January / February 2009

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SPECIAL REPORT:

Recovery Forecast 2009 Gold, Silver, Platinum

Last year in the forecast issue, I started off by saying “The big question most investors in all markets wonder about these days is when the tummy-churning uncertainty will end. The answer is, unfortunately, uncertain.”

At least on that point, I was 100%on target! After twelve horrifically disastrous months that rank among the most devastating in America’s economic history, the uncertainty prognosis still applies as we face 2009 standing chest-deep in the worst global financial crisis since the Great Depression.

I warned readers a year ago to expect the unexpected and sounded the alarm of a probable recession. But neither I nor Wall Street nor Washington nor the world’s brightest economists foresaw the shock and awe of monumental surprises that were in store.

This is historic. This is epic. Never before in history—not even in the Great Depression—have we seen an economic meltdown of such magnitude, ferocity, and speed strike with coordinated synchronicity around the globe and across all financial sectors, with simultaneous recessions in the U.S., Europe, and Japan, and sharp slowdowns even in the booming China and India expansions. Never before have we seen such a massive global mobilization of government intervention in market operations, and it has only just begun.

There have been other ominous surprises, too. Like the sudden and inexplicable ascendancy of the U.S. dollar as a flight to safety asset in preference to gold. The dollar?! There’s no rational explanation for this rush of confidence in a failing currency. But these have been panicky times, and investors rarely think rationally in a panic. Gold got caught in the undertow of an across-the-board pullback in commodities. Gold was also a source of liquidity for equity investors who had to sell their best assets to cover margin calls on their worst assets. Meanwhile, the dollar should have fallen off a ledge when the crisis blew up, but when other major currencies took a dive at the same time, the buck apparently seemed like the least of several evils.

Aside from investor selling, though, demand for physical gold has been overpowering. Buyers are begging to buy gold…silver and platinum, too. But gold, silver, and platinum coins are hard to come by. Those that we can find carry a hefty premium, and it takes a long time to get them. The gold is out there, just not in a form that most retail buyers want. Mints the world over stopped producing most precious metals coins months ago with the explanation that they couldn’t get the materials to make them. The excuse doesn’t hold water in all cases, but they’re sticking to that story. We may see some new flow of coins when they get 2009 production cranked up, but it will take awhile to work down the pile of pent-up demand.

GLOBAL VIEW: INDICATORS TO WATCH

The big picture factors influence market activity in general. And in this extraordinarily synchronous downturn, every market sector is affected. This is unusual in that typically some geographic areas or market sectors will be moving down while others are moving up. That’s what results in “sector rotation” as the investor herd migrates to where the grazing is best. In this current phenomenon, the pastures are brown and dry everywhere. However, the synchronicity of the downturn implies that the boom to come may also be synchronized. So when one segment shows signs of life, it could very well be extrapolated that other segments could perk up at the same time. Watch the big picture developments for clues that can also apply to the future of gold, silver, and platinum.

U.S., Europe, Japan economies — The major developed economies have been hardest hit, with the U.S. leading the way and dominoing into Europe and Japan. The U.S. has better structural mechanisms to deal with the crisis than either Europe or Japan and will probably be the first to emerge on the other side. Watch the GDP reports for the U.S. for indications that the trend is stabilizing or reversing. Keep in mind that one report is not a trend. The GDP reports are trailing indicators of what has already happened, so they should be viewed as confirmation signals, not forward-looking indicators.

Unemployment figures are also trailing indicators, but more timely (weekly) than GDP stats. In December, jobless claims hit a 26-year high, highest since 1982. Layoffs had reached nearly two million at that point, and the number is expected to rise to three million by the spring of 2010. That’s more than a year away, clearly indicating that the turnaround is not going to happen soon.

Emerging market economies — The myth of emerging markets disconnecting from the U.S. and developed economies to go merrily on their separate ways unscathed by our problems has been busted. China and India, the main growth drivers among emerging economies, are both suffering sharper than expected slowdowns. Keep an eye on developments in GDP, unemployment, inflation, and civil disruptions in emerging countries, especially the BRIC (Brazil, India, China, Russia) bloc.

Resource nationalism — Emerging markets own the lion’s share of the world’s producing natural resources capability (the U.S. has resources but environmental restrictions make it unprofitable or even legally impossible to exploit them). Except for Canada and Australia, most of the oil, iron, nickel, coal, gold, silver, platinum, timber, and pretty much everything else except food comes from emerging countries.

Historically, the developing countries have sold their resources cheap. But now they are awakening to the power they hold and are beginning to use their resources not only to fatten the treasuries but as a political weapon as well. Russia, which supplies most of the natural gas needed by Europe, has discovered that the valve on a gas pipeline can be an even more powerful weapon than a fleet of bombers or divisions of tanks. South American producers allied with Venezuela’s socialist revolutionary Hugo Chavez, have been flexing their muscles with threats of cutting off supplies unless they get their way on various demands.

“Commodity prices could erupt suddenly and dramatically as resource nationalism cuts of supplies with little or no notice. It’s difficult to anticipate such events, but watch the headlines for possible hints of impending actions that could sharply impact supplies of commodities.”

