The Golden Rule? Gold Will Rule

More metal talk today. There's been more buzzing about the mining companies shedding their gold hedges. From Briefing.com:

"However, the industry has clearly realized this and gold companies have been de-leveraging, and thus are once again drawing investor attention due to the potential for earnings acceleration as the price of gold rises."

"While prices are expected to rise more moderately this year compared to 2006, the bullish gold fundamentals will likely drive prices even higher in 2008."

This bodes well for those invested in mining companies. Just as rising oil prices benefit oil exploration companies, rising gold prices benefit mining companies. And why would the price of gold rise? Well, in addition to an increasing demand, the supply of gold is decreasing:

"On the supply side, production has been curtailed due to the absence of new discoveries as well as environmental activism in North America and Asia, and political and labor turmoil in hot spots such as Venezuela and Angola."

Ah what great news that is. At the beginning of the month I recommended a couple of mining companies. This month I recommended a few funds that are derived from various mining companies. I shed the mining funds last week due to volatility, but I'm retaining the two giants: Newmont Mining (NEM) and Barrick Mining (ABX). Not invested yet? There's still time; gold hasn't exploded yet.

Gold Funds That Make Sense

One of the purposes of this blog is to educate myself. I have been educated. I'd like to address the issue of gold funds right now. I recently suggested three gold funds that I thought were good buys: XAU, HUI, and GDX. Apparently, they are more sensitive to price changes than the previous ETFs I suggested: IAU and GLD. I made a mistake. To illustrate, let's look at the return (or loss) from both. Here's the first group:

I recommended XAU at a price of $158.26. Since then, we've seen a drop to $147.25. That equates to a loss of 6.95%.
I recommended HUI at a price of $368.93. Since then, we've seen a drop to $345.79. That equates to a loss of 6.27%.
I recommended GDX at a price of $42.99. Since then, we've seen a drop to $40.30. That
equates to a loss of 6.26%.

Now let's look at the losses incurred by the second batch over the same time period:

IAU's closing price on the same day of the recommendations was $67.43. It closed trading today at a price of $65.67. That equates to a loss of 2.61%
GLD's closing price on the same day of the recommendations was $67.47. It closed trading today at a price of $65.65. That equates to a loss of 2.70%

What I see here is that the first two funds I recommended seem to be much less susceptible to the volatility seen in the precious metal market. The first three funds lost much more equity than the last two. For this reason, I recommend that the funds I first suggested be the ones to focus on for your portfolio. I hate flip-flopping so soon after recommending them, but sometimes it only takes a few days to analyze the implications. XAU closed at $147.25. HUI closed at a price of $345.79. GDX closed at a price of $40.30. Reallocate your portfolio to reflect removing those funds and place the diminished proceeds into IAU and GLD; over the long term, gold will continue to rise. I will record the losses of the other three in shame. (And here I thought I was making progress...at least I have the homebuilders)

More Metal ETFs and Indexes

Gold and other metals are poised to rise. Here's a few more recommendations for cashing in:

XAU: "The XAU is an index traded on the Philadelphia exchange. It consists of 11 precious metal mining companies."

HUI: "The AMEX Gold BUGS(Basket of Unhedged Gold Stocks)Index represents a portfolio of 14 major gold mining companies.The Index is designed to give investors significant exposure to near term movements in gold prices."

GDX: "Global Markets Vectors tracks the Amex Gold Miners Index, which includes a total of 37 large-, mid- and small-cap U.S. stocks and ADRs. It is heavily weighted with two Canadian firms, Barrick Gold at 14.45% of assets and Goldcorp at 9.45%, followed by Newmont Mining at 9.51%."

As the dollar continues to weaken and adjustable mortgage rates continue to reset (leading to more bad mortgage-backed securities), gold and other metals will continue to rise. And because mortgage-backed securities are illiquid, the bull market should be slow, long, and drawn out. Over time, a bubble could develop.

XAU ended trading at $158.26; HUI ended trading at $368.93; GDX ended trading at $42.99.

