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Updated @ 6:45 a.m. EST, Tuesday, January 8, 2008.


WELCOME TO TRUE CONTRARIAN! I will attempt to create an entertaining, readable, and hopefully refreshing viewpoint a few times each month. Each issue will feature my intermediate-term financial outlook, my long-term financial outlook, and a personal reminiscence.

As scarce as truth is, the supply has always been in excess of the demand. --Josh Billings

GOLD AND ITS SHARES ARE COMPLETING A VERY NEGATIVE DIVERGENCE (January 8, 2008): It is very significant that even as gold has been able to surge to new 28-year highs in January 2008, including this morning, all gold mining share indices and funds have continued to make lower highs as compared with their peaks of November 7, 2007. Whenever this kind of negative divergence has been seen in previous years, there was always a subsequent substantial pullback for both precious metals and their shares over the next several months. It is doubtful that this will be the first exception to the rule, especially as the U.S. dollar began a powerful rally on November 22, 2007 that will likely continue for most of 2008.

The recent behavior of crude oil has confirmed this negative divergence. Crude moved slightly above $100 per barrel on January 2 and January 3, 2008, prompting a wild media frenzy and inducing speculators to increase their call options bets tenfold on the most active crude contract moving above $200 per barrel by the end of 2008. More details on $200 oil bets can be found at http://bloomberg.com/apps/news?pid=20601087&sid=ayFtQXGhk_lw&refer=home .

Whenever this much excitement accompanies relatively modest price increases over previous peaks, it is time to ask how far prices will move in the opposite direction. The answer can be closely estimated from a study of historic patterns. Gold mining shares, for instance, tend to surrender slightly more than one third of their value roughly once per year; details can be found in the link just below. Such a correction likely already began on November 7, 2007, and will accelerate over the next several months.

This time, the total pullback for gold mining shares is likely to be close to 40%, since those emerging-market countries like India which are the largest per-capita consumers of gold will likely experience the greatest disappointment in their anticipated growth rates. Gold and silver, being nonessential items, will be among the most negatively impacted commodities by the ongoing global economic contraction. This worldwide slowdown has also induced stock markets everywhere to begin important corrections in the fourth quarter of 2007 that will likely continue until the second quarter of 2008.

Although there is a popular myth that the stock market and gold move in opposite directions, the fact is that whenever the S&P 500 or the Nasdaq is declining over any period of several weeks, gold mining shares generally fall by an even greater percentage over the same period of time.

As for crude oil, it bottomed slightly below $50 per barrel in January 2008, so assuming that it continues its pattern of forming moderately higher lows, a pullback to around $60 per barrel for crude is likely by the spring or summer of 2008.

DON'T COUNT HILLARY OUT YET (January 8, 2008): The last we heard from the mainstream media, the election was all but over, at least on the Democratic side. Don't believe it for a moment! First of all, unless one candidate is able to obtain an absolute majority of delegates, nothing is going to be decided until the summer convention. Secondly, media sentiment has become so frenzied against Hillary Clinton that any rebound in her chances will come as a real surprise, and like any truly unexpected event (such as a rising U.S. dollar) will therefore create a significant change in public perception. It's a marathon race, so don't be fooled by whoever is ahead after the first mile or two.

While precious metals shares have been in a strong long-term bull market for just over seven years, there have been five pullbacks averaging more than 1/3 for gold mining shares in less than six years. More details about this and similar information about precious metals investing can be found in the link immediately below:

  • Overview of Gold Mining Shares, updated on January 8, 2008.
  • Learn more about Steven Jon Kaplan and watch a live interview on MarketWatch.
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    COMMODITIES ARE SET FOR A SHARP PULLBACK THROUGHOUT THE FIRST HALF OF 2008 (December 28, 2007): Commodities have become extremely popular as an asset class for investment, to the extent that many investors who wouldn't have touched them a few years ago are now jumping aboard the bandwagon. On any financial cable TV show, you will see one bullish commodity analyst after another telling you why demand from China will drive this or that commodity higher, or how the falling U.S. dollar will continue to increase the demand for commodities, or whatever they think the public will find easiest to understand. One almost never sees a bearish commodity analyst.

    What all of these analysts have forgotten is that the financial markets are cyclical, not linear. Once any trade becomes too popular, it will cease to be profitable.

    The U.S. dollar index began a major rally on November 22, 2007. So far, this historically important rebound has received so little media coverage that analysts continue to speak about "the falling dollar". Whenever any trend is so completely "dissed" by the media, it will always intensify until it can no longer be ignored. The U.S. dollar will continue to move higher throughout 2008. Partly this is because anticipation of a new U.S. President will strongly support the currency; partly this is because an eventual withdrawal from Iraq will be positive for the budget deficit; partly this is because amateurs around the world have been selling short the U.S. dollar. After being burned by selling short the Japanese yen which later surged, Japanese housewives switched to selling short the U.S. dollar, "which can't go up" [just like real estate "can't go down"]. Do you think they're going to suddenly be right this time?

