Cole's Market Insights - June 8, 1997

Mixed Signals on the Economy

Economic statistics were mixed last week. Construction spending fell in April and retail sales were soft in May. April personal income posted its smallest monthly increase since October. May payroll employmentrose a modest 138,000, but changes in the seasonal adjustment factors used by the Bureau of Labor Statistics were responsible for some of this moderation. By contrast, job gains for March and April were revised sharply higher. The unemployment rate fell to 4.8% -- the lowest level since 1973.

Despite strong job growth this year, wage gains remain modest. This reflects persistent corporate downsizing activity aimed at reducing the head count of highly paid senior employees - and replacing them with lower paid workers, both domestic and foreign.

Bonds and Stocks Soar

Bond yields fell steeply on Friday, reflecting heavy foreign buying, Secretary Rubin's statement that inflation remains under control, as well as the modest wage gain in the May employment report. The yield on the benchmark 30-year Treasury bond fell 13 basis points to 6.77% last week -- the lowest reading since late February. Some have speculated that the bond rally partially reflected heavy Chinese buying -- a quid pro quo for the Clinton Administration granting them most favored nation status.

Big cap stocks soared Friday along with bonds. That day's 130 point jump in the Dow Industrials may also have reflected the decision by Dow Jones and Company to license the venerable DJI for use in mutual funds, options, and futures.

For the entire week, the Dow Industrials climbed 105 points, or 1.4%,while the S&P 500 rose 1.1%. Despite considerable under performance Friday, the Russell 2000 index of small cap stocks again beat the big boys with a 1.7% gain for the week.

Stocks Likely to Rise Further, But Major Top is Nearing

Last week's action reinforced the writer's conviction that stocks will climb considerably further before this greatest of all bull markets comes to a screeching halt this summer. The Dow can easily go to 8000 in this move from its current level of 7436. The S & P 500 may well make it to 900 from 858. And with the small cap sector coming back to life, the Russell 2000 is projected to climb as high as 450 -- 16% above its latest reading of 387. The small cap sector has by far the best risk/reward ratio at this juncture.

But make no mistake -- the aftermath of this speculative binge will not be pleasant for those left holding the bag. And that means the public at large. Public wrath when the bear finally comes out of hibernation and 401Ks start declining in value month after month could have a big impact upon a fat and happy financial sector. Banks, brokerages, and other financial stocks probably will be among the biggest losers when the market turns south in a big way. The political system may also be shaken to its foundations as dreams of safe and secure retirement go up in smoke for many, and current "free market" dogma comes under challenge.

Platinum and Palladium Surge; Gold Continues to Tread Water

Reflecting a severe short squeeze and shipment delays from Russia, platinum and palladium continued to surge last week. July platinum soared from $401 to $455 and the spread over gold skyrocketed from $56 to $122. Earlier this year platinum sold at a slight discount to gold, illustrating just how fast sentiment can change. June palladium jumped $42 to $214 and June silver from $4.65 to $4.77. But June gold dipped from $344.80 to $343.20.

The gold market is much larger than the markets for platinum, palladium, and silver, and hence more difficult to move. Too, these "white" metals do not have to contend with the persistent threat of central bank sales. They are not viewed as potential inflation indicators by central bankers as is gold.

But the upward surge in the whites still is potentially very positive for the noble metal. Past gold bulls generally have been preceded by strong upward moves in platinum and palladium. And these markets do share one major feature in common -- huge short positions by speculators. In the gold market these speculators "know" there never will be a big short squeeze because "inflation is dead" and the cental banks will not permit it. We shall see.

New Gold Bull Close

The writer still anticipates that a major secular gold bull market will commence this summer at approximately the same time as the stock market makes its final peak. The rationale for this assertion really is quite simple. Gold is extraordinarily cheap relative to financial assets, as cheap as it has ever been. Once the "smart money" concludes that the huge bull market in financial assets is over or almost over, the attraction of the immensely undervalued gold market with its huge short interest will prove irresistible This is especially true after recent surges in the "whites".

And once investor demand takes off, the central banks will no longer be able to prevent gold from skyrocketing via the sales or lending routes. Instead they will have to tighten money sufficiently to send the global economy into a severe recession. The odds against such a drastic tightening are immense.

Gold's attraction will be enhanced further if the looming bear market triggers political turmoil directed against the ruling establishment. Historically, gold does best when capital runs scared. And capital may well be running very scared before the next bear market is over. Recent events in France may be just a small portent of future developments.

For those inclined to doubt this can happen in the United States, the 1920s experience bears repeating. From supreme confidence in 1928, capital was running very scared indeed by 1932. I believe it was John D Rockefeller who stated during the depression, "I would gladly give up half my fortune to be sure of keeping the other half." If this sentiment ever again appears among U.S. ruling circles, gold probably will be selling at $3000 an ounce.

Of course there is no guarantee that history will repeat or that things will again grow so dire for capital in the United States as they were in the 1930s or the 1970s for that matter. But the odds are much greater than the zero probability most today would assign.