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Using the analogy of what happens just before a tsunami hits shore, the recent action in the financial and precious metal markets is indicating to me that the water at the beach has begun to recede. Some are fleeing to higher ground; while others who have not yet learned what these ominous signs mean, are walking on the beach observing the unusual spectacle with great curiosity.
Unaware of the great wave of financial implications that roars towards the coast, many unfortunately will be lost in the disaster that lies ahead. Today we'll review our current economic environment... and look at why right now could be the best time in 5 years to invest in gold mining shares and the broader mining market.
Why is This Happening in the Financial and Precious Metal Markets?
The root cause is the US financial system, which is in very deep trouble. Continuing the analogy, what is happening to many US financial institutions can be likened to a great earthquake that fractures on the ocean floor and causes a giant wave of water to form. This wave is now rippling across the ocean with amazing speed and headed for shore.
The core issue is deflation, which is rearing its ugly head. Take a look at just a few of the recent examples of this deflation:
1.Merrill Lynch (NYSE: MER) has written down US$46 billion in asset values and sold US$30.6 billion in CDOs at 22 cents on the dollar!
2.Morgan Stanley (NYSE: MS) has taken US$14.4 Billion in write-downs on its mortgage related portfolio since the third quarter of 2007.
3.Fannie Mae (NYSE: FNM) has slumped to a quarterly loss of US$2.3 Billion and revealed that it set aside US$5.3 billion to cover credit losses over the three months to June. Freddie Mac, by its own admission, has a negative net worth! The latest reported net market value of its assets is negative US$5.6 billion and growing. Shares of Fannie Mae have lost 86 percent over the past 12 months while shares of Freddie Mac have surrendered 91 percent.
In addition, on August 12, J.P. Morgan Chase disclosed an incremental US$1.5 billion loss related to residential mortgages since the end of its second quarter. The company's shares plummeted 9.5 percent, wiping out more than US$12 billion of market value.
All other big US financial stocks lost another US$50 billion in value on top of that, taking the total one-day loss in the US finance sector to US$62 billion.
The US financial industry is still the year's worst performer with a 28 percent fall so far for 2008.
American International Group (NYSE: AIG), the big insurer, plunged nearly 20 percent for its worst one-day performance in nearly four decades!
AIG shares have plunged 59 percent this year. AIG's quarterly loss was driven by US$5.56 billion in second quarter pretax write-downs tied to all its credit-default swaps. AIG has posted more than US$18 billion in losses over the past three quarters.
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These plunging asset values mean deflation at the moment is gaining the upper hand. This will result in a systemic cross defaulting amongst the titans of US finance. An avalanche of US bankruptcies is about to hit our shores, affecting millions of investors.
The Continuing Inflation/Deflation Debate and How it will Affect the Financial and Precious Metal & Mining Markets
Many continue to argue whether deflation or inflation will ultimately rule the day in our economic environment moving forward. While the jury is still out on this issue, my take is that we could see both. First let's define what I am talking about.
Inflation is an increase in the quantity of both money and credit, while deflation is the opposite. In a genuine monetary deflation, all prices fall. It is a situation where the quantity of money and credit contracts. This type of scenario is definitely moving through the system at the moment. Most are already feeling the affects of this deflation in lower house prices and reduced or suspended lines of credit in many situations. There is a real scramble for cash at the moment.
This contraction in the quantity of money and credit is also putting the real estate market in a very tough situation. House prices, which were softening across America, now look like they could implode to the downside as more and more homeowners are feeling the squeeze. It is estimated in one report I read last week that 70% of mortgage holders that purchased a home since 2003 cannot sell their house for what they owe on it. This is an ominous statistic in the face of what is currently underway, and means a huge proportion of US home mortgage holders are looking at staggering losses if they sell. In many cases homeowners will simply walk away and hand over the keys... putting even more pressure on the lenders.
On the Inflationary Side of Things...
The Fed is under enormous pressure to create gargantuan levels of money out of thin air to bail out the many institutions that are in trouble. They have no other option at this point but to create this money. While some believe this will be highly inflationary, others argue that money created for bailouts will not be inflationary since it will only be replacing money in the system that has been destroyed. In other words, replacement money.
While the tug-of-war between the two forces of inflation and deflation continues to be debated, my take is that we will witness deflationary forces at first but see massive inflationary forces later.
