Topical Testimony


By Jon Nadler

Feb 24 2009 4:35PM


Good Afternoon,

Gold prices fell sharply on Tuesday as speculative funds took flight once it became apparent that a third pole vault to levels above $1K was not in the cards for the week. Options expiry turned out to be as tumultuous as we expected it to be since last week. New York spot bullion lost nearly 3% on the day, at one point touching nearly $50 below the highs we had seen just on Friday. The alarm we rang one week ago today, about the lack of corrective action in gold since Feb. 9, well,...ring it did.

Afternoon trading had gold values still off by $28 per ounce, quoted near $963. Silver lost 58 cents to sink to $13.83 per ounce. Platinum fell $32 an ounce and finished at $1043 per ounce, while palladium managed a $2 gain to $198 per ounce. Not much is to be expected from the noble metals group until the economy in general, and automakers in particular, get their act together. Or, should we say, until someone gets their act together for them.

Today's testimony by Fed Chairman Bernanke was riveting in its singular focus on the banking sector. The Fed Chairman made fixing America's banks the sine qua non of any economic recovery. Some thought it was mainly a matter of clearing out the toxic inventory of overpriced and/or vacant homes. Guess not. At any rate, Mr. Bernanke opined that there is no immediate need to repaint bank signage across America and insert the word "Federal" anywhere on any marquee.

Bank "stress test" will start soon, and then we shall see whose plaster facade cracks and falls first. Anyway, his words were more or less immediately echoed by a 236-point sized cheer from the Dow, and as soon as that took place, the day turned less than pleasant in the precious metals pits. Dollar down, oil up, did not help. Sometimes, the "old" inverse correlations appear to be nice to have, had they remained intact...

If this kind of spring cleaning is a trend, we might as well take a critical look and "stress test" insurers as well. AIG will soon unveil...drum roll...the largest loss in US corporate history: $60 billion. Oh well, too big to fail. Again. In other news, Home Depot showed signs that it needs emergency repairs for its leaking P&L, and Radio Shack suffered from poor reception amid static generated by its 39% drop in net income in Q4. German business confidence continued to improve on its perfect record of absenteeism and was once again invisible this month. Rounding out the sour frosting on today's economic cake, the 18.5% fall in real estate values in the 20 major tracked markets during the past year. And, it's still not enough. There is a 'fair' price out there, it has not been seen just yet...

For the first time in quite a while, we finally noted someone with sufficient guts to stand up and warn consumers not to go out and pay 10 percent or more for run-of-the-mill bullion coins. Amid what is shaping up as a mania (which is normally the setup for subsequent disaster), Eric Roseman (he, of the Sovereign Society) blew the whistle on bullion dealers (and other marketing operations who would like to call themselves bullion dealers) who fleece customers and offer them one-ounce bullion coins for ridiculous premia - while singing the 'shortage' blues from rooftops. Good for you, Eric.

We've said it before: caveat emptor. No, wait, someone else said that. We said, be a good consumer, realize that these coins come out of the mints at between 3 and 4 percent above spot gold prices, and that there are coins available out thee for between 6 and 8 percent above content. Pay 10% or more, and you could face a situation familiar to all too many in the rare coin niche (those are being flogged with the 'confiscation' bull as the excuse): that is, that gold prices may head north, while your coins head the other way in value (as supplies improve and premia decline). As for buying the metal at current levels, if you have not done so at all previously, well...go ahead and buy - but do so with the idea of not needing to cash in.

Timely caveats are offered by Max Chen, courtesy of ETF trends:

"As everyone is proclaiming the wisdom in buying gold and buying more gold, is it blasphemous to be uttering the idea of shorting gold and related exchange traded funds (ETFs)?

It may be unconventional and risky, but the prospects of profitability in shorting gold are there if an investor is intrepid enough to take on the gold rush head on, writes Louis Basenese for Investment U. We don’t necessarily agree with the points Basenese makes, as we’ve bullish on gold for a long time now, especially as long as it’s above its trend line.

But he sure makes some interesting points and arguments for taking the short side.

