me as I hack at them back. Believe me, it is far harder to cut a new trail than to travel a well worn path. On the other hand, I was pleasantly surprised to see that Prudent Squirrel subscriptions held up the same anyway! So, with lashes on my back and thorns grabbing at me, I hack on... OK US recession already in genesis? The world economy is on the verge of a great phase change. We are seeing the unwinding of massive credit bubbles in real estate and will probably see them unwinding in stocks, and commodities as well. The US is on the crux of a recession, and that is going to seriously hurt world industrial demand, which is going to hurt commodities. In fact, I believe the US is already in the initial genesis of a recession. Of course, gold is a flight to safety commodity, and if there are serious stock market panics, then gold will rise due to flight to safety... But, if there is an orderly decline in stock markets, as economic news gradually recognizes a US recession, then commodities and gold will track down together (gold may track down some but not near as much as things like copper). I have seen many gold writers tenaciously holding on to short term gold bullish scenarios. They have seen my recent articles and have commented on them, vigorously disagreeing in some cases. The trouble I see, is not that they disagree, but that they appear to be hanging onto a market perception that is more associated to the last couple of years of rising inflation and commodities, but not really appropriate to the present changing macro environment which is clearly weakening. We will discuss these gold writer comments on my recent articles and then do some analysis later on the CRB, gold, the USD, and the transportation index. Lets look at one comment by Mike Swanson, a guy I respect, about the reaction to my recent gold bearish articles- he publishes the WallStreetWindow newsletter that has tens of thousands of subscribers: Will Gold Stocks Fall with the Stock Market? - (8/21/06) Submitted by Mike Swanson on Mon, 2006-08-21 11:59. There are many gold bugs warning that gold stocks are going to fall along with the US stock market. They are totally wrong. To see some of their warnings check out some of the recent articles being posted on Kitco, gold-eagle, and 321gold.com by writers who are usually very bullish and you'll see exactly what I'm talking about. One such commentator is Chris Laird, who claims that gold should be way above $700 an ounce because of all of the bad news in the Middle East, including Israel's attack on Lebanon and the airline terror scare. He presents two theories... More important is Laird's fears of a gold crash, which he has discussed in other recent articles and posed as a second theory for gold's supposed "weird action." This second theory is that gold is about to get dragged down along with a crashing US stock market. Judging by some of the emails I've recently received, this theory has terrified a lot of gold investors. Some are so scared that they can't pull the trigger right now on what is an incredible buying opportunity. As you know, I've been saying over the past few weeks that we are beginning a new cyclical bear market in the broad market so I agree with Laird when he worries about a big stock market drop. I just don't think we are headed for an immediate crash and disagree with him on what this will mean for gold stocks. He claims that "Big stock drops are very deflationary. A lot of money is lost in these things and people and companies really pull back spending. That can be a very downward force on gold ultimately, unless there is a currency crisis at the same time. Also, a big US stock drop (probably to include Japan) would be a currency boost to the US and the Yen as people flee to cash domestically. So if the USD and other currencies strengthen, then gold would find this somewhat suppressive. That could be the initial reaction." I totally disagree. I think we are heading for a slowdown in the economy that will bring a large decline in the Dollar. The inverted yield curve is proof that the Fed is not going to start jamming interest rates up again. The chart for the Dollar shows short-term support at 84 and it appears that it is about to crack this number and go down toward 80. A fall below that will take us into no man's land for the Dollar and cause an explosion in gold prices. This is where we are headed! Now, if my writings terrified a lot of gold bugs, I do apologize. But isn't the issue about whether there is indeed a mid term sea change for gold, oil and commodities? - if there is a serious US recession? Shouldn't gold investors be given analysis that looks for both sides of a market, and does not always talk bullish? Of course, if you have followed my short term gold predictions, gold has indeed dropped significantly every time this year that I published short term gold bearish articles. The most recent was this week, when about 30 minutes before my latest article, Short Mid and Long Term Gold was published, gold started dropping and is still dropping this Friday, down now well over 20 bucks since Thursday to 611. In that article, I had forecast that markets and gold would probably drop in the short term- 2 months. I had said that absent a stock market panic, gold would probably drop more. Now, that article had many scenarios, and I said "if this happens then gold does this..." It was not specifically a prognostication. It said I suspect gold will drop. It did. Anyway, I got lots of appreciative emails - and subscribers- for my latest hacking of the new trail, while, frankly, lots of other writers are still more comfortable on the old nice comfy one- gold bullishness regardless. Now please don't misunderstand me. I am a long term gold bull. I just see short term gold bearishness. And I am not the only one. Take a look at this article from non other than the International Monetary Fund: IMF warns over boom in commodity prices By Krishna Guha in Washingtonand Kevin Morrison in London Published: