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Jim Willie CB is the editor of the “HAT TRICK LETTER” For specific detailed analysis of the Gold, USDollar, Treasury bonds, and inter-market dynamics with the US Economy and Fed monetary policy, see instructions for subscription to my newsletter research reports, which include stock recommendations positioned to rise in the commodity bull market. Gold in US$ terms has surpassed $490 per ounce, with the “magical” $500 level within spitting distance. The financial markets and their shallow mavens have grasped the price inflation issue as a relevant factor, and little else. In fact, that might be THE ONLY FACTOR they are capable to comprehend. Well, except for jewelry demand. This is funny really, since price inflation is under-stated to the extreme, and the Consumer Price Index is ridiculously restricted to urban consumers of retail products, mostly imported from Asia. Despite the suppression and narrow focus and even hedonic adjustments (where quality improvements motivate artificial price reductions), the CPI is rising against a serious bias. My personal seminal article “25 Reasons Why Gold Will Rise” pointed out that media mavens were absurdly lacking in providing newsworthy justification for the assault of the gold price toward $300 per ounce back in 2002. Try not to laugh too hard, but back then the media shared their twisted wisdom. They enlightened us as to how the Middle East tension between Israel and Palestine was pushing gold up. The mainstream of the entire nation overlooked how the US trade gap was wide and growing wider. They overlooked how the US Treasury bonds were offering up short-term yields below the already low-balled consumer price inflation rate. They overlooked large USGovt federal budget deficits, sure to grow as stimulus was demanded to avoid a recession. In my humble opinion, the US press & media is horribly inept when gold is concerned, but just a purchased pliable mouthpiece for Wall Street on investment discussion, interpretation, analysis, and advice. Here are several reasons why gold is breaking out, and establishing 18-year new highs. In this sphere, no certainty exists to link market movement to clear forces. These factors are typical topics in my Hat Trick Letter (see subscription links at top or bottom), covered more fully. Let’s put the factors on paper in a top level. Back last night from a gold conference in Munich ,Germany, my jet lagged body is a mess. What a wonderful bunch of people. They speaked most excellent goodly English with me. Some put together sentences and use correct grammar better than many Americans. A few (from Ireland and repatriated from the US) were colorfully quick with our native tongue. My repertoire in German is limited to about 20 or 30 words. GOLD BULL FACTORS: The price inflation boogeyman has finally arrived after three years of preliminary construction to a platform. It is not here in full force, but that is largely because its measurement constitutes a grand deception. The pre-Clinton calculation formula would reveal the CPI over 7%. But no, we prefer to disseminate a grand lie which has been circulating for a full ten years. Higher energy costs, higher industrial component feedstock costs (like for farm fertilizer), higher material costs (like plastic, cement, steel rods), higher shipping costs, these are all in the process of being passed along to customers. They are slowly becoming accustomed to fuel-based surcharges. While producer prices have been rising at a faster pace than consumer prices, a grand squeeze has been at work until final product prices could catch up. To be sure, the presence of China and India has kept a gigantic wet blanket in place above entire price structures. Despite the low-ball bias, consumer prices were recently measured to be on a 4.7% climb year over year. Bear in mind that such a rate exceeds the yield on the 10-year Treasury Note, the flagship long bond. The end of USFed rate hikes seems on the horizon. The battleground of investor and speculator opinion lies within the crucible known as the Fed Funds futures contract. In the last few days, especially after release of the last FOMC meeting minutes, the Fed Funds contract reveals a shift in consensus. Its March contract now shows a 30% likelihood (down from 80% likely) of only two more USFed rate hikes. The message is that numerous additional measured rate hikes might not be endured. If true, that would push the short-term target to 4.5% and no higher. The stock market has responded favorably. Higher interest rates have provided enormous support and lift to the USDollar, the arch enemy of gold. Gold has shed its strong connection tether to the USDollar, whereby it has moved in the opposite direction for three years. It has clearly decoupled since July 2005. Nonetheless, if the USDollar is no longer offered financial artillery support from rising interest rates, then you can be certain that yet another positive thrust will be given to gold. The beginning of a Euro Central Bank tightening cycle might be upon us. The ECB head Trichet has given an unmistakable signal for at least one interest rate hike. Once begun, they should continue. Whether a new tightening cycle, complete with numerous rate hikes, is to come, time will tell. In June 2005, the ECB defended an assault on the euro currency (from the 120 level) by selling a massive amount of vaulted