Geopolitical disruptions —There are so many hot spots in the world these days that it’s almost easier to list what areas are not at risk. Israel is constantly rumored to be readying an attack on Iran. India and Pakistan have their fingers on the nuke swords pointed at each other’s throats. China’s military is growing, and they cast covetous eyes on Taiwan. Russia and Venezuela play war games together south of our border. Africa boils with war and corruption; Nigeria is crippled by rebellion, Somalia has no government at all, and Zimbabwe is ruled by an incompetent but ruthless dictator. Pirates raid the seas at will off the coast of Somalia, becoming more brazen by the day in a blatant manifestation of the growing state of world anarchy.

Geopolitical risk remains a wild card to watch in regard to commodity prices, which tend to spike sharply when news breaks of a violent blowup or confrontation that could disrupt supplies of oil and other raw materials. But be careful of getting caught in these spiked traps.

New power regime in Washington — What effect the changing of the guard in Washington will have on the economy in general and precious metals in particular remains an open question. If President-elect Obama and the Democrat-dominated Congress actually delivers on its promise to “govern from the middle,” we could see a normalization of economic fundamentals sooner rather than later.

However, if they pursue the agenda characterized by Obama’s past record, the business climate could turn decidedly sour, drive more corporations to set up shop outside U.S. borders and could chop a recovery for stocks off at the knees. For gold, silver, and platinum, the impact of the new administration and Dem-powered Congress will depend on monetary and economic policies. It’s too early to tell yet where this road leads.

New World Order currency restructuring— It’s only in the talking stage now, but some savvy analysts saw back room plans are actively being drawn up by the G-20 to totally overhaul the international currency system. What we may wind up with is a New World Order with at least three reserve currencies instead of just the dollar. It would include the dollar, euro, and yen (possibly also the Chinese yuan), but they would be called something different to distance them from the stigma of today’s failed fiat currencies. The new system most likely will include a gold reference component for a system of fixed exchange, replacing today’s floating exchange system.

Depending on how the new scheme is structured, gold could zoom to $1,000, $2,000 or much higher virtually overnight. Having a stash of physical gold is the only way to play this development: dollar-denominated paper gold, as in ETFs or even mining stocks, could be negatively impacted by the sharp devaluation of currencies. The actual way it would affect them isn’t clear as long as the plan is in the shadows. Owning physical gold is much safer. At the very least diversify your commodities portfolio with physical gold.

GOLD WATCH: INDICATORS FOR GOLD

The markets at present are driven mostly by emotion (fear and greed, with fear dominant at the moment) and will continue to be irrational, mercurial, and unpredictable as long as that is true. No one really knows when sanity will return to the marketplace. When the markets regain their senses and reason returns, the fundamental forces influencing gold price movements should become more reliable indicators of what to expect (in addition to or in concert with the above macroeconomic developments).

Dollar—The traditional inverse link between the dollar and gold will at some point re-establish a connection. So when the dollar goes down (which it should do when all the major central banks have cut their interest rates to zero), gold goes up. At least that’s what the long term historical pattern has been. Gold mirrors the dollar almost step for step in the historical record. Except for the unknown quantity of what the New World Order will mean, there’s no reason to believe the fundamentals of the inverse relationship will change going forward. Watch the dollar index (not just the dollar-euro forex numbers) to see how it’s doing against a basket of currencies. Better yet, keep an eye on the dollar-gold ratio.

Interest rates—The Fed is running out of bullets with interest rates as a means of regulating the economy. Once they get to zero, the gun is empty. Fed chairman Ben Bernanke knows he has so few weapons.

Inflation — The interesting thing to watch is what happens when the hyperstagflationary squeeze hits, very possibly in 2009. When the massive flood of bailout money and gushing money supply along with “free” money (no interest) piles up against a sharp decline in available goods and services (companies with fewer employees to provide services or shut down entirely), hyperinflation to double digits appears almost baked into the cake. However, with the global economy in deep recession (some thoughtful analysts even predict a depression), the Fed’s hands will be tied on interest rates. So the dollar likely will not get any sweeteners added to it in the form of interest rate increases for quite some time. That means it should be a much less desirable safe haven competitor to gold in these hard times.

Oil and commodities —The reason for the sharp decline in oil and other commodities is mainly because of a reduction in demand due to the global recession. Nothing has changed much on the supply side, certainly not for oil. When the recession bottoms out and some hint of a recovery begins to show, expect oil, commodities, and precious metals to soar again. This downtown is only a hefty correction in the supercycle bull market for resources. These supercycles historically run on average about 23 years. We’re only in the seventh year of this bull market.

Gold and oil often (though not always) move in parallel. Gold’s extra dimension as money sometimes results in temporary divergence from oil. As oil prices rise again with resumed demand with economic recovery, the rising tide should also lift gold.

Supply and demand —Though the spot price of gold doesn’t reflect it, demand for physical gold has been extraordinary over the past several months. Coin dealers often cannot get enough product to meet the demand, so premiums have soared and delivery times stretched from days into weeks…if there’s even any product to deliver. The Mint’s restrictions on gold coin production should ease some beginning in January. However, they have announced that production will be limited and some bullion coins won’t resume production until some unspecified future time in 2009.

