Welcome to the Room - May 18, 2007

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Last Updated May 11, 2007



Dear Readers,

There is, as usual, much to comment on this week. And, as usual, little time to do so.

As I am sure it has caught your attention, gold has been having an “interesting” week, driven mostly by news of no long-term importance. Following is just a sampling of the news out this week.

The economy, as predicted here ad vomitum, is showing signs of slumping. Including, it is worth scribbling in the corner of one’s Moleskine® notebook, the news that last month retailers posted the biggest sales decline… ever.

On that topic, the folks at Bloomberg did a quick dial around and came up with one Edward Hemmelgam, the prez of Shaker Investors who went on record as saying ”The Fed's pretty much on hold, and yet the economy is slowing.”

That surely must mean that inflation will moderate, over time, as the prices of things can’t go up when the economy is on the down-lo, right?

Well, not quite. Because we also had news this week that the prices of imported goods climbed for the third month in a row, led, of course, by oil.

Not to worry… oil is just one component of the import price index. Albeit, one also must note, a pretty darn important one. After all, doing without oil means riding around in ox carts, hand-felted caps shading us from the sun while keeping eyes peeled for edible roots.

Speaking to Bloomberg, one Bankim Chadha, the chief equity strategist at Deutsche Bank Securities was heard to posit his view that “The key risk for the market this year is inflation.”

Now hold the phone here, Bankim… Eddie just told us the biggest threat to the market was an economic slump. What gives?

Then there was the news that the dollar was strengthening because the Fed was talking tough about inflation, despite the weakening economy. To which we reply, “talk is cheap.” As if Bernanke & Co are going to raise rates any time soon.

And we had the technical level of $675 on gold being taken out on the downside. Per recent comments in this space and elsewhere in the Casey Research collection, futures markets have become a major factor in gold prices… and futures traders are particularly keen on technical analysis, a form of divination that we only keep a casual eye on.

Not that technical analysis can’t be useful; it can be for those with short-term attention spans… and futures traders tend to be very short-term oriented, with the decision to keep a trade on overnight a matter of great deliberation and consternation. For long-wave riders, investors who like to catch a mega-trend while it is still in the early stages and ride it until it crests – a profile we fit – technical analysis has almost no value.

Even so, in the interest of keeping you “in the know,” we wanted to provide you with an update on the price levels the techies now consider important.

For the answers, I turned to longtime friend Ian McAvity, who has been writing a technical service, Deliberations ( http://www.chartguy.com/Deliberations.htm), since before I’ve known him… which is some time now. Here’s his response.

“Downside break points on Comex near active for silver would be $12.50/12.00. Break $12 with any conviction and you could see a test of $10 or maybe $9.50. But it is still above its 200 Day moving average (MA), which is now around $12.80. On the upside, silver would have to take out $14 and $15 with some conviction to give the bulls their jollies.

“Gold looks to have failed at $700. On the downside, the 200 Day MA, which is around $634, has not been broken yet. Breaking the March low Comex near active at $634.50 would get some bearish emotion going and could lead to a test of last year’s lows of around $560/$545. The last push up left a lot of price/momentum divergences that poisoned the well for the bulls. I've heard talk of $660 being important but don't see it on my charts. $635 would give a religious experience to the true believers I suspect. Not impossible, it could bounce off the 200 day MA or turn higher and still take out $700/$725, but I think that's a lot less likely. Have to include that caveat until $635 is broken to confirm to the downside.”

(As you might ascertain, Ian is not very bullish on the metals, believing that they need a solid 15% to 25% correction before they can decisively bottom. At least that’s what his charts are telling him. Hmmm.)

Weighing heaviest on the market this week, however, has been something of a “surge” in selling of gold by central bankers. “Conspiracy!” say some, pointing out that said sales reliably pick up as gold nears $700. “Just taking advantage of higher prices,” say others.

None of this will mean anything in the long run, says we.
But here’s something that may…



The Trade Deficit

This week, we also had news of the sort that should send the Wall Street types early to the martini bar: the U.S. trade deficit widened well beyond the level that most pundits expected.

A quick chat about trade deficits seems timely. Starting with the notion that they are inflationary, right?

Well, technically, they don’t have to be. That’s because, in the absence of government intervention, all a trade deficit should mean is that the people of one country are willing to trade their money for something on offer by the people of another country. In the 1800s, the U.S. ran big deficits and did quite well because our country was full of opportunity and promise, so foreigners invested here, more than we invested there.

