January 7, 2011

Here’s the news of the week – and how we see it here at McAlvany Wealth Management:

1. Are You Happy or Sad? People have often observed with amazement how our family can view bad news as good news. It’s not that we have a fascination with the macabre, but the tendency is admittedly counterintuitive.

Gold was down for the week (after finishing its 10th year of gains). Certainly one week does not a year make, but I am happier because of it.

Consider the closing price on Friday: $1,370.00 (see chart at right). It is marginally below the 50 day moving average (DMA) and likely to see the 100 DMA at $1,340.00. These are both logical places for gold to correct to, followed lastly by the 200 DMA at $1,269.00, or 7.3% lower. I would admittedly be happy to see these prices.

Can it go lower than that? Is volatility increasing such that the swings could take us below $1,000.00? In probabilities, I’d put that at less than 1%. Here’s why.

The last severe correction in gold was in the fall of 2008. The context was unique: a witch’s brew of tight credit, insolvency issues, and outright market panic. After being conditioned to view treasuries as the safest of all paper (certainly the most liquid), the world investment community dropped all “risk assets” and moved to the treasury market. Commodities, emerging markets, U.S. equities, and anything that could not be nailed down, gold included, was sold en masse.

Remarkably, gold recovered by year-end, and out-performed all but the treasury market that year.

This is not 2008, nor are we likely to repeat anything on that scale, as the perception of risk has altered since then. Averting a (bank centric) debt crisis, we have put ourselves in queue for a currency crisis (axiomatic in a post-1913 world – see Monetary History, Exchange Rates and Financial Markets, Vol. 2, p. 63) accompanied by a radically different appraisal of treasury instruments. Should the market encounter disappointments, the movement to treasuries would be lessened by the fiscal issues overhanging our credit rating – much more pronounced in a post-2008 world following the government-engineered bailouts. Since 2008, the EMU has also blown up and defined for a new generation of investors what “sovereign risk” looks like (at least one version of it). Let’s return to gold.

In the 2008 panic selloff, gold fell 17.6% below its 200 DMA; the lowest in a decade. In today’s terms, such a selloff would bring us to a number last noted when India purchased tonnage from the IMF at an average cost of $1,045.00 per ounce. This number is not likely to be breached ever again (similar to $150.00 gold in the ’70s). Think of such an event as increasing your purchasing power by an additional 150-200%! (Achieved when the Dow:gold ratio moves from 8.5:1 to 10:1.)

As the market matures and gains a different vantage point than that of fall, 2008, investors will be less likely to move into an infinite sea of IOUs than into the finite pool of gold.

Should we be fortunate enough to see the price at pre-Indian levels, it will be as if the train backed up just for us to climb aboard. I think that, instead, we should expect it to reach 100 DMA (1340) and 200 DMA (1269) levels, purchase accordingly, and look for more upside volatility in gold as the metals markets continue their decade-long march by moving two steps forward, one step back. Don’t be sad if the price doesn’t fall enough for you, and put a smile on if it does!

2. Is the Stock Market Half Empty or Half Full? Whether you are looking at the S&P, the Dow, or the Nasdaq, all have risen smartly in 2010, and what’s more, they finished with a bang. The question is: can these rallies be sustained?

The drivers of current market growth have rested mainly on the prospects of Fed intervention – the “QE” projects if you will.  However, those efforts, as we have mentioned before, are probably a constant for the markets since forced bankruptcy for the country is simply not a political option. So what we are concerned with is not merely the money being printed, per se, but the effects the money printing has in the general economy – both in the short and long run.   Obviously the markets have benefited in the short run, but what we’re watching for is the inflection point at which the inflationary impact of the Fed’s actions will begin to dampen economic progress and subsequently the markets.  Since commodities outperformed stocks nearly 2 to 1 last year in an environment of moderately rising rates, it’s logical to conclude that the economy – specifically corporate margins – will be at risk as the Fed’s monetary expansion takes effect.

Despite the hype of holiday sales and jobs creation, fourth quarter earnings tell a different story – that inflation is forcing folks to spend more on necessities than “discretionary items.” Gap Stores and Target both disappointed, citing weakness in their margins due to higher costs of certain items.  Shoppers apparently gobbled up lower-margin products instead of high-ticket items during the holidays.  Supporting that thesis, Best Buy, the nation’s largest electronics retailer, posted a 5.5% decline in domestic sales year over year.  And Samsung electronics reported a 13% drop in operating earnings on a year over year basis, confirming the Best Buy news.

On the jobs front, ADP reported a stunning number of jobs created – nearly 300,000.  But a closer look reveals that 97% of those jobs were service oriented and highly skewed toward temporary jobs (included in the statistic even if a person worked only one hour!) during the holidays.  Today’s job report told a different story, as jobless claims continued to rise even in the wake of a better overall unemployment number, which dropped from 9.8% to 9.4%.  We can probably assume the drop in unemployment is also temporarily/seasonally skewed.

As the earnings season unfolds and the holiday job spike subsides, we’ll have more to report.  For now, it seems apparent that the time has arrived when a dollar created translates into a dollar’s worth of inflation. In that environment, it’s our opinion that the economic value of stocks, bonds, and real estate will diminish.  The same may hold true for jobs.  Full employment should eventually be attained, but it’s our suspicion that Americans will be going back to work for less, with a return to a manufacturing bias – unfortunately while prices rise, reducing the standard of living.  That is, of course, if you are not in the “right boat” – as Dave McAlvany mentioned last week.   Stay tuned…

Have a great weekend!
David McAlvany
President and CEO

David Burgess
VP Investment Management