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Updated @ 10:30 p.m. EDT, Sunday, June 11, 2006.


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  • People don't always get exactly what they want from the financial markets, but they always get exactly what they deserve. --Steven Jon Kaplan

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    A special thanks to Mr. Don McEachern for designing the beautiful banner at the top of the web site, and a slightly different one seen on the back issue list.

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    WELCOME TO TRUE CONTRARIAN! I will attempt to create an entertaining, readable, and hopefully refreshing viewpoint roughly once per week. Each issue will feature my intermediate-term financial outlook, my long-term financial outlook, and a personal reminiscence from my journal.

    Your comments are always welcome, or send an e-mail to sjkaplan@earthlink.net.

    Recent comments are in boldface. Using an excellent suggestion of Mr. Dmitry Bouzolin, I am labeling each paragraph with the date on which it was written, beginning with my last update.

    LIQUIDITY IS BEING DRAINED FROM THE FINANCIAL MARKETS WORLDWIDE (June 11, 2006): It is human nature to project the recent past into the indefinite future, no matter how atypical the recent past may have been. If it has not rained for several weeks, you may stop carrying an umbrella, even when there are threatening clouds outside. If it continues to not rain for several months, you may even forget where you put your umbrella. That's not so terrible by itself, even if you get caught in a downpour. But if you stop building roofs on houses, since you figure it will never rain again, then you're inviting real danger.

    I see a lot of houses without roofs these days--both literally and figuratively. Literally, there are unbelievably many new, but as yet unfinished, houses and apartment buildings being constructed wherever I walk. The rarest sight in most U.S. cities these days is a truly vacant lot not scheduled for development in 2006 or 2007. The fact that this is happening when there is already a record number of homes for sale in the U.S. is probably not a positive sign for housing prices. Figuratively, investors have become accustomed to the all-time record low volatility in equity markets during the past 2-1/2 years. The only thing worse than experiencing record low volatility is becoming accustomed to it, since once the markets begin to show their true colors, one is completely unprepared for it. Most investors probably think that the financial markets are going from average volatility to extremely high volatility, but as measured by any historic yardsticks, they are still well below their average volatility of the past century, even after the past month's sharp market moves.

    Central banks recognize that, due to the recent increase in prosperity, combined with relatively low unemployment, and record high real estate valuations, this is a rare window of opportunity to tighten the availability of credit. The bogeyman of potentially rising inflation makes a convenient excuse for such tightening, no matter how flimsy its premise.

    The ability of people anywhere in the world to borrow as much money as they want has never been as extreme as it was in the past 2-1/2 years. It is as though the whole world has "maxed out" on their credit cards and "cashed out" of as much real estate as they can legally mortgage. That certainly creates the illusion of prosperity, but those debts are going to have to be repaid. If debts grow, along with compounded interest, while assets decline, there is real trouble ahead. Thus, the money supply is being contracted wherever possible, and interest rates increased, around the world. It's happening gradually, but inexorably; like a frog in a heated pot, investors don't realize that they're being boiled to their inevitable doom.

    If one looks at past periods of severe liquidity contraction, such as began in 1980, 1990, and 2000, one discovers that when liquidity is being drained, almost everything which thrives on liquidity declines in value. Equities, regardless of their individual merits, fall sharply in price. Commodities, no matter what the supply/demand fundamentals, decline even more precipitously. The overeagerness for risk which constitutes a thriving market transforms itself into an extreme aversion for risk; money flows from emerging markets to established markets; money floods into U.S. Treasuries, also propping up the U.S. dollar.

    When the U.S. Treasury curve first inverted in late December 2005, it got quite a bit of media attention. When it happened again in the past week, it received almost none. By January 11, 2006, the media had trumpeted the fact that the "inverted yield curve was wrong". Indeed! Several major technology indices such as QQQQ hit their final peaks that day. Similarly, the inverted curve might presage a very short-term rally in equities this week, and the media will again be saying that all is well.

    And, yet, central bankers will be tightening worldwide, even in small countries, and even in China. Most of the speculative excesses of the past few years, and in fact of the entire decade, will likely be completely wiped out, and then some, over the next four or five years. By the time that this contraction is fully completed, the average person will have almost entirely converted his or her portfolio from a position of maximum return on capital to a position of maximum return OF capital--i.e., losing as little as possible.

    Remember that the Presidential cycle has behaved reliably since World War II. This is not likely to be the first exception to the rule. October is the most common month for a low, so that still leaves another four months or so of downside action. Those who take no action to prepare their portfolios for this event will have their portfolios "taken care of" for them--in the Tony Soprano sense--by the markets.

