I thought I would spend an in depth examination into the Commodity market and how it will be influencing the economy over the coming years. The big driver of the global economy is currently China. China is trying to develop an infrastructure to cope with its burdensome population. To currently increase global production equates to burning more oil.

Most of Wall Street has expected oil to return to $20/barrel, yet it still is above $40/barrel. The pricing of oil is pure supply and demand. Uranium and coal have also had increases in their basic commodity prices as the alternatives gain favour. China has even announced new plans to build future nuclear generating stations that are meltdown proof, and studying fusion for fusion reactors. I should say one thing about Uranium before I return to the theme of this article. Uranium stocks are starting to look like gold stocks did in April prior to the sharp decline. Donald Coxe has a rule called the "Page 16 Rule - If an article appears on this page offers investment potential, an individual will neither lose nor make money. Establish positions in these kinds of stories and hold on. When the article hits the front page, consider lightening positions". Uranium has been mentioned by George Bushes staff, by several newsletter writers, and hedge funds establishing positions. Maybe the trend continues for longer than anyone thinks. If someone has been on Uranium for a long time, it probably is best to hold on. If someone needs money to pay bills or live off, then it might be wise to take some profits.

The reason for this slight change of tone regards the balance of inflation and deflation. As long as China and other countries continue to buy US T-bills, and the US consumer spends, then commodity inflation will exist. The problem with commodity inflation is it has a deflationary effect on the rest of the economy. If a family has X dollars being saved, or used for non-necessities in life, higher commodity prices seen like gas and electricity (derived from Natural Gas) will decrease the amount of money spent outside the home. Higher commodity prices will squeeze business profit margins since their true manufacturing cost rises, but must keep the final price low enough to beat the competition, or survive longer than them before they can raise the price.

Families and businesses getting squeezed translates into one thing…….less money is injected into the economy. Car manufacturers basically have to give cars away now. Most people have taken advantage of the cheap car prices (I do not call a $30,000 car cheap, but anyhow, that seems to be the average price of a car nowadays) so excessive inventories will result in layoffs. Car manufacturing accounts for approximately 20% of jobs in the US (I am not sure how this is broken up) so it is a significant amount. These people laid off will stop eating out and will only purchase necessities in life. Many will be forced to sell their homes. When the supply outstrips demand, the housing prices fall, leaving many with mortgages well above the resale value of homes.

The scenario is a domino effect that goes from top to bottom of society. A slowdown in spending by the US will result in less growth in China, which will translate into less demand for commodities. When does this stop? Good question. When it does, a deflationary environment is the likely scenario in assets linked to credit. I think gold and silver are not viewed as investments right now or necessary by the general populous (I am not going to go into the manipulation of gold and silver since we all know it exists). Things like copper, oil, Uranium, natural gas etc. are required items to run countries. A country can go without gold and silver but they can not run without oil in the current paper system employed by global markets. Eventually all paper will expire worthless as most calls or puts do, and the need for a gold and silver backed currency will be needed. Until the paper system catches fire and burns, it will continue to function even though every piece of paper is soaked in kerosene. Paper soaked in kerosene is not worry some at all……until a spark is near. There will be some spark that does ignite the global paper system that will ravage all of those that hold it. There is a catch though. Will people use cash to pay down debt, or will it find its way to gold and silver??

I have been bullish on gold and the HUI, and will remain to be so until the Elliott Wave patterns I am following do not develop as expected.. Gold and silver have been in a bear market for 22 years, and face supply deficits relative to demand. Every time in history is different, so if people sense deflation now, will the accumulation and demand for silver and gold follow or will fiat paper be used to pay off debt first then money rushes in to the precious metals? This is a difficult question that no one can answer. The Elliott Wave chart of the HUI is mapping out a bullish scenario, so until it is breached I will have a bullish bias (meaning that a decline to 160 in the HUI would not affect the longer term up-trend).

