Gold and Oil Stocks

The US military will expand its War in the Middle East around October 2006 … causing a historic stock market MELTDOWN and a commensurate SURGE in the price of Gold and Oil…

I am a great fan of Dr Marc Faber of www.gloomboomdoom.com
Dr Faber is the ultimate contrarian.
His regular newsletters are clever, creative and extremely contrarian.
How many of us have been watching Lebanese stocks? Dr Faber has.
In his latest market comments Dr Faber thinks that most asset classes are near correction time. I totally agree!

Dr Faber says, “As to the catalyst that will trigger the correction, I suppose that inflationary pressure may necessitate more additional interest rate increases than the market now expects…But it does not really matter what the catalyst will be. When all asset markets are as extended as they are now it does not take much for a vicious sell-off to get underway.”
Once again, I totally agree!

When major markets correct, you can bet the Fed won’t be around to take the blame.
No!
The public’s focus will be steered somewhere else.
Somewhere far from home.
My bet is that the public will put the blame squarely on the EXPANDED MILITARY CONFLICT IN THE MIDDLE EAST.

Why does the Fed keep raising interest rates?

If you follow 30-year interest rates and Fed speak you’ll believe that inflation is well under control.
If that’s the case, why has the Fed been increasing Short-term rates for over 2 years?
And where has the increase in Gas, Health, Education and … everything else shown up?

I’ll be honest; I get confused by the inflation, deflation and stagflation arguments.
Maybe it’s because I’ve never personally lived through these periods.
The crux is, every analysis I read about inflation, deflation or stagflation ends the same way - BUY GOLD!

Chart 1 - 30-Year Bond Yields

Here’s what I think is happening:

Short-term interest rates reflect how much the Treasury will pay you to keep your money in Paper Dollars.
If confidence in the Dollar slides they need to offer you more to keep you interested.
How do you know when confidence is declining?
The price of Gold rises.
Gold rises with the level of FEAR.
As long as Gold continues to rise the Fed will keep increasing rates to make sure you remain ‘interested’ in their PAPER economic system.

All of this has certainly not been lost on our enemies.
The forces intent on our destruction use FEAR to get the Fed to raise interest rates via increasing Gold prices. How long will they do this? Until … breaking point!

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Is it any wonder America has such vehement enemies?
The law of Nature dictates that every force has an equal opposing force.
America is steeped in Individualism, Secularism and Consumerism.
Islamic Fundamentalism (IF) is its complete opposite.
As ugly as IF appears to us, our self-satisfying lifestyle appears worse to them!
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Now it so happens that IF centres around the major Oil producing countries in the world.
It also so happens that the economies of the West are completely dependant on Oil to grease the wheels of Capitalism.
Is there a growing shortage of Oil in the world - some people talk about Peak Oil?
I don’t know.
What I do know is that IF has the ability to continue fanning the emotion of FEAR by threatening the flow of Oil.

I also know that what they are doing is working because the price of Crude has been marching steadily higher week after week after week.
And with that the level of rhetoric and threats has risen right along.
Our enemies plan to keep us engaged militarily for as long as possible.
They can never win through outright might.
They will continue to goad us into combat wherever they can, always trying to increase the level of FEAR back home.

Chart 2 - Crude Oil

Here’s an interesting idea:

In this environment (of increasing Gold prices), the Fed MUST keep raising interest rates.
The FED must fulfil its reason for existence as guardian of price stability.
But the Federal Reserve also realises there is a limit to the amount of increases a debt soaked society can absorb.

The predominant form of economic activity undertaken in America today is Consumption financed through debt. As interest rates increase, more money is diverted to debt servicing and less to Consumption.
Spending slows, profits decrease and we end up in a credit crunch.
As Richard Russell puts it, Debt is the anchor that weighs down the economy.

We know that Home prices have been rising. We also know that Consumers have been taking cash out of their homes through Mortgage refinancing. The cash has been spent on even more Consumption. This works well as the engine of Growth until house prices stop going up…

Chart 3 - Housing Index

Now we can begin to understand why the US Government is so Gung Ho to go to War?

War is expensive.
If the consumer slows or even stops spending, the government could substitute with Military spending.
There is no limit to the amount Governments will spend during wartime.
Also, if we take over a country or two in the Middle East it could go a long way to address our long-term oil needs.
Oh, and did I mention we have a willing and committed enemy to fight?
It’s diabolic but perfect.
We play into our enemies’ hands but they play right into ours.
There is always a bigger picture to consider.

Under the pretext of Iran, Al Qaeda, Democracy, Insurgency, Energy Crisis … take your pick… in late 2006 the US will escalate the War in the Middle East and replace the tired consumer as the engine of Growth (spending).

I think it’s logical to expect a SURGE in the price of Oil under such conditions.

The market will FINALLY wake up to the reality that constant rate increases hurt profits and choke off liquidity. The stock market will NOSE DIVE.

Chart 4 - Yield Curve (red) versus S&P500 (blue)
Note: The yield curve is the spread between short-term and long-term interest rates. If the price (red) is falling, the spread between short term and long-term rates is narrowing. Money is becoming tighter. The assumption here is that the Fed continues to increase short-term rates but long-term rates remain range bound.

Under such extreme FEAR and PANIC, Gold will play its natural role as the ultimate store of Wealth and LAUNCH into its next BULL Leg.

Why Late 2006?

Gold Stocks (which lead the metal) are now in an intermediate term correction. To date all intermediate term corrections in this Bull market have lasted around 6 months. Which takes us to September / October for the next up-leg.

September and October are never kind to the Stock Market!

Chart 5 - Gold Stocks (red) versus S&P500 (blue)

FINAL WORD:
I believe the US will ultimately be victorious.
Suicide bombers that kill innocent people or slicing off someone’s head on TV with a kitchen knife is just plain EVIL. No matter the justification!
History has shown conclusively that Evil never prevails for long.

The US is founded on sound ethical principles.
Principles which I note are shared by many Gold Bugs.
The coming War and Financial Chaos will reshape America - probably forever.
This era will be remembered as the one that returned us (painfully) to our founding principles.

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This article is intended solely for information purposes. The opinions are those of the author only. Please conduct further research and consult your financial advisor before making any investment/trading decision. No responsibility can be accepted for losses that may result as a consequence of trading on the basis of this analysis.