Finally!
November 05, 2004

Now that the US election is over, the market can get on with business as usual, and that means it will shift its focus back to the economy.

During an election year the incumbent administration presents the economy in its best possible light, to show how beneficial its policies have been to the economy and the country as a whole. This election year, the administration was unable to portray the US economy as healthy.

Weakness in the economy weighed down the stock market and could have cost George W. Bush the election, since the incumbent president rarely gets re-elected if the stock market declines during an election year. But then, the incumbent is also rarely defeated if the country is at war. This year the latter outweighed the former.

President Bush has a problem: the War on Terrorism is draining an already weak economy. On Wednesday both General Motors and Ford announce declines in their October sales; 4.7% and 5% respectively. Regardless of the cost, President Bush is unlikely to end the war anytime soon. At least the Defense sector has reason for joy.

Defense stocks rallied the day after the election: Northrop Grumman shares rose 4.1%, General Dynamics increased by 4.3% and Lockheed Martin registered a 3.2% gain. It seems a sure-bet that President Bush will increase defense spending, and that means the Federal budget deficit is going to grow.

In the budget year that ended September 30, 2004, the budget deficit came in at $413 billion. Next year’s budget deficit is projected to approach $600 billion and has to be financed by issuing new Treasury bonds. This added supply of bonds is sure to put downward pressure on bond prices, which means that medium to long-term interest rates are going to rise. To quote the Wall Street Journal, on the day after the election “Bonds were thumped” and the thumping continued into Thursday. According the Wall Street Journal “ Bond investors worry that government spending will remain high. That, analysts said, raises the specter that at some point holders of Treasuries might -- as they did in the early 1990s -- convey displeasure by pushing up yields.”

None of this is unexpected; it’s what I’ve been writing about for almost a year now. The reason I’m still writing the same story is because, for gold investors, this is the story. The price of gold (in US dollars) depends on the dollar exchange rate.

Dollar volatility this week caused gold price volatility with the dollar first declining as speculators went short and then rising as some of those short positions were covered on Tuesday. In response, the gold price, which has been rising since mid-October, fell on Tuesday when the dollar rallied in response to short-covering. The dollar caught many market players off-guard on Wednesday, the day after the election, when it declined instead of rallying, and after Senator John Kerry delivered his concession speech the currency’s decline accelerated. The decline continued on Thursday as, to quote the Wall Street Journal again, “…the currency market turned its attention back to the longer-term pressure that the large U.S. current-account deficit (trade deficit) is placing on the dollar. Additional pressure is coming from uncertainty about the sustainability of the economic recovery and the sense that there are few real dollar defenders among the ranks of U.S. and foreign monetary officials these days.”

I know this is only two days’ trading, but this is what I have been waiting for, and saying will happen: The dollar declined because the currency market is now starting to focus on fundamental issues affecting the greenback, and the greenback’s prospects are bleak. At the same time, bond prices are falling (i.e. interest rates are rising) because the bond market is now also looking at fundamentals, and it doesn’t like the prospects for US bonds either. So here we have the dollar falling at the same time as interest rates are rising.

Again, I know it’s only been a couple of days so far, and so I absolutely would not call it a trend, but if the dollar keeps falling while interest rates rise, the next major advance in the gold price has begun. At least that’s my story and I’m sticking with it.

On the lighter side, thanks to one of my readers, I finally understand the story of the Wizard of Oz. The McKinley-Bryan election of 1896 that I wrote about last week was also the inspiration for Lyman Frank Baum's tale, The Wonderful Wizard of Oz. Here’s the link to the website I was referred to: www.wccusd.k12.ca.us/elcerrito/history/oz.htm. Thanks Mark.

Paul van Eeden

Paul van Eeden works primarily to find investments for his own portfolio and shares his investment ideas with subscribers to his weekly investment publication. For more information please visit his website (www.paulvaneeden.com) or contact his publisher at (800) 528-0559 or (602) 252-4477.

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