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A Dangerous Eruption

Bob Hoye
Institutional Advisors
January 14, 2006

Golds: Gold reached $551 - so much for the Keynesian tout that "gold is a barbecued relic."

However, it has been all too obvious that gold has been rallying with strong commodities and a weaker dollar, which has hyper-excited the goldbugs. And, frankly, this is always dangerous.

Just how dangerous is this eruption?

Ross is preparing a ChartWorks that points out that senior gold shares are at an overbought condition seen only 7 times since 1900.

There was a typical pattern that completed each speculative peak and this would require a brief rebound.

Using the current proxy, the XAU (which set a high of 141 on Friday), the decline measures to 121 to 123.

Clearly, this would be a tradable correction in a cyclical bull market for golds. When timely, Ross will refine the optimum reentry point.

As measured by our gold/commodities index, gold's real price rallied from 185 on June 1 to 240 on December 9. This was well corrected on the way up, with the most recent being a drop to 227 on December 21.

While gold's nominal price made new highs, the real index only made it to 239 on Monday. At the high of 240 in December, gold's dollar price reached 220. The gain in real terms has been zip, which compares with a 14% gain for gold's nominal price.

Goldbugs at play!

Silver Dreads Amongst The Gold: There is much more to silver than the widely known and almost as widely compelling shortfall in silver supply relative to demand.

In our recollection, this analysis is chronic and tends to obscure the fact that the gold/silver ratio (GSR) can act as if it was a credit spread. Such spreads narrow during a boom and widen during a contraction.

With a boom, the GSR decreases and this declined from 82 in June, 2003 to 58 at the end of December, 2005. The increase since to 60.9 could be important, particularly if it accomplishes a trend change.

Often a dramatic slump in silver relative to gold presages a liquidity crisis. Of course, this has occurred at the conclusion of a boom, not at the beginning.

Indeed, silver was part of the frenzy in gold and crude through 1979 and the GSR plunged from 45 in late 1975 to 14.8 in January, 1980. Of specific interest is that the ratio reversed to rising a week before that wild mania climaxed.

Thus our focus on the gold/silver ratio now.

When this boom fails, and it will, the ratio could eventually reach around 100. This would mark a significant underperformance for silver and silver stocks.

Our advice would be to underweight silver stocks and to lighten up on the bigger cap golds. Funds derived could be applied to selected exploration stocks at somewhat lower prices.

Of interest is that the exploration index ( ) has soared from 99 in May to 161 this week, which is virtually at the high at the top of the bull market at the end of 2003. Technically, this represents a considerable overhead resistance and a moderate correction seems likely.

Impetuous Moves: Often impetuous moves mark the end of a big speculation. Frequently, such impetuosity, either down or up, can run for as long as 7 trading days without a setback.

This has occurred now in a new important series, including the Dow, Nasdaq, S&P 500, and Hong Kong is the champion with 8 days. Impetuosity is not just the privilege of equity markets as it showed up in emerging debt prices (MSD) and base metals prices as well.

This is another step in building a cyclical peak in most, if not all, of the games.

Bob Hoye
Institutional Advisors


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