    HUI CORRECTIONS IN THE PAST 4 YEARS (February 5, 2006): HUI, the Amex Goldbugs Index of Unhedged Gold Mining Shares, has experienced four corrections averaging more than 1/3 in magnitude in the past four years. Here are the precise dates and figures of each such pullback:

    2002: 154.99 on June 4, 2002 to 92.82 on July 26, 2002: 40.1%.

    2003: 154.92 on January 6, 2003 to 112.61 on March 13, 2003: 27.3%.

    2003-2004: 258.60 on December 2, 2003 to 163.81 on May 10, 2004: 36.7%.

    2004-2005: 248.18 on November 17, 2004 to 165.71 on May 16, 2005: 33.2%.

    2006: 401.69 on May 11, 2006 to ???.?? on ??? ??, ????: ??.?% [I'm guessing the eventual low will be near 248, a decline of 38%].

    CONSIDER FUNDS FIRST: Most readers will probably be interested in purchasing gold funds for the majority of their investment, either not having a brokerage account or not wishing to assume the increased risk and volatility of owning shares of individual companies. There are several dozen gold funds. (May 29, 2006) As of May 22, 2006, there is a new exchange-traded fund of gold mining shares called GDX, which is intended to track the Amex-listed index GDM. More information on GDX can be found at http://www.vaneck.com/gdx. The management fee for GDX is currently only 0.55%, which may be increased to 0.79% in another year. Since GDX has the lowest fee of all true gold funds, and can be traded intraday, it is currently my favorite gold fund. ASA is a closed-end fund of precious metals shares, heavily weighted in South Africa. Since the management fee is currently 1.15%, I do not heavily favor it, but it does trade intraday, and so may be worth buying in small quantities whenever its discount to net asset value exceeds 15%, which happens occasionally. All but three of the open-end gold funds charge more than 1.2% percent of the total assets each year as a management fee, in some cases two or three percent annually. Some of these funds even charge significant upfront or redemption fees. If you feel that a particular fund manager has a track record which justifies such a high expense ratio, then please continue to invest in such a fund. However, it is possible that such a manager may not continue his winning streak, or that his success may encourage him to leave for another company or to start his own hedge fund, and the subsequent management will not necessarily be as competent, and may charge a significant fee for switching out of the fund. Caveat emptor. The two funds which charge the most reasonable fees are BGEIX, the American Century Global Gold Fund (current annual expense ratio 0.67%), and VGPMX, the Vanguard Precious Metals and Mining Fund (current ratio 0.48%). I have a strong preference for BGEIX over VGPMX, for the following reasons: 1) BGEIX charges a redemption fee of 1% only if the shares are held for less than 60 calendar days. VGPMX charges a 1% fee if the shares are held for less than a year. 2) BGEIX contains all pure gold mining companies. VGPMX contains several energy and base metal producers. If there is a fear of a recession, or similar economic developments, energy and base metal producers will likely underperform ordinary gold mining shares. Besides, I do not want diversification if I am purchasing a gold fund; I want gold mining shares, period. 3) BGEIX has always been open for new investment. VGPMX sometimes is closed for new investment, even if one has a considerable current holding in the fund. Appendix (May 30, 2005): One of my readers, Mr. Alan Sorin, pointed out that FSAGX, the Fidelity Select Gold Fund, has an expense ratio of 0.89% and a short-term trading fee of 0.75% for shares held less than 30 days. While this is not as low a fee as BGEIX, there is one big advantage: FSAGX is priced every hour on the hour, beginning at 10 a.m. New York time, rather than only at 4 p.m. As readers who have been tracking gold mining shares for many years already know, being able to buy and sell at 10 a.m. is worth a lot, since it is around this time of day that gold mining shares usually make their lows when they are forming an important bottom. Sometimes HUI will rise several percent between 10 a.m. and 4 p.m., as it did on May 10, 2004 (when HUI made its nadir of 163.81). Once it is appropriate to sell gold mining shares, it is also usually advantageous to do so at 10 a.m., when they generally peak during the formation of market tops.

    CURRENT ASSET ALLOCATION (June 11, 2006, marked to market): My own personal funds are currently allocated as follows: LONG POSITIONS: stable value fund (retirement fund with stable principal paying variable interest, currently 5.00%), 32%; long-dated U.S. Treasuries and their funds, and long-dated municipal government bonds, including TLT and MYJ, 20%; gold and silver coins and related metals collectibles, 7%; other collectibles, 0.5%; cash and cash equivalents including a long position in VMSXX, negative 26%; SHORT POSITIONS: Nasdaq-equivalent (QQQQ, NDX) and related shorts, including short SMH, 43.5%; short CFC, 3%; short GLD, 20%.

