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Affect on gold stocks of a severe decline in the general stockmarket


Clive Maund
March 15, 2004

One of the most important questions facing investors in precious metals stocks is that of what would happen to them in the event of an all-out crash or, at least, a severe decline in the broad market. This question is of course very topical following the sudden sharp decline in the general stockmarkets over the past couple of days.

This article is an attempt to answer that question and to highlight what I believe to be the most likely scenario and the most effective way for PM share investors to deal with it.

An important point that should be borne in mind is that, although what we are talking about here is a potential panic scenario in the general market, it does not mean that WE have to panic. This article, although prompted by the broad market action during last week, is not a knee-jerk response to it, as I have throughout been aware of the continually growing probability of the over-extended bear market rally coming abruptly to an end.

Another important point to grasp is that although Thursday's general market plunge was clearly, in part at least, a knee-jerk reaction to the horrific events in Madrid, and we may therefore see a rebound in coming days/weeks, it was also a manifestation of the internal rot that has been festering away in the market for a long time, exemplified by heavy insider selling. It is important, therefore, not to be fooled should the market steady and try to struggle higher again even if it succeeds in limping along for another few months.

The bear market rally in the general market and Tech stocks, that I have dubbed "Son of Bubble," which started a year ago certainly looks impressive and has in some quarters been hailed as a new bull market, which it is not, although that conveniently depends on how you define a bull market. It rather takes the shine off it when you view it measured against other currencies, i.e. taking into account the fall in the dollar, when you do that you realize that in real value terms, you are looking only at an anaemic bear market rally that has come nowhere near the 2000 highs.

As the rally proceeded many advisors who realized that it was a bear market rally fell silent, myself included. There's simply no point in 'crying wolf' continually and ending up looking like an idiot. I have contented myself with observing it with ghoulish fascination, watching for the first cracks to appear, and they certainly have over the past few days. I reasoned a long time ago that it would top out on the Dow at around 10,200, due to the weight of overhead resistance, but due to the quantity of speculative money at large in the system, it has made it as high as 10,700. Despite the fall in the dollar, chart resistance levels are still operative due to the fact that many investors within the US have not factored in the real value losses resulting from a weakened currency.

Another big reason for being reticent in calling a top is the rampant manipulation of the market, and not just the stockmarket, but the entire financial edifice for the purpose of political expediency and short-term speculative gain. The consequences of the various credit-fuelled bubbles popping simultaneously would be dire and simply cannot be countenanced. All efforts are therefore directed to keeping them pumped up, which of course will have very undesirable and far-reaching consequences. The point of no return was passed a long time ago - implosion and collapse are now not a matter of if, but when.

The name of the game now is to keep the merry-go-round going for as long as possible - at least until the election. It is widely known amongst politicians that severe recession accompanied by high unemployment does not go down too well with voters, so if you have the opportunity as a politician to avoid that, by whatever means, you take it. After all, the average voter doesn't usually think about anything very much, and a runaway deficit is an abstract and distant problem that is much less of a concern than whether they have a job and money in their pocket. In this situation an obliging Federal Reserve that is prepared to ramp the money supply and gush liquidity into the system is the answer to a politician's prayer. The resulting problems of hyperinflation followed by deflationary collapse that may be result after the election are a minor nuisance that can be dealt with later.

In what follows I ask readers, especially my many US readers, to bear in mind that I am not 'America bashing,' there is much about the US that is still great, but that's no reason to bury one's head in the sand and pretend certain things aren't happening.

The United States is now technically bankrupt. The debts across the spectrum are now so great that the truly productive elements remaining within the economy have no chance of ever balancing the books. The country will therefore at some point be forced to file for bankruptcy. This is now a 'catch 22' situation. The current ridiculously-low interest rates, fostered to kick-start the economy sufficiently to keep the grazing electorate happy enough to vote back in the incumbent administration, are a powerful incentive for the great body of foreign investors to pull their investments in the US and thus pull the rug out from under the dollar. So, unless rates rise significantly, the severe downtrend in the dollar can be expected to continue. If rates rise significantly, the humongous debt levels will ensure an economic implosion. This is what is known as being between a rock and a hard place. I have read an article that postulates that the authorities are deliberately following a course that will end in Federal bankruptcy, in order to make it politically possible for remaining areas of the economy that are still publicly owned to be privatised.