gold bullion in order to purchase the euro itself. It succeeded. Fast forward to today, where the USFed has delivered three more sledge hammer blows to the disadvantageous euro rate differential. The euro saw a 116 handle last week, and now rests above 118. The rebound is due only to the Trichet comments, taken widely as signals of imminent rate hikes next week. In the process, the euro has perhaps found a bottom. Chart support is not historically strong at 117, but it does exist. Monetary disarray has grown in recent months like a virulent disease. The Europeans are running scared to prevent both an economic slowdown and a currency meltdown. The ECB rate hikes anticipated will stem their currency downtrend, and make it easier for bigger federal budgets to be financed. Amidst the disarray, money on the old continent flies into gold. In Japan, a different set of problems makes for a different experiment in crisis management. The release of their government postal pension fund to private ownership has undercut confidence in the stability of the financial system. As more money is diverted from USTBond support, it goes increasingly into the Nikkei for large-cap stocks. It also flies into gold. Lastly the USGovt, despite off-budget deficits which dwarf the laughably low stated budget deficit, is running nearly $1000 billion in red ink. The easiest way to bring down the US federal budget shortfall is to declare $100B here, $200B there, as removed from the official tally. What a joke! What an insult to our intelligence! And Wall Street repeats the trimmed figures with a straight face! Amidst the grand deception and clear indication of massive deficit funding, money flies into gold. The episode of foreign central bank gold bullion sales seems to have concluded. October official bullion sales were magnificent, nay colossal. The goofy financial markets attributed the gold correction to USDollar strength, to reduced price inflationary expectations, to confidence in the US Federal Reserve to meet the task of arresting runaway price increases. We are talking about a great many tons of gold bullion dumped onto the market. Is it a coincidence that gold breaks northward, onward and upward, upon end of official gold sales? Methinks NOT. Arabs are buying gold with both hands, make no mistake. They do so via routes through Turkey and Dubai, in order to avoid some mainstream detection. King Abdullah detests the United States and much of the West, but harbors more friendly feelings toward Europe. The Arab world extends beyond the Saudis. They might sense future losses in USTBond holdings from USDollar declines. They might suspect future US bank seizures in the event of another terrorist attack. They might resent an Iraqi occupation, annexation, intervention, action (call it what you wish). Gold fits within the Islamic religion far more closely than paper money tied to government bonds. The end of the REFCO fallout might be upon us. It is widely regarded that the best of all outcomes might be sweeping this historic fraud under the carpet. Full reckoning of fraudulent contracts in the stock market and futures market might generate such a down draft that the outcome might resemble a black hole on the order of another Enron or perhaps a LongTerm Capital Management scandal. The REFCO mess emerged almost a month ago. Its full repercussion might never be known. With such a powerful negative current of sentiment gone, backed by reality, many investors could possibly see a glimmer of a green light. So many investors clearly waited, held back, and resisted the urge to commit funds in gold instruments. That dark cloud could be in the process of dissolving. A slew of covered naked calls for gold contracts might be squared, or in the process of being squared. Some might extend from the REFCO mess, in need of resolution. Some might be from the infamous gold cartel, which routinely sells gold short with big volume in order to preserve of system and precious way of “paper” life. Covering naked calls is conjecture on my part. One can be sure that with any breakout above critical longstanding resistance levels, a massive amount of short covering ensues. The Commitment of Traders report shows some rather substantial covers among large commercial entities. Credit derivatives are out of control, no question about it. In early October, the USFed convened a meeting to address a situation gone amok, totally out of control. It seems $8400 billion (yes that is a ‘b’ and not an ‘m’) in credit risk derivatives remain unconfirmed. In a climate where the gold cartel has been joined by outsized bond insurance policies to protect the walking dead of General Motors and Ford Motors, derivatives have grown far beyond what regulators can monitor, let alone control. The list of convened bankers covered the gamut of icons in the banking industry. JPMorgan, Citibank, Morgan Stanley, Banc of America, Barclays, Deutschebank were among those invited. Nothing was resolved. More likely, more effective methods were devised to sweep the derivative monster under the rug. A bigger rug is needed. The growing Chinese trade gap heads for $200 billion per year. In July 2005, the Chinese upgraded their yuan currency value by means of altering their currency regime. No longer tied by a tight link to the USDollar, it has for four months been governed by a basket calculation to determine its value. But the low 2% upgrade did