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January 3, 2005

All That’s Gold Does Not Glitter

What a way to start the new year! Gold and silver were off precipitously, knocking the wind out of mining stocks like Pan American Silver, Newmont Mining, and Placer Dome, each off between 4 and 5 percent. The metals were ripe for a sell-off considering all the press they have been getting recently. The excuse for the drop was a rally in the dollar, but this “rally” was so miniscule, it can hardly be blamed for the large moves in metals. More likely, we saw some unwinding of leverage, phase II of what we saw at the beginning of December.

These drops will present an excellent entry point for metals in the near future, but picking that point is going to be tricky. If a serious dollar rally materializes, which is likely given the negative sentiment, we could see a grinding decline in metals before things recover. It is also difficult to judge how much leverage needs to be unwound before demand starts to overpower supply once again. My personal strategy will be to pick points where the metals seem to show strength. If these points don’t hold, I will average in lower at later dates. With or without a near-term dollar rally, I am convinced the currency’s longer term trend is continued weakness.

It was also nice to see oil get clocked for 3% today considering I am bullish on this commodity, but don’t yet have any open positions. Everything got cheaper, including some oil service companies mentioned by oil guru, Kurt Wulff, in Barron’s last week. Encore Acquisition (EAC) was off 4.3% and Burlington Resources (BR) was off 6.1%. Because I believe there is a high probability of a recession (or something more serious) in China/Asia this year or next, I have been reluctant to step in front of the commodities train with both feet. China’s expansion has been a big factor in commodity price rises and a break in China’s momentum will likely scare traders out. This scenario is by no means guaranteed to unfold, so it’s wise to consider other entry strategies if you believe commodities should be part of your portfolio. Timing an entry point into oil will be tricky and difficult to define ahead of time. As a former justice Stewart said (though about a slightly more lascivious topic), I can’t define it, but “I’ll know it when I see it.”

Equities started the first hour with a bang and then quickly fizzled… hardly the New Year rally that we are so used to seeing and that many bulls were hoping for. The Nasdaq started up about three-quarters of a percent and then dropped nearly 2% from the high. The S&P500 likewise started up a half percent before ending the day down nearly a full percent. Tech stocks took it on the chin with this drop, except for Google and Yahoo, which rose on an upgrade to Goldman Sachs (people really still listen to those guys?). Many people may point to the fact that Google gained over 5% today (breaking $200 per share) as a sign that strength still exists in the equity market. Considering the fizzled rally today, I see Google’s move as a concentration of speculative money. There isn’t enough money available to move the broader market, so traders are focusing on specific plays. Today’s play was served up by Goldman.

Author’s disclosure: Long PAAS, Short YHOO

 

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