September 7 2006 03:00 | Last updated: September 7 2006 03:00 The commodity price boom over the last three years is unsustainable and will result in sharp price declines by the end of the decade, the International Monetary Fund has warned.... http://www.ft.com/cms/s/944c8ef0-3e0c-11db-bd60-0000779e2340.html The IMF is commenting on the commodities bubble now that the CRB index is well down. We will discuss the CRB later in the newsletter. Now there are other articles out for the last several months of expected weakness in commodities, to include, aluminum, copper, and others, and even gold... because of increasing supply by mines building up capacity (not for gold tho). There are also articles not only by me, but by financial news outlets talking about what a US recession would do to commodities demand in 2007 onward. I did not know that the IMF would write something just like I have been discussing for the last month - I had already come to these conclusions after reading about a thousand articles and data over the last two months. (I read over 10,000 financial news articles plus zillions of market price checks in only one year! That's part of what you pay me for...) In any case, I also noticed that most gold writers are, or were just before Thursday, still saying that this is a great buying opportunity for gold stocks. Then, come Thursday, the HUI and gold drop several percent... It does seem that I'm trying to swim against Niagara Falls... when I dare to write short term gold bearish articles. I have a lot of respect for Swanson by the way. http://www.wallstreetwindow.com/drupal/node/256 Here is another Gold writer who commented on one of my latest, the Mogambo Guru: But this is not about suffering or Supreme Court treachery, but about some people saying that gold will go down in price. For example, Chris Laird, who is the Editor in Chief of PrudentSquirrel.com, penned the essay that got a lot of people all lathered up, which carried the title "Expectation of US Recession a Hand Over Gold Market." He writes "The fact is, if economic activity- in the world's largest economy by far- collapses, as I suspect it will beginning in 2007, gold will find that inflation vanishes, industrial production drops precipitously, and all those expensive commodities now are going to tank starting in 2007." That is, of course, very interesting. He could be right... http://www.freemarketnews.com/Analysis/102/5932/lock.asp?wid=102&nid=5932 I am concerned that many perpetual gold bulls are not presently in tune with the fact that the US is going to have a deep recession, that it is going to hit commodities hard, and things will happen like the USD strengthens from flight to cash... Swanson had predicted a USD drop in the midst of the recession, while I foresee all stops pulled out by foreign central banks to buttress the USD above 80 or near there because they are so afraid of what a USD drop will do to them, especially Japan. And so on... In other words, many gold writers are still writing like it was 2005. But we're fast approaching 2007, and a vastly different macro economic world. I also believe the US is already in the genesis of a recession. If I am right, this gold bullishness 'no matter what' is going to cost a lot of gold bugs a ton of money. I'm a gold bull long term, but short to mid term - horizontal or down. Now, please understand that this is my macro economic view, and that I am not necessarily advising anyone to sell any gold stocks or bullion especially! These are just my economic views- for your consideration, to add to your research quiver. Then You decide what to do... There are also news articles out about how gold demand is not as strong as it should be at this juncture: Gold Drops to Two-Month Low on Speculation Demand Won't Recover By Pham-Duy Nguyen Sept. 8 (Bloomberg) -- Gold in New York fell to a two-month low on speculation demand from investors and jewelers won't recover in the fourth quarter. Palladium plunged more than 6 percent, and silver tumbled for a second straight day. Merrill Lynch & Co. yesterday said gold will average $625 an ounce this year, down 3.8 percent from a June 9 forecast of $650. Jewelers, the biggest buyers, slashed purchases in the first half, according to the producer-funded World Gold Council. Gold, which reached a 26-year high in mid-May, is down 2.6 percent this week. ``At this stage, we've got to start looking for support down at $600,'' said Michael Guido, director of hedge fund marketing at Societe Generale in New York. ``A lot of confidence has been stripped out of the market...'' http://www.bloomberg.com/apps/news?pid=20601012&sid=aA0JDFDJgMCM&refer=commodities Evidently, I am not the only one short term gold bearish, but jewelers in India and Asia seem to be too! This article continues: "Jewelers Investment demand helped drive gold futures to $732 an ounce on May 12, the highest since January 1980. Higher prices deterred jewelers, who accounted for 73 percent of purchases last year. Gold demand fell 16 percent in the second quarter, the third straight decline. Jewelry demand has helped gold gain every September since 2000 as manufacturers stock up for holiday shoppers. Investors had expected the trend to continue after the metal gained 2.3 percent on Sept. 5, even as energy prices fell and the dollar gained, Guido said. ``This move was a head fake,'' Guido said. ``You had a lot of money coming into the market. The sharp reversal caught a lot of people off guard.'' A pick up in jewelry demand is crucial to sending gold to a sixth straight annual gain, some analysts said. Merrill Lynch reduced its forecast amid expectations of a drop in jewelry demand. `Without Genuine Demand' ``Gold is without genuine consumer demand,'' said Philip Klapwijk, executive chairman of GFMS Ltd., a London-based metals research firm. Oil futures touched a five-month low today, and the dollar reached a six-week high against the euro. ``Given the collapse in energy prices, the seemingly lessened threat from