Value investors are left with few choices to preserve their wealth. They can short stocks - a difficult game for value investors who as a group tend to equate shorting to the dirty and fickle game of speculating; or they can hold their assets in cash and patiently wait for the stock market to correct to prices where intrinsic value once again, exists. But even the prospect of holding cash is not without significant risk, as the dollar is subject to devaluation and is in a two-year bear market. Interest rates on cash are below the real (not reported) rate of inflation. They can hold their cash in foreign currencies if they feel that the foreign currencies will "hold up" better than our US dollar, however, there are no guarantees there either as currencies are subject to whatever governments wish to do. Alternatively, they can hold a portion of their savings in precious metals. While not totally absent of risk, this seems to me to be the best way to preserve accumulated wealth. While the short- and even intermediate-term trends are subject to a bumpy and wild ride, the long-term technical picture is quite clear and bullish. Tonight, I will present a technical overview of the precious metals sector, a viable option for preserving accumulated wealth.

Precious Metals - Represent Value

At the turn of the 20th century a one-ounce gold piece would enable you to purchase a suit of cloths. The same is true at the turn of the 21st century, yet the same amount in dollars would not allow you to even buy a decent necktie. Fiat currencies can and are routinely devalued, whereas precious metals have maintained their purchasing value over time. What exactly is a "strong dollar policy"?

Precious metals provide protection against currency devaluation from inflation, but what if there is deflation? Even though it has not existed for a couple of generations, there are some astute economic minds that fear that deflation will occur. How will precious metals do in such a deflationary environment? It is difficult to say for certain, but they will probably hold up a lot better than technology stocks. The price of a suit may decline to $200 if there is deflation, but you could still purchase a suit with the same 1-ounce gold coin. I don't think that in a deflationary environment the same will be true for 15 shares of the QQQ I-Shares.

Holding savings in precious metals can preserve value, however you may note that precious metals were trashed just a few years ago. So who is to say that the same thing will not happen again? By the same token, many people think that precious metals may become the object of a mania as occurred in the late 70's, and the late 80's for Japanese stocks, and the late 90's for technology stocks (and 2003). Only ten thousand dollars invested in Cisco in 1993 was worth over $800,000 at the top of the technology bubble.

Below is a long-term chart of gold going back to 1990.

As you can see, gold bottomed at about $250 per ounce in the 3rd quarter of 1999, before beginning a new bull market in the first quarter of 2001. I think it is relevant to note the psychology that gripped asset values when gold bottomed is unlikely to return any time soon. It is also relevant to note that the recent "Ganymede Rally" that ended in January 2004 saw many technology stocks bid up to bubble 1999 levels, yet in spite of this, precious metals remained in their long-term bull market. My opinion is that if the Nasdaq were again breaking out to above January 2004 levels with precious metals not acting well, there would be cause for concern. But this is unlikely.

Note that while in the short term, gold is subject to a lot of volatility; in the long-term the bull trend is quite clear and bullish. It is also notable that the price of gold has followed the 52-week exponential moving average in a fairly consistent manner. This is true even when gold took a "hit" in April of this year. (It only "whipsawed" the 52-week EMA though.) My view is that once establishing a position, long-term investors can ignore the inevitable short-term gyrations and focus on the longer-term bullish trendline.

Following is a similar chart for silver.

As you can see, the bull market in silver took a longer time to get going, but it is now clearly in bull market territory. In spite of the clear and distinct uptrend since the beginning of '02, there are many severe gyrations throughout. It seems like it would be fool hearty to invest in silver if your temperament does not allow you to put the gyrations out of your mind as you hold this precious metal. To me it suggests that the position size should fit the volatility of silver. If you are not OK with the gyrations, then a smaller position may suit your temperament better. If you can ride out the gyrations, then consider the following chart, which is the silver to gold ratio since 1992.

Gold or Silver?

Below is a chart of the silver to gold ratio dating back to 1990. When the line is heading up, silver is outperforming gold.

