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May 27, 2008

Hot Money Rotation

Metal heads are not happy campers today. Silver got pegged for a whopping 5% and gold, over 2%. I mentioned in my weekend post that silver was about to bump into some overhead, but I did not anticipate such a rejection. However, with the one-two punch of a rising dollar and sharply lower oil, precious metals didn't stand much of a chance. Let's step back and take a longer-term view of silver:

silver chart

Something is defintely different about the 2008 correction. It has so far been much more shallow than the '04 and '06 sell-offs. The difference is the environment in which these corrections ensued. This year's correction came on the heels of a credit crisis of epic proportions. In fact, one could argue that we have not yet reached the "heels" of the crisis, but rather that the Bear Stearns rescue marked the end of the first phase (if you think subprime was scary, wait until HELOC becomes a household acronym). The Federal Reserve is still floating loans like mad to keep the problems hidden. The pertinent question is whether the printing presses have simply delayed a larger correction in precious metals or aborted it altogether.

So far, freshly printed dollars have been spilling into commodities, driving up the price of living for everyone, most notably in the form of higher energy costs. Oil's last significant correction, which occurred during the second half of 2006, left oil at $50 per barrel.

oil chart

Whether oil's run ends now or after another lurch higher, it begs the question: where is the hot money going to go? Can stocks buck the problems in financials and surge to new highs? I wouldn't bet on it. Bonds? Who wants to buy 2-3% coupons when inflation is recognized by everyone (except the government) to be at least 7%? Nope. Hot money will find another commodity or two to drive higher. Will it be precious metals? Wheat? Sugar? Soybeans? I don't know, but anyone with a good trend-following system ought to be able to make a fortune over the next several years trading commodities.


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