Fighting The Headwinds

With almost everyone expecting the gold price to weaken further, can the metal possibly rally?

...Or is this precisely the reason why it will?

The gold market is now characterized by a near-unanimous bearish view for the short term. And the reasons are pretty convincing, including...

•     Commercial net short positions have risen to nearly equal the dizzying heights reached in late February, before a sell-off in the Shanghai stock market sent the world’s investment markets reeling into a liquidity vacuum.

That, in turn, sent gold plummeting, thereby rescuing the commercials’ short positions. The commercials are usually right in their market forecasts, and they were proven so again in February.

Now, they’re betting against gold once again. And with their glittering track record, it’s getting tougher for them to find others willing to take the other side of the bet.

•     As in that previous instance, the Chinese market looks vulnerable. The most recent data showed that GDP grew at a remarkable 11.1% annual rate in the last quarter, compared with 10.4% in the previous quarter.  Moreover, retail sales jumped 15%, fixed-asset investment increased 24%, real estate investment was up 27% and residential housing projects grew 30%.

Perhaps the most worrisome indication that the economy could overheat was the inflation rate. The top line CPI for March came in at a 3.3% annual rate -- well above the central bank’s top boundary of 3.0%.

In reaction, the Shanghai index lost 4.5% on the day. While only about half the loss the Chinese market experienced on February 27, this decline was eerily reminiscent of the thrashing global equity markets -- and gold -- took in the wake of the sell-off of two months ago.

•     The U.S. stock market has taken off on a surprising, and impressive, rally in recent days. Speculative funds are moving into U.S. equities to participate in this rally, draining available funds to some degree from gold and other commodities.

•     Geopolitical tensions, particularly the nuclear standoff with Iran, appear to be easing.

•     Central bank gold sales under the Washington Agreement have ramped up, exceeding the weekly “run rate” necessary to meet the annual quota. (The banks have been well under this run rate for most of the year.)

•     Even very bullish analysts are calling for gold to consolidate its recent gains before renewing an attack on the next “big number” of $700. In addition, gold has been trying to hold the 500-euro level, and is failing to do so. From a technical standpoint, the charts are calling for traders to step aside for the time being.

•     Gold and gold stock investors are anticipating another dreaded spring correction. Like some cheesy pop song with a catchy beat, the “sell in May, go away” mantra keeps playing over and over in our heads. Money is being taken off the table at every opportunity and, as the anniversary of last year’s May 12 peak approaches, the selling pressure may only increase.

Can It Get Any Gloomier?

Taken together, it all makes for a pretty bleak picture for gold in the near term. There should be no reason to buy it right now, and no way that the metal will renew its climb toward $700.

Which may be the precise reason why it will.

Gold has seized many opportunities to make fools of the investing herd during this bull market, often rising just when it seemed virtually certain to fall.

It is the job of a bull market to shake the confidence of longs -- and to shake as many as possible out of the market -- along the way. It remains to be seen whether the latest correction and bearish anecdotal information has done enough to drain enthusiasm and set the stage for a new rally.

Frankly, I wouldn’t be surprised to see gold rebound very soon, as investors once again awaken to the fact that the dollar will fall as the interest rate differential between the U.S. and Europe shrinks...that Chinese economic growth (and demand for commodities) will continue to grow...and that supply constraints for gold and other metals will continue to drive prices higher over the long term.

In addition, the very propensity of savvy and cynical investors to pull in their horns at this time of the year has prevented the development of a euphoric, frothy, speculative market in the metals or the mining shares. That was the type of market we had last year at this time, and the type of market from which severe corrections occur.

With all that said, however, I still advise caution in the days and weeks ahead. For one thing, the buoyant-but-not-yet-overblown price levels for many stocks have spawned yet another orgy of financings.

A couple of days ago, for example, I noticed news releases from five separate companies had come into my e-mail inbox at virtually the same time. There they were, five announcements, all lined up in a row. Surely at least one of them would hold news, good or bad, of exploration results?

Nope. Not a single one. All five were announcements of new financings. And you could almost hear a bell ringing somewhere....

Bottom line: The financings we’ve been seeing will come free around the end of the summer, sending a flood of paper into an already engorged market. It will be the perfect way to put in the bottom of a cycle...and to buy aggressively.

In the meantime, I suggest that you enjoy whatever rallies (and associated trading volume) that the metals and mining share markets deliver, and use them to position yourself for a potential dry period through the early to mid-summer.

“Position” doesn’t necessarily mean “sell,” however, as some exceptional buying opportunities have developed — all of which are detailed for subscribers in the upcoming edition of Gold Newsletter.

*****

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. To learn more, visit www.neworleansconference.com.