2005 Review and Outlook for 2006

By Peter Grandich              January 3, 2006 www.grandich.com

2005 – I would like to review my past year’s observations and remind myself and my readers of the good, the bad and the ugly comments. Overall, 2005 was a pretty good year. I began it by being staunchly bullish on precious metals, base metals and uranium, but suggested overweighting to precious metals and uranium after spring arrived. Gold, silver and uranium’s continuous climb outshined my stumble on copper.

My “controversial” change from bull to bear on oil just two days before Katrina struck (which prompted lots of negative emails-even hate mail) wasn’t popular but so far has proven to be the top in oil. Finally, my belief that the U.S. Dollar Index was only in a “counter-trend” rally and would stay in a 85-92 trading range, held even though the top of that range came close to breaking.

Because of my compensated working relationships with junior resource companies, the expectations by some are that I will always favored this group. I know the record shows that on several occasions I expressed some hefty factors that needed overcoming before one could be very bullish on junior resource companies. (See http://www.grandich.com/docs/res_world_09-05.pdf.) I also constantly emphasized the fact that success is the exception in the junior resource game and most juniors won’t become producers- including those I work with. In early 2005, I began speaking aggressively about my expectation that we will see a marked increase in mergers and acquisitions in the mining industry.

On a personal note, a car accident that I was involved in led to a most pleasant surprise -- an overwhelming and gracious response from literally hundreds of readers. This awesome group overwhelmed the sparse few who drag me through the mud in cyberspace. It made taking these unfair and erroneous peanut gallery remarks much easier. Thanks to the vast majority who appreciate my sincere effort to be totally upfront and objective while recognizing my potential biases.

2006 – The year the “Don’t Worry, Be Happy” crowd on Wall Street begin to pay the piper.

While I discuss my overall economic, social and political outlook in the Blue Chip & Income Report which will be released in the next day or so, let me just say here that I believe the vast majority of Americans have been robbing Peter to pay Paul and Peter is tapped out. America has been living well beyond its means and like anyone who has put on too much weight (like me), they eventually have to diet or face serious health issues. And while an energy and terrorism crisis is real, the crisis that dwarfs both of these combined is the coming aging crisis. Furthermore, a debt and deficit crisis, unlike anything the United States has ever experienced, is continuing to grow out of control despite how much the “Don’t Worry, Be Happy” crowd and TOUT-TV (CNBC-TV) pushes it under the rug.

Gold – As noted earlier, I remained staunchly bullish throughout 2005 and kept saying $500 gold was not a question of “if”, but “when.” I issued a special alert on December 9th noting that my technical work gave its strongest short-term sell signal in several years. Within a couple of trading days, gold fell $60. It has been my contention that gold is in a secular bull market and it has been rising in a two steps up, one step down mode. While the corrections are sharp and swift, it’s the best of all worlds for the long term. Besides, we all know that it won’t be near a top until TOUT-TV covers gold extensively for months and the two leaders of the “Don’t Worry, Be Happy” crowd, Larry Kudlow and Jim Kramer, tell us gold is a buy – not good-bye.

The factors that drove gold in 2005 all appear to be set to lead gold higher into 2006.

• Physical and investment demand – According to the World Gold Council (WGC), demand for gold coins, bars and bullion-backed shares rose 56 percent in the third quarter of 2005. Investors and jewelers bought $12.5 billion worth in gold, or 838 metric tons in the third quarter, up 7.6 percent from a year earlier. (Jewelry demand accounts for 73 percent of gold consumption). The rapidly growing economies in China and India have been key and while soft patches are likely going forward, the enormous wealth creation on-going there appears to assure strong demand for gold for the foreseeable future.
• ETFs – While gold pundits will argue if these investment vehicles are truly direct ownership of physical bullion, there’s no argument that the introduction of them has added to overall investment demand. For every one person who may have bought physical bullion in a different manner before and now has instead invested in an ETF, I suspect 99 other ETF buyers are either first time buyers of bullion or used to buy mining shares as a proxy for gold (more on mining shares later). The bottmline is that gold ETFs are a net positive to the demand equation. And when TOUT-TV moves the oil babe over to the Comex, you can bet the “Talking Heads” will be preaching ETFs as a way to invest.
• Geopolitical concerns – Since gold has proven to be a reliable asset to own going all the way back to Biblical times, the marked increase of geopolitical concerns here and abroad can only help serve to underpin the gold price for the foreseeable future. While Iraq is the main centerpiece at the moment, another country that begins with an I is going to move center-stage – Iran (see comment below). While America continues to lose the love and affection of many in the world, I believe we’re going to see some of the ugliest political mudslinging right here in the good ole USA. The wheels in Washington, already slowed in making progress on several critical issues facing America, are all but likely to come grinding to a halt as Democrats and Republicans act more and more like the Hatfields and the McCoys.
• Debt, deficits and the #1 crisis in America – While I love my country and am tired of having to defend it each and every time I travel outside the country, I do believe it continues down a slippery slope that has no simple happy ending. In fact, if all of America woke up today and stopped robbing Peter to pay Paul and lived only within our means, it would be years before the pain would ease and many would never truly recover. That’s why seeing we remain full throttle downhill, I remain so bearish and trying desperately to educate people through both of my businesses.

