November 2007 HRA Journal
Long View
David and Eric
Coffin's
Hard Rock Analyst Journal
Nov 26, 2007
The housing market just keeps
getting uglier and profits for many sectors are flattening. While
we haven't yet changed our view that the US can skirt a recession
it is easier to see the pessimistic case than the optimistic
one.
In addition to ever weaker
housing stats we have oil prices hitting all time highs and,
of course, gold looking like its poised to do the same sometime
soon.
Oil's price is partially political,
but recent announcements from OPEC that it is not ramping up
production as quickly as hoped just added to the upward momentum.
The obvious ill effects on the US Current Account from a $94
oil price combined a rate cutting Fed has created a historically
weak Dollar.
We use the term "historic"
advisedly, as the chart above shows. This is a 34 year
Dollar Index chart, stretching all the way back to the end of
the Vietnam War and the gold standard. Even allowing for
new weightings from creation of the Euro and emerging market
gains would not change the reality the Dollar Index has never
been this low in modern terms.
That concept bears thinking
about for a couple of reasons. First, it starkly highlights
just how serious a mess the US currency is in. As we've
emphasized for years, this is not a short term phenomena.
It's very much part of a very long term trend. Though the
greenback may take some "oversold bounces", there have
been no recent fundamental changes in US fiscal behavior, public
or private, that strengthen the Dollar.
Secondly, from a technical
perspective we have entered terra incognita. We take a
fundamental view but realize currency and commodity markets are
rife with chartists who shouldn't be ignored. There are
no obvious support levels on the chart now that the long term
80 weighting has been so convincingly breached. Rallies
will create new near term bottoms, but don't expect them to hold.
The sub prime issue isn't over
by any means. Washington and Wall St. are proposing Super
SIVs (aka "Project Flushaway"), and the Canadian ABCP
market is still frozen. Most of this will get fixed - somehow
- but not easily or cheaply.
All the "fixes" we've
seen have one thing in common: they are designed to avoid
price discovery in the structured debt markets. Super
SIVs have the advantage of moving as much of the mess off balance
sheet as possible. The irony of proposing the sort of accounting
gimmickry that made Enron famous is apparently lost on Treasury
officials. The Fed's largest liquidity injection, over
$40 billion, was made after the October rate cut.
We're obviously not out of the woods yet.
There have also been rumblings
from the Far East about China and others selling dollars.
We're skeptical about that even though we know it will happen
at some point. The August numbers did show large investment
flows out of the US currency, but much of that was related to
the credit crunch.
Currency comments out of Asia
are political, warning shots across the bow of a US Congress
talking China trade sanctions again. But they DO have plenty
of dollars to sell, as do others. A very real move away
from the US currency is underway, but it will be paced, at least
until there is an Asian currency with enough strength to underpin
a larger move. Ugly if you are long the greenback, but
friendly to gold.
Gold Price Support
As this article was started,
gold traded through $800 for the first time in 28 years.
Notably, silver joined the party for the first time in weeks
and closed solidly above the $14 level not seen since April,
and appears ready to make a new long term high.
The yellow metal has looked
overbought several times in the past few weeks and does look
stretched now, but pullbacks have been small and quickly reversed.
We wouldn't be surprised or alarmed if gold consolidated again
before creating an $800 base, but that base is for practical
purposes already made.
Oil is an important part of
the story, as gold appears to be shadowing it again. Both
are really reacting to the dollar's demise, and to politics.
The markets had a big sell off the day after the Fed's last 25
point cut. This underscores another important point on
market sentiment. The latest Wall Street rally was all
about rate cuts. Traders, assuming Bernanke is now done, sold
into the announcement.
The liquidity injections by
the Fed and "solutions" aimed at the debt markets tell
us there will be a lot more bad news from the banking and investment
banking sector over the next couple of quarters.
And the good news? Precious
metals should continue their uptrend, and other metals will continue
to be supported by a weakening Dollar, in Dollar terms. Washington
will sacrifice the dollar to stave off a recession, and so they
should. Expect more US rate cuts.
Despite the start of moving
away from it in the oil sector, the greenback is still the world's
pricing currency. This means US policymakers can effectively
savage their own currency without seeing a broad bump in inflation.
That is why the US has not seen the "Banana Republic"
scenario some bears fear (hyperinflation and rocketing interest
rates). Since a falling currency is relatively painless
for American homebodies, it is expedient for politicians.
How long will this lopsided
arrangement last? Until the mighty US consumer can't afford
to buy imports. What are most likely to hasten that day
would be continued gains to oil's price. Much more then
any place else on the planet, North American lifestyle is greased
by oil. The more that costs, the less there is for anything
else. That has helped check broader inflation, but is not
a solution.
Oil's price will peak soon.
It is becoming unaffordable. The only question is whether
it does enough damage on the way up to cause a US recession rather
than economic flat lines for a couple of years. We
doubt it will since the reality of high commodity prices are
finally sinking in, which should be followed by lesser dependence
on debt based consumption. Or so we hope. So does
gold's price drop with oil's? We think not.
In fact we think oil price
decline will signal the real start of gold's gains, across the
currency index. Euro or "commodity $" holders,
as well as newly wealthy Asians, will be more likely to buy the
yellow metal with energy costs covered off. So too will
Americans looking for a neutral currency hedge. We expect
a continued focus on base metal equities, simply because they
are not yet expensive. But gold's relative weakness as
a hard-asset will become more attractive as both hedgers and
wealth accumulators look for ways to weather storms in this millennial
economic shift.
David Coffin
& Eric Coffin
 Editors HRA Journal
editorial@hardrockanalyst.com
David Coffin
and Eric Coffin are the editors of the HRA Journal, HRA Dispatch
and HRA Special Delivery publications focused on metals exploration,
development and production stocks. They were among the first
to draw attention to the current commodities super cycle and
have generated one of the best track records in the business
thanks to decades of experience and contacts throughout the industry
that help them get the story to their readers first. Please visit
their website at www.hraadvisory.com for more information.
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