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Russell on Gold & Stocks

November 18, 2002

First, be sure to read Doug Noland's great and scary piece on the current absolutely astounding state of credit in the US, better known as the Greatest Credit Bubble in recorded history. He's at site, which is a fine site on its own. How this incredible credit bubble is going to resolve itself, I can't imagine. Well, yes I can. It will be resolved via maybe the greatest and most tragic bear market in US history.

I have to wonder what Sir Alan Greenspan is thinking (I have to address Greenie with a Sir because he's now a Knight). He must know that he's created more credit on his watch than all the other Fed chiefs taken together since the Central Bank was first formed back in 1913.

Ah well, we know that there's one item that is not a product of the Fed's credit creation, and of course I'm talking about gold, and there's more about real money (gold) below.

As for the stock market, we're enjoying (unless we're incorrectly short) a correction in a bear market. So far the correction hasn't produced a whole lot of steam, but the fact is that the sellers have been willing to stay on the sideline, thus allowing buyers to hit the asking prices and stocks have pushed higher.

For those who like to keep busy, I've advocated buying the Diamonds (DIA) which sell for roughly 1% of the price of the Dow. My thinking is that it's hard to conceive of this rally pushing higher without the Dow somewhere in the lead. But for the sake of safety, I've also advocated keeping close stops under the DIAs.

If this upward correction is going to develop into something really dynamic, the Dow will have to better its November 6 peak of 8771. If the Dow does better 8771, add to your Diamonds (add another 50% of whatever your position is now).

International investors at last seem to be losing their appetite for US assets. The US current account deficit is due to hit $500 billion this year; it's going to take inflows of $1.9 billion a day to keep the dollar from fading.

International investors are now waiting for proof of Greenspan's promise that better times are on the way. Because if Greenie is whistling in the wind, our foreign friends are going to become increasingly nervous about sending their hard-earned money here. Net inflow to US bonds from overseas is already slowing down. And US interest rates are now substantially below European rates.

The dollar is now just below the value of the euro, and it is hoped that the ongoing dollar decline will at least continue at a slow rate. A rapid decline in the dollar would quickly breed panic among US creditors.

In the meantime, US industrial output in October declined for the third month in a row with industrial firms now using just 75.2% of capacity. Demand for US goods has declined as the stimulus of tax cuts and mortgage refinancing has receded.

It remains for the housing industry to keep the US economy bubbling. But here the credit situation has reached such gigantic proportions that instead of going into it, I again urge you to read Doug Noland's eye-opening report on the prudentbear site.

From my end, I will be watching the action of Fannie Mae (FNM) and Freddie Mac (FRE). The action of these two government-sponsored mortgage buyers is now of critical importance, and I'll probably be reporting on these two daily along with the action of six of the major home-building stocks (all of which are now selling below their 200-day MAs).

I want to say something about gold in the next section, since the manipulations and the battle to hold back the price of gold have reached dramatic proportions.

Gold -- Silently, quietly -- there's a fierce battle going on to control the price of gold. I wrote yesterday about the large contingent which does NOT, for what ever reason, want gold to go higher. These are certain hedged mines, some gold accumulators, and obviously all gold shorts.

The shape of this huge battle can be seen in the so-called Commitment of Traders. For the latest week, the Commercials (gold banks, some mines, large brokers) decreased their long gold contracts from 49 thousand to 43 thousand. That's a drop of 6 thousand long contracts.

But the Commercials also increased their shorts from 106 thousand to 122 thousand, an increase of 16 thousand shorts. In other words, the Commercials are shorting the hell out of gold. Clearly, the Commercials are attempting to manage (or some call it "manipulate") the price of gold.

Aligned against the Commercials are the large traders or large speculators. For the latest week this group increased its long position from 38 thousand contracts to 57 thousand contracts. At the same time they increased their shorts slightly from 18 thousand contracts to 20 thousand contracts.

Which group will win? The powerful Commercials tend to win, but this is a bull market in gold and the Commercials now have the problem of trying to manipulate a bull market. They may be able to do it on a temporary basis, but in the end the primary trend will have its way. In fact, the longer a primary bull market is held back, the more powerful is the ultimate advance. Bull markets, like bear markets, ultimately must express themselves.

It's obvious that the Commercials do not want gold above 320, and it's even more obvious that they do not want gold above 325. So the battle lines are drawn and the gold war is on.

This is the problem for those who are speculating in gold vs. those who patiently hold gold on the basis of long-term fundamentals. And there is an advantage in holding physical gold over gold futures or even gold shares. When you hold physical gold (coins) you don't really give a damn what the short-term trend of gold is. You're holding real money, and the history of gold is that it has outlived every paper currency that has ever been invented. You just sit with your physical gold and wait.

But holding gold futures or gold options can be scary because you are heavily margined and you're fighting time. Holding gold shares fully paid for can be scary if a temporary drop of 15% or even 25% causes you to lose sleep. But holding gold shares in a gold bull market can be very rewarding, and it can be well worth the fight.

Can the Commercials be defeated? Occasionally, they can. But the odds usually favor the Commercials. Nevertheless, the current situation is fascinating in that the Commercials have taken such a strong position against the primary trend of gold.

On occasions when the Commercials have been defeated by a stronger market force, the move can be spectacular. In other words, if gold can climb above 325 and more importantly above 330 we could see a panic up-move as the Commercials are forced to cover.

The battle is on. For the gold bulls, the important thing is NOT TO BE LEVERAGED. If you hold your gold coins or gold shares for cash, you can't be knocked out of the picture, regardless of manipulation by the Commercials. And that is the crux of the situation. The primary trend of gold is bullish. The secondary trend of gold can at any time be bullish or bearish.

Of course, the ultimate question is -- why are certain interests so intent on holding back the price of gold? Some day the whole ugly story will be told. In the meantime, all I can do is try to put the story together to the best of my ability and with whatever market evidence I have at hand.

In the meantime, Barron's puts the trailing P/E for the S&P at a fat 34.03 times earnings while the dividend yield for the S&P is at a low 1.74%. Eventually, I believe the industry (in the interest of honesty) will use S&P "core earnings." Core earnings taking in all expenses run $18.75 for the S&P. On that basis, the S&P is selling at just under 50 times earnings.

The true (common stocks only) A-D line for the NYSE runs as follows -- Nov. 11 minus 5.46; Nov. 12 minus 5.20; Nov. 13 minus 5.26; Nov. 14 minus 4.78; Nov. 15 minus 4.62.

The Confidence Index has moved up to a still-low 72.4.

Current interest rates are now so low that those who need income are, in many cases, being forced to take on more speculative vehicles. Remember, in a bear market everyone loses, and the winner is the one who loses the least.

By its low interest rate manipulations, the Fed is forcing or allowing millions of Americans to take on highly speculative positions, the chief of which are bubble-priced primary and secondary homes.

So to sum it up, what I see is the great debt and credit pyramid in recorded history, so far holding together. But this is a primary bear market, and in big bear markets whatever is vulnerable will ultimately be attacked. Since the whole fabric of this nation is now built on credit and debt, it's credit and debt that are vulnerable.

Only items of true intrinsic value on their own will be able to withstand the coming onslaughts of the bear. As far as money is concerned, there's only one money that is not vulnerable to a deflationary credit collapse. They call that item gold.

And that does it for Saturday, and sorry about my clumsiness in wiping out yesterday's site.

Gold is one of the most recycled substances in the world.
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