Gold revs its engine and squeals down the track

Prices were stuck in a $50 trading range until the Fed sent the dollar reeling

By Myra P. Saefong, MarketWatch

June 27, 2008

SAN FRANCISCO (MarketWatch) -- The U.S. Federal Reserve gave gold the fuel it needed to restart its engine and the precious metal has already driven through the trading range barrier it's been stuck in for the past month. 

Gold futures had been trapped in a $50 trading range between $860 and $910 an ounce on the New York Mercantile Exchange since May 28. It climbed past $920 in electronic trading Thursday evening as the U.S. dollar slumped in reaction to the Fed's failure to signal urgency to raise rates to curb inflation.

On Wednesday, the Fed decided to hold short-term interest rates steady at 2%, but sharpened its focus on inflation, saying that the risks posed to the economy by upward pressure on prices have increased.

"Gold broke decisively out of the trading range that had constrained it as investors came to realize that the Federal Reserve won't be able to begin a rate-hike campaign until 2009," said Brien Lundin, editor of Gold Newsletter.

The Fed's policy statement essentially acknowledged the "trick box" the central bank is in -- "facing growing inflationary pressures, but unable to raise rates while economic conditions are so weak and with a national election so near," he said.

That combined with growing expectations that the European central bank will begin its own rate hikes well before the Fed can act to create a bearish environment for the U.S. dollar which in turn, provided a very bullish outlook for gold, he said.

"People are finally coming out of the fog and realizing that we're in a world of hurt and people are plain scared," said Dale Doelling, chief market technician at Trends In Commodities.

"Stocks are in the toilet, the dollar is getting hammered, oil is going through the roof, food commodities are in the stratosphere [so] there's only one solution," he said. "Buy gold! Buy silver! Buy them because they're the only defense against what's happening in all the other markets."

Fed Muck

James Steel of HSBC says that record-high crude oil and dollar weakness are boosting gold prices. (June 27)

Fed Chairman Ben Bernanke is "caught between wilting growth and rising inflation," said Julian Phillips, an analyst at GoldForecaster.com. "With such toothless words against inflation, their rate-holding action told [everyone] that they can expect no interest rate support for the dollar in the foreseeable future." "This is positive for precious metals," he said.

Gold's value as a hedge against inflation -- especially as it pertains to a weakening dollar and rising oil prices -- helped lift prices for the metal to nearly $1,034 an ounce in mid-March, the highest futures price level ever recorded. 

And with ongoing concerns about inflation and a slowing economy, gold may be poised to return to record territory, analysts said.

"Inflation is a lot like toothpaste -- once it is out, it is very hard to get back into the tube," said David Beahm, a vice president at coin and precious metals retailer. And gold is a "tremendous hedge to both protect wealth during these inflationary periods and also generate positive investment returns when other asset classes decline in value."

The Fed's policy statement noted "two situations weighing on the economy: tight credit and the housing contraction -- that could be best addressed by an accommodative monetary stance," said Lundin. But at the same time, it noted just one, high energy prices that could be combated by a tighter monetary policy.

Crude prices climbed near a record $140 a barrel earlier this month and U.S. retail prices for regular gasoline stand near an all-time high above $4 a gallon.

"In short, they're damned if they do and damned if they don't," said Lundin. The Fed can only talk inflation down and talk the dollar up for now. "It won't be able to take any real, substantive action until after the fall elections."

Dollar Doom is Gold's Boom

Of course, at the root of the issue for gold is the dollar, Lundin said.

"Whatever developments drive the greenback will send gold in the opposite direction," he said.

The Fed can protect the U.S. dollar by sharply increasing rates, but that would sink the economy and make servicing our huge debt loads unmanageable, said Peter Spina, an analyst at GoldSeek.com. So the Fed "must keep rates low and keep liquidity in the system, which will ultimately lead to further debasement of the dollar's value," he said.

Protection for the dollar can really only come in the form of confidence or perception and then capital controls, he said.

Spina said he senses "increasing desperation" on the Fed's part and if the economy hasn't recovered as we enter 2009, "the confidence game could unwind quickly."

The Fed is "in a corner and the U.S. dollar is going to be a victim of their policies," Spina said. "It already has been punished harshly."  . . .

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Over the past 200 years, the stock market's steady upward march occasionally has been disrupted for long stretches, most recently during the Great Depression and the inflation-plagued 1970s. The current market turmoil suggests that we may be in another lost decade.

The stock market is trading right where it was nine years ago. Stocks, long touted as the best investment for the long term, have been one of the worst investments over the nine-year period, trounced even by lowly Treasury bonds.

