June 6, 2006

Be Careful What You Ask For...

In retrospect, our strategy of taking outsized profits off the table when we could, over the past few months, seems to have been a good one. Still, if you’re like me, you wish you could have sold even more, and perhaps bought less, during that period.

Hopefully, you followed my advice better than I did myself, and find yourself with a hoard of cash in search of some irresistible bargains. At this point, some are beginning to materialize, although I would prefer to give this corrective phase a little more time to assert itself before jumping in.

As I look back at my recent advice, I notice that I was also correct in pointing out how investors were refocusing on the dollar story, and losing their fascination with the geopolitical headlines that had been driving gold to a large extent.

My mistake was in presupposing that the focus on the dollar would be bullish for gold. In fact, and unfortunately, the hot-money speculators that push the gold market to and fro over the short term naturally think only of the short term. In other words, they tend to view inflationary signals as being bearish of gold (and bullish of the greenback), because such data will lead to Fed rate hikes.

That these players have returned to the gold market has been illustrated by recent sell-offs, as the hot money sloshed to and fro based on each day’s headlines or rumors. Fed Chairman Ben Bernanke’s hawkish, anti-inflationary comments on June 5, for example, sent gold, as well as the U.S. stock market, on a tumble.

So what does this mean for the future? In the near term, volatility...as bargain-hunting physical buyers battle it out with hot-money speculators looking for a quick hit, and margin-call victims trying to stay above water.

Over the longer term, this corrective phase will pass us by (perhaps sooner than most suspect), as the dollar continues its slide.

On that note, there have been reports that the Bush administration is quietly accepting that a dollar decline is necessary to restore some semblance of balance to the U.S.-China trade equation.

Moreover, despite Bernanke’s protestations to the contrary, the Fed will find it difficult to continue its campaign of rate hikes in the face of a weakening housing market. With home prices still high and mortgage rates rising, more consumers are forced to rent in a very tight rental market. This is driving rents higher, which is the primary housing component of the CPI.

You see, over the years, the CPI has been cleverly constructed to avoid some of the more worrisome price signals, the better to mask rising inflationary pressures and cover politicians’ backsides. One of the more odious schemes concocted by the government bureaucrats was to hide rising home values by choosing rents as their measure of housing costs.

Over the decades, as housing values soared, their little machinations worked wonders, helping to significantly understate the rate of inflation. But now, with rents rising more quickly than housing prices, the bureaucrats are being, to paraphrase Shakespeare, “hoist by their own petard.”

In other words, by raising interest rates to stem inflation, the Fed is now, ironically, putting intense upward pressure on its own index of inflation. It seems likely that the Fed governors will recognize this, and thereby resist the temptation to raise rates much higher.

So, to sum up, the roller coaster ride will continue, and on any given day I would not be surprised to see either an impressive rebound in metals and mining stocks...or an acceleration to the downside as margin-related selling builds steam.

If you can avoid selling in this environment, you should do so. Better yet, if you can afford to pick away at some bargains, you should consider it.

Brien Lundin is the editor and publisher of Gold Newsletter, a publication that has ranked among the world’s leading precious metals and resource stock advisories since 1971. To learn more about Gold Newsletter, visit www.goldnewsletter.com.

Mr. Lundin is also the host of the famed New Orleans Investment Conference, the world’s oldest and most respected gold investment event. This year’s New Orleans Conference will feature Steve Forbes, Jim Rogers, Dr. Marc Faber and Dennis Gartman...plus dozens of today’s top gold and resource stock analysts...and a blockbuster debate between Doug Casey and Newt Gingrich. To learn more, visit www.neworleansconference.com.