The problem comes when a government, say China, steps into the picture and deliberately suppresses its currency to attract businesses to certain sectors of its economy – for instance, city dwellers. That causes an aberration, the result being a lot of U.S. dollars shipping out to China in exchange for all manner of consumer goods… dollars that the Chinese have then turned around and invested in U.S. Treasuries. More on that momentarily.



End Game?

The massive deficits with China are unstable because, rather than being the result of open trade, they are based largely on political decisions made by a handful of people in the Chinese government. In time, those people – or their successors -- may decide that there is more advantage to spending the dollars. Or they will be forced to do it. Say, to appease other segments of the economy now penalized by the higher cost of foreign goods. Or they might have to spend the dollars to pay the cost of a war or to bail the country out of a financial crisis.

Regardless of the reason, at some point the political advantage of spending those dollars, rather than hoarding them – which the Japanese did to their detriment -- will reach a tipping point after which those dollars will come flooding back to the market, devastating the value of the dollar on foreign exchange markets.

The dollar has already, since 2002, lost about 26% of its value. Of course, a good deal of that depreciation has been offset by the interest foreigners earned on their Treasuries. But treading water is one thing, and standing by while your pile of cash starts to go up in the flames of a monetary crisis is another.

Viewed from another angle, over time it isn’t the trade deficit that is inflationary. Rather, it is what is effectively the subsidy provided to the U.S. by China… a subsidy that comes from the Chinese having used the river of dollars provided by U.S. consumers to buy the unbacked paper of the U.S. government. That has allowed U.S. interest rates to remain artificially low and forestalled inflation in the U.S. It is as if China is building up a big bank of inflation points. Sooner or later, they are going to spend those inflation points.

Make no mistake, we are in uncharted water; it is unprecedented that the claims represented by the fiat currency of one government – that of the U.S. -- have been accumulated in such massive quantities for the reserves of other governments. And we’re not just talking China, but virtually the world. And the world is getting nervous.

To quote Thai Finance Minister Chalongphob Sussangkarn in his recent address to the annual meeting of the Asian Development Bank in Kyoto:

"Should the financial markets lose confidence in the U.S. dollar, huge capital outflows from the U.S. could lead to a rapid depreciation of the U.S. dollar, and thus dramatic appreciation of other currencies."

The whole matter of trade deficits is, unfortunately for investors not paying attention, just one of far too many aerosol cans now roasting in the fire. When they start exploding, you’ll want to be safely hiding behind a wall of gold and silver.

In the final analysis, every day gold goes up and gold goes down, with the movements based on any number of inputs. To avoid being panicked one way or the other, a long-term perspective is required to see these fluctuations in their proper perspective. And, despite all the jagged fits and starts these past few years, and all the nay saying along the way, three years ago to the day, gold was trading for $440 an ounce… 51% lower than it is today.

And the better gold shares have offered exponentially higher returns than that.

While it means next to nothing in the broader scheme of things, despite all the pressure on gold, including fairly tame producer price data released today, gold has managed once again to push back off the floor and is trading back over $670 as I write.

Steady as she goes.



A New Price and a New Day for Uranium

As you can see by glancing at the upper right hand of this page, the price of uranium is now shown as $120. That’s the price reported by TradeTech, based on commercial contracts signed a couple of weeks back. But the trade data is now something of an artifact, thanks to the fact that, as of May 6, uranium contracts have begun trading on the NYMEX futures exchange.

It takes a bit of clicking about, but if you start with the link just below, you can find your way to the close-in futures price of uranium where you’ll find that the contract date June 7 is last at $130.00.

http://www.nymex.com/index.aspx

We’ll have more in-depth analysis of the impact of the new futures contracts in the next edition of the Casey Energy Speculator, due out May 15.

[Ed. note: If you aren’t yet a subscriber, why not give the Energy Speculator a try? It comes with a 6-month money-back guarantee, so you have an abundance of time to see whether it’s right for you. Click here to learn more and get started .]



Base Metals Bears

It is not our purpose in life to try to massage the data to fit our point of view. In fact, we are nothing if not open minded. Last week, I asked readers to propose scenarios that might cause things to break in a direction other than that we expect. We received a couple of ideas worth responding to, and several that were rather too unfocused to warrant your attention.

