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Thus Spake Bernanke. Messages from Jackson Hole.

By Jon Nadler       Printer Friendly Version
Aug 22 2008 2:51PM

Good Afternoon,

Gold prices fell during this winning week's final session, reaching lows of near $823 as participants continued to ponder whether the 5% rally from last Friday's 775 lows was real or just virtual reality. The yellow metal has repaired on third of the damage it sustained since the $910 high seen three Fridays ago, and about one fifth of the hit it took after recording its mid-March record-setter of $1033.90

Bouts of intra-day volatility continued to buffet the markets, with sharp drops and equally sharp spikes punctuating the few periods of relative calm during which traders get to catch their breath. The Friday session last saw gold down $8 at $828.20 as players digested the apparently soothing words offered by Mr. Bernanke to jittery investors and decided that there was no imminent reason to back up the truck on commodities. Today' support came from a Bundesbank that appears firm in its resolve to hang on to its gold reserves. Wish the same could be said about, say, Italy.

Mr. Bernanke spoke. He was as calm as the waters in the lake outside of the Teton Lodge. Markets listened. Speculators acted. The public continued to scratch its collective head. How and when will the storm end? What will the damage be? Where is the next great investment to be found?

We found this passage from his speech referring to the trends we've seen since mid-July in commodities and the dollar, as most relevant.

"Recent developments in commodity prices and the dollar, combined with slower growth, should lead inflation pressures to ease, Bernanke told policymakers and leading economists attending the Fed's annual retreat in Jackson Hole. The recent decline in commodity prices and the increased stability of the dollar have been welcome trends. If not reversed, these developments, together with a pace of growth that is likely to fall short of potential for a time, should lead inflation to moderate later this year and next year."

Read into these words what you will; we interpret them to imply that if the dollar slips back towards where it was aiming in mid-March and mid-July, the Fed will pull the interest rate trigger sooner rather than later. Ditto, if it senses that oil and other inflation-boosting commodities start getting out of hand again. There are, of course, other triggers to resort to (as in regulatory ones) as regards excessive speculation in commodities and/or currencies. That seemed to have been implied as well. In light of these prospects, we are not sure we would be running out, to load up on additional commodities positions. Unless, perhaps, we were turned into long-term holders after having bought at higher levels and saw wisdom in bringing down our cost averages. Stocks appeared to react with a positive response to the speech. Oil gave up nearly three-quarters of yesterday's massive gains as the speculative bears chased the Russian bear back into the woods. Gold looks like it could well retest $800-$815 again.

Mr. Bernanke also used the "too big to fail" term several times during his speech when referring to financial market instability. The take-home notes from today's presentation may conclude that while Fannie and Freddie will very likely not be left to curl up and die, there might be one or two firms which - if not successfully adopted by outside interests - could be allowed to go under and restore the sense of fairness as regards to the 'moral hazard' issues that many are obsessing about. Too big to fail is not the same as too interconnected to fail. Supervision and regulation will become the hot buzzwords in financial markets as we move along and leave the current debacle to be analyzed by scholars. On that, the Fed may (finally) be ahead of the curve.

In all, a reassuring talk, albeit one that admits that we still have problems remaining in the financial world, and that their sorting out could extend up to the next such late-summer Jackson Hole summit. Our take is that the '09 meeting might be considerably more upbeat. Silver dropped 30 cents to $13.53 while platinum reversed course and fell $27 to $1422 following yesterday's very impressive rally. Palladium gained $2 to $289 per ounce. The greenback was up .50 at 76.52 on the index and was quoted at $1.481 vis a vis the euro.

Commodities resumed their downtrend overnight, following a surge in the US dollar that basically obviated yesterday's decline and following an easing (albeit not too dramatic) in crude oil values after yesterday's "Molotov Cocktail" (nice word pick from RBC's George Gero) explosion to the upside. Markets were fixated on the unexpected stall in the UK economy, the London real estate shakeout and the Jackson Hole meeting of the wise men and women who are supposed to come up with a solution to the on-going credit debacle. Thus far, the solution appears to be to wait. Time and supportive words are supposed to allow the markets to work this out. In any case, the same markets will have a far better grasp of where this is all going once a firm decision is made in the Fannie/Freddie operating room and either the patient is dissected while still alive, or its various organs are donated back to the government.

A most important Mineweb article was written this morning by Lawrence Williams. We urge you to dissect it as it contains the truth about the US gold and silver Eagle 'situation' and (perhaps more importantly) why the allegations that the production glitches are part of some wild/sinister plot are as misguided as their Reynolds-cap wearing creators. First the article:

"There has been considerable speculation, and some misinformation, published regarding the suspension of sales last week by the U.S. Mint of some of its gold coinage - notably the 1 ounce gold American Eagle coin. Yesterday the Mint clarified the situation with a statement elicited by U.S. Representative John B Larson (D-Connecticut) which supported almost in its entirety the situation as defined in the Mineweb article Another gold conspiracy unveiled!

