Precious Points: Seeing Clearly

By: Oroborean | Sat, Dec 9, 2006
Print Email

Despite the inundation of market commentary you saw flooding the Internet with predictions of a dollar collapse and a pending economic disaster last weekend, we instead warned that cooler heads were likely to prevail and that "serious brakes" would soon be put on the precious metals rally. Specifically, we said:

"But, it's important to keep in mind that it's still unclear to what extent old benchmarks in the ISM still prognosticate the health of the current non-manufacturing based economy ... To the extent that the perennial terrorist threats fail to materialize during this holiday season, and economic data comes to reflect moderate expansion instead of recession, cooler heads and optimistic outlooks, not necessarily inducing rate cuts, could still prevail and this would put serious brakes on the recent gains in precious metals."

Indeed, when the better than expected service numbers were released this week, the gloom began to dissipate and with it faded the luster of the precious metals rally. We'd been saying for weeks that metals would be able to move higher for longer if they rose at a gradual pace and, since silver in particular was beginning to look too bold, were not surprised to see some consolidation. Gold, which peaked at about $648, fell below its September high. $600 remains a psychologically significant level that, if penetrated, will certainly delay the next move upward.

Probably the best call of last week, though, was our $14.16 resistance level for silver, which we called almost to the penny. Silver's selloff occurred just as it approach our anticipated resistance area, whereupon it traded down to $13.50, but caught a break on Thursday and managed to close the week at about $13.70. We're now closely watching the previous September high for support at the $13.30-50 level. The long term silver bull is still alive and kicking with a higher low anywhere above $10.65-10.70, which is important if this stall in the rally becomes self-reinforcing and fast money continues to find a home in other sectors.

We'd been in "buy" mode since the October FOMC meeting until our precautionary warning last week. We'd implied in previous updates that the Fed's rhetoric was a smokescreen for rate-cutting aspirations. But, with the dollar having now come under serious pressure and scrutiny, it's clear the Fed will only cut rates in case of an emergency because lower interest rates, beyond simply creating inflation, would devastate the dollar if foreign governments finally decided to make good on their threat to stop supplementing their dollar reserves. The currency issue is so important, in fact, that top Treasury officials and the Fed chairman will be traveling to China next week to discuss time tables for the country's economic reform. We can only speculate that parties to the meeting might be discussing contingencies that would involve China supporting the value of the dollar should the U.S. economy slide into recession and the Fed be forced to cut rates.

It appears, then, that the key for the Fed is to keep talking without actually changing rates until the issues surrounding China's currency and reserves can be coordinated and the fate of the economy confirmed. At the very least, a rate cut here would put the economic future of the country in the hands of the foreign governments. Considering that, with Europe and Japan tightening, steady fed funds are already a de facto rate cut, it starts to look like all the hawkish talk could have some substance. The Fed could hike rates to motivate continued foreign investment in the dollar, but only if the economy proves to be recovering and expanding, or else the downward spiral of the economy would also consume the dollar.

Another factor emerging this past week was the publication of the Gold Fields Mineral Services Ltd (GFMS) quarterly newsletter, which includes the astounding prediction that silver demand in 2007 will shrink by about 28 million ounces while production increases by about 16 million ounces. The production forecast is actually for a decrease in primary silver production, but GFMS sees this being more than replaced by an increase in silver mined as a by-product of copper, zinc and gold. In other words, the renewed mining activity created by recent years of higher prices and higher demand are finally reaching the market in the form of higher supply.

The current GFMS prediction that global industrial growth will decrease as supply of metals increases, if correct, could spell the end of the silver supply deficit and create a serious threat to the metals bull market. But, despite the headline, by its own estimates, the GFMS expects total fabrication demand for silver in 2007 to exceed 915 million ounces while total mine production will only see about 666 million ounces. Even with government sales and scrap silver coming to market, that's still a healthy annual deficit.

Not surprisingly, the December report concludes that silver will probably move higher with gold in 2007 instead of following base metals, which they predict will go lower on weaker industrial growth worldwide. Though the private firm describes itself as "the world's foremost precious metals consultancy", GFMS' annual estimates have come under serious question since at least the early part of this decade, and its dubious reporting was the subject of a 2005 editorial by Franklin Sanders.