A look at stocks during downturns

The Standard & Poor's 500-stock index, the basis for about half of the $1 trillion invested in U.S. index funds, finished at 1352.99 on Tuesday, below the 1362.80 it hit in April 1999. When dividends and inflation are factored into returns, the S&P 500 has risen an average of just 1.3% a year over the past 10 years, well below the historical norm, according to Morningstar Inc. For the past nine years, it has fallen 0.37% a year, and for the past eight, it is off 1.4% a year. In light of the current wobbly market, some economists and market analysts worry that the era of disappointing returns may not be over.

Until last fall, many investors had viewed the bursting of the tech-stock bubble as a nasty but short-term setback. The market had resumed its upward march, reaching new highs in October.

Then the credit crisis began weighing on stocks, as did the possibility of a recession. By March 10, the S&P 500 was down 18.6% from its Oct. 9 record close, nearing the 20% decline that signals a bear market. It has rebounded since then amid the Federal Reserve's efforts to stabilize the financial system, but it remains 13.3% below its October record.

Conventional stock-market wisdom holds that if investors buy a broad range of stocks and hold them, they will do better than they would in other investments. But that rule hasn't held up for stocks bought in the late 1990s or 2000.

Over the past nine years, the S&P 500 is the worst-performing of nine different investment vehicles tracked by Morningstar, including commodities, real-estate investment trusts, gold and foreign stocks. Big U.S. stocks were outrun even by Treasury bonds, which historically perform much less well than stocks. Adjusted for inflation, Treasurys are up 4.7% a year over the past nine years, and up 5.8% a year since the March 2000 stock peak. An index of commodities has shown about twice the annual gains of bonds, as have real-estate investment trusts.

Stocks also underperformed other investments during the 1930s and the 1970s. During both of those periods, stocks would rally strongly, only to fade. It took well over a decade in each case for stocks to move lastingly upward.

Righting the Ship

So far, the current decade hasn't featured the high inflation of the 1970s or the high unemployment of the 1930s. That makes some analysts and economists hopeful that the stock troubles won't be as bad or last as long as they did back then, despite the housing crisis and the breakdown in parts of the mortgage and lending businesses. Many of them hope that the Federal Reserve will do a better job of righting the ship than it did in those prior decades.

Finance professor Jeremy Siegel at the University of Pennsylvania's Wharton School has written about stock behavior back into the 19th century. During the past decade, he points out, the worst years were from 2000 through 2002, when stocks fell sharply. Although the S&P 500 has been inconsistent since then -- rising strongly in 2003, then registering single-digit gains in 2004, 2005 and 2007 -- he considers the bad times largely past. Other optimists agree.

The Pessimistic View

But Yale economist Robert Shiller, who predicted the market trouble in his 2000 book "Irrational Exuberance," warns that the market still hasn't shaken off its excesses. He and some other analysts think the latest volatility is a symptom of more trouble to come.

"I have to say that this isn't a great time to be in the stock market," says Prof. Shiller. "The housing crisis that we are going through is going to put a damper on the economy that is longer than a recession. I don't see the stock troubles ending as quickly as many people are imagining."

Historically, stocks rise about two years out of every three, for an average gain of 7% a year when controlled for inflation, according to Prof. Siegel. Stocks have shown gains for almost every 10-year period since 1925 -- 98.6% of the time, according to Ned Davis Research.

But when stock investing becomes a mania, as it did in the 1920s, the 1960s and the 1990s, it leads to prolonged periods of subpar performance, according to financial historian Richard Sylla of New York University's Stern School of Business.

"When you have extraordinary returns, as we did from 1982 through 1999, then usually the next 10 years aren't very good," says Prof. Sylla. His research suggests that exceptional booms steal gains from the future. When the booms end, returns become subpar, so that average returns over the longer term fall back to the 7% norm. Economists call this "reversion to the mean," the idea that exceptional performance can't last forever.

Bullish investors believed that the bad days were over late in 2002, when stocks rebounded following the technology-stock wreck, the Sept. 11 terrorist attacks and the collapse of Enron Corp.

The S&P 500 rose 26% in 2003, amid hopes for a quick victory in Iraq. In 2004, the S&P 500 rose only 9%. It was up 3% in 2005, 14% in 2006 and 3.5% in 2007. The index is down 7.9% so far this year. Those numbers are not adjusted for inflation, which would lower annual returns by a few percentage points.

The Dow Jones Industrial Average, which had fewer technology stocks than the S&P 500 and suffered less in the bear market from 2000 to 2002, has held up better, but not a lot better. It has risen less than 1% a year since January 2000.

Role of Individuals

Prof. Sylla expects to see stocks turn more lastingly upward some time in the next two years. The market's direction will depend partly on the individual investor. The 1990s stock bubble and the bear market that followed came at a time when more individuals were managing their own retirement savings through 401(k) accounts, individual retirement accounts and the like.