Iran regarding its nuclear power programs, and U.S. dollar strength, gold has collapsed,'' said Dennis Gartman, gold trader, economist and editor of the Gartman Letter in Suffolk, Virginia. Gold yesterday fell below the 100-day moving average, signaling the metal may drop further, traders who follow historical price charts said. I saw articles stating that physical demand for jewelers and such is not appearing as usual... meaning there is big resistance to these prices. IF investment demand is all there is right now, well, gold is showing weakness, and that investment demand is likely to swing to the down side instead of upside! They love shorts! After the summer holiday, the gold speculators tried to create a gold rally recently and it just has not held up. They bailed out fast, and so the drops late this week. I suspect a consensus is forming with speculators to go the other way - down - on gold and commodities soon. The gold speculators could not care less if gold rises or falls, they can make money both ways. IF gold starts to trend down, I'm quite sure the speculators will be very happy on the down side, as they were in the upside. What all this is telling me is that gold writers are still very caught up in the recent gold bull trend of the last few years but cannot, or will not, see the present change in the world macro environment to economic weakness and recession. Also, if they do see the economic weakness, they will not entertain any short term gold bearish implications. IF that is true, then their readers are going to be behind the changing situation. I am a long term gold bull, but I foresee some short term weakness for the reasons specified above. One of the reasons why gold is not terribly bullish now is because gold reflects economic expectations... and in this case they are recessionary. Of course, if the Central Banks panic and start to print their way out of a coming deflationary environment, and perhaps drop interest rates drastically, gold could rocket up well past $700. But if we do indeed fall into deflation, here and elsewhere, gold will not want to stay above $700... That does not mean gold will lose its luster as a flight to safety place for money. But gold can anticipate economic recessions by weakening in price some. If gold were to weaken some, I would not get too worried about it. In the last great US economic depression of the 1930's, gold stocks did initially weaken some in the stock collapses, but soon after skyrocketed- probably due to flight to safety. US recession already underway? Commodities bull long in the tooth? One of the reasons for my short term gold bearishness is because, in deep recessions, commodities and oil find quite a bit of reduced demand. I don't see this present economic environment being any different. Sure there is new huge demand from China and India, but remember, China has only about 20% of the size of US GDP. Also, clearly China has had super economic growth for years exceeding 10% a year. But the trouble is that China has a huge problem of overinvestment in industrial capacity. I can easily see a case where a recession in the US spreads into China and India, and breaks their industrial bubble. In such a case, Chinese demand for things like copper and oil will decline significantly for a period of time. So, oil and commodities drop some. The same situation goes for the US, but in our case we have primarily a real estate bubble that is going to pop, and since new home building is going to drop a great deal, and eventually commercial real estate too, then our demand for commodities will also drop. The trouble is that in great real estate booms, there is quite a lag between the onset of a drop in prices and actual building statistics. Right now, new home construction looks to be dropping, but not as fast as one would think. The same goes for commercial real estate. The reason is that there are tens of thousands of homes 'in progress' of being built, and many large commercial projects presently being built. These take up to a year to complete. But, once those in pipeline projects are completed, look for a precipitous drop in construction activity. Even though there is a housing market collapse now going on, new construction activity typically lags drops in sales because of this in progress building. If the US is indeed entering recession already, then wouldn't that be reflected in commodities already? Yes. Let's look at the CRB index.  USD strengthening? Along with commodity weakness, the USD is holding up quite well in this present recession that has just begun. I surmise that a serious recession will initially cause some flight to cash in the USD and Yen. Gold would not be the only flight to safety place for money, particularly if the recession is deflationary. Now most gold bulls will look at this situation and assume that the USD would weaken. In fact, Swanson above mentions that a major reason he disagrees with me about coming commodities weakness not necessarily being reflected in gold. He expects the USD to weaken significantly in a coming serious recession. The trouble is, that is not happening... at least at this point, the USD is actually strengthening a bit...  And gold is also showing lower
lows and lower highs, a bearish indicator.  Summary: I think a clear case can be made for continued gold price weakness:
I also expect US, and later, world, inflation to be weakening significantly in the coming quarters. Lastly, the Transportation Index has broken well below 50 and 100 day MA, a very bearish sign for the US economy. As I said, the US is already in a recession that has just begun.  The Prudent Squirrel Newsletter is one of the few macro economic gold newsletters. It has a very good track record of predicting gold's activity this year where the macro economic environment has turned recessionary in the US. Stop by and have a look. Chris Laird The Prudent Squirrel Newsletter is a big picture gold and economic commentary. Stop by and have a look. 321gold Inc |
