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July 5, 2005

Gold Flattened

Gold showed its malleability today, getting crushed under the weight of a strong dollar. The yellow metal closed in New York at $423.90, down more than $5 per ounce from its Friday close and more than $13 from its Thursday close. Mining stocks, after holding up fairly well in the face of Friday’s metal price slough, were also beaten down today to the tune of 2%. Silver miners fell in sympathy, although silver prices were down only modestly today. I noted Friday that the strength in the mining stocks relative to the metal may provide an opportunity to profitably switch from equity to the metal. That opportunity appears to have been closed rather swiftly.

The dollar’s gain was more modest, but the greenback hit new interim highs against the Euro and Yen. In the short term, I remain a very mitigated bull on the dollar. Mitigated meaning I am not brave enough to attempt a long trade. Longer term, I still expect the dollar to suffer, although the next sell-off is unlikely to start before we receive clear signals that the Fed’s current round of rate increases is nearing an end.

Which brings us back to gold. There don’t appear to be any strong candidates for replacing the dollar as a reserve currency. The Chinese renminbi may do so eventually, but not anytime soon. So if people start losing faith in the dollar again, where will they go? For the passed several years the answer was the Euro. However, the Euro is now in a crisis of its own. It’s my thought that the next dollar “sell-off” may not see it drop sharply against any major currency, but rather we may see all major currencies drop sharply versus precious metals.

Stocks appeared to be headed for a follow-through sell-off this morning until a report out of Prudential stated that stocks are at historically low valuations versus bonds. The report is intended for Prudential’s institutional clients and recommended to them 100% stock allocation. Whether this report is the true reason stocks rallied today is unknowable. However, the rally did start at the time the report was released. The concept seems a little perverse since 1) there are other alternatives to stocks than bonds… just because stocks are cheap relative to bonds doesn’t mean they are cheap absolutely, and 2) the report is intended for institutional clients, but was released publicly. For this reason alone, one has to doubt its veracity.

Regardless of the reason, stocks erased three days of decline with today’s move and closed near the highs. The technical strength has to be respected. Likewise, today was the first day of a new quarter and the first day after a holiday. These days are typically strong, so today's technical strength also has to be confirmed for the market to continue to push upward.

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