The massive amount of debts first need to be removed from the system and that process is underway. The house needs to be cleaned of bad debts so to speak. This is causing deflation at the moment. At some point however, the forces of inflation look like they must hit with a fury as foreigners, fearing the financial condition of the U.S., start dumping our IOU's to them. I am of the opinion that most of the inflation we are going to see will come from foreigners, such as the Saudis, the Chinese, and Japanese, who will at some point start dumping dollars and T-Bills they hold in masse. They are going to want to buy something of real value with those dollars and when that happens, the inflation that we have exported for decades could suddenly come home to roost.
Up until this point, since foreigners have been content to hold our dollars, we could get away from feeling the affects of this inflation. At a point, however, in our not-to-distant future, the forces of inflation look like they will take over. The Fed has said repeatedly they will print as much money as is necessary to avoid deflation. I take them for their word on that promise.
All of this activity will prove good for gold, silver and eventually our mining shares.
Dreadful Times = Opportunity in Gold Mining Shares
I have mentioned several times this year that before we get to the parabolic moves that many are expecting in the metals and mining shares, we may have to witness a downside that could be absolutely dreadful. Well, unfortunately, dreadful is where we are right now.
On top of the carnage in mining shares, gold and silver prices have been hammered to the downside taking the metals to unexpected levels causing investors even more concern and worry. Gold has now sold off almost 25% from its last new high made in March of this year at US$1,031. Typically we have seen gold and silver sell off 10% to 15% after making a new high so this new development is making some headlines. It has been as difficult a time as I can remember in this market, especially since the fundamentals are so strong for much higher prices.
The sell-off in gold and silver this past week, which was unexpected by most including myself, is a short-term phenomenon. It will not last long. We can best endure it by understanding what is happening and knowing that this volatility is a clear indicator that something is really wrong, prompting in my opinion near-term explosive moves in the metals.
The Fed, knowing a financial hell-storm is about to hit, is trying to prepare as best they can by propping up the dollar. In my opinion the Fed has informed the central banks around the world of what they are dealing with and have asked for help in supporting the dollar. A massive collapse of the dollar would be bad for all involved. So in collusion with other central banks around the world, the Fed has propped up the dollar temporarily knowing what is coming is going to be very negative for the greenback. Their hope would be that as the financial tsunami hits, they can keep the dollar from going below the 70 level on the US Dollar Index. Just prior to this up-move for the dollar of almost 5%, the US Dollar Index was teetering around the 71 to 72 level. We'll just have to wait and see what happens.
Two pieces of information I look which have been reliable in the past are the Gold/XAU and Gold/HUI ratios for determining where the bottom may be for gold and silver prices. Based on these ratios, I see that the price of gold and silver may have bottomed last Friday. For me this was a totally unexpected buying opportunity last week and a gift for those who were looking to add precious metals to their portfolio. Bullion dealers everywhere however have been reporting that they have little or no inventory of items to sell. On top of that the U.S. Treasury announced they have suspended the minting of gold and silver eagles for the time being. All of this is very unsettling but very positive for much higher gold and silver prices.
An Upturn in Mining Shares
Our mining stocks are acting even more problematic, but I sense this market will soon bottom out as well over the next several weeks. Hedge Funds, which are blowing everything out the door in order to raise cash, have been the biggest culprits affecting our mining shares. With so few buyers at the moment in the precious metal markets, we are seeing the best purchase opportunity I have seen in the junior mining shares in the past five years. There are some exceptional values out there at the moment. Several of our stocks will be moved back into the buy category in the August Mining Speculator which will be out later this week. In this edition I will have a full update on our mining stocks and which companies would be the best places to put new money right now. I sense the turn to the upside could be very close as we head into the fall.
For now, all we can do is exercise patience and prepare as best as we can for the major changes that are coming. Please do not panic and sell your mining shares at these ridiculous levels. A better time is right around the corner.
Greg McCoach
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| Gold | $822.80 | -6.70 |
| Silver | $13.38 | -0.10 |
| High Grade Copper | $3.49 | 0.01 |
| Palladium | $288.00 | -1.00 |
| Platinum | $1,434.00 | -7.20 |
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Economic Releases for the week of Monday, August 25th, 2008:
Aug 25 - Existing Home Sales
Aug 26 - Consumer Confidence
Aug 26 - New Home Sales
Aug 26 - FOMC Minutes
Aug 27 - Durable Orders
Aug 27 - Crude Inventories
Aug 28 - GDP
Aug 28 - Initial Claims
Aug 29 - Personal Income and Spending
Aug 29 - Michigan Sentiment
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