GOLD
IMPETUS & RISKS
by Jim Willie CB
January 11, 2007
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Jim Willie CB is the editor of the “HAT TRICK LETTER” For specific detailed analysis of the Gold, USDollar, Treasury bonds, and inter-market dynamics with the US Economy and Fed monetary policy, see instructions for subscription to my newsletter research reports, which include stock recommendations positioned to rise in the commodity bull market. PREFACE TO GOLD The commodity world has been jolted in the last few weeks. While most market watchers, mavens, and supposed experts comment upon the weather, the real story behind the oil price is the cheating on OPEC output quotas. Furthermore, Saudi Arabia seems engaged in a coordinated plan with its US brethren to destroy Iran using economic weapons, like oil price. The Saudis have discounted by $1.75 its oil price on topline sweet crude sales to its US customers. If Iran cannot be given the shock & awe treatment like Iraq, since Russia is tied like a direct strong umbilical cord in defense, then Saudis will deliver serious financial blows to Iran instead by aiding and abetting the oil price down. They offer lip service to production cuts and other associated FedSpeak tactics. They are flooding the market with oil, even as Russia does the same, while almost all OPEC players are cheating. THOSE ARE THE REAL STORIES, NOT SILLY WEATHER. Heck, blame it on the weather, and the majority of shleps will believe that, especially when short sleeved shirts grace the landscape in New York City. There are three topics of conversation identified as “small talk” pursuits among people who struggle to engage each other at a base level without depth: weather, sports, and politics. One can be sure that Goldman Sachs, the USGovt, and the Saudis are enjoying the embraced diversionary topic of weather, as backroom deals are struck, tactics are shared, extreme profits flow, and effects are pronounced. Just like the GS Commodity Index weights on gasoline were tinkered with last August, some mammoth output and pricing forces are at work now. My Gosh! Weather is responsible for perhaps $3 to $4 in the oil price, no more! Russia is even adding fuel to the fire, as it angers OPEC by selling more oil when output cuts are debated openly and sometimes with hostility. The Russian oil production runs now at 9.75 million barrels per day. Russia angers US officials also, since its Urals crude is being sold in Rotterdam in euro terms. Anyone familiar with history realizes that the Saudis were as crucial as the bankers in destroying the Soviet Union. The Saudi royals were coordinated with US policy as they permitted the crude oil price to go under $10, and bankers called in huge loans. Call it a Soviet loan default, but please ignore the underlying force. History rhymes here with respect to Saudis versus Iran. An aside… now we have Russia selling oil in rubles, and also several nations selling oil in euro transactions like Norway, Venezuela, and Iran. The gold price cannot sit still with such assaults on the oil price. Gary Dorsch points out in his usually expert diligent comprehensive style in “What’s Behind the Crash in Crude Oil and Gold?” (click here) that arbitrage in the oil versus gold ratio has contributed toward pulling down the gold price. My scribbles have long cited oil as the ultimate commercial capital blood and gold as the ultimate financial capital blood. They are tied inextricably though, each inversely correlated to the USDollar. As crude fell in price, so has gold been pressured. My analysis points to two other crucial factors regarding gold, which unfortunately have come to the fore. In August, a few key conversations took place between me and other respected writer analysts who generously take the time to talk to me and share their experience. Each of them expected gold to zoom after September finally arrived last year. Not me, and we had respectful disagreements and interesting discussions, with a measure of debate. Seasonality is not enough in my book. Monetary inflation is not enough in my book. Weak USDollar fundamentals are not enough in my book. Each does aid the gold price from higher demand, but historically powerful trends are in place. Now we have a continued energy market decline to slug through. These topics are all covered in the January issue of the Hat Trick Letter, due out early next week. THE USFED RISK – SLOW TO ACT The stock market and the precious metals market each anticipate a new round of rate cuts in response to the USEconomic slowdown. Almost all component evidence points to a slowdown, as focus on housing, manufacturing, car industry, durable goods, and consumer spending all show signs of fatigue and exhaustion, and in most cases decline. It is again funny how the components all show distress, yet the aggregate data from Washington DC agencies shows strength. Believe the components, ignore the noise. An economy so dependent on the housing equity piggy banks on the upside will surely be harmed by removal of the home equity on the downside available for raids, despite denials from our USGovt public nitwit leaders and our Wall Street compromised promotional spokesmen. The gold market had priced in an official USFed rate cut when its price flirted with the 670 level in July and with the 650 level in November. Times have suddenly changed. A FedFunds futures contract has seen expectation of a rate cut by spring evaporate. Credit goes to falsified jobs reports, coordinated actions among central banks, controlled language from central