 Metal Fatigue
David and Eric
Coffin's
Hard Rock Analyst Journal
May 17
2004
The following
excerpt is from the May 2004 HRA Journal, sent to subscribers
May 12, 2004
Inflation
fears are hammering the markets and dealing blows to all the
major indices, and oddly to commodities. Thursday will
see release of the April PPI number, followed by the CPI on Friday.
They'll be closely watched and heavily traded. If either
number exceeds expectation of 0.2-0.3% gains by any great amount,
markets will continue this nasty correction, and smoke the Bear
out of its cave. Gold and silver could be wobbly too, though
base metals should start seeing support going forward since they
are growth-loving markets and gold/silver will see their inflation/disaster
hedge value come back to the fore. Keep your powder dry until
those numbers are out.
We've voiced concern before about the over-hot Chinese economy,
but didn't expect markets to signal full retreat on China agreeing
with us. The Chinese commodity boom is not over, not if Beijing
has anything to say about it at least. But that's neither
the only nor the main issue the markets will have to struggle
with right now.
We noted since this sell-off began the extent of a demand decrease
we'll see from China is unknowable. But the Chinese government
is looking to slow growth, not induce a recession. Its
comfort level for growth rates is 6-7%, by developed country
standards a still very steep demand growth curve.
Will there be a demand slowdown? Yes, but not necessarily
a large one. Has the market overreacted? Definitely,
and its reacting to the wrong stimulus as well.
Why all the fuss? The steep drops in a host of commodity
prices are a measure of the spec money that had been chasing
them. We think most of the declines have been speculators
(hedge funds and the like minded) unwinding long positions at
a furious pace. This is borne out by the market action
itself. The commodities with the fastest upwards movement
due to having less liquid markets, have also seen the biggest
downside moves.
This partially explains why silver and nickel have been particularly
painful, though silver's physical market still looks tight and
nickel's definitely is. Funds tend to "be half the
market" when they sell, so smaller markets get hardest hit.
Based on demand factors, we continue to view the current environment
as in keeping with the early to mid stages of a secular bull
market for metals. The problem for all markets right now is the
certainty of rising interest rates.
As we've pointed out before, most inflation driving indicators
have moved up, strongly in some cases, for the past 3-4 months.
Very little of this is reflected in the CPI yet. That means
little to us since we view US CPI as being increasingly overly
fabricated by adjustments that lower it. We'll have more
to say on that over the next few months. Suffice to say
for now that the real inflation rate is at least a couple
of percent higher than the "official" one.
We've been firmly in the "inflation camp" for a while;
a feeling strengthened by $40 barrel oil and resurgent employment
costs. Energy and labour are such huge components of aggregate
cost that these gains can't help but drive inflation higher,
even if rising labour costs are not yet cashing up consumers.
The 10-year note we use as a benchmark is now 105 basis points
(over 1%) off its recent lows-hardly an insignificant move.
We think there will be more to come. The Fed will do its
best to hold the line on rates. The bond market is way ahead
of Greenspan, and we expect Chairman Al will intentionally stay
behind the curve for a long time on this move.
Those rate increases led to pain in commodity markets.
Stop losses got hit and hedge funds bailed because their quantitative
models tell them higher interest rates are automatically bad
for commodities. Why? They may lift the US Dollar,
but mainly they imply higher costs for what has effectively been
a "carry-trade" in commodities, centred in the hedge
funds. The higher rates go, the more expensive speculative
trades get and no costs are small for heavily leveraged funds
playing the spec game.
The Dollar argument is valid, in the short run, but by no means
a given in the long run. As rate gains in the US
narrow the spread between it and Euroland, a higher dollar is
to be expected. But rate increases won't deal with the
root causes of Dollar weakness, and may in fact make the
situation worse by shifting even more US borrowing off-shore.
Foreign borrowing is already a US growth industry, so the burden
of higher US interest rates is a further juicing of the Current
Account deficit.
This debt/deficit concern is in the currency markets.
The "huge rally" in the Dollar hasn't really been that,
given the backdrop. The greenback has only just risen above its
200 day moving average, and recouped only one-third of the drop
that began last October. Much of that is a knee-jerk off
loading of Yen against the need to slow China's growth, which
will be temporary.
The US Dollar Index chart looks similar now to October's version
when we warned the Dollar was due for another fall. This
drop may not occur until the Fed actually pulls the trigger on
rates and takes the focus off them. Raising rates should
then refocus the market on the US's structural problems.
