Metals Sell-Off, Relax!

We've seen a dramatic pullback in precious metals recently as I expected. Gold prices have corrected 22%, as of today, since peaking at $725/oz. on May 9th -- but remain up 9% ytd!

Today the CPI came out with overall rate at .4% with core rate at .3%. Clearly there is inflation. The markets (stocks, commodities, except bonds) seem more worried about the cure than the disease. They fear Bernanke raising rates to fight inflation and killing the markets along the way.

But stop a moment and think about it. What have 16 rate hikes done already? Apparently nothing, given today's CPI numbers. Rates have gone from 1.1% to 3.5% and we still have a 5.6% price increase on a wholesale level and a little less on consumer prices. Pass thrus are yet to come.

Gold bugs love run-ups, but love price-breaks even more. Average people buy high and sell low, but not gold bugs and true believers in the fundamentals. Bottom line: NOTHING HAS CHANGED -- Inflation is here and the world knows it, which is bullish for gold long-term.

I can't imagine that another rate hike will kill the inflation cancer. Not one, two or even three. All it will do is kill housing, stocks and other markets on a short-term basis.

The Dow closed Tuesday down on the year. I think what we're seeing is a worldwide liquidity problem. Liquidity is not available money. Liquidity is the ability of an item to be sold with very little affect on price. If a stock is liquid it can take a large sale without much downside movement.

Right now the world is so tense that any selling sends prices south. This could and will change overnight once a market of "choice" emerges. I believe that market of choice will be tangible assets, given it is the only bull market that is real, that you can hold it in your hand -- without a financial statement, which may be cooked, to establish value.

Despite a 20%+ correction, gold remains up 9% ytd. What other market could sustain such a steep fall and remain up on the year? Even more impressive is the investment coin market's stability during this bullion market volatility. For example, U.S Gold Commemorative prices moved up this week despite the decline of gold, indicating great upside potential in the future.

While many pundits like myself see this correction as nothing more than a healthy breather in a strong bull market, others are calling it the end of the bull market and the beginning of a bear market.

"The precious-metals bull market is officially over," Dale Doelling, chief market tech at Trends In Commodities told CBSMW today. One CNBC floor reporter said "gold is now in a bear market because it has fallen 20% since May 9th."

"This downside is paltry compared to the upside potential for gold. Gold could reach a price many times higher than it’s at today, regardless of whether inflation or deflation becomes the problem...", wrote Stephen Leeb on Monday.

Larry Kudlow said on CNBC this is the end, while James Turk told CBS Marketwatch he still sees $850 by years end. Mr. Turk further told Barrons on May 29th that gold could go as high as $8,000/oz in this bull cycle.

"Gold analysts predict that the gold price will regain its upward momentum, but warn investors to expect a bumpy ride. The gold price was expected to recover in August as June and July were traditionally weak months for the metal", Numis Securities analyst John Meyer said in a note to clients Monday.

So which is it -- a strong bull market correction... or beginning of a bear market?

Bull and bears will never agree, but from my perspective I'm glad to see the 'hot money' leave the metals and commodity markets for now, to allow real, long-term investors an opportunity to take a position at more reasonable prices this summer before the next major leg up in this bull market. The fact is no one knows, but here are a few facts we do know for sure...

1) The U.S. dollar is still off 40% over the last 4 years, even after 16 consecutive interest rate hikes -- and shows no signs of reversal without severe rate increases very soon. If the Fed was to raise rates to an inflation-fighting level it would plunge America (and the world) into a deep recession. Major players like Warren Buffet are still shorting the dollar, knowing full well it's value over time must drop further. The M-3 money supply report is no longer offered. At last look it was growing at 8% per year.

2) Inflation expectations are real. Most countries, fund managers and sophisticated investors are taking defensive positions against rampant inflation. Core rates have been consistently going up. As they go higher, bonds will take a beating.

3) The U.S. Government needs to borrow huge amounts of money to finance the deficits. With a $9 trillion debt ceiling the world, which historically is willing to lend us money, is becoming very nervous about our ability to pay them back. Many foreign holders of dollars have been prevented from using those dollars to buy real companies or assets (such and CNOOC buying Unocal oil company or Dubai Port Worlds buying ports in U.S.) More and more restrictions are being put in place in the name of homeland security. I believe it's to keep the holders of dollars doing just that - holding dollars -- instead of real assets like gold.

There should be no doubt in anyone's mind that the price of all real assets will increase on a long-term basis, given what's happening in paper currencies around the world. I haven't even mentioned issues like Iran, the war on terror, oil above $65 bbl., etc.

Any single event in the world could easily reverse the recent cooling of the metals markets. Therefore, I believe it's incumbent on us to stay the course with our strategy of acquiring gold, and buying the dips. Between 5-15% of a portfolio should have an insurance position in gold. Gold should remain the bedrock of a portfolio regardless of price. Recent increases from $265/oz. in 2001 to $565 today -- a jump of 213% -- are great, they're just the beginning of a long-term bull market that should continue for many years to come.

Remember: The long-term trend is your friend. Commodities and high quality collectible investments are on track to outperform paper investments like stocks, bonds and CDs again in 2006, just like they have every year since 2001! -CRS