All things considered, the short-term picture for metals from here is less than ideal. It's become an accepted fact that capital is cheap and liquidity sufficient, and it's unlikely precious metals will depreciate dramatically in such an environment, at least while uncertainty reigns. Silver's investment demand is also at an all-time high, with the latest run in the white metal proving that investors continue to see it as a haven against inflation when the dollar declines, as well as a play on strong growth and industrial demand.

That said, the current market environment is decidedly optimistic of Bernanke and Paulson's high profile support for a strong dollar and a soft-landing in the economy and their meeting with China. At least, most traders are willing to defer judgment. It's unlikely the positive atmosphere will entirely change next week, though retail sales and inventory figures, in addition to Friday's CPI number, will either challenge or confirm the outlook. Based on our expectations, it appears the precious metals' bull run may be taking a rest for the time being as the entire sector continues to consolidate and feel for support. For a good look at precious metals and all the major indices, to contribute your expertise to our unique blend of fundamental and technical analysis, or to comment on this article, join us in the forum. See Dominick's weekly update for a special money-back offer.

Featured Mining Stock

Almaden Minerals (AAU)

What could hold down the stock of a mining company with over 40 projects at various stages of development, 14 of which are currently joint ventured? A company with a team of geological engineers, geologists, and prospectors representing over a hundred years of world-wide geological experience and a proven record of discoveries?


For starters, shares of Almaden Minerals (AAU), which fits the descriptions above, are hampered by the fact that the company lost about $0.06 per share last quarter versus a profit of $0.01 per share during the same period last year. It can't be great news that a mining company's largest current source of revenue is interest, or that it's been forced on several occasions in the past several years to dilute its ownership by issuing shares and warrants. Almaden has propsected largely for copper, a commodity that has suffered from high supply in recent months. And, as a principally exploration-based interest, the company lacks the equipment and resources necessary to develop its properties and so is subject to favorable agreements with outside contractors for construction and production.

But many of these challenges are common to any junior miner and it would be unjust not to highlight the positive factors working for this innovative company. Despite its recent stock performance, Almaden actually has a favorable financial situation compared to many of its peers. The company has about $18.5 million in assets (unaudited) with practically no debt. They're sitting on a reserve of 1,500 ounces of gold, with a diverse portfolio of mineral rights including proven and probable gold, copper, silver, lead, zinc, platinum and diamonds. These minerals are all on property in Canada and Mexico, where the company is more likely to run afoul of environmentalists or Indian land claims than nationalization of resources or exorbitant taxation. There is also a regional joint venture agreement between Almaden and Japan Oil, Gas, and Metals National Corporation.

So, with a fair and balanced view, what does the future seem to hold for AAU? Perhaps the company slogan says it all: "Invest in our Ideas. Profit from their potential". Now that it's officially closed a recent private placement, Almaden has the capital necessary to finance the next round of exploration, including the expansion of the drilling program at the old Elk Gold Mine, part of the Spences Bridge Gold Belt in southern British Columbia, and several Mexican properties. As long it as can continue to successfully option out development rights on the territory it aggressively explores, the company will continue to capitalize on their valuable resources.

In the end, it doesn't take many major discoveries to make a profitable enterprise. With a portfolio as safe and diverse as Almaden's, it's a strong possibility that, sooner or later, AAU will find its literal and figurative gold mine and see significant upside. In the short term, priced below its 50-day and 200-day averages, with most metals still trading up from last year, Almaden appears significantly undervalued.




Author: Oroborean

Joe Nicholson (oroborean)

This update is provided as general information and is not an investment recommendation. TTC accepts no liability whatsoever for any losses resulting from action taken based on the contents of its charts, commentaries, or price data. Securities and commodities markets involve inherent risk and not all positions are suitable for each individual. Check with your licensed financial advisor or broker prior to taking any action.

Copyright © 2006-2008 Joe Nicholson

All Images, XHTML Renderings, and Source Code Copyright ©