A number of theories have been proposed to explain the anomaly of excess demand and lack of price response —from Mint incompetence or indifference to back room conspiracies by all sorts of people. But hard evidence to back up these theories has been rather skimpy. Ultimately, it’s less important to know why it’s happening than to recognize that it’s an unsustainable condition that will be force-corrected by the markets eventually.

Backwardation — Backwardation in commodities occurs when the futures price sinks lower than the current spot price. It signals an immediate shortage of the product, where buyers are willing to pay more for delivery now than less at a later time. Backwardation rarely happens in gold or silver.

However, gold backwardation happened in December 2008. It’s rarity confers special significance to the event, according to Antal Fekete of Gold Standard University. “It is nothing short of awesome.

This is a premonition of a coming gold fever of unprecedented dimensions that will overwhelm the world as soon as its significance is fully digested by the doubting Thomases,” wrote Fekete. The gold fever may be heated up even more by the proposition by GATA chairman Bill Murphy writing on LeMetropoleCafe to buy gold futures contracts and actually take delivery of the physical gold. The reasoning is that if the gold cartel and world governments want to keep the spot price of gold low while demand is through the roof, then gold buyers should make some easy money and stick it to ‘em. Gene Arensberg, writing on Resource Investor, agrees: “If the COMEX is determined to under price its physical metal, then they ought not to mind seeing it leave their warehouse for the popular physical market.” Stock market – Not uncommonly, gold slips when the stock market rises, at least in a short time window. However, gold suffered along with the stock market during this year’s plunge for reasons I mentioned at the beginning. In a bigger view, though, gold has done well when there’s a sense of prosperity in the air. As the Dow climbed to a record high in 2007, gold was climbing right along with it toward its own nominal high in 2008. When the stock market finally bottoms out and investors can stop dreading hearing the phone ring for margin calls, gold can benefit from the return of optimism. In other words, when the Dow finds footing for a sustainable rally, the prospects for gold prices should also brighten.

PLATINUM & SILVER WATCH Except for those parts in the above commentary related to monetary policy, most of the guidance also applies to silver and platinum. Neither of these metals has a monetary function as is the case with gold, but they share with it the same influences that affect gold as a commodity. Noted precious metals analysts Mary Anne and Pamela Aden suggest that silver and/or platinum may lead the precious metals sector higher when the next up leg of the supercycle bull market resumes. Gold has been less harmed by the downturn because of its money characteristics, so has a shorter distance to travel back to the mean. Silver and platinum have both been pounded severely, though. So the rubber-band rebound could be spectacular when it comes. Watch for sudden and sharp moves to the upside in silver that span several sessions, a possible indicator that the rocket is lifting off from the launch pad. For platinum, much hangs on when the auto industry pulls out of the slump. There’s a demand for platinum jewelry and coinage, but the primary demand driver for the PMGs (platinum metals group) is for catalytic converters in automotive emission control systems. When auto sales pick up, platinum should rebound smartly.

LOOKING FORWARD

Are there more shocks and surprises ahead in 2009? Probably!

The volatile instability of the world’s financial condition virtually guarantees that this year will bring yet more bizarre twists and turns that we could never have imagined were possible… until they happen.

There are almost certainly more financial time bombs beneath the rubble that could explode at any time. A wholesale overhaul of the international monetary system could be in the works. The risk of a dramatic terrorist attack on U.S. soil (e.g., threats against New York’s subways) has escalated recently following the murderous rampage in Mumbai, India. India and Pakistan are at each other’s throats over that and other grievances, and they both have nukes. Rumors keep bubbling up that Israel plans to bomb Iran, with or without America’s blessing.

The list goes on… no doubt you can add a couple dozen more potential surprise shockers to the list.

The cyclical nature of financial markets assures that after each boom comes a bust, and after each bust comes a boom. We will see better times ahead. The unanswerable question is…WHEN?

I can’t tell you the answer. I don’t know anyone who can, at least not with any dependable degree of confidence.

It could be months. It could be years. It could be a decade or longer.

It’s a futile exercise at this point to second-guess when the economy and markets will bottom out and begin to recover. What’s important at this point is to hold onto your wealth (or what’s left of it after the 2008 debacle). Investor concerns at this point should be less about return on your money and more about return OF your money.

In spite of the dollar mania of late, which I believe is about to come to an abrupt end, precious metals (especially gold) remain the most reliable wealth protection safety net for the simple reason that they have real value, unlike paper currencies or paper anything.

For the longer term, looking beyond the recession to the eventual recovery, the gold and commodity bull supercycle megatrends have not been violated and are still in play. I expect they will be for another two to three years at least before the cycle runs out. This has just been a deeper than usual correction in the normal advance of a bull market.

In the shorter view over the next several months, given the great uncertainties, I won’t even try to predict what’s going to happen with gold, silver, and platinum in 2009. That would be a fool’s errand. But there are some key indicators you can watch for clues about what’s likely to happen next in precious metals. These are the factors that are likely to be the most influential in the future pricing of the metals markets for the short term.