Market Update

Gold Simmers in the Summer

7/11/06

Dollar and Bonds:

From the June 4th Update:

“The Euro might hang around the upper 1.20's for the next few weeks but a firm breakout above 1.3 is in the cards by this Fall. This is our conservative view.”

“Like the dollar index, US long bonds failed to stage any meaningful rebound in May. The long term trend stays bearish.”

The expectation of interest rate hikes provided a boost for the dollar index in June. However, the dollar rally seems to have run out of steam after the FOMC raised the short term rate by 0.25% to 5.25%. I believe we have the proverbial "buy on rumor, sell on news" situation regarding the dollar / interest rate movement. Consequently we might see the dollar meandering between 84 and 88 before eventually breaking down to test an all-time low of 81 by year's end.

US long bonds tried to climb back above the channel but failed as the Bank of Japan is rumored to be about to lift interest rates, which are currently near zero percent, for the first time in almost six years. This is a bearish development for US bonds.

Gold and Silver:

From the June 4th Update:

“We think gold's downside from here is very limited (10% at the most). A firm breakout by the Euro above 1.3 will mean gold is ready to retest this year's high of $730. We expect gold to return to rally mode in September but wouldn't be surprised if gold retests $700 in the summer. Silver's action will continue to amplify that in gold.”

Both gold and silver broke out in late 2005 and have likely just successfully retested the 200 DMA (day moving average, red line) in June. Gold is currently just beneath the 50 DMA of $630. Given that it has risen over 20% from the correction low of $520, we wouldn't be surprised if it corrects one more time back to 200 DMA of $560 before resuming the uptrend.

XAU:

From the June 4th Update:

“We expect a healthy rebound in June. Many junior stocks are trading as if gold is at $500. We believe the sector currently presents a wonderful, low-risk entry point.

The ratio of XAU over gold already shows gold stocks on the rebound. We expect gold stocks to outperform gold in the next few months.”

In June the XAU index briefly dipped below its 200 day moving average, bottoming at about 120. The XAU is currently at about 143. Given that the XAU has run up 20% in just 3 weeks, we could see a dip to the 130's. Again, as we noted, summer is the time of consolidation. Volatility is the name of the game until the XAU makes its emphatic break out towards the latter part of the year.

The ratio of XAU over gold is currently just above its 200 moving day average of 0.23. The past peak of the XAU/gold ratio is about .28. This indicates that mining equities are not overvalued relative to the current price of gold. We still don't see a premium in gold stocks.

S&P500, Nikkei, Shanghai

From the June 4th update:

“Both the US and Japanese equity market staged a sell off in May, with S&P500 down over 3% and Nasdaq down over 6%. The long term charts show the S&P has not yet broken down from its bearish rising wedge while the Nikkei is still above its 200 DMA uptrend.”

In late June, The S&P 500 broke down from its 2-year-long rising wedge. This is bearish for the equity market. If S&P stays below the channel by the end of August, this will likely mean that a multi-year peak is in place for S&P 500. Such a case would not exactly be friendly to the gold stocks (since gold stocks belong to the equity class) and we should pay close attention to the overall equity environment.

CRB and Oil:

Also from the June 4th Update:

“Crude oil failed to break away from $70, while the CRB remains comfortably in an uptrend. Neither of the markets are a cause for alarm for metal bugs.”

Last week crude oil prices set new records, climbing as high as $75.55 a barrel. This year the price of oil is up about 23%.

The CRB ended last week at around 350 and remains comfortably in its uptrend. Both markets confirmed the commodity uptrend.

Conclusion:

Throughout the rest of the summer we expect that the precious metals and junior mining equities markets will remain choppy. Much of the volatility will be attributed to thinning liquidity and speculations surrounding the Federal Reserve's next move. Ben Bernanke will have some tough choices to make ahead. If he pushes interest rates up to far he could slow the economy, but if he becomes too lax with rates inflation could get out of control. In contrast to the conventional belief that the Federal Reserve is in the driver's seat over the economy, our view is that the Fed is in a reactive mode, with policy-making heavily dependent on the action in the stock market and commodity markets.

In April, we reported that Newmont's president Pierre Lassonde predicted that the $850 gold price of the 1980s could be challenged in the next 18 months. Lassonde also said that he wouldn't even consider hedging at the time because he anticipated "an exponential increase in the gold price." We believe such action could take place as early as September. This summer we expect gold to exhibit volatility between $550 and $700.