We're not going to go through all the ramifications of inflation
and interest rates gains this month. We do want you to
take a look at the chart below, however. It shows the CRB
metals sub-index in blue, and the US CPI rate in red since 1970,
with periods of recession shaded pink (our current CPI distaste
aside, it is the oldest inflation measure). A glance tells
you the current period is anomalous. The main reasons are
Asian demand and massive carry trade speculation against 40 year
interest rate lows.
Most analysts compare the current situation to the 1990s when
Fed tightening coincided with falling commodity prices.
The 1994-97 period of flat metals prices accompanied a series
of rate increases, culminating in the Asian Crisis that sent
prices tumbling as demand dried up.
We don't agree with comparisons to the 90s. The current
situation is much closer to the 1970s. That was a period
of rising demand and rising inflation. Yes, there were
a couple of gut wrenching corrections in the seventies thanks
mainly to the 1973 oil embargo and the recession it helped induce.
Notwithstanding that, the overall trend rose through the 70s
until double-digit interest rates brought the economy to a halt.
Both the 1970s and the current decade kicked off with US currency
declines, a hangover from Vietnam in the 70s and a purposefully
induced one this time. Inflation became a fixture in the
1970's until being beaten down with vicious rate hikes.
The Fed is again behind the curve, and likely to stay there.
Greenspan used massive liquidity injections to keep the US economy
growing. It's vital he not turn off the tap too quickly.
Doing so could see unwinding like that in the commodity sector
repeated on a broad scale that can bury the US economy.
The US is awash with debt and Greenspan simply cannot afford
to be ahead of the inflation rate. The current Fed funds
rate in real terms (net of inflation) is negative. It will
probably stay that way for some time. We are still in the
woods, but it looks like the world may have its first synchronized
expansion in a decade. The demand implied by that would
help drive metals higher once the carry trade is unwound.
Greenspan will be "Easy Al" for a good long while.
That will drive inflation, but so what? He doesn't care
if nickel and copper prices double again - he does care
that people would start defaulting on mortgages if rate gains
were sharp.
We'll revisit these topics next month, but will leave you with
a couple of thoughts. One, the equity markets are NOT priced
to higher rates. Don't buy Wall St's happy talk on that
point. We may have already seen this year's highs on S&P
and NASDAQ, and they could fall much farther. Two, the
market for commodities has a long way to run yet. Wait
for bottoms, yes, but remember - the hardest trading decision
to make is also the wisest one, namely being willing to buy shares
when no one wants them.
David Coffin
& Eric Coffin
Editors HRA Journal
editorial@hardrockanalyst.com
Now in our
ninth year of publication, the HRA family of publications delivers
superior gains and insight on gold, silver, metals and diamond
stocks from editors with combined direct industry experience
of over 40 years. Want to know how HRA can help YOU profit
from the bull market in commodities? Please visit our website at and check the free
"Articles" section on the right side of our main page.
There you'll find a description of our services and complimentary
excerpts from past HRA Dispatch and HRA Special Delivery issues
as well as a free copy of a recent HRA Journal.
DISCLAIMER
The
HRA Journal is part of the "HRA Subscriber's Service"
a set of interrelated independent publications produced by Vanguard
Consulting Ltd., which is committed to providing timely and factual
analysis of junior mining and other venture capital companies. Companies are chosen on the basis of
a speculative potential for significant upside gains resulting
from asset-base expansion. These
are generally high-risk securities, and opinions contained herein
are time and market sensitive. No
statement or expression of opinion, or any other matter herein,
directly or indirectly, is an offer, solicitation or recommendation
to buy or sell any securities mentioned. While we believe all sources of information to
be factual and reliable we in no way represent or guarantee the
accuracy thereof, nor of the statements made herein. We do not receive or request compensation
in any form in order to feature companies in this publication. We may, or may not, own securities
and/or options to acquire securities of the companies mentioned
herein.
From time
to time Vanguard Consulting Ltd. may
have acted in a consulting or contracting capacity for companies
reviewed in this publication; the superscript VC indicates a
company for which Vanguard has acted in a paid capacity in during
the previous 6 months.
This document
is protected by the copyright laws of Canada and the U.S. and may not be reproduced in any form
for other than for personal use without the prior written consent
of the publisher.
This document
may be quoted, in context, provided that proper credit is given.
______________
321gold Inc
|