In the above article it was pointed out that it was only the 1 ounce Gold Eagles for which sales had been suspended and that the Mint's other gold coins (smaller sizes and the higher tenor 1 ounce Gold Buffalo) were still available from the Mint contrary to some other reports.

According to the statement from the Mint, "Because our vendors are not able to supply enough one-ounce gold bullion blanks to meet the unprecedented demand we are experiencing, the United States Mint notified our authorized purchasers on August 14, 2008, that we must temporarily suspend sales of the 2008 American Eagle One-Ounce Coin.

"However, one-half ounce, one-quarter ounce, and one-tenth ounce 22-Karat American Eagle Gold Bullion coins are still available to authorized purchasers and are in stock at the United States Mint. In addition, one-ounce American Buffalo 24-karat gold bullion coins are still available to authorized purchasers and are in stock at the United States Mint."

While the Mint's statement does clarify some of the wilder speculation which followed the original suspension of the Gold Eagle sales, nonetheless it does emphasise the huge surge in demand for the U.S. gold coins demonstrating that demand from the coin collector and small gold investor has been very substantial indeed and that sentiment towards gold has not been damaged by the recent price dips. Indeed there is speculation that the publicity regarding the sales suspension has been one of the factors helping the gold price recovery of the past couple of days.

The Mint also notes that it is currently working diligently to build up its inventory and hopes to resume sales of American Eagle Gold Bullion coins shortly. Meanwhile the Mint has also had to suspend sales of 1 ounce American Eagle silver proof coins, due to a similar shortage of blanks from its suppliers."

We have written - time and again - as to the shortage of blanks not being the same thing as a shortage of raw material from which to make them. The link within Lawrence's article exposes and underscores that same conclusion. So, let's just say that if people REALLY like the current price and REALLY want to buy, they still have wonderful alternatives available to them. Some, FROM THE VERY US MINT that is supposed to be unable to get its hands on gold and silver! Unless, of course, one is fixated on the female form, as opposed to the more manly...buffalo. In which case, patience will have to do.

Speaking of really liking a particular price, it is time once again to gaze into Mark Hulbert's crystal ball of contrarian sentiment. The last two or three such snapshots of the state of newsletter sentiment have been spot-on enough to have served as red flares for the bulls. Let's see how it works out this time around. Marketwatch relays Mark's latest findings:

":You can learn a lot about market sentiment by following the debate over whether commodities are in a bear market or a mere correction.

Chart of GLD

According to the "official" definition, of course, which defines a bear market to be any decline in excess of 20%, there should be no doubt that many commodities are indeed in a bear market. Before the rally over the last week, for example, crude oil was trading nearly 25% below its all-time high. Gold's decline was slightly less severe, but still in excess of 20%.

But to hear many analysts tell the story, commodities have experienced nothing more than a mere correction in an on-going bull market. They go to great lengths trying to dismiss the significance of the decline. On one level, of course, this debate is pointless. A 20% decline is still a 20% decline, regardless of what we call it. The real question is what is going to happen going forward.

And it is in answering this latter question that the debate begins to take on some significance. What those in the "commodities are in a mere correction" camp are really trying to say is they think commodities are headed much higher. Those in the "it's a bear market" camp, in contrast, are also speaking in code, this time trying to say that commodities are headed much lower.

This is why contrarians are so intrigued by the debate. If the consensus opinion right now was that commodities were in a bear market, then the contrarians would be drawing bullish conclusions. But with so many arguing instead that commodities suffered nothing more than a mere correction, contrarians are not detecting the sentiment foundation that would support a significant rally.

Consider the latest readings of the Hulbert Gold Newsletter Sentiment Index (HGNSI), which reflects the average recommended gold market exposure among a subset of short-term gold-timing newsletters tracked by the Hulbert Financial Digest (HFD). Because the HFD doesn't collect sentiment data for other commodities, the HGNSI will have to suffice as a proxy for the entire sector.

As of Thursday night, the HGNSI stood at 6.4%. Needless to say, that is a lot higher than where it would be if the average gold timer was convinced that gold was about to enter into a major decline. For example, in the correction that ended in early May, the HGNSI dropped to minus 10.7%. And during gold-market weakness in early April, the HGNSI dropped to as low as minus 17.9%. Both of these earlier HGNSI readings were following by significant rallies.