Bear Stearns: WORTHLESS

It's being reported tonight that the riskier of the two Bear Stearns hedge funds is as good as worthless, while the other troubled fund is worth about NINE CENTS on the dollar. From the NY Times:

“'The preliminary estimates show there is effectively no value left for the investors in the Enhanced Leverage Fund and very little value left for the investors in the High-Grade Fund as of June 30, 2007,' according to the letter."

In a related story, Bloomberg reports that Goldman Sachs and JPMorgan are among a few bank who are unable to dump their debt:

"'The private equity firms, being very tough negotiators, are unlikely to let the banks off the hook,' said Martin Fridson, chief executive officer of high-yield research firm FridsonVision LLC in New York. 'They'll say that's your problem and that's why we're paying you: To take risk.'''

"'Those bonds are probably worth 94 cents on the dollar, or $43.5 million less than when they were sold on June 28', according to Justin Monteith, an analyst at high-yield research firm KDP Investment Advisors in Montpelier, Vermont."

I have a feeling that the faulty debt problems will be mostly contained within the banking industry. I can't see this affecting tech stocks very much, if at all. As for gold, these developments will only cause upward pressure on metal and metal stocks, especially if it gets bad enough for a federal bailout.

Investment banks beware. When the chickens come home to roost, the cock-fights will get bloody. Did you follow my advice? What about this? Are you covered?

(Edited 7/17/07 7:57 PM: edited to fix the NY Times link)

The Silver ETF

I recommend entering the silver market. As with gold, when paper currency floods the market, the price of precious metals goes up. Consider this argument from silverstockreport.com:

"Silver has been consumed by industry. The world is running out of silver; industry consumes more than the mines produce."

"There's no room for any investment demand to enter the silver market without driving the price sky high. We've just begun to see a little bit of investment demand."

"The current ratio of silver to gold is 50:1, 50 ounces of silver will buy 1 ounce of gold. The historic ratio is 15:1, that means you can make 3 times your money owning silver, but if we do better than the historic ratio, due to the scarcity factor, we could make 6-10 times as much money in silver than in gold."

Gold will make you money; silver could make you rich. The newly introduced silver ETF, iShares Silver Trust (SLV), is the easiest way to get in on the action. It closed trading today at $128.45.

Newmont Mining Axes Gold Hedge

My timing is impeccable. On Monday, I suggested a couple gold ETFs and a couple mining companies. Coincidentally, today one of the mining companies announced that they're doing away with the portion of the business that acted as a gold hedge:

"'With the elimination of our gold hedge book, we have renewed our commitment to maximizing gold price leverage for our shareholders,' CEO Richard O'Brien said in a press release."

I will take this announcement as an indicator that industry insiders are bullish on the future of gold. Don't say I didn't tell you so.

Gold Funds, Mining Stocks

Gold is getting primed to take a shot up. To cash in, I suggest these ETFs: iShares Comex Gold Trust (IAU) and Streettracks Gold Trust (GLD). The former ended trading today at $65.10 while the latter ended trading at $65.02. I also recommend two mining companies: Newmont Mining Corp (NEM) and Barrick Gold Corp (ABX). The former ended trading today at $39.89 while the latter ended trading at $29.79.

This graph displays the three measures of the money supply:


You'll notice that M1 and M2 extend further out than M3. (Definitions of the components of the money supply can be found here.) The government claimed in 2006 that M3 didn't produce enough useful information to justify the cost of tracking it. You can see where it was heading - up up up. The textbook definition of inflation is an increase in the supply of money. An increase in the money supply causes prices to increase. Since the beginning of the NASDAQ bubble, the money supply has taken off. Major contributing factors include low interest rates, relaxed mortgage lending standards, and major expansions in revolving credit. With every loan made, the money supply expands causing inflation. Inflation is WONDERFUL for gold, gold funds, and mining stocks, thus my recommendations.

