FSU Editorial: "What's Next for Gold" by Greg Silberman 05/31/2006

WHAT'S NEXT FOR GOLD?
by Greg Silberman
May 31, 2006

You ever wondered what DEFLATION feels like?

This is it!

Asset Prices Crumble.
And People get worried!

It’s amazing how short people’s memories are. A lot of foreign Emerging markets have seen back-to-back gains of 30 or 40% p.a. for the last 2 years. Now we’re surprised when these self-same markets are BATTERED down 15 or 20% in a few days?

I guess its human nature to always want more. But hey, get a Grip! What goes up must also come down. What’s really Worrying people is not so much MAGNITUDE but SPEED. A DEFLATIONARY COLLAPSE CAN HAPPEN IN THE BLINK OF AN EYE!

That said, what does the future have in store for us?

First things first is to determine if this is a routine pullback in a Bull Market or a re-emergence of the Bear Market that started in 2000?

To answer this I will defer to the tireless writings of Richard Russell. Richard says that Bear Markets end in exhaustion and at incredibly LOW Prices. People don’t want to hear about Stocks or the Stock Market. The prevailing mood is BLACK!

Secular Bear Markets come in 3 Waves. The first he believes took place in 2000 – 2002. Valuations never got down to anything resembling BARGAINS.

Long before despair set in, the World was floating Higher on the Back of Generational Low interest rates and Massive Liquidity (not lost on the Price of Gold). The Black Mood was never allowed to Fester and People were not turned off stocks for very long.

It’s therefore unlikely according to Mr Russell (whom I respect greatly) that the Secular Bear Market ended in 2002. Therefore what we are witnessing now may be the Bear Market Strikes Back Episode II.

Ok Greg, so we’re going lower. How Low?

I calculate Downside targets using the same methodology as Upside targets. To recap, I take the % magnitude of the previous Up or Down Wave. I multiply by the Golden Fibonacci ratio of 0.618 to give me the magnitude of the next Wave. I then add or subtract that from the previous peak or trough.

Therefore, the last Down Wave in the Dow went from 11500 to 7100. A fall of 4,400 points or 38%. Applying the Golden Fib gives me 24% (38% x 0.618). Now reduce the previous low of 7100 by 24% to get 5400 (rounded). Lastly apply a 10% margin of error on each side.

I BELIEVE THIS NEXT WAVE WILL TAKE THE DOW DOWN TO THE 5000 – 6000 AREA!

Gulp!

How long you ask?

I’d say it will roughly match the length of the previous BEAR Market Wave – 2 years.

Here’s how I see it playing out:

The intermediate trend of the market is now Lower. Yes we will have Sucker Rallies – we are in one now. But overall I think we will trend lower over the next 2 years.

First Milestone (Jun/Jul ’06)

The first milestone we Hit will be a change in Fed Stance in late June – Expect NO rate increase.

PROBLEM 1: If Short rates remain flat and Long Term rates fall (as a slowdown in the economy is discounted into the Bonds) the Yield curve will Flatten. Money Supply will be CHOKED OFF.

Liquidity dries up, Speculation falls.

Asset prices fall further – expect those assets that climbed most to fall the Hardest (I’ll discuss Gold later).

FEAR levels ratchet up a bit – watch the VIX.

Second Milestone (Aug/Sep ’06)

Fed responds to stem the ‘downdraft’ in the markets the only way they know how. Reduce Short Term Interest Rates and FLOOD the market with Liquidity.

PROBLEM 2: The Bond Market understands what the Fed is trying to do and Sniffs Inflation, Rates start to Rise. Where is all the new money going to go? Who is going to borrow it? House Prices not looking so HOT anymore.

Chart 1 – It will takes 6 months before Consumers feel the Price Weakness forecasted by the Philli Housing Index.

Call in the Troops!

About this time (Nov / Dec) War Mongering from the Pentagon ratchets up BIG TIME. Remember how the onset of the ‘War on Terrorism’ marked the beginning of the end of the 2000 – 2002 Bear Market? There’s nothing like War to Crank up Economic Activity. Same Trick – Iran will be Bulls-eye. Expect actual Military action in late ’06 or early ’07.

PROBLEM 3: Talk of War and Actual War sends FEAR levels through the Roof. Nobody but the government is Spending (and we all know how the government pays off it’s debts). Inflation and Interest Rates soar. Gold and Oil Rocket!

The Public that was mesmerized by the media when the market dropped 15% in May ’06 now feel like they are going thought a Frontal Lobotomy! Without Anesthetic.

Asset prices Evaporate!

Wave 2 ends late 2008. Dow hits 5000 and HUI 1200. Nobody is in the mood to buy stocks (except maybe us). If you think this sounds dubious, let me remind you that for most of 1987 Interest Rates were rising along with the Stock Market. That was until October 1987.

Here’s what you need to do:

Plan your response to the Market in a Military Fashion. Plan for the next 2 – 3 years out.

The average Gold or Silver stock is now roughly 30% below its peak of early May ’06. You’re Hurting – we’re all hurting. But the ironic thing is its now time to BUY not SELL. I calculate 280 on the HUI to be the rock bottom of this Correction! That’s only 10% lower than Wednesdays close. STEP UP AND BEGIN BUYING! But be smart, average into the market over the next 3 to 4 months.

Gold has been acting as a Commodity and a Poor one at that:

Chart 2 - Gold has severely underperformed Base Metals. This will change when FEAR sets in.

Once the current correction in Gold Stocks is over (Oct / Nov ’06) I believe Gold will detach from the Stock Market and begin to behave in a way fitting for the King of metals. Gold will see its BIG moves when FEAR really sets in!

At the beginning stage of this collapse the Dollar may rise as all asset classes deflate. Average into Non-US Miners now.

When War gets underway and FEAR takes over, get out of the Dollar in Favour of Gold. US Miners will benefit here.

There’s one HUGE benefit to the current correlation between Gold Stocks and the Stock market. Both are moving in the same direction. This is not Historically so. Gold Stocks usually move opposite to the Stock Market. Buy Gold Stocks and Buy Puts on the Dow (I like Jan 07 110 Puts Stock Code: ZAWMF.X)

The BENEFITS:

If the Stock Market and the Gold Stocks continue moving downward together, the Position will be hedged to an extent against downside loss (Puts will gain in value).

If Gold Stocks decouple and head upwards when the Stock Market falls, the position will do VERY WELL. You’ll make on Gold Stocks and on the Dow Puts. DOUBLE WHAMMY! This is my anticipated scenario.

If the market goes nowhere you lose the premium paid for the Puts. I for one don’t expect the Markets to Stand Still over the next 1 to 2 years!

Happy Trading.

Greg

CONTACT INFORMATION
Greg Silberman
USA
Email l http://blog.goldandoilstocks.com/

I am an investor and newsletter writer specializing in Junior Mining and Energy Stocks.
Please visit my website for more free articles and analysis.
Click here: http://blog.goldandoilstocks.com/

The opinions of FSU contributors do not necessarily reflect those of Financial Sense.