bank officials, revised price inflation calculations in Japan, tepid price inflation measures, a pause in the US housing crash, a warm weather respite on energy bills, and more. One should always recall that the USGovt sells debt through bonds, and sells no stocks. They also harbor a deep desire for commodity prices to remain in check. Oil is a more complex story. The Senators from the State of Oil, who reside in the White House, might have wanted the entire Iraq War in order to double the oil price, secure Halliburton service contracts, and profit from corporate profits in the energy sector which are truly extraordinary. Now that the housing bust is on the doorstep and a recession faces us squarely, Goldman Sachs has tipped the official government hand on the direction next for energy prices. They want the prices down in order to stave off a recession in the USEconomy which would tarnish the presidential legacy, and perhaps wreck havoc on Wall Street. A currency crisis with the USDollar as epicenter is not desired. A side note is justified. The USEconomy did NOT lift from the 2001 recession from tax break incentives. It rose from war and a housing bubble, plain & simple. We live in a war economy which critically depends upon new bubbles, each of which is justified through propaganda and sheer mythical revisions to economic theory. Political poppycock must always be removed if reality is important to your viewpoint. Gold remains at risk until the US Federal Reserve does the responsible thing, namely to lower interest rates. However, the USGovt lies about economic strength, like with jobs and growth. Not a single major economic statistic they pump out makes any sense and bears any semblance to reality anymore. The GDP incorporates a 4% to 5% lie, so we are deemed recession proof. The USFed knows all too well that the initiation of a new rate cut cycle will do damage to the USDollar. Fed Governors might talk about a price inflation risk, but what they really mean is a USDollar risk, which if it declines dangerously, will deliver heavy blows systemically to the USEconomy from higher costs throughout, from energy to metals to food to finished Asian products. The system cannot risk such a decline. It is a currency risk, not an inflation risk, more distortive language to be sure. As long as the USFed delays the next official rate cut, gold is exposed as vulnerable. In my view, silver is far more resilient in holding its price. The gold to silver ratio is in a rather notable downtrend, all covered in the January HTL issue. In time, the USFed will lower rates again, but only when they must, and only when it is late in the game, true to form in a vivid historical pattern. They hike late and hike too often. They cut late and cut too often. Now they are waiting too long. When a boy, my ears were told by my father that the federal debt of the United States is owed to ourselves, and thus not such an outsized risk. No longer. It is owed to many nations of the world, and perhaps half of it rests in actual enemy hands, despite trade partnerships. Heck, the partnership with China is the most destructive in modern history. That with the Saudis is also reprehensible, not to mention its diversion from non-oil solutions. The USFed cannot easily lower interest rates without triggering a rout on the USDollar. We live in a bond driven world, and the higher bond yield offered by USTreasurys has supported the USDollar currency since early 2005. Take it away, and all hell breaks loose. In my conversations with the other analysts, my position was that the USFed would cut rates several months later than they each expected. We disagreed. What the USFed must do is not what the USFed will do. Defense of the highly vulnerable USDollar is of paramount importance. They sell bonds, and bonds are doing just fine, thank you! THE HOUSING RISK – WEALTH DESTRUCTION Integrated with the anticipated USFed rate cut is the expected attempt to rescue the USEconomy from a housing market decline. The housing sector is worth between $20 and $22 trillion in value. A 10% decline is a substantial sum, a huge amount of wealth. Of course, USGovt officials and Wall Street promoters claim that the overall economy is insulated from housing sluggishness and any possible decline. This is truly incompetent in its assessment, analysis, and forecast. Again it is worth repeating. An economy so dependent on the housing equity piggy banks on the upside will surely be harmed by removal of the home equity available for raids on the downside, despite denials from our USGovt public nitwit leaders and our Wall Street compromised promotional spokesmen. Details on the home equity withdrawals are mind boggling, detailed in the January HTL issue. Overall mortgage originations have declined by 45% from 3Q2005 to 3Q2006. Overall equity raids have declined by 70% in the same time frame. To assess as insignificant a $551 billion reduction in mortgage loans, and a $516 billion reduction in extracted cash, to me is pure folly. Of course it is significant. Certainly the USEconomy depended upon the cash raids on people’s homes in order to fund routine spending behavior. To some extent also, many household investments were funded by home equity. Some of that borrowed money found its way into gold metal positions, gold funds (like mutual funds or ETF’s), and gold mining stocks. To think that hundreds of billion$ in absent liquidity does not matter is plain off the mark. To think a $2 trillion cut in housing valuation does not matter is plain off the mark. Many gold analysts