I believe the debt and deficit crisis has been one of the least talked about, but one of the major reasons why gold has performed so well. I’ve spoken to many sophisticated foreign investors and one of their core concerns is the out-of-control fiscal house of our government and many of our citizens. By 1980, U.S. public debt reached one trillion dollars--191 years after we first started keeping records (note that 1980 witnessed the last great run-up in gold prices). Now, just 25 years later, it’s on the threshold of $8 trillion. In 1980, each American’s share of the debt was $4,405. It’s now $26,700.

When we add the Current Account and trade deficits, we get a very gloomy future. But the number one problem that will tower over these already gigantic headaches is the aging crisis unfolding here, and to a lesser extent, in many other areas of the world (it will become acute in Japan and parts of Europe in just a few years). The social, political, economic and religious upheaval it can cause will have an indirect positive impact on gold because the U.S. dollar is going much lower over the next 3-5 years and interest rates will eventually (not in 2006) have to be much higher to continue attracting foreign capital to sustain us.

Manipulation – I find it ridiculous when any and all comments about gold being manipulated are immediately dismissed as pure nonsense. Anyone who has been involved in the financial markets and in particular commodities can attest to several known past manipulations. So, why then is it so hard to give even a reasonable moment to the claim that gold has been manipulated and/or capped? For starters, it may have been the style of the person or persons that led this cry but like it or not, there’s ample circumstantial evidence to support these claims. And, I would find it hysterical if it wasn’t so sad to see so-called experts who have been so wrong for so long on gold ceremonially throw such claims under the bus yet the media doesn’t question why these folks were wrong for so long. Yet, those who lead the manipulation bandwagon (www.gata.org) have been far more right on gold for several years now.

Bottomline – taking in all the above and throw in the belief the U.S. dollar can renew its long-term downtrend and eventually break below 80 on the U.S. Dollar Index (more below), I believe gold has all the underpinnings to make former multi-decade resistance around $500 the new floor and a test of at least $600 in 2006 is quite possible.

Silver – Called the “poor man’s gold” by some, it too, has some strong underpinnings as we enter 2006 and should at least match gold’s performance. I will likely heighten my enthusiasm if and when the first silver ETF begins trading.

PGMs – While watching paint dry was more exciting than watching platinum and palladium for most of 2005, the PGMs began to garnish some attention thanks to two key factors:

o The forecast that platinum supplies were going to overtake demand once again failed to materialize. Growing demand for diesel auto catalysts is expected to push the platinum market into deficit for a seventh-consecutive year, according to Johnson Matthey, the precious metals group. However, I suspect that automakers are going to look at palladium more as a cheaper alternative, especially if and when platinum rises above $1,000.
o After skyrocketing and then plummeting, palladium finally became so oversold at a time when fundamentals began to look bullish again. It’s important to note that demand for palladium jewelry has risen at the expense of platinum jewelry demand.

I like palladium (its role as poor cousin to platinum is ending) over platinum and think the spread between both will narrow in 2006 and eventually we can see less than $500 between them.

Base Metals – I believe the United States and some other key economies worldwide are entering a period of economic slowdown or even recession. While many base metals have good supply versus demand scenarios, I do think base metals can be more affected by this perceived slowdown than precious metals. I’m especially concerned about a big meltdown in copper as we get into 2006. This doesn’t mean you sell anything base metals-related, but if you find yourself over-weighted you may want to lessen your exposure. This also doesn’t mean that a copper producer isn’t a worthy purchase because we’re likely to see $1.75 or even $1.50 again. Again, it just means the current one-way street in copper has two-way traffic straight ahead.