There was a clear linear downtrend as silver lost its favor to gold until the 4th quarter of 2003, but in the first quarter of '04, the trendline was decisively broken. Now, the market seems to favor silver in the long run. Still those gyrations are difficult! Lets look at the spring of 2004 thrashing of silver.

From its bottom at about $4.15/ounce to its top at $8.50, silver only retraced less than 62% of its advance. This is a normal amount of retracement, although it probably was little consolation for those long-term holders of silver who held through the paper loss.

Long-Term - The Stocks or the Metal?

The larger more established stocks, as represented by the $HUI, the Un hedged Gold Bugs index, under performed the metal during the precious metals bear market and out performed during the bull market. However, there is a recent trend of the stocks under performing the metal that is worth watching.

While the gold bugs to gold ratio has followed its upward sloping 52-week moving average, the trend appears to have been broken in the early part of 2004. The moving average has turned downward, and the ratio has crossed below the moving average and remained there for several months. This is bearish for the stocks relative to the metal, unless the trend reverses soon.

It is difficult to analyze silver in a similar fashion as gold since there are so few silver stocks, and no specific silver index, however there are three charts I will highlight. The following chart is the Pan American Silver (PAAS) to silver ratio. Until the beginning of '04 it paid to own Pan American Silver versus owning pure silver, however that trend has since changed. Note that in early July there were simultaneous breaks of the trendline (in green) and the 52-week exponential moving average (blue). However, what appears to be a trend break may be either a "whipsaw" or something more bearish for the stock could be unfolding.

Following is a similar chart for Silver Standard versus silver.

The healthy and apparently healthy long-term uptrend appears to be intact and favors ownership of SSRI stock versus pure silver.

Following is a similar analysis for Apex Silver (SIL).

There does not appear to be a compelling technical reason to own Apex silver versus owning pure silver. The ratio of SIL to silver is below its downward sloping moving average.

Gold Corp. - Bullish Trend break

If you had bought Gold Corp. in March of 2000 while shorting Gold and held your position until the stock's top in December of 2003, you would have still tripled your money in spite of the bull market in gold. Gold Corp has been a great performer.

Yet since its top in December 2003, the stock has been thrashed. Fundamentally the stock appears to me to be very "clean". The company has a debtless balance sheet, and pays a decent dividend. In spite of the recent lousy stock market performance, Gold Corp appears to have broken its downtrend. Even shorter term, since March 2004, the stock appears to be in an uptrend. Could this recent action be suggesting that Gold Corp. is getting back to its old bullish habits?

Something for Nasdaq Bears - A Bullish Chart

For those of us maintaining a bearish speculative position in the Nasdaq, the following is a chart that is compelling. It is a chart of the ratio of gold to the Nasdaq 100 trust.

Note the very flat upper trendline (and 52-week EMA) that was simultaneously broken to the upside. This suggests that if you own gold and are short the Nasdaq 100, you may make money on both sides of the trade! However, I would not advocate a long-term bearish position in the Nasdaq, since the Nasdaq, long or short, is for speculation only.

Short-Term Patterns

My focus has been on the long-term, yet any new position should be entered at a fair price. Below is a short-term chart of silver.

As is clear, in the short term, silver can probably be purchased at its trendline. A break of the trendline would allow long-term investors to "average in". The volatility of silver suggests that long-term holders average in to their positions. Of course, the thrashing taken by the precious metals in April can happen again, and that is why position sizes should be appropriate, and the focus should be on the long term.

Gold is in a less bullish pattern in the short-term. The short-term trendline that was once support now may be resistance. Again, averaging in to long-term positions is recommended.

Summary

Gold and silver are in a long-term bull market. Silver appears to be technically stronger at present, although the amount of fluctuation is greater. The gyrations in both gold and silver charts suggest that investors choose their entry point carefully, "average in", select an appropriate investment size, and focus on the long term. Stocks can provide more reward than pure precious metals, but at a cost of additional risk. Larger cap gold stocks are now generally under performing gold, and it is generally similar on the silver side, although Silver Standard (SSRI) is outperforming silver.