expect the housing decline to prompt the USFed into quick action, since the USEconomy is so utterly dependent upon housing. Without the fumes from housing foundations, consumer spending would dry up. The November personal income (up 0.3%) and consumer spending (up 0.5%) highlight the problem. US households have negative savings (minus 0.2%) at a time when price resets from adjustable mortgages are moving up rapidly, when minimum credit card payments have already risen, and when pay raises are few and far between. The savings rate for October was flat. Just as the USGovt lies about almost all economic statistics, the NAHB deceives about prices in the housing sector. In new home prices, nowhere are the builder incentives factored in, like a new car, a quarter of paid property tax, a few months of forgiven monthly, even a jacuzzi. If value based hedonic improvements are permitted in the CPI statistic, why not also to pull down the average sales price for homes? The unsold home inventory is at a high level, actually the highest in 15 years. But factor in purchase contract cancellations, and the ratio looks even worse. Deceptions abound in statistics. Mark Twain knew it (I love the guy’s work). One does not require a professional statistician to expose the corrupt practices, just an alert head and open eyes, combined with a healthy distrust of people who harbor a vested interest. In my conversations with the other analysts, my position was that the USFed would react to the housing bust very slowly, denying it all the way down. We disagreed. What the USFed must do is not what the USFed will do. Defense of the highly vulnerable USDollar is of paramount importance. They sell bonds, and bonds are doing just fine, thank you! NEW IMPETUS FOR PRECIOUS METALS Two new factors will soon figure as important to precious metals. First is the banking sector distress extended from the mortgage loan portfolios and mortgage bonds themselves. So far, the damage has been kept quiet, as private sales of discounted mortgage bonds to hedge funds have not hit the mainstream news in any way, shape, or form. Complete silence has prevailed on the matter. Second is the price inflation from the falling USDollar broadly, and the rising Chinese yuan specifically. The DX dollar index is flirting with critical resistance, next to face a congestion zone in the 85 range. The bounce from its late November oversold position is complete. The trade deficits remain an ongoing drain if not hemorrhage of capital. The housing bear market gains attention, with constant mention in the press & media serving as proof of its bearish validity. The next move for the USFed is a cut. The Euro Central Bank might hint at relaxed additional hikes, but their past talk in the most recent several months has proved quite deceptive and transparent.
Gold and silver will shine in 2007, but not until the US Federal Reserve does what it must do eventually. That is, to begin a new round of interest rate cuts. They are in no hurry, and have marshaled many troops to forestall the inevitable. Never underestimate Goldman Sachs. They sit in the seat of financial power at the White House cabinet. They control the largest and perhaps most successful hedge fund in existence. They influence press reports on economic status. They order shuttle missions overseas as distractions. They coerce currency traders at key points. My view of the timing for the next USFed rate cut, expressed to my analyst colleagues last August, was sometime in the spring of 2007. They thought cuts would come before the end of 2006. My new revised time frame for official rate cuts in the second half of 2007, maybe as late as autumn. A crucial period is March and April, when both home builders put their completed homes up for sale, and when motivated homeowner sellers put their homes up for sale. Builders cannot wait, anxious to sell immediately upon finished construction, as stranded capital seeks payoff and a return on investment finally. Homeowners wish to sell and finalize the transactions near the end of the school season, so the summer vacation is not interrupted. This represents two sources of supply flooding an already saturated housing market. Unaddressed is the other reactive flood, the feedback effect, of sellers motivated to avoid severe equity loss and perhaps negative equity in their homes. The unsold inventory of homes expressed in monthly sales supply is the statistic to watch. It is worse than reported, since cancellations are not factored properly into the sales pace. The US Federal Reserve is playing a game of high stakes chicken. They openly desire some demand destruction, a lower commodity price structure, and more affordably priced residential homes. However, the longer they sit on their hands, the longer they disseminate deceptive reports on strength and price, the more they risk the downward momentum gathering too much force. In time, the housing decline and consumer pullback might not respond to a few simple 25 basis point interest rate cuts. If momentum hurtles downhill, the USFed by yearend might be pushed to stimulate much more than already expected in consensus. We might see most central bankers aggressively cut rates before 2010 once again down to 2%, maybe even by 2008. Only slightly lower rates mean little to a mountain of unsold home inventory or to consumers whose prized asset has lost its mojo.
The opinions of FSU contributors do not necessarily reflect those of Financial Sense. |
Jim
Willie CB is a statistical analyst in marketing research and retail
forecasting.