Uranium – Up until recently, it appeared that “Pet Rocks” had more of a chance of coming back than nuclear plants. Now, Finland is planning the first nuclear plant in Europe since 1991. France, which already has 58 plants, plans on building another 30 more. China says it plans on spending $50 billion on atomic energy construction by 2020. Even the good ‘ole USA has seen over a dozen companies speak again of building new plants. And despite these facts and an energy crisis clearly in our future, you hardly hear anyone outside of those involved with a junior resource uranium stock speaking of one of the most bullish fundamental plays in all areas of the financial world- uranium. I said back in 2003 and again in 2004 and 2005 it was, in my opinion, the most likely metal to rise. That’s no different for 2006.

Mining and Exploration Shares – Going back to my days as a broker in the 80s and 90s, I cringe when I hear people state owning gold stocks was like owning gold. I respond to this falsehood by noting how on Black Monday, 1987, gold rose $11.80 and 6 or so of the 10 or so only stocks up on the New York Stock Exchange that day were gold stocks. The next day, gold lost about $10 and was still up for the two days, yet mining shares lost about half their value. Why? Because people cared little that they mined gold and needed to raise liquidity.

2005 was a year when most mining shares underperformed the underlying metal or metals they mine while junior exploration shares performed even worse. Why? I believe my comments from http://www.grandich.com/docs/res_world_09-05.pdf are still relevant today. The difference now is that we broke above $500 and I stated throughout 2003 through 2005, we would need to get comfortably above that price before enough sustained media and investor interest would finally make most boats rise. We’re at that threshold now.

Oil – I continue to believe my head for the exits called in August during the spike to $70 should prove to be the cyclical top. We’re correcting a very oversold condition and support around $57 held as expected the first time around. I believe we’re now in a broad trading range of $55-$65, but if I’m right about an economic slowdown unfolding, the danger is a sub-$50 price versus breaking above $70. Hurricane season and war rattling are always potential spike factors.

U.S. Dollar Index - While an argument can be made that the U.S. Dollar Index has made a bottom technically, my interpretation is it must get above 95 in order to reverse its downtrend from the 120 area. This time last year, people were tripping over themselves to declare the dollar dead. In addition, the U.S. government for 2005 only, allowed U.S. corporations to repatriate dollars that were overseas and this combined with the Fed’s raising of interest rates allowed IMHO a counter-trend rally to occur. I’m looking for the neckline above 92 to hold and a resumption of the downtrend in the second half of 2006 to take place.

Iraq, Iran and the Middle East – I try to do my best to leave out my personal views when trying to form objective observations for my readers. I will admit I had an internal battle before my country entered Iraq. While very much a Christian conservative who believes the blueprint for life is Jesus’ Sermon on the Mount (message: love our enemies), I also appreciated the belief by those who felt Saddam Hussein must be removed from power. The fear was whether he had weapons of mass destruction (I wish the NY Jets had them instead of weapons of self-destruction) at the time, which I suspect he did but they’re in Syria now and/or destroyed. Even if he didn’t, I believed, like many, that he would eventually acquire them and we all would face a very serious problem.

We can debate this through hindsight until we’re all blue in the face, but I can tell you that Iraq, IMHO, is going to be just the opening act to a showdown likely to come to a head in 2006. The bigger issue will likely be Iran and its drive for nuclear weapons. In fact, I believe Iran can become one of the big news stories in 2006 and the foreseeable future.

Iran’s new President, Mahmoud Ahmadinejad, is purging government institutions up and down the ladder in what “The Guardian” U.K. newspaper called “a coup d’etat.” Throw in his call for wiping Israel off the map, reports that members of Al Qaeda are roaming freely in Tehran and living in homes belonging to Iran’s Revolutionary Guards (according to a German monthly magazine) and a small matter regarding a nuclear bomb, and I believe both Iran and Iraq will become flash points and underpin gold. Israel has become very vocal and has vowed not to allow Iran to have a nuclear bomb. Former Israel Prime Minister Benjamin Netanyahu openly called for a pre-emptive strike against Iran’s nuclear program. London’s Sunday Times reported that Israel’s prime Minster Ariel Sharon has given orders to be ready by the end of March for possible strikes on secret uranium enrichment sites in Iran. The German newspaper Der Tagesspiegel said on December 31st that the United States government has begun coordinating plans with NATO for a possible military attack against Iran. And to top it all off, The London-based Jane’s Defence Weekly has reported that Iran and Syria signed a strategic accord that pledges Syria will store Iranian nuclear weapons and missiles.

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