We’ll get to the better ones as they relate to gold next week, but there was a very sound-sounding bearish view on base metals we thought worth sharing. You can read the entire Bloomberg article by clicking here.

The theme of the article is that, due to high prices, the supplies of base metals coming onto the market will quickly reach the point where they overwhelm demand, driving prices down. This scenario is especially inevitable, according to the base metals bears, because China’s rocket-like economic expansion must surely slow, thereby reducing the demand.

According to the Bloomberg article, despite the strength of their argument, these same bears, most notably the folks at JP Morgan, have been wrong about the base metals for some time now. To quote Bloomberg…

“An investor who acted on the advice of JPMorgan, the third-largest U.S. bank, missed gains of 67 percent for nickel, 30 percent for copper and 41 percent for lead, the best-performing commodities in the 26-member UBS Bloomberg CMCI Index.”

As many of you know, we ourselves have been cautious on the base metals, but rather than eschew the sector altogether, we have simply tightened the criteria a base metal play has to meet before we’ll invest. (Tooting our own horn, the copper play recommended in last month’s edition of the International Speculator has already advanced 52% based on subsequently pulling 60 meters of copper grading 1.60%.)

Just for giggles, I sent the Bloomberg article on to Clyde Harrison, the brains behind both the Rogers International Commodity Index and now the Bridgewater Index.

After reading it, he gave me a call. His view can be summed up as “They may be right, in the short term. But a year down the road, the base metals are going to be trading much higher than they are today.”

Why?

According to Clyde, the debate about China’s growth is already over, underscoring that contention by sharing just a few data points… such as the fact that there are currently 168 power plants being built in China. In addition to the massive amount of metal used in constructing those plants, consider the copper wire those power plants are going to be connected to. “Will there be a fall-off in demand for copper? Not likely,” Clyde replied, answering his own question. He also noted that China built and sold as many cars as the U.S. last year.

And it is important to understand, Clyde continued, that today one billion people use 2/3 of the world’s natural resources. The balance of 5.6 billion people use the other third, but they are quickly becoming more successful, setting up a serious competition.

Which goes a long way toward explaining why there are now 50,000 students studying geology in China, versus 900 in the U.S. (of which 300 are foreign). And why the Chinese are increasingly showing up in remote corners of the world, checkbooks open, eager to trade our dollars for tangible resources. Unlike businessmen from the U.S., the Chinese buyers don’t insist that the sellers start labor unions or clean up their pay practices, they’re just there to do business.

In that regard, the Chinese have no qualms of passing across a briefcase full of cash if that’s what’s required to get the deal done. That’s something a U.S. executive would go to jail for. Behind Door A is a briefcase full of cash. Behind Door B is a Happy Meal and nothing else. Who do you think is going to get the deal?
Then there’s this.

According to Clyde, historical data shows that when a country starts to industrialize, per-capita usage of oil typically goes from about 1 bbl at the beginning of the industrialization, to between 17 and the 27 bbl per capita by the time the industrialization is completed.

That China is just beginning to industrialize, and has much further to go, is evident when you consider the Chinese currently consume just 1.7 bbl per capita per year. And the citizens of India use just 0.9.

Clyde will have much more to say on the topic at our Chicago Gold & Silver Stock Summit, coming up May 30 & 31. I’ve just been told that there are less than 20 seats remaining. If you’ve been putting off signing up, it’s time to get off the fence.

For more details and to sign up, click here now.



Field Report from the Panamanian Jungle

My favorite partner Doug Casey and senior researcher Louis James have spent the week in Panama kicking rocks on a couple of plays and, as part of the due diligence, meeting with Panama’s president, Marin Torrijos (who, Doug told me in a call, was very intelligent, very nice guy… more on their meeting in an upcoming edition of the International Speculator).

To give you a sense of the field work they were there to do, I asked Louis to send along some notes, which he did last night. His comments follow…

“I'm sitting here in the restaurant in my hotel in Panama City, one of the most modern and most nicely appointed hotels I've stayed at. There's a giant Easter Island-style sculpture, maybe 30 feet tall, in front of me. Over this, in this very tall room, the ceiling has round skylights. Except they are not skylights but glass ports in the bottom of a huge hot tub bubbling over my head. Unfortunately, there are no girls in the water at the moment, but perhaps if I sip my after-dinner tea slowly enough...