Mortgage Rate Reset

It's amazing the way things are unwinding: very slowly and very predictable. This could have served as a warning of things to come for Bear Stearns:

"Bear Stearns Funds Own 67 Percent Stake in Everquest"

"Funds run by Bear Stearns Cos. own two- thirds of Everquest Financial Ltd., a firm that invests in debt backed by subprime mortgages and buyout loans"

On May 11th, the same day the article was published, Bear Stearns closed at $156.40. At the end of trading today, Bear closed at $139.10; Bear has lost 11 percent of it's value since May 11. It will continue to drop, we'll see where the bottom is. This chart, found on page 47, is dated March 12, 2007:


Looking at the graph, we can see that the fifth month, May 2007, was about the starting point to a rough time for homeowners with adjustable rate mortgages. As if on cue, foreclosures jumped 19 percent from April to May. If this chart is an indicator of times to come, the late summer will see another spike in mortgage resets, which should lead to an increased foreclosure rate.

Financial institutions and hedge funds that hold those mortgages should get hit harder in a few months than they are right now. This article (which I've referenced before), implicates JP Morgan Chase, Citigroup, and Merrill Lynch in the Bear Stearns fiasco, which is just picking up speed. I'm bearish on all four. I've already recommended selling Bear Stearns. Now I recommend selling the other three. This article implicates Goldman Sachs. Sell Goldman Sachs. There will be companies that will end up with the bad debt - it doesn't just disappear. A bailout from the government, a possibility depending on the severity of defaults, would be very beneficial for gold (which I've previously recommended buying).

Citigroup (C) ended trading today at $51.69. Merrill Lynch (MER) ended trading today at $83.98. JP Morgan Chase (JPM) ended trading today at $48.36. Goldman Sachs (GS) ended trading today at $216.74

The beginning...

Welcome to my blog!

As I start this blog, general market conditions look bleak.
The housing market is in tatters; and still, people keep yammering about a rebound. It's not coming anytime soon. Interest rates have been rising constantly over the past few weeks, which means more loan defaults and an even greater supply of housing on the market. AND, a rise in interest rates means less people will be eligible for mortgages; thus, less houses will sell.
The stock market keeps making gains; Dow Jones record highs are a weekly event. I'm anticipating a market top in July. I like the week of the ninth as a target date. This year, the Fourth of July falls smack dab in the middle of the week; I don't believe that investors will shake their bullish attitude until after the holiday. I'm somewhat amazed that the market hasn't tanked sooner, especially with all the recent bad news. It's a perfect example of psychological factors trumping fundamentals; it's like faith trumping reasoning. Soon enough there will be a price to pay. Get out now while you still can.
Gold has been up and down this year. Hovering around $600 at the beginning of the year, the price of gold shot up to $690 around the middle of April. Currently, the price is $651.60.

Chart: http://www.thebulliondesk.com/

Looking at the five year chart reveals a distinct upward trend. At this point in time, I'd recommend buying gold due to the lull in price; it makes for a perfect jump in point. I expect that the price of gold will continue to rise through at least the end of the year.
Oil has been a bit volatile since the beginning of the year. On January 18, 2007, the price of crude was $50.20. Today, June 14th, oil traded at $67.69 per barrel; that's a 35 percent increase since the winter months. Seasonal cyclical patterns are apparent in the short term.
The long term will inevitably create upward pressure. There is a finite amount of oil in the world; because of it’s relative scarcity, it makes for a great economic topic. In 2007, the United States is consuming oil at the highest rate: 20,730,000 bbl/day. Compare that to China's paltry 6,534,000 bbl/day, a mere 31.5 percent of our consumption. There are 1.3 billion people living in China, compared to 301.1 million people inhabiting the United States. To put it another way, the whole of the population of the USA only amounts to 23 percent of the population in China. So what happens when their oil consumption catches up to ours? I recommend holding oil for the long term. If I had no position, I'd recommend seeing what happens in the next few months prior to jumping in; however, crude oil and oil stocks should see gains in the long term.

---EP