April 20 2007

Watch This Space

Precious metals investors have been in a happy mood lately.  Although gold and silver have lagged their base metal brethren they are showing signs of life again and buying is  returning to precious metals equities, though not in amounts that many have hoped for.
We’ve been bullish on gold for a number of years, though we have focused on other metals at different periods in HRA when they offered better short term gains.  We continue to expect  2007 to be another strong year for precious metals.

Although we believed and stated, several years ago, that metals had decoupled from the US Dollar, the value of the greenback will always be an important price driver, since it’s the benchmark against which commodity and precious metals prices are measured.  We’ve noted in more recent comments that gold and silver, but especially gold, has not responded to increasing prices with supply increases.  This lack of supply response coupled with increased investment demand explains some of the upward trend in precious metals prices.

Even though precious metals no longer slavishly follow an inverse price relationship with the USD, it’s a big factor, and it comes into play with particular strength when the value of the Dollar reaches important milestones.  One of those is approaching now.

One hardly needs to be a master technical analyst to read the direction of the trend in the chart below, which shows the value of the USD Index since 2000.  The Dollar dived from the start of 2002 until the end of 2005, reversing only with stronger economic numbers and the start of the latest Fed tightening regime.  That lasted until the Fed stopped raising rates and evidence increased that the US economy was starting to slow.

Trade and government spending have always impacted exchange rates and the news from that front has been bad for years, with increasing current account and stubbornly high government deficits in the US that demand constant inflows of funds.  In large part it explains the overall trend above.  This is “old news” however and over the next few months we expect interest rate differentials between different areas will be the major determinant of currency moves.  On this basis alone, we expect the Dollar index will test the 2005 low in the 80 range and move below it.  The Dollar has also exhibited seasonal weakness in the second and third quarter ( the blue arrows on the chart) of the past several years and this is likely to exacerbate the downward trend.

The Fed has talked tough on inflation lately, but we think its really just talk.  They have intervened in the long bond market to keep the 30 year rate below 4.75% which is not behavior we would expect from a central bank intent on raising rates.  The US economy is growing too slowly to justify higher rates.  The US also has a major advantage in hosting the world’s pricing currency.  Even large downward moves in the dollar have not impacted domestic inflation rates much.  We’ve long considered US inflation measures a bit of a joke, but the market runs on the mythical “core rate” and as long as it stays at currency low levels the risk of rate increases is low.

This is not the case in the Eurozone, Britain or Japan.  British inflation increased to 3.1% this month, a 9 year high and above the mandated target range for the Bank of England.   This all but guarantees another rate increase next month, bringing the bank rate to 5.5%. The ECB held rates steady last week but they have already warned that rates will almost certainly need to rise again from the current 3.75% level at the next rate setting meeting in June.  European growth has been more robust than many analysts, especially the Wall St variety, expected. 

Last night, China put out extraordinarily strong growth numbers – 12% YOY for the first quarter of 2007.  More rate increases from the bank of China to cool the economy are all but assured.  The single laggard has been the Bank of Japan, which is clinging to its decade long weak Yen policy in the face of increasingly strong growth numbers.  We don’t expect the BoJ to be easily swayed and Washington loves the carry trade that helps hold US rates down but Tokyo will see increasing pressure from other quarters.

Russia now has the world’s third largest FX reserves and is moving away from the dollar. Ditto Brazil, which is accumulating FX rapidly on the back of record resource prices.  China is awash with dollars and will increasingly recycle them for real stuff.  Chinese buyers are circling the globe buying up resource assets.  The writing is on the wall for the dollar.  Short of several very unlikely rate increases, the Dollar Index will break below the 2005 low and isn’t likely to stop until it gets below 75.  The future looks grim for the dollar, which means it should be rosy for gold and other precious metals.

*****

David Coffin and Eric Coffin are the editors of the HRA Journal, HRA Dispatch and HRA Special Delivery publications focused on metals exploration, development and production stocks. They were among the first to draw attention to the current commodities super cycle and have generated one of the best track records in the business thanks to decades of experience and contacts throughout the industry that help them get the story to their readers first. Please visit their website at www.hardrockanalyst.com for more information.

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The HRA – Journal,  HRA-Dispatch and HRA- Special Delivery are independent publications produced and distributed by Stockwork Consulting Ltd, which is committed to providing timely and factual analysis of junior mining, resource,  and other venture capital companies.  Companies are chosen on the basis of a speculative potential for significant upside gains resulting from asset-base expansion.  These are generally high-risk securities, and opinions contained herein are time and market sensitive.  No statement or expression of opinion, or any other matter herein, directly or indirectly, is an offer, solicitation or recommendation to buy or sell any securities mentioned.  While we believe all sources of information to be factual and reliable we in no way represent or guarantee the accuracy thereof, nor of the statements made herein.  We do not receive or request compensation in any form in order to feature companies in these publications.  We may, or may not, own securities and/or options to acquire securities of the companies mentioned herein. This document is protected by the copyright laws of Canada and the U.S. and may not be reproduced in any form for other than for personal use without the prior written consent of the publisher.  This document may be quoted, in context, provided proper credit is given. 

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