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August 23, 2005

Dazed and Confused

Today's market poses one of the hardest reads in recent memory. From the depths of April, equities drove firmly to new highs on the first trading day of August. They have spent most of August retreating. The bulls argue that the recent pullback is simply a pause in an ongoing bull market and point to the August high as their proof. Bears say the April-to-August rally was a blow-off and that a secular bear market, of which they are so firmly convinced, will now continue to run its course.

From a technical standpoint it is difficult to take sides. Fundamentally, current valuation levels give the bears the upper hand. However, whenever fundamentals start imposing reality upon the markets, the Fed forcibly responds with the liquidity spigot, and bears should never underestimate their propensity to ruin their game plan.

Which brings us to commodities. Whenever monetary inflation is running high, commodity prices tend to rise. Gold and silver, the only form of real money accepted through human economic history, can protect wealth from the insidious effects of inflation. Therefore, I consider precious metals to be a hedge for bears who may see their trades busted by FOMC irresponsibility.

But there is another catch. China and India appear to be on the verge of their first significant slowdowns in a decade. If their economies were to hit bumps, the commodity bull market would most likely be put on hold for a bit. Since people generally perceive inflation as price increases rather than the true definition of monetary expansion, they may not perceive the inflation threat immediately. Therefore, gold and silver may not rally immediately upon fresh liquidity injections by the Fed.

It is clear, though, that eventually equities will be losers (at least in real terms) and that precious metals will be winners, though the road will be volatile. Nevertheless, traders seem to be dazed like deerÂ… standing confused in the dark, though disaster heads straight toward them with bright lights shining.

Thus is the thought process of a trader who continues to short tech and housing stocks and own precious metals.

Disclosure: None


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