Action in Gold Won't be Chased Away this Summer

With the passing of Memorial Day the stock markets have unofficially entered the summer doldrums, or a period of time leading into September when traders take vacations, investors spend some time buying suntan lotion rather than stocks, and interest/volume disappear from the markets.

This week's batch of economic reports is likely to back the doldrums theme. Disregarding what should be mild jumps in consumer confidence and Chicago PMI, the rest of the reports due out (personal income, home sales, and factory orders) are all for the month of April (1Q02 productivity revisions). As such, reaction to the bulk of this weeks leading reports should be particularly mundane: the consumer is confident and spending -- old news…

That said, what is not old news is the gold bull market. Rather, as stocks enter the summer doldrums gold may be bracing to reach another price echelon ($325+ an ounce)

Gold Debate
It is likely that there will be another terrorist attack in the U.S., turbulence in the Middle East and India/Pakistan could escalate, and the U.S. dollar may continue to fall. Yes, the reasons why the price of gold may continue to climb are plentiful.

By contrast, the reasons why the POG could soon collapse are equally abundant: a terrorist attack against the U.S. may not materialize, geopolitical fears (war) may subside, and the U.S. dollar may hold its ground…

Dollar Drop
You could say that the drop in the U.S. dollar since April has been organized, or without panic. Nevertheless, as the dollar has steadily declined gold (stocks) have conversely raced ahead. Accordingly, given the Fed's inability to raise interest rates, the proverbial 'unsustainable current-account deficit', and the possibility of further acts of domestic terrorism, one trend could remain in place for some time: weakness in the dollar - strength in gold.

Gold Rallies
This bullishness aside, gold is prone to terrific bouts of volatility. Since breaking free from its dollar peg in 1972 gold has jumped from under $100 an ounce to over $800 an ounce and back down to $250 an ounce. Thus, clearly from historical price fluctuations alone it is logical for the investor to consider market price before buying gold.

With this in mind, general terrorism/war/U.S. fears, news of producers reducing their hedge programs, a pause in central bank sales, and isolated demand (Japan) for hard gold is largely responsible for the latest rally in gold. However, these occurrences alone are not enough for gold to sustain its bull run. Rather, the 'expected unexpected' must transpire to proliferate the uptrend ('expected unexpected' meaning a further drop in the U.S. dollar, terrorism, war, strengthening demand, etc).

Such is what has plagued previous gold rallies: the unexpected has not transpired. To be sure, the U.S. dollar has not seen a bout of panic selling (since?), Y2K was a no show, and the precious metal hoarding adventures of many prominent investors over the years have only pushed prices higher temporarily.

In sum, it is essential to understand that the gold market, as is the case with the stock markets, is forward looking. $320 gold today is predictive of financial troubles – troubles which could arrive from any number of sources but are expected (priced in) to arrive nonetheless.

The Golden Rule: Don't Chase
I'll be the first to admit that rules are made to be broken, and that gold could rally significantly if the expected unexpected occurs. However, I also admit that one day Amazon could turn into a solid company with real profits and a respectable set of valuations - but I tend not to invest in a company for a period beyond that of my life expectancy.

Point being, the signals for the motherload gold rally may not be clear beforehand. Accordingly, perhaps the best way to look at gold as a potential investment is like buying flares to put in the truck of your car - you don't plan on getting into an accident but you have flares just in case.

Investor Infatuation With Turnaround Stories?
First, consider Japan – its economy is climbing out of a decade spackled with recessions, land prices have dropped for 11 straight years, public debt equals 135% of GDP, and bad loans at Japan's major banks hit a record 25 trillion yen ($197 billion) for the year-ended March 31. Ugly, isn't it? And yet the Nikkei is up more than 25% since February.

In sum, Japan could and probably should enter a 'crisis' phase tomorrow – but try telling this to those Nikkei investors who are in love with a good turnaround story.

* To note: Gold is the turnaround story for the first half of 2002.

Accordingly, what is most wondrous is how rising prices, both with regards to the Nikkei and the price of gold, can quickly dispel investor apprehensions that were present when prices where significantly lower. For certain, gold is the ultimate safe haven. However, knowing this doesn't take away the risks of buying potentially inflated gold stocks, or a precariously high POG.

Death Match
I am reminded of a quote from the Matrix:

"One of you is going to die." The Oracle

Quite frankly, if a U.S. economic rebound can continue to be patched together and the Fed is preparing to raise interest rates come August (stable to strong dollar) the gold bull run will be over. By contrast, if the expected unexpected happens the gold bull will live on. Only one thing is for certain: the U.S. stock markets (economy) and the gold bull market cannot survive together for very long. So much for the doldrums…