    Mostly, the U.S. dollar will rise because the "decoupling" myth will be smashed. This myth, which is extremely popular with the media, states that the U.S. housing market and the U.S. economy will slow, while the economies of emerging markets will accelerate. To believe this nonsense is to go against all of economic history, which has proven that whenever the dominant economic power of the day has gone into decline, the rest of the world has gone into an even greater contraction. Yes, U.S. housing prices have fallen, and are now down 6.1% year-over-year, according to the Case/Shiller index. But housing prices in the rest of the world will fall by an even greater percentage, since they are even more overvalued in most countries. Sure, the U.S. economy will probably slow, and quite possibly even go into recession in the first half of 2008. But if the anticipated U.S. economic growth rate, currently set around 1.5% by most observers, ends up being negative 1.5%, then that is a shortfall of only 3%. Double-digit growth rates anticipated for China and other emerging markets in 2008, which currently average around 13%, are much more likely to be around 6%. This would represent a disappointment of 7%, which is obviously much greater than the U.S. shortfall. Therefore, the U.S. dollar will rise in value, since currency fluctuations are primarily a function of actual growth rates versus their anticipated values.

    What this all means is that the prices of commodities, especially gold, silver, and crude oil, are set to fall sharply over the next several months.

    If you look closely, the financial markets have already been anticipating this development. When gold mining shares were peaking in early November, there was substantial insider selling by top executives of gold producers. Over the past three months, there has been persistent and intense insider selling by top executives of nearly all energy companies. Just as the public has been eagerly buying, the big boys (and a few big girls) have been selling. Ask yourself this: who will be right, those folks who are living in real mansions, or those who bought McMansions with zero money down in recent years?

    In addition to the insider behavior, if you look at a chart of the indices of gold mining shares or energy shares, their downtrends are evident. Gold mining shares as a group, for example, have fallen by double-digit percentages from their peaks of November 7, 2007. During this time, the price of gold has remained little changed. Historically, the shares have always led the metal, both higher and lower. It is more likely that the Hillary Clinton will become a Republican than to see a failure in this reliable financial pattern.

    It is also true that gold commercials, who are the wealthiest and most knowledgeable participants in the gold market, have never been more heavily and consistently net short than they have been in recent weeks (this data goes back to 1986). Additional information about the traders' commitments can be found at http://www.cftc.gov/ or http://www.softwarenorth.com/ .

    How much will commodities decline? The price of gold will eventually go below $700 per ounce, probably in the spring of 2008. The price of crude oil will decline even further, eventually going below $60 per barrel, no later than the summer of 2008. Gold mining shares will most likely make some kind of double bottom with their lows of August 16, 2007, which would imply a decline of roughly 30% from their current levels. Whenever top executives start buying these shares again, and you hardly ever hear commodities discussed any more on your favorite financial cable TV show, that will be your signal to jump in to ride the next wave higher.

    FINALLY, A SINCERE THANK YOU to Barron's for featuring me on page 50 of their November 19, 2007 issue, which appeared on newsstands worldwide.

    CURRENT ASSET ALLOCATION (January 8, 2008): 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%), 14.5%; municipal bonds, including MYJ, 2.5%; KRE, 1%; XRT, 0.5%; TOC, 1.5% (bought at a 15% discount); gold and silver coins and related metals collectibles, 6%; other collectibles, 0.5%; cash and cash equivalents including a long position in VMSXX and in the PayPal money-market fund, 7%; SHORT POSITIONS: Nasdaq-equivalent (QQQQ, NDX, GOOG, in that order) and related shorts, 38.5% (I closed all remaining short positions in SMH on January 7, 2008); short EWM, 1%; short ILF, 1%; short GLD, 17.5%; short GDX, 2.5%; short USO, 4.5%; short BIK, 1.5%.

    REMINISCENCE OF THE WEEK (January 8, 2008): When I was in second grade, we moved from one part of Baltimore to another. At the new school, each class was learning a different song for the school musical to be performed in December, "The Wizard of Oz". The assigned song for our class was "Ding, Dong, the Witch is Dead", and since we had moved several weeks after the fall semester had started, I worked diligently each evening and even on the weekend to memorize the words so I could catch up with everyone else. Finally, I came in one day confident that I would be able to sing along with the other students in the class--and that day I was abruptly transferred to a different class. "No!" I screamed, "not a whole new song!" (The story has a happy ending, as I was able to eventually also memorize "Follow the Yellow Brick Road".)

  • Best of Previous Reminiscences
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