Individual investors helped create bubbles in the markets for technology stocks and for real estate. In recent years, investors have been putting far less money into U.S. stocks than they did during the stock-investing boom. In 2000, at the height of that boom, Americans added $260 billion to U.S.-stock mutual funds, according to the Investment Company Institute, a trade group. Last year, investors took more money out of those funds than they put in -- a net outflow of $46.4 billion.

America's shift toward self-managed retirement could soften some of the stock-market volatility. People appear to be much less likely to move money around in retirement accounts than in other investment accounts, according to economist John Ameriks at mutual-fund company Vanguard Group.

Many 401(k) participants leave their allocations alone for long periods of time, says Mr. Ameriks. If they set up their accounts to send money into stocks each month, those accounts tend to keep doing so through bull and bear markets alike. That may provide some support to stocks.

Some investment advisers say passive contributions like that actually make some sense. People whose retirement accounts have bought stocks each month, year in and year out, haven't done nearly as badly as those who bought in the late 1990s and stopped buying, Prof. Sylla says. While the S&P 500 is down since 1999, it is up since mid-2001, meaning that most stock purchased since then by retirement accounts shows a gain.

Stock Fundamentals

A big problem for the market right now is what analysts call stock fundamentals. Strong corporate-profit gains and low inflation have supported stocks since 2002, but they are becoming harder to sustain.

In a typical year, Prof. Sylla says, corporate profits run at about 5% or 6% of total economic output, after tax. In 2006, that number was 9%, a record. Historically, this number tends to revert to the mean, suggesting that profits now could weaken. "Profits may fall to 3% or 4%" of economic output, Prof. Sylla says.

Spending by ordinary people could have an effect on those profits. Consumer borrowing and spending kept the economy afloat after the stock bubble popped in 2000. Emboldened by high home values, people borrowed at levels rarely seen, pushing down the national savings rate to zero.

That's what worries Prof. Shiller. After studying the housing market, he sees home values continuing to weaken for years. He expects consumers to borrow and spend less, and to rebuild their savings.

A consumer pullback would hold back economic growth and corporate profits, putting a damper on U.S. stock gains and giving investors an incentive to continue putting money into commodities or stocks in Brazil, Russia, India and China. Baby boomers concerned about retirement income could look for safer investments with guaranteed returns, such as Treasury bonds and bond-like products offered by mutual-fund companies.

On the Horizon

"We have to accept that this is no longer a nation of 4% real economic growth. This is a mature nation that no longer has a strong manufacturing base," says Steve Leuthold, chairman of Leuthold Weeden Research in Minneapolis. He believes that another bull market is on the horizon, perhaps following some additional stock declines. But that future bull market, he contends, could be followed by another bear market that could bring stocks back close to where they are today.

Before another lengthy bull run can begin, stocks need to overcome two problems: the hangover from the high prices of the late 1990s, and the continuing effects of the exceptionally low interest rates instituted by the Federal Reserve in 2001 and again today. Those low interest rates helped push corporate profits higher, but also fueled borrowing excesses that led to today's economic problems.

To some analysts, stock prices still look inflated. Prof. Shiller calculates that the S&P 500 traded in the late 1990s at more than 40 times its component companies' profits -- far above the historical norm of 16. (To avoid distortions, he uses average profits over a 10-year period.) Today, the S&P 500 still trades at more than 20 times profits -- still far above average.

"The S&P 500 never got back down to its long-term trend line" after the 1990s, says Jeremy Grantham of Boston money-management firm Grantham, Mayo, Van Otterloo & Co. Mr. Grantham, who has long warned of a prolonged period of subpar stock performance, says exceptionally low interest rates temporarily propped up the indexes.

There are reasons to hope that things won't be as ugly this time as they were either in the 1970s or in the 1990s in Japan, which went into a prolonged slump after bubbles in its housing and stock markets.

For one thing, although inflation has been running above 4% this year, it remains well below the double-digit rates of the 1970s. That's made it easier for the Fed to stimulate the economy without worrying about sparking runaway inflation.

One big question is how much worse investor confidence will get. The bearish Mr. Grantham expects investors to become gloomier, but not as pessimistic as they were during past bad stretches.

"I think the global economy will stay, on balance, not so bad," he says. "There is no reason for people to become as pessimistic as they did even in Japan, and certainly not as pessimistic as in the Depression."

By Atul Prakash and Bate Felix

LONDON (Reuters) - Gold fell more than 2 percent in a broad commodities sell-off on Friday, with a rise in the dollar and softer oil prices dampening the metal's allure as an alternative investment.