little to remedy a massive trade gap. In September, the bilateral trade gap with China ballooned to a record $20.1 billion in that single month, versus a $17.7 billion figure registered in July. So the adjusted currency regime has not slowed the Chinese trade deficit, a summer forecast of mine. My reason had to do with reducing Chinese costs, since they import materials priced in US$ terms. It also had to do with recognizing a 2% change as inconsequential on import prices, which transfer only a fraction of that increase to WalMart (or other retail chain) inventory shelves. A challenge to the USA stance on the Iraqi War has been openly delivered in US Congress. While widespread public opposition for the war has been present, the debate had not reached the floor of the US Congress. That has changed in the last week, as House Representative Murtha from Pennsylvania urged the US Military to return its troops. He believes the original objectives for the military mission have been accomplished, disorder continues within Iraq, and the Iraqis must step forward to manage their own nation. A change in the US war position could unleash geopolitical chaos. The housing bull market has stalled as numerous measures worsen. Time for a property unsold on the market, ratio of unsold to newly listed properties, and percentage price reductions all have changed for the worse. The investment community might smell a change in the wind. Bear in mind that the US housing foundation has served as a giant piggy bank from which to extract home equity. In the year 2004, at least $600 billion was removed from homeowner equity. Its destinations were many: to pay for bills, for vacations, for room additions, for education, for second homes, for boats, for frivolous and questionable luxury items. If shopping malls are the sick commercial nucleus for the USEconomy, then home equity is the sick money vault. Overly lax lending guidelines and outright over-extension in mortgage loans has set the stage for a magnificent round of loan defaults. A stench is in the air, sure to assist gold. The collapse of General Motors and Ford Motors looks increasingly certain, if not inevitable. They lose money on each car sold. They face rising material costs. They have crippling obligations to pensioners, for retirement income and health care. They are behind in technology to the Japanese. Their suppliers have faltered, both Delphi and Visteon, leaving the car giants on the hook. Labor unions are regulating the lethal blood letting process. The fallout to the bond market and the credit derivative market is profound, immeasurable, and uncertain in its scope. A test to the shock wave impact was seen last June, when a race to enter USTBonds was witnessed. Apparently, the long Treasury bond is the anchor on many credit default contracts. The primary strategy is to base a “spread trade” on borrowed low 10-yr TNote yields, and purchased high corporate bonds. The GM bond securities have been downgraded twice, first to junk bond, second to deeper junk bond. My view is that whatever happens to GM happens next to Ford. Gold demand from the jewelry industry is for real, only this time of year. The last few months of every year bring with it notable demand for the metal, used to forge and pound into jewelry. They cannot wait for the right price. If they have not secured supply by now, they must pay up. CONCLUSION: The USEconomy might be ready soon for another uninterrupted new round of monetary inflation, led by reduced interest rates. The markets might smell the end of the current tightening cycle. If past is prologue to future events, then an easing interest rate cycle might begin sometime in the year 2006. If you require evidence, look to the charts of the bank (BKX), broker (BBX), and insurance (IUX) indexes. Check instead the entire financial index (XLF). They all look better in recent weeks, as signals for six months hence. The Treasury yield spread bottomed at a tight 8 basis points (0.08%) last week, between the 2-yr TBill yield and the 10-yr TNote yield. It now shows 20 basis points, which is still small, but movement has been seen. The financial sector requires a much wider spread to establish healthy profit margins, and to create the favorable conditions for bond speculation. The sad unfortunate fact of financial life nowadays is that WE DON’T KNOW. Certainty has been replaced by a network of nested and connected unknowns. Gold still remains the safest form of stored capital. Bonds might be smart money, but gold far surpasses it in intelligence. Gold is telling us something. Gold senses something deeply wrong and out of kilter. Imbalances are just too damned big. American markets are not listening. My suspicion is for numerous shock waves in 2006, as though 2005 was not loaded with pyrotechnics. © 2005 Jim Willie, CB
Editorial Archive HOUSEHOLDS SHOULD HEDGE WITH MINING & ENERGY STOCKS. INVESTING IN CANADIAN STOCKS RIDES THE ENERGY TRADEWINDS. THE HAT TRICK LETTER COMBINES MACRO ANALYSIS WITH INVESTMENTS  Jim Willie CB is a statistical analyst in marketing research and retail forecasting. He holds a Ph.D. in Statistics. His career has stretched over 23 years. He aspires to thrive in the financial editor world, unencumbered by the limitations of economic credentials. Visit his free website to find articles from topflight authors at www.GoldenJackass.com
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