“This is about as different a setting as I could be in from where I was a scant few hours (and a turbo-prop hop, a mad dash in a pickup truck, and a harrowing helicopter ride in the clouds, just above the jungle canopy) ago.

“In fact, almost exactly six hours ago, I was lying flat on my ass in a rushing mountain stream, half way down a mountain path -- no, it doesn't really deserve the name "path," rather, let's say that I was hiking as briskly as I could down a very steep mountainside covered with tropical rain forest, trying to follow the boot prints of my Indian guide. In places it was so steep, it was like a ladder, and I was using my geologist's hammer like an ice-ax to make non-slippery-wet-moss-covered hand-holds as I went.

“My guide, a Nobe-Bugle (pronounced somewhat like: "no-bay-boo-glay." The Nobe and the Bungle are actually two different tribes, but I couldn't tell them apart) was, of course, skipping ahead like Legolas, the elf from Tolkien’s trilogy, running over the deep snow. He had the good grace not to laugh at me, even when I fell in the stream. That was my bad. I knew the wet rocks just out of the water were more slippery than those in the running water, and had simply splashed through most of the creek. For some reason, just as I was about to climb out the far side, I forgot and hopped on an inviting-looking flat rock...

“I got up laughing; I was having a great time doing what I love. Not falling, of course, but kicking rocks with knowledgeable geologists passionate about their work. At that point, I was on my way to rendezvous with the chopper that was supposed to whisk us from those Panamanian mountains to the nearest airport, but I had just climbed about 900 vertical meters from the chopper platform to where the Panamanian geos had, with exquisite care and back-breaking labor, cleared the jungle from hundreds of meters of rock faces (near-cliffs, actually) in order to take samples.

“Some of those samples came back with high grades of gold and copper, which was no surprise, given the huge area of alteration, wide swaths of stockwork veining, and telltale green rocks where the copper grades were highest. And this wasn't just a few meters of enrichment but a whole mountain-side of rock that had seen repeated mineralizing events.

“I liked it.

“Even though a large squadron of viciously hungry Panamanian attack mosquitoes have left me looking like I have the measles.

“It's a jungle out there...

“Speaking of which, ‘impenetrable jungle’ is not just an expression from 19th-century romances. Had we not had a machete-wielding Nobe-Bugle there with us, we'd have had trouble even where actual paths had been cleared before. ’Machete‘ may not be the right word; that thing was more of a one-edged sword, easily boasting a meter-plus blade. The guide was felling respectable trees with it. And the jungle was anything but quiet; numerous insects, birds, tree frogs, etc. kept a constantly evolving cacophony going.

“Normally, I'd take hundreds of pictures a day in such an environment, but it was raining much of the time, so my cameras spent most of the day in plastic bags and I only got a couple dozen pix.

“As I tried to control my descent through the nearly vertical rain forest, eyeing the thick clouds that made it all look so mysterious, I was glad when I heard the chopper approaching somewhere below me--and more than a little joyous when I heard its motor shut down rather than fade away, as it would have done had it not been able to land on the rough-hewn wooden platform the Nobe-Bugle had made for it at a high point on a knife-edged ridge. The clouds were not so obliging when it was time to go; they closed in and didn't seem inclined to leave any time soon. And I had a flight to catch (and one of my children's birthday to make tomorrow).

“In the end, the pilot decided he knew the lay of the land well enough, and that not much farther down the mountain we'd be under the cloud cover, so we went for it. He took off with effectively zero visibility--banked sharply into the clouds and took the chopper down the side of mountain just above the tree tops. He was right about his memory of the mountain side and about breaking out below the cloud cover pretty quickly (or I would not be here writing this while having dinner), but the ride certainly was... interesting.

“When I got to the local airport, I left a trail of mud from the truck that drove me there from the Chopper's landing point, all the way through the terminal and out to the plane that took me back to Panama City.

“Where was the project? Stay tuned for a Casey Research report on our findings in Panama, coming to a newsletter near you soon.”



That’s It for This Week

As you can see from Louis’ report, your Casey Research team will brave incredible hardships to bring you the story.

Bud Conrad, for instance, had to sit through a lengthy meeting with Robert Hormats, vice-chairman of Goldman Sachs, last week. Bud will compile his notes and share them with us next week.

Until then, thanks for reading and for subscribing.


David Galland