During gold's recent decline, in contrast, the lowest point to which the HGNSI fell was minus 0.7%. Of course, gold and other commodities have mounted a decent rally over the last few days. And, needless to say, that rally could continue.

After all, sentiment is not the only thing that makes the investment world go 'round. Still, contrarians would be more confident in that rally's staying power if there weren't so many investors and advisers otherwise arguing that the greater-than-20% decline is nothing to worry about."

Well, there is at least one newsletter that would not fit in with some of the crowd being tracked by Mt. Hulbert. We took the liberty of quoting a relevant passage from last night's send by Steven Jon Kaplan to his subscribers. Could be an interesting metric to watch, the one Steve alludes to:

"Today's first main topic is the implications of the current commodity bounce, and how to track it.

Whenever any asset class has plunged from a particular trading range all the way down toward an important support level, its immediate subsequent behavior gives you valuable clues as to its future direction over the next several months.

As a rule, when any very depressed asset attempts to continue to decline, while experiencing gradual positive divergences, this is a classic setup for a sustained rally of higher lows. For example, if gold and silver had continued their pullback, while gold mining shares had fallen each morning and mostly recovered each afternoon (see May-August 2005 for a classic example of this behavior), this is how powerful bull markets are made.

Whenever a recently collapsed asset instead enjoys a powerful rebound, while closely correlating asset classes move in nearly perfect tandem, this sends a danger message that the recovery is false and cannot be sustained. As a rule, bear-market bounces tend to be heavily synchronized; they tend to induce heavy short covering by an army of late-arriving amateurs; they tend to see the formerly weakest groups suddenly becoming the strongest; and they tend to be particularly intense.

We are experiencing exactly this kind of false rebound for commodities and their shares. Not only did precious metals move higher today, but so did all other commodities. The U.S. dollar, which clearly remains in a major bull market that began on March 16, 2008, plummeted sharply.

In other words, all of the general commodity/currency trends of the past five months saw a nearly perfect inverse day in the opposite direction of these trends.

Why did this happen? The answer is simple. As commodities continued and accelerated their respective downtrends, the media began to turn gloomier toward commodities. A number of analysts began to ask, is the commodity bull market over? Especially during the past two weeks, amateurs have been piling into commodity bear funds and unloading their commodities and commodity shares. Amateur short positions were piling up.

The financial market hates any crowded trade. Therefore, it will always shake out all late-arriving participants to any important trend by staging a dramatic countertrend designed to scare anyone who is not an experienced player.

Many people had asked me whether precious metals had bottomed, or whether other commodities may have bottomed. Until today, I was not sure. Now I am positive that they have not, because the only possible sequel to today's action is the eventual resumption of another major downtrend for commodities and their shares.

How will you know when this downtrend is about to resume? The key lies in the behavior of a fund which is little known to the general public, but which should be familiar to readers, DBA.

DBA is an exchange-traded fund of futures contracts for wheat, soybeans, corn, and sugar. Agricultural commodities, having been the latest hot-money investment choice since August 2007, seem to have been established as the leading edge of the hedge-fund trading universe.

Therefore, for all of the past year, if you see what DBA is doing, you know what the commodity complex will do the following week.

Today, DBA reached a mid-morning peak of 38.16. If you take the high for DBA of 43.50 from February 27, and the low of 32.88 from August 8, the midpoint is exactly 38.19 which almost matches today's high. The 61.8% Fibonacci retracement is equal to (43.50 32.88) * .618 + 32.88 or 39.44. Therefore, additional upside is possible, but today's high must be watched closely.

If DBA begins to make a pattern of lower intraday highs over the next several trading days, while the U.S. dollar continues to decline to complete a reverse right shoulder, this would be a classic indication that the commodity downtrend will resume in full force as soon as the greenback begins to find support and forms the next phase in its uptrend.

On the other hand, if DBA continues to form a pattern of higher highs, then keep an eye on the 61.8% Fibonacci retracement level of 39.44. This may be broken by a marginal amount, and then a pattern of lower highs may ensue. Otherwise, if this level can be easily broken to the upside, followed by additional higher highs, then commodities will be enjoying an extended short squeeze which will continue for the near future.

Either way, DBA will give the most accurate signal of when the commodity downtrend will continue. The recent intense, coordinated rebound ensures that the downtrend must continue, and therefore it is only a question of when, not if."

Watch for more words from the "Hole" and for Lehman-related developments. Flash e-mail chatter crossed many a laptop about a Korean buyout of the firm (KDB). Monday will tell more. A second week of repairs/consolidation is almost an absolute must at this juncture. Show of hands, anyone?

Happy Trading. Pleasant Weekend.

Jon Nadler
Senior Analyst
Kitco Bullion Dealers Montreal



Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.