Other key precious metals, base metals and major soft commodities traded lower, with investors pocketing profits before the end of the quarter.

Gold fell to $926.50 before rising to $933.30/934.20 an ounce at 11:40 a.m. EDT, against $951.80/952.60 in New York late on Thursday. Last week, it hit a record high of $1,030.80 an ounce before tumbling to a one-month low of $904.70.

"The market is really correcting itself, but it's a general move out of commodities. It's not just gold," said Jeremy East, head of metals trading at Standard Chartered Bank.

The market witnessed a heavy sell-off last week before rebounding on technical buying. Now it was witnessing a continuation of the downward trend, with people liquidating their positions and running for cash, East said.

"But I don't think the bullish trend is over. There is still buying interest, but in the short term the market has probably overdone on the upside. We are in a consolidation phase and gold may break back down below $900 again."

The dollar edged higher but hovered not far from record lows against the euro after U.S. data showed inflation pressures were tame in February, affirming expectations of further interest rate cuts by the Federal Reserve to boost a weakening economy.

A firmer dollar makes gold costlier for other currency holders and often lowers demand. Lower oil prices reduce the metal's appeal as a hedge against inflation.

Oil fell more than $2 to near $105 a barrel as crude flows through Iraq's pipeline system were restored after disruption by a bomb attack on Thursday.

"It's going to take until the second half of the next week before the market is going to be ready to make a more convincing push upward again."

U.S. gold futures for April delivery fell $16.6 an ounce to $932.20 -- off last week's record of $1,033.90.

LONG-TERM POSITIVE

Analysts were positive on the metal's outlook in the medium to long term.

"The sudden price pull-back across the precious metal complex during March has raised concerns that the bull run in this sector has drawn to a close. We disagree," said Michael Lewis, global head of commodities research at Deutsche Bank.

"We believe weakness in the U.S. dollar has not been exhausted and with U.S. real interest rates expected to move deeper into negative territory, we are maintaining our bullish outlook towards gold and silver prices," he said in a report.

In other metals, spot platinum rose to a one-week high of $2,040 an ounce before falling to a low of $1,980. It was last at $2,010/2,020, versus $2,023/2,033 in New York. It struck a record high of $2,290 on March 4 on supply fears driven by mining disruptions in top producer South Africa.

Platinum gained around 50 percent in 2008 after a power crisis in South Africa forced gold and platinum mines to shut down for five days in January, driving platinum prices.

But the metal, mainly used in jewelry and auto catalysts to clean exhaust fumes, tumbled to a six-week low at $1,805 an ounce last week.

Silver fell to $17.93/17.98 from $18.50/18.55 an ounce -- off a 27-year high of $21.24 hit on March 17. Palladium dipped to $439/446 an ounce from $445/450.

(Reporting by Atul Prakash; editing by Chris Johnson)

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January 7, 2008

With more voices adding every day to the chorus predicting the world's biggest economy will go into a recession, diversifying away from U.S. stocks is a healthy strategy, analysts told CNBC on Monday.

Traditional defensive sectors are consumer staples and food. But apart from those, commodities, especially gold, are increasingly believed to be a safe bet.

The technology sector, which has been used as a refuge until not long ago, should be carefully assessed and stocks linked to the financial sector or consumers should be avoided, Alexis Dawance fund manager at Global-Cap SA, told "Worldwide Exchange."

But technology companies in the restructuring or outsourcing business are likely to fare well, added Dawance, who also said he was "pretty negative" on the U.S. economy.

His gloom is shared by other economists.

Change in Portfolio

"From what I have seen so far, I would still tend to be very cautious on U.S. equities," Professor David Costa, Dean at the Robert Kennedy College, told "Power Lunch Europe."

"I think this is an excellent time to change your portfolio in view of being a bit more defensive," Costa added.

A more defensive strategy would focus on commodities, agricultural staples such as wheat but also on gold, which is positively influenced by the current situation when "central banks are cutting rates and are probably buying gold," he said.

Gold prices, which reached a record high of $869.05 an ounce last week, surged 32 percent in 2007 and are around 4.5 percent up this year.

Gold Rush

The fall in the U.S. dollar, concerns about inflation and fears that the effects of the subprime crisis will spread to the overall world economy have all contributed to this rise.

But supply and demand factors also play an important role, Ross Norman, from TheBullionDesk.com, told "Power Lunch Europe."

Global mine production is falling, with output in South Africa, the world's largest gold producer, at its lowest since the thirties, Australia and Canada also declining, and only China rising, Norman said.

"On the supply side we are seeing peak gold, just as we're talking about peak oil production," he said. "The supply-demand fundamentals are very attractive, and this is driving institutional investors in." 

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