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Updated @ 4:45 a.m. EDT, Friday, August 4, 2006.


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  • Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it. --Warren Buffett

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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.

    WHAT THE WORLD'S CENTRAL BANKS ARE REALLY DOING (August 4, 2006): In the morning of Thursday, August 3, 2006, the Bank of England raised its benchmark interest rate by a quarter percent. It was the first such increase in two years, and greatly surprised nearly all central-bank forecasters. An hour later, the European Central Bank also raised its benchmark rate by an equal increment. Market participants are wondering whether the U.S. Federal Reserve will raise interest rates at its August 8 meeting.

    Before answering this question, it is important to consider how central bankers behave, and their primary motivations. The true loyalty of the U.S. Federal Reserve is to the U.S. Presidential administration, which is solely responsible for appointing all Fed members. In order to maximize the possibility of re-election, the administration in power always intentionally slows the worldwide economy in the first half of the Presidential term, in order that an acceleration in the second half will appear that much more dramatic. In this case, even though the U.S. President himself cannot be re-elected, his party's replacement certainly can.

    This is why equity markets worldwide have had a "hard landing", right on schedule, every four years since World War II. Notice the years of all major worldwide equity bottoms in recent years: 1974, 1982, 1990, 2002--each one is an even-numbered year which is not an exact multiple of four. Even the in-between years in this pattern, such as 1994, 1998, and so on (2006 will soon join this list), experienced meaningful equity pullbacks during the year. Those who think that the Fed is acting "on behalf of the people" or "for the common good" have been reading too many children's bedtime tales, and should wake up and smell the coffee.

    In order to achieve such a slowdown, central banks worldwide cooperate in raising interest rates in the first half of each Presidential term. This inevitably has the effect of curbing speculation at the margin and making equities proportionately less attractive relative to fixed-income investments. In an extreme case, such as in 1980-1982, when there is a serious risk of rising inflation, central bankers will intentionally go far overboard, even if it means that equities will reach their lowest inflation-adjusted levels in decades, such as we had at the market nadir in 1982.

    One way that central bankers around the world achieve their aims is to create the appearance of great power. The more options that any central bank has at any given moment, the more pronounced is this power. It is for this reason that I believe that the U.S. Federal Reserve will not raise interest rates on Tuesday, August 8, 2006. If the Fed does raise rates, then it will become clear to everyone that it will be their last such rise in the cycle, assuming that the U.S. economy continues to slow. Thus, the Fed's power will be greatly reduced in such a scenario, since their only perceived options for the next year will be to either do nothing, or to lower rates. The fact that the Fed would be unable to raise rates further, and that all market participants would be aware of this fact, would make the Fed much less potent. It would be equivalent to a gunfight in which it has become clear that one of the fighters has used up all of his bullets.

    Thus, in order to maintain the illusion of omnipotence, the Fed will intentionally stand pat, thereby leaving it free at the next meeting on September 20 to either raise, lower, or keep rates unchanged. This will also further its aim of slowing the economy without having to use up its final "bullet", as the uncertainty created by this action will itself serve to make the financial markets more volatile in subsequent weeks. As many market participants shun volatility, this uncertainty will continue to put downward pressure on equities worldwide, which is exactly what the Fed is trying to achieve.

    It is no coincidence that both the U.K. and European central banks have raised their rates just before the Fed's decision. Since the Fed knows that it would prefer not to raise rates on August 8, but it still wants to reduce market liquidity worldwide, it asks its pals on the other side of the Atlantic to cooperate in order to achieve this aim. As equities accelerate their decline of 2006 over the next several weeks, while commodities simultaneously plunge, it will become clear that the world's central banks have once again succeeded in accomplishing their true goals.

    (August 4, 2006) HUI, the Amex Index of Unhedged Gold Mining Shares, has fully and convincingly completed a very bearish head-and-shoulders top with 2 left shoulders and 3 right shoulders, as follows:

    First left shoulder: 349.48, January 31, 2006.