I always find the US election year highly amusing. The candidates appear out of nowhere and zig-zag all over the country attending colourful rallies where supporters are herded together like sheep and whipped up into a state of wild enthusiasm for the benefit of the cameras. The vast majority of these innocent supporters have no idea that the two parties seemingly pitted against each other, the Democrats and Republicans, are actually two sides of the same coin. America is governed by huge corporations who bankroll election campaigns and candidates according to whoever will further their interests once in power. The duopoly of the two main parties is a circus designed to create the illusion amongst the masses that they live in a democracy.

If you live in the US and you don't believe me then ask yourself why your children face growing up consuming GM foods and drinks containing aspartame, why your national parks are being opened up for logging and mining and why, with millions living in conditions of poverty, the defense budget is being hugely increased and so on. The public, of course, will believe anything, as long as it's presented to them in the right way by a compliant syndicated media. Hence the grossly distorted figures for inflation and unemployment, which have been massaged downwards. There is a tremendous incentive for reducing the inflation figures because it means that you can dodge paying cost of living increases to the unfortunates on fixed incomes.

Returning to our main theme, although it makes little difference to powerful corporate interests who gets into the White House in November, quite obviously the incumbents would like to hold on to the reins of power. They have been gambling that the Fed's super low interest rates, which have had the effect of fleecing savers, coupled with an explosion in the money supply, will "keep the wheels on the wagon" long enough to get them returned to power. I have myself been dubious for a long time that they would succeed in getting away with it, and it now looks like it will be a close run thing. A recent ploy has been to get the Japanese to do the dirty work of propping up the dollar, at ruinous cost - now that's what you call friendship! Whether or not they can keep things humming along until the election depends largely on whether they can succeed in preventing a run on the dollar, a flight by foreign investors and the consequent interest rate hikes before the election. But rise they must at some point and this is when we will see a severe plunge or even a crash in the stockmarket.

When this happens, what will be the effect on gold stocks, more generally on the precious metals sector?

In considering this I must emphasize to readers that we have never been in a situation quite like this before, so it is best to put ourselves in a position where we are able to be flexible and include the worst-case scenario in our planning. When the storm breaks and interest rates go up, it is reasonable to expect stockmarkets to plunge - in fact as the markets will anticipate these rate rises we can expect this to happen BEFORE the rate rises take effect, we could possibly be seeing the first signs of it now. At this time I would expect gold to go up, but perhaps not by much initially. Now here is the point; at a time like this the precious metals stocks could get caught up briefly in the general melee, with across the board general selling, as investors try to safeguard everything they can and also use the sale of stocks which are at better prices to average up their losing positions. The result of this may be what I would call an "icicle" formation on the charts in many PM stocks - a vicious plunge followed by a strong rally. My view is that as the crisis deepens gold (and silver) will forge ahead and the PM stocks, after swiftly recovering from a possible plunge in sympathy with the general market during its crash or steep decline phase, will then move ahead in strong uptrends. This view is somewhere between that held by Prechter who believes that gold and silver will fall and the PM stocks will get dragged down with the general market, and Jim Sinclair, who is all-out raging bullish.

How do we, as precious metals share investors, protect ourselves against a possible sideswipe resulting from a plunge in the general market? The answer, fortunately, is relatively simple, due to the existence of close clearly defined important support levels in many stocks. Should these support levels give way the right course of action, especially for traders as distinct from long-term investors, is to exit first and ask questions later. Having done so we are safe and then have 2 choices... to try to bottom fish after a short, sharp decline, which could result in amazing bargains, or to wait until the broken support levels, which have become resistance, are penetrated again on the upside. In fact it would make sense to exit positions, certainly for those who consider themselves to be traders rather than longer-term investors, on breaks of these key support levels regardless of what happens in the general market.

Finally I have to say that I really do not know if the PM stocks will break down below these important support levels in the event of a severe general market decline, but at least, these levels give us some kind of defensive line in the sand. It is entirely possible that the general market will recover from here and limp along for a few months more before a plunge begins, and in the meantime a new intermediate uptrend in gold stocks could start, in which case we will have to raise our defensive stops.

Details of these support levels for an array of key stocks, including some "barometer" stocks, which help to provide a general signal for the sector, follow for subscribers.

12 March, 2004
Clive Maund

Clive Maund is an English technical analyst, holding a diploma from the Society of Technical Analysts, Cambridge and living in southern Bavaria, Germany where he trades US markets.

Visit his website at clivemaund.com.

No responsibility can be accepted for losses that may result as a consequence of trading on the basis of this analysis.

Copyright © CliveMaund 2004. All Rights Reserved.
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