I am becoming more inclined to have a balance of 60% bullion and 40% gold/silver stocks relative a portfolio makeup (i.e. if precious metals constitute 25% of a portfolio, then the above would represent the portions of the 25%). Governments are going to be very short in money, and highly profitable gold mines could become a "Gold Mine" (please excuse the pun) for revenue generation. Mines could become nationalized or taxed heavily, especially if gold goes to $2000/share. I do not know if this would happen, but the possibility exists given the extraordinary amounts of money the governments must spend to keep the social nets in place. I am an owner of Nevsun, and look what that African government has done to them. The best stocks to own are companies with most of their mining assets in Canada and the US. I personally think society as a whole is going to function like the high wire trapeze artist without a net below. Everything functions well until footing is lost. The fall is unstoppable and swift. There will be those fortunate to have a waist harness to gently allow them to continue their walk without a fear of slipping……ever, but those will be few and far between.

Canadian gold companies are probably the safest bet on the planet for political stability and preservation of capital. Governments are likely to loot the profits somewhat, but compared to countries like Russia and China where investors could lose everything, it is a safe bet. I would stress Canadian investments, especially for those with US dollars that stand to decline in the longer term relative other currencies. Paying down debt, accumulation of cash in terms of 50% cash, 50% bullion is recommended. Spare money should be thrown on gold stocks, oil stocks or Uranium stocks. It can not be stressed to not have all of one's money parked in one place. The current monetary environment has never been encountered, so the outcome is not certain. People will still have jobs, own homes, get their mail etc., but there will be a larger portion of society that do not fit into this scenario. I expect families to take in other family members so they do not hit the street. The year 2008 is when the baby boomers start to retire en masse. By 2010 the effects of cash shortages in companies will be felt. Look at Air Canada. They were $0.06/share and now do not trade. The former shareholders will not see one penny of their investment. Bondholders have been lucky to see 0.10 on each dollar they invested. The pension fund is likely to be taken over by the company that insured it, and they do not have to pay the 100% of the original amount. Someone who earns a $30,000 pension is likely to see $18,000 per year instead. This has happened in the US, and is likely to happen in Canada also. Given the pension deficits most companies have, they likely will all go into bankruptcy protection, and re-emerge with no debt. I think that most companies in the US will be forced into bankruptcy protection to shed the debt levels and start anew. Any company that fails to do so will have unfair competition with competitors that went bankrupt. People will still have jobs, just expect a smaller pension and reduced salary.

The picture painted above is likely to take years to unwind. The FED and global governments will fight deflation tooth and nail. Commodity prices are likely to remain high, given that global oil production is set to peak (also lower prices discouraged any reason to go out to try and find more oil). When people need money, they will sell stocks to pay bills. Currently the investment crowd has been rotating in and out of different commodities. Pay attention to the above points for crowd sentiment. Obviously people that employ this method will still have a scale of interpretation from 0 to 100 with the mean around 50% of the price move, so careful observation is required to stay ahead of the crowd.

Not to sound like a pessimist, there are strategies for surviving. A list is shown below.

1. Pay down debt, set aside 50% of spare money in cash and bullion. Put the other money into gold stocks, oil stocks, Uranium stocks etc.
2. Stay married, stay fit and take vitamins. Marriage means two incomes are likely present, married people are generally happier, healthier and live longer. People who exercise will often die in their sleep when they hit their late 80's. The afflictions of old age are delayed until much later. High vitamin C and vitamin E doses help to prevent the hands of time from beating up on our bodies. Vitamin pills help prevent any deficiencies in today's highly processed diets.
3. Keep job training up to date and work hard. Survival of the fittest will become vogue. Take a hobby that can make money eventually. I do this kind of work as a hobby. Maybe some day it will become a full time endeavour, but for now, it is a hobby.
4. Get a job in the mining or oil industry, farming etc.. This is where the jobs will be: commodity based. I am in Biotechnology, and the global gene base is sick for prolonged life extension from modern medicine. Up to 25% of the US population could be dead without drugs or medical treatment in one year, so this area will likely continue. Governments will seek generic drug companies to produce drugs. Innovative drugs will take the back burner to cheaper equivalents. The only way health care can likely go forward is with a generic approach. The Biotech industry should peak around 2016-2020 (hopefully longer) but the commodity job market will dwarf job prospects.
5. Plant a garden and get a freezer. If food prices skyrocket to reflect the true cost of growing food, growing a garden and freezing spare food will ease the pocket book longer term.

David Petch
Market Letters Digest
September 5, 2004

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