    Second left shoulder: 354.59, April 6, 2006.

    Head: 401.69, May 11, 2006.

    First right shoulder: 342.68, June 5, 2006.

    Second right shoulder: 353.50, July 12, 2006.

    Third right shoulder: 348.74, August 2, 2006.

    HUI is also completing a long-term bullish interlocking head-and-shoulders bottom with 3 left shoulders and 1 right shoulder, as follows:

    First left shoulder: 278.47, March 10, 2006.

    Second left shoulder: 270.54, June 13, 2006.

    Third left shoulder: ???.??, September ??, 2006 (274.5 estimated).

    Head: 2??.??, October ??, 2006 (248 estimated).

    Only right shoulder: 2??.??, November ??, 2006 (282.5 estimated).

    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 open-end 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 (August 4, 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 5.25%), 16%; long-dated U.S. Treasuries and their funds, and long-dated municipal government bonds, including TLT and MYJ, 30%; Treasuries between 2 and 10 years in duration, such as IEF, 8%; TOC, 2%; gold and silver coins and related metals collectibles, 6%; other collectibles, 0.5%; cash and cash equivalents including a long position in VMSXX, negative 27.5%; SHORT POSITIONS: Nasdaq-equivalent (QQQQ, SMH, NDX, GOOG) and related shorts, 42%; 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. (July 27, 2006) At the current time, inflation is about 3.15% while the anticipated Federal funds rate is approximately 5.40%, yielding a real rate of return of positive 2.25%, its highest positive level in more than 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 in 2010, more than doubling sometime thereafter, and then making a final double-bottom retreat in 2018, followed by a roaring bull market that will (August 4, 2006) create a very long-term double top for the Nasdaq just above 5000 by perhaps 2037, followed by the next secular bear market. The all-time Nasdaq high of 5132.50 from March 2000 will probably not be seen again until around 2060, six decades after it had previously visited that mark, and obviously representing a much lower real level because of inflation. (February 5, 2006) 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 1.92%, is between 6.5% and 10.5%. Great bull excesses are usually followed by equally severe recessions.

    REMINISCENCE OF THE WEEK (August 4, 2006): At the age of fifteen, when I was studying music one chilly Saturday winter morning at the Peabody Preparatory of Music in Baltimore, a sharply dressed nine-year-old boy approached me and asked if I could please turn pages for him. Assisting other students was a common courtesy, so I told him that I would happily do so, and could he please lead me to his classroom. The boy's father appeared, and told me that the request was not for a lesson, but for a recital later that afternoon. The father then invited me to have lunch at an elegant restaurant in the neighborhood with himself, his wife, and the kid. I happily accepted, surprised that I would receive such royal treatment just for turning a few pages at some obscure "Prep" recital that perhaps a dozen people would attend. After our meal, we proceeded to the back of the main Conservatory concert hall, which made me wonder why we were taking such a circuitous route to the building where I had always given my own student piano recitals. Suddenly I found that we were ascending the backstage area at one of Baltimore's premier concert halls, with several dozen professional musicians around me tuning up their instruments. I was puzzled, so I blurted out, "What's going on?" The boy's father replied, "My son, who recently won the U.S. under-ten piano competition, is about to perform Beethoven's Fourth Piano Concerto. It is the final rehearsal and the media should be in attendance. Please follow him onto the stage and sit to his left, where we have placed an extra seat for you." The boy's parents left the stage. A moment later, the curtain rose, and as I walked to my seat, I heard a sudden loud applause. I turned toward the source of the noise, and gasped as I faced the largest audience I had ever seen anywhere, complete with TV cameras zooming in and out. The boy remained quite relaxed throughout, but I don't think I have ever been as nervous as I was during that performance. Fortunately, my page turning was sufficiently competent that it did not interfere with his playing. The father was gracious enough to give me free tickets to the final concert the following week, which the young prodigy performed without sheet music, and which received very favorable nationwide publicity.

  • Please Take Me to the Best of Previous Reminiscences
  • (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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