What the "R" Word
Brings to Gold
Boris Sobolev
Aug 28, 2007
Market Talk
What are the major concerns
on the Street today? Market analysts are starting to pronounce
"recession," that nasty "R" word once again.
But most are saying that the US economy is going to avoid it
for now. Here are their arguments:
1. The wise and powerful Federal
Reserve is keeping a close eye on the markets and is ready to
react at any moment. The FOMC has already lowered the discount
rate which is starting to help the financial institutions. Inflation
remains under control, and if the credit crunch continues, the
Fed has a number of levers that it can use to avoid a full blown
recession. In an attempt to restore liquidity, the Fed has already
allowed banks to pledge asset backed commercial paper as collateral.
2. The global economy remains
exceptionally strong. China's growth has only been accelerating
and the economies of Japan and Europe appear to be on solid footing.
In addition, major corporations have very strong balance sheets.
The weaker dollar is helping corporate profits. Most recessions
are caused by deterioration in corporate spending and we have
yet to see any signs of that.
3. The stock market correction
was relatively shallow for the magnitude of the events in the
credit markets. Major indices are now appearing to make a bullish
"W" bottom.
Market Whispers
But we do not hear much about
the following:
1. The Fed relies mostly on
lagging economic indicators and there is a risk that it will
not drop the fed funds rate fast enough to prevent a recession.
True, the Fed has lowered the discount rate in an attempt to
restore confidence in the financial system. Yet, that does nothing
to help the hurting consumer. The Fed is now behind the curve
and the fed funds futures are predicting an immediate rate cut.
As the stock market recovers, the Fed will feel less compelled
to lower rates in a hurry. But it is a dangerous game to play.
This is why a big rebound in stocks could be a setup for a large
leg down in the coming months.
2. The fact that the global
economy is strong now is not a good enough reason to say that
a recession can be avoided. A strong economy now means we are
at the top of a business cycle and there is a higher downside
rather than an upside risk.
3. While most of the focus
is on the financial sector, the consumer is starting to feel
the pain from depreciating house prices. Lenders are being more
selective and mortgage rates are rising. So far, the Fed has
done nothing to help the consumers who make up 70 percent of
the GDP, and it is questionable whether it can (read more on
this here).
The retail sector has been
underperforming the S&P 500 since mid-2005, another alarming
signal for the health of consumer spending. Last week's rebound
in the sector was discouragingly weak.
The fact remains that the American
consumer is much more sensitive to the decline in the housing
market than in the stock market. Low mortgage rates and rising
property values helped keep the 2001 recession relatively shallow
and painless despite the crashing stock market. The coming recession
may prove to be much more difficult to weather. Consumers have
lost their source of cash from refinancing. Many will now have
much higher mortgage payments as a record number of ARMs get
readjusted at the end of 2007 and in 2008. As a result, as many
as 2 million foreclosures could occur in the near future.
Gold & Gold Stocks
With their piggy banks empty,
consumers are looking to borrow even more but no one is willing
to lend for cheap this time around. When bad economic news
starts to filter in, the "R" word will be on everybody's
tongue. A recession is deflationary based on textbook economics.
But the Fed has proven time and again that it will do anything
to prevent a contraction in the money supply. It will attempt
to inflate away all economic problems. In conclusion, while
a deflation scare is short term bearish for gold and bullish
for the dollar, the inevitable surge in the money supply is very
positive for gold intermediate to long term.
Another major round of liquidation
on the deflation scare is likely this fall. But we are not changing
our outlook
on gold, especially since the gold bugs sentiment has turned
even more bearish while gold price has held up very well. Physical
demand remains high as GLD gold holdings are at an all-time-high
of 515 tonnes. The latest COT release is also very supportive
of a short term rebound.
Most gold investors and traders
tend to be pessimistic about the economy and the stock market.
This is one of the reasons why gold stocks could be vulnerable
to a second wave of liquidation related to the deflation scare
this fall. We are urging caution, refraining from doing any
more new buying and maintaining a cash position. Even though
there is tremendous value in many junior producers and exploration
companies, it is difficult to tell what the downside risk is
to prices. We believe that highly bullish fundamentals on gold
and the weakening economy will produce a significant rally in
the next few months. But we do not know at which levels this
rally is likely begin. Caution continues to be the name of the
game for now.
Boris Sobolev
Denver, Colorado
email: Contact@ResourceStockGuide.com
website: www.ResourceStockGuide.com
Disclaimer: The above information
in this article pertaining to investing, stocks, securities must
be understood as information provided and not investment advice.
The information provided by Resource Stock Guide is obtained
from sources believed to be reliable but is not guaranteed as
to accuracy or completeness. Resource Stock Guide advises all
readers to seek advice from a registered professional securities
representative before deciding to trade in stocks featured on
Resource Stock Guide or any stocks for that matter. All statements
and expressions of the companies featured are not meant to be
a solicitation or recommendation to buy, sell, or hold securities.
Copyright © 2006-2007 Resource Stock Guide, All rights reserved.
321gold
Ltd
|