    GOLD AND REALITY: Gold and gold mining shares often correlate closely to the real rate of return for short-term U.S. time deposits. The lower the real rate of return, the better for gold and its shares, and vice versa. The real rate of return is equal to the nominal time deposit rate (roughly equal to the anticipated Federal funds rate) minus the inflation rate. (April 3, 2006) At the current time, inflation is about 3.10% while the anticipated Federal funds rate is approximately 5.10%, yielding a real rate of return of positive 2.00%, its highest positive level in five years. Since gold and silver strongly prefer a negative real interest rate to a positive one, this is bearish for precious metals. Investors in gold appear to have entirely forgotten its important negative correlation with the real rate of return, making it that much more important at this time. It should be noted that when gold experienced its lowest point in 1999-2001, the inflation rate averaged 2.0% while the anticipated Federal funds rate was as high as 6.5%, yielding a real rate of return of as much as positive 4.5%. This positive 4.5% rate of return is the primary reason why gold fell all the way to $252 per troy ounce, not because of some ridiculous manipulation theory.

    LOOKING FORWARD TO 2060: I'll make a very far forward prediction by stating that I believe U.S. equities will make a double bottom in 2010 and 2018, with the Nasdaq bottoming below 400 in 2010, more than doubling sometime thereafter, and then making a final double-bottom retreat to below 550 in 2018, followed by a roaring bull market that will bring the Nasdaq to the 3000-3500 level by perhaps 2035, followed by a relatively mild bear market. The all-time Nasdaq high of 5132 from March 2000 will probably not be seen again until 2060 at the very earliest. (February 5, 2006) Amazingly, Jeremy Grantham, in the February 6, 2006 edition of Barron's, makes the exact same timewise prediction: U.S. equities will achieve their deepest nadir in 2010. His logic is that any asset class typically takes about one decade to go from top to bottom (U.S. equities peaked in March 2000). U.S. residential real estate lovers, take heed: the peak in August 2005 [National Association of Realtors] implies that the bottom for U.S. housing prices will occur near 2015.

    LONG-TERM GOLD OUTLOOK: Gold will continue to make a pattern of higher lows as its strong bull market from a nadir of $254.00 in April 2001 to the present continues throughout the next decade or so. Important higher lows included $319.10 on April 7, 2003; $371.25 in the morning of Monday, May 10, 2004; $410.75 on February 8, 2005; and $428.00 on August 30, 2005.

    YOUR TYPICAL GARDEN-VARIETY SEVERE BEAR MARKET BOTTOM: U.S. equities in general will continue to decline until the dividend yield on the S&P 500, currently at 1.95%, is between 6.5% and 10.5%. Great bull excesses are usually followed by equally severe recessions.

    REMINISCENCE OF THE WEEK (June 11, 2006): When I had my first computer course in college, the final exam consisted partially of an assignment that had to be completed in the main computer room, and that was supposed to take two or three hours. When I arrived in the computer room early Sunday morning before the assignment was due, I was stunned to find that all of the computer terminals with video monitors were already taken by other students. The only terminals remaining were the old-fashioned ones (by 1978 standards) that had the lowest quality of yellow computer paper that looked as though it had been faded for decades, and spooled incredibly slowly and mechanically through a feeder that looked like the inside of a player piano. I sat down anyway, and began to type the assignment. Every single character that I typed, even if I hit the backspace, was recorded faithfully by the ancient yellow paper. After about an hour, I had completed only a half-hour's worth of work, and it got slower from there. The assignment which was supposed to take two or three hours took more than eight, and at the end I had a thick scroll of yellow paper that looked something like a Torah. At that point, I was too tired to edit the scroll into something resembling a term paper, so I just took it home and figured I'd do that job in the morning. Unfortunately, it was an 8 a.m. class--the bane of my college existence--and awakening near 7:30, I barely had time for a quick breakfast before walking to school. Therefore, I just put a few strong rubber bands around the scroll and handed it in as is. The professor was quite surprised, and I hoped not too unpleasantly so. When I received it back two weeks later, it was marked "You have missed a few important points, but since you obviously worked so many hours on it, I'm giving you a B."

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  • (c) 1996-2006 Steven Jon Kaplan Your comments are always welcome.

    AUTOBIOGRAPHICAL SKETCH: I was born and raised in Baltimore, Maryland, U.S.A., and was graduated from the Johns Hopkins University with a Bachelor of Engineering Science degree in May 1982. I have been studying the precious metals markets since the 1970s, and began this web site in August 1996. I have been writing music and short stories since the mid-1960s. I maintain a fiercely independent stand toward the financial markets and toward everything else in life, and am not compensated for my writings by any person or organization with the exception of the advertising banners posted on this site. I am also a pianist, computer programmer, music composer, bridge player, and runner, and enjoy world travel. I appreciate all those who have quoted the various sayings on my web site over the years, which have wound up in some pretty interesting collections.


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