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Updated @ 1:10 a.m. EDT, Monday, October 22, 2007.


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.

Money, it's a gas; grab that cash with both hands and make a stash. --Pink Floyd, "Money"

AS A DOUBLE TOP IS COMPLETED FOR MANY ASSET CLASSES, THE BIGGEST WORLDWIDE EQUITY/COMMODITY CORRECTION IN NEARLY SIX YEARS HAS BEGUN (October 22, 2007): The media has talked a lot about how the financial markets "keep making new highs". While this has been true for the indices which the media talks about most often, such as the S&P 500, the Dow Jones Industrial Average, and the Nasdaq, and is even more true for emerging-market indices and most commodities, there are several notable exceptions which are likely serving as a clear warning for the serious investor.

To begin with, most U.S. domestic equity mutual funds have not surpassed their mid-July peaks. Investors who check their accounts online, or peruse their brokerage statements, are probably puzzled as to why they have not enjoyed the gains that they keep hearing about. Similarly, many broad-based domestic equity indices including the Russell 2000 (RUT), the S&P Midcap 400 (MID), and the S&P Smallcap 600 (SML), among many others, never surpassed their highs from the middle of July 2007. A double top is a classically bearish chart pattern.

While the prices of gold and crude oil had continued to set new peaks as recently as Friday, October 19, the shares of the companies that produce these and similar commodities have struggled, especially since October 11. Very few investors probably realize that even with gold having surged to its highest point on Friday, October 19, 2007 since way back in January 1980, the high for gold mining share indices such as HUI, the Amex Index of Unhedged Gold Mining Shares, has glaringly underperformed. This index topped out at 423.16 on October 11, 2007, which was only 5.345% above its previous peak of May 11, 2006. A mediocre money-market fund would have provided a better rate of return over the same 17-month period of time, with far less volatility.

Much more importantly, emerging-market equity indices began to rise nearly vertically in September, and have only begun to move lower during the past four trading days. Whenever any financial asset reaches the point of euphoric ascent, there are only two possible outcomes: 1) a continued euphoric ascent; or 2) a collapse. Now that the nearly vertical rise has terminated, the only realistic path is a plunge. If China's Shanghai "A" Index were to decline by 57% from last week's historic peak, it would still be above its February low, so even a half-price blue-light special for many emerging markets would not make them bargains on a fundamental basis.

As equity indices accelerate their very recent downturn, global speculators will be selling their most strongly appreciated assets such as gold and crude oil, and likely covering their enormous profitable short positions in the U.S. dollar, in order to pay for margin calls on their other accounts--or simply to have tax gains that will be offset by their losses in financial shares, housing-related sectors, and other underperforming equity groups. The steeper that these declines become, the more widespread will be such margin calls and tax-loss selling. The time of year with the greatest tax-related adjustments (i.e., November and December) is closely approaching, so this could create a worldwide snowballing juggernaut effect that will bring down virtually all equities and commodities in its wake.

Only the U.S. dollar and U.S. Treasuries are likely to appreciate in such a scenario, as has been the case during the first several months of every major equity/commodity correction since gold was delinked from the U.S. dollar in 1971.

Gold "commercials" are jewelers, fabricators, and others who are most familiar with the gold market since their business is buying and selling physical gold. As a group, they have not been this heavily net short gold since the traders' commitments were first reported in modern form (which was after January 1980), according to the data at http://www.cftc.gov/ . See also http://www.softwarenorth.com/ for more than one decade of this data in easily readable chart form. The traders' commitments are released each Friday at 3:30 p.m. Eastern time. Currently, gold commercials are long 77,405 and short 316,501, for a net short position of 239,096 contracts. Each contract represents 100 troy ounces of gold. This means that once gold begins to decline, it will be a long way down.

