Short term outlook on gold and silver

by John Lee

04/26/2005

Since the last update, we had expected the dollar to turn down from 200 DMA.

The dollar didn't disappoint. I am surprised that ECB and Bank of Canada haven't followed US in raising rates. Euro and Canadian interest rates are now trailing US rates by as much as 0.75%. Inflation is now a problem in Canada, price increases in the past 12 months in Vancouver restaurants are obvious. I expect interest rates in other countries to catch up to US. The Fed is not able to go behind another 50- basis-point hike and that's dollar-bearish.

I like to show you the graph (first shown last year) again.

On the backdrop of positive interest-rate differential, the dollar's rebound has been very weak. There are some good contrarian analysts that call for the dollar to resolve to the 90 range. This would translate to the euro backing down to $1.2 and Canadian dollar to C$1.3. It's possible, but I don't see it.

US Bonds

US bonds continue to bewilder us. 30-year yield is lower now than when oil was $20 cheaper last year. We are of the opinion that Bank of Japan and the Fed are soaking up lots of US bonds. Stay away from bonds.

Swiss Francs

While still long, the COT commercials have reduced their net long position, this means the dollar has more room to fall against SFrancs.

Silver

Silver is a great hedge between safety and growth. On the "growth" side, there is a loosely positive correlation between silver and the Dow since the silver bull started in mid-2003. On the "safety" side, a steadily rising gold price exerts a positive influence on silver.

For those who think silver is an industrial metal and does not warrant an investment status, talk to Buffet and the folks at Kitco who are selling silver bars like hot cakes.

Now above 18 DMA with COT commercials net short at 58k (a small number since the silver bull began in 2003), silver can take out $8 with by summer end in our view. The catch of course, is if there is a structure change in markets with metals bull ending. Base metal stocks seemed to have signaled such possibility. Right now it all rests on the dollar and since we believe that dollar has one more down-leg to go, we like silver's upside.

US market

We removed the negative call on US market in June 2003 when the Dow was 8897. Then I noted.

http://www.goldinsider.com/6_2_st_stocks.htm

"Another hard evidence of abundance of dollars? The bond market has reached new high in May yet SPX stays above 900. This shows there is a lot of money to go around. Shorting US stocks = Shorting assets against the dollar = Deadly idea.

The stock markets are coming to grip with the currency shock, we will witness much turmoil in the stock markets for the weeks and months to come, however we believe the low for the market has been established for the next 18 months."

We have to imagine money shuffling between stocks and bonds. Bonds were at very high level during the recent equity ice patch. This meant there is more money floating than ever. Stocks, despite the lofty valuation, is still better than US bonds. I expect this shuffling to continue. The VIX has been unnaturally low amid rising inflation, corporate warnings (GM, IBM), and high oil price. Interesting thought: it takes less than 1/5th of what it cost in Iraq to maintain current lofty equity levels through futures. We are not about to argue with the market, neither would we go short at this time.

Gold

It's been disappointing to see gold stuck at $420. In March 04 when gold traded at $420, oil was less than $35 and CRB was at 260 (now 310). Gold has been tracking the currency markets but large gold buyers have not shown urgency to step in.

If we classify a bull market in 3 phases (stealth, public awareness, mania), once gold takes out 350 euro then we can say the second bull phase has begun. For now the gold is in a trading range.

XAU

XAU broke down from key support level, perhaps signaling downward move of gold to follow. We happen to think current valuation is very attractive for new purchases with a 12 months horizon. Gold might briefly dip below $410 but the downside for shares are limited in our opinion.

It's important to keep the big picture in check. The dollar's fundamentals have not and will not improve for the next few years. We don't think this is yet fully discounted by the market. Gold has not broken any key support levels since its bull started in 2001, gold shares are trading at very favorable levels and warrant long term accumulation.