Bond Market Pattern Emerges

The bond market, as measured by the 10-year note's price, has been trending in a pretty regular cyclical pattern since October of '02. It seems that of late, practically every piece of economic data has been that which would support the bond market. The bond market has accomplished two rallies that have lasted several quarters over the last three years. Yet when the bond market drops, it drops rapidly. The last two drops in the 10-year note price have each been approximately $10 and took less than one quarter. The last two rises have been of a similar magnitude as the corresponding rises, but the durations were over 3 quarters each. It seems as though the rise/fall relationship is similar to Olympic weight lifting, where the athlete strains to lift the weight slowly, but once its time to put the weight down, he drops it at the speed of gravity. This is illustrated graphically in the chart below. Note the intermediate term downward sloping channel.

If the pattern that "worked" since about October of '02 continues, the 10-year note price would peak (and interest rates bottom) in about early November, before beginning their longer-term downtrend. It is also notable that the Note price made a top in the early summer and is in a wide swinging downtrend, not much unlike the top made by the Nasdaq in January of '04. People taking out variable rate mortgages are basically buying into a chart that is in a downtrend. In spite of the pre-election rally, it appears that bonds may be headed down (and interest rates up) after this shorter-term rally ends.

Business Movies

MSN posted an article about the ten best business movies; a theme that is underutilized in the cinema. After reading the article, I'm looking forward to seeing "The Magnificent Ambersons" , and "The Solid Gold Cadillac". I would also add to their list, "Wall Street", "Boiler Room", and "Executive Suite". In addition, there is a controversial documentary playing at the Roxy (Philadelphia's intellectual-style movie theater) called "The Corporation. If you know of any other worth-seeing sleeper business movies, please send me a note.

Today's Market

There were two more pieces of bond-friendly economic data today. The index of leading U.S. economic indicators fell in July and Philadelphia-area manufacturing expanded at a slower pace this month. Again it seems as if recently (it seems like about the last couple of months), every piece of data is what would be required to support the bond market, and the bond market is responding albeit at a "measured pace". Remember, when the bond market falls, it falls fast, when it rises, it rises slowly. At least that has been the trend since July of '02. To support stocks in the face of slowing economic fundamentals next quarter will be the continued weakening of the US dollar, and a couple of excuses - the "transitory" price of crude oil, and the weather in Florida. It will be interesting to see if the 10-year note's price follows the yellow trendline until November.

Bloomberg radio commentators were crowing about how successful the Google IPO was. Well, that's a matter of perspective. There were 19.6 million shares sold to investors via the IPO process at a price of $85. There were 22.3 million shares traded in about ˝ day of trading suggesting that practically every IPO share in the float was sold to the public today at about a 15% premium to the IPO offering price. Was it successful to Google? Well, they settled for 15% less money that the public was willing to pay. Was it successful to Google management? Probably, since their lockup period is a mere 15 days according to what I heard on Bloomberg radio today. If this is indeed the case, then it will be interesting to see how the stock responds and if insiders unload beginning in 15 days. We'll probably see it in the chart. Was it successful to the public who paid about $100 per share? Only if a larger pool of "greater fools" moves in to bid the stock higher. But if Google management is OK with only $85 per share, well… They compete with Yahoo, Microsoft and AOL.

The Dow, S&P 500, Nasdaq, and Russell 2000 were all down marginally on low volume. Gold was up $2.70 per ounce ($409.30), silver down $0.02 ($5.81), the HUI was up 4.24%, and the XAU up 4%! It's a Bull Market. Gold Corp put an exclamation point on the trend break referenced above as it was up 6% on two times average daily volume. Note that gold is on its resistance line that was previous support.

The 10-year note was up in price and down in yield, an apparent result of the bond-friendly economic data.

Lets look at the QQQ index-traded shares, which seems to be the shares that most move the Nasdaq for reasons unknown. In spite of the last two days of lack luster volume, these shares traded more than an average day of trading.

We're right at the neckline of the pattern formed by the QQQ shares. Previous support is now resistance. Will the resistance be broken? Stay tuned, and have a great evening.

Martin F. Goldberg, MS, P.E.
Market Analyst
mdelmgoldberg@comcast.net

As published in www.financialsense.com