The biggest surprise for investors in gold mining shares will be how quickly they will return to their lows of August 16, 2007. If HUI repeats this bottom, as I suspect will likely be the case, this would represent a decline of more than 32% from its October 11 peak. Such a pullback would be merely average when compared with the previous five such corrections during the past seven years, as described in detail in the link below:

  • Overview of Gold Mining Shares (substantially updated on October 22, 2007)
  • Learn more about Steven Jon Kaplan and watch a live interview on MarketWatch.
  • I am currently offering a daily e-mail subscription service for $110.50 (U.S. dollars) for one year, or $37 for three months. Under this service, I will send you an e-mail every business day, and a special weekly review on Sunday, giving specific timely buy/sell recommendations, as well as long-term guidelines for money management. I will also respond to all e-mail questions that you may have regarding my daily updates. Payment can be made through PayPal, credit card, or check, whichever you prefer. Your e-mail address will not be given to any other person or organization under any circumstances.

    The price of this subscription will increase to $119.50 for one year and $40 for three months the next time that HUI goes below 290 [increased from 270], since that is when it will be most timely to purchase gold funds.

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    THE U.S. DOLLAR RALLY HAS BEGUN IN DRAMATIC FASHION (October 8, 2007): Just when everyone was convinced that the U.S. dollar was set for a certain collapse, it has enjoyed a powerful rebound from its all-time low on September 30. In just the past eight days, the greenback has rallied past one key resistance level after another.

    Of course, this should not have been a huge surprise, since any asset with such a record low percentage of bullish participants is almost certain to move higher, since there is no one left to sell it (or, more to the point, to sell it short). While Japanese housewives and average-Joe speculators all over the world are trying to figure out how to "diversify away from the dollar", the greenback has begun a powerful upward move which will last for at least a half year, and perhaps for more than a full year.

    Gold mining shares had signaled this move well in advance, as they completed a very bearish double top on September 21--nine days before the U.S. dollar index completed its historic bottom. This high on September 21, 2007 almost exactly matched its peak of May 11, 2006, and thus has significantly negative implications for mining shares--and probably for global equities in general--over the next several months. Gold mining shares then notched a nearly matching peak on October 1, to confirm the existence of this double top.

    Historically, the first five or six months of a U.S. dollar rally are very negative for precious metals and their shares. After about a half year, investors have fully anticipated continued gains for the greenback, and therefore additional increases no longer have any negative impact on gold or silver. This was seen most clearly in 2005: as the U.S. dollar began a powerful rally at the very end of 2004, gold and its shares continued to move lower until May 16, 2005, when gold mining shares completed a historic bottom. The U.S. dollar continued to advance for another half year, but gold and its shares were able to rebound--eventually in dramatic fashion--as the dollar's increase was no longer a surprise.

    Therefore, the decline in gold and silver and its shares will likely end sometime around March 2008, with an estimated total pullback for gold mining shares of between 30% and 40% from their September 21 peak.

    The October rise in the U.S. dollar has barely been mentioned by the media. Commentators continue to act as though the U.S. dollar were still falling. Whenever there is this much skepticism and indifference toward a major trend change, it is certain to intensify and create even greater surprise among market participants.

    CURRENT ASSET ALLOCATION (October 22, 2007): 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%), 1.5%; long-dated U.S. Treasuries and their funds, and long-dated municipal government bonds, including TLT and MYJ, 35%; Treasuries between 2 and 10 years in duration, such as IEI and IEF, 12.5%; TOC, 1.0% (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, negative 30%; SHORT POSITIONS: Nasdaq-equivalent (QQQQ, SMH, NDX, GOOG, in that order) and related shorts, 53.5%; short CFC, 0% [had been 3%]--recently covered at a substantial profit; short GLD, 17.5%; short GDX, 2.5%.

    REMINISCENCE OF THE WEEK (October 22, 2007): For many years, I have been attending an event each January in which sophomores and juniors from my alma mater visit Manhattan for a few days. I serve as one of their mentors, telling them about how to pursue job opportunities in finance, and the best way to make the most useful personal networking connections. During the first few years of mentoring, I was barely older than the students whom I was assisting, so when they asked me when I graduated, I would always joke that it was "before you were born". This response would inevitably generate great laughter. Now, it is no longer humorous--at least to me--because it is true. If I continue with this mentoring program long enough, I'll eventually be able to say honestly that I graduated before their parents were born.

  • Best of Previous Reminiscences
  • (c) 1996-2007 Steven Jon Kaplan Your comments are always welcome.

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