**It’s contrarian. Everyone is buying gold, but a contrarian investor will be the one deliberately going against the conformists.
Informercials. When investments get so popular that they are advertised in the wee hours of the day with “but wait, there’s more” offers, it may just be time to get out of the general flow.

**Truth in rumors. There was a false rumor floating around about Germany, the world’s second-largest holder of gold, selling gold to offset its deficit. This may be a prudent idea with gold prices as high as they are, and if governments start dumping gold, then prices will quickly drop.

**Gold-to oil-ratio. History has shown that an ounce of gold would purchase around 14 barrels of oil, but now gold can get you almost 23 barrels, which is 64% above the historical mean.

**Gold-to-silver ratio. An ounce of gold usually buys 31 ounces of silver, but the ratio currently hovers around 73 ounces, which is 134% above its historical mean.

**High HGNSI index. The Hulbert Financial Digest has tracked the average recommended gold exposure among some newsletters, which comes out around 32.6%, but it is now at 60.9%. They found an inverse correlation where if the index is high then gold is heading down.

**Jewelry drives demand. Around 75% of gold is demanded by the jewelry market. Investors, be it government or speculators, won’t be able to sway the gold market as much as consumers.

**Right now. Gold is supposed to increase in value as the economy worsens, but gold has not flown past last March’s high. By factoring all the cash infusions into the markets on a global level, we are at a low economically and at a peak for gold.

**Analysts. A majority of analysts believe gold will reach a minimum of last March’s high of around $1,032 an ounce this year. Yet, these were probably the same analysts that screwed up all the other forecasts we already heard about.

**Hedge funds. Hedge funds, or institutional speculators, do provide a boost in gold, but a majority of them have keeled over last year. Gold prices should reflect the absence of these former behemoths.

**Vacillating investors. In a tumultuous market, we use gold as a safe haven, but once the economy stabilizes, investors will flock to riskier assets.

**Recovering economy? The Federal Reserve and Obama see the recession ending by the second half of ‘09. An average recession lasts 14.4 months. The Baltic Dry Index has also experienced a 61.4% rally from its December low."

Okay, so you've never heard of Max Chen. Fair enough. Surely, you've heard about Irwin Kellner before. Marketwatch's chief economist supplies a list of signs of hope amid all of the gloom, doom, and rubble. Why, a few of them look familiar from the previous list:

  • The Conference Board's index of leading economic indicators has risen for two months in a row.
  • Producer prices have increased for two straight months.
  • Consumer prices rose in January -- the first monthly gain in six months.
  • The Baltic Dry Index, which measures the cost of shipping key raw materials like copper, steel and iron, has more than doubled from its recent lows.
  • Existing-home sales rose in December, and participants in our weekly survey think that another rise took place in January.
  • Pending home sales went up in December.
  • Builders' confidence inched up this month.
  • Thanks to lower interest rates, applications for both new mortgages and refinancings of existing mortgages are rising.
  • Real hourly earnings rose 4.5% in December following a 3.3% increase in November.
  • An index of consumer expectations rose in January.
  • Retail sales shot up by 1% in January -- the first monthly rise since June.
  • The decline in consumer credit moderated in the latest month.
  • New orders for consumer and nonmilitary capital goods went up in January.
  • The ISM index of manufacturing went up last month.
  • The ISM index of services rose last month for the second month in a row.
  • The money supply is soaring, a sign that there's plenty of liquidity in the economy.
  • The 3-month London interbank offered rate, a measure of banks' willingness to lend to each other, has dropped to 1.2% from close to 5% a number of weeks ago.
  • Other measures of the state of the financial markets, like the TED spread and the 2-year swap spread are down, as well.
  • Prices of credit default swaps for banks have fallen from their peaks.
  • The corporate-bond markets are thawing out, too; some $127 billion in dollar-denominated debt was issued in January, the most for any month since last May.
  • Some securities on banks' books are starting to recover in value. "

That said, the road ahead is long (12 to 18 months long, easily) and not free of potholes. However, indications are that it is not leading to a cliff edge - just close enough to jolt everyone into wanting to turn that wheel sharply. Real estate and banks. Banks and real estate. Drivers in at least those two sectors cannot pull any harder on the steering wheels.

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.