Gold and silver in short supply and highly leveraged in currency war

In an interview with Ron Struthers, editor of Struthers' Resource Stock Report, he stated that his indicators have him thinking gold will soon move easily above $2,000 an ounce, taking silver higher with it. He expects this move to last over a six-month period with higher inflation and excess money printing.

Author: JT Long
Posted: Thursday , 16 Aug 2012

The Gold Report: Last November, you talked about indicators you use to make investment decisions, mentioning the S&P 500, the PHLX Gold/Silver Sector Index (XAU:NASDAQ), the AMEX Gold BUGS Index (HUI:NYSE) and the TSX Venture Exchange. You recently predicted junior explorer stocks would stay low over the summer before recovering, along with the commodity price. What indicators are behind that, and do you foresee a dramatic rise or a gradual slope?

Ron Struthers: We have seen a downward correction in the market space, a deflation scare because of Europe, and that has been the theme for some time-a battle between deflation and inflation-while central banks print money to make up for a contraction in money because of imploding debt and slowing economies. But everything has corrected substantially; the senior gold stocks bottomed in May, and since then, gold has gone sideways. Gold stocks and the S&P 500 have rallied, but we've only seen part of a potential summer rise so far. Now the S&P 500 is at 1,400 and the high before the correction was 1,420. There will be substantial resistance, but the S&P 500 should rise above that.

On the correction, the S&P held its 200-day moving average and bounced off, forming pretty close to a perfect doji star reversal pattern. That's a strong candlestick indicator of a major bottom. With gold stocks measured by the AMEX Gold BUGS Index, we've seen the same doji star reversal pattern (that is a dark, down candle in a downtrend, followed the next day by a doji cross indicating indecision and the third day a long up or white candle); thus the predicted bottom during the early summer. A nice rally went into mid-June, came back down in mid-July and then bottomed close to the May bottom but above it, which makes sense, since the doji star reversal pattern indicates a bottom. The July lows were close enough for a double-bottom, meaning we have a strong base to rise from.

I closely watch the old Reuters Commodity Index, referred to as the Reuters Continuous Commodity Index (CCI), which has a strong correlation with the TSX Venture Exchange. It has been a constant measure of the same baskets of commodities and weighting, the only index for longer-term analysis. Most of the mainstream is fooled by the new Reuters CRB Index that is widely quoted in the mainstream press. It became a black box algorithm in 2005, constantly adjusting weightings every month, giving the perception of a better performing index. But that's far from the truth-it's just another modification to mask the inflation rate.

Meanwhile, while some say the commodity bull market is over, we are really seeing a correction in the continued bull market. The new CRB index has gotten nowhere close to its 2008 high, but the true measure of commodities, the CCI , reached well above the 2008 high of about 600. It fell back to 600 in late 2010 and went to a new high of almost 700 in 2011. The higher inflation scenario from excess money printing is alive and well.

Short term, both commodity indexes bottomed in May, and are moving steadily higher. The old CCI bounced off 500; now it is at 563, and it was 566 a few weeks ago. The bottom stands mainly because agriculture prices won't come down anytime soon, but there has been a strong correlation between both the CRB and CCI indices and the TSX Venture Index going back to 2008. We have seen a substantial rally in the CRB, so the TSX Venture should soon follow, and the move will be dramatic because the gold stocks and juniors are so depressed. They have not seen such low valuations since the 2008-2009 bottom, when there was severe panic in the market. We had an average gain of 155% in 2009 with gold stocks in my newsletter. I see the same opportunity now for late 2012 and 2013.

TGR: So this could be a sharp jump instead of a gradual increase?

RS: We could see a strong move over a six-month period, which most would consider short term.

TGR: How can you tell the difference between a correction and a turn toward a bear?

RS: I watch for several things in the long term. To be termed a bear, it should break substantially below a previous long-term low. The S&P 500 held above its 200-day moving average, so it didn't get into bear territory. You might call gold stocks a short-term bear market-the correction is about nine-months long. However, we have not broken down below the early 2010 low where the 2010-2011 rally started, so long term on a 5- or 10-year chart, we have not seen a lower low.

TGR: What impact could the presidential election have?

RS: Elections are not a factor. Whoever is elected will work for Wall Street and the big investment banks. There may be short-term reactions, but we will continue our course, with artificially low interest rates, quantitative easing and money printing until the bond market cracks and interest rates rise. The U.S. debt is bigger than Europe's; it just has not received the same attention.

In addition, the Federal Reserve will probably hold off quantitative easing (QE) until after the election. It wants to maintain the illusion of being unbiased and doesn't want to be seen as affecting the election. After its September meeting, something could change; it could argue that changes won't have an effect until after the election, but for now, it will stay the course and use the QE3 when they really have to-after the election.

TGR: You say it is easy to outmaneuver automatic trading systems. Does that impact the junior market, where volumes are lower and volatility can be affected?

RS: It is surprising that computer trading has entered the smallest juniors, even the thinly traded nickel and dime stocks, but computer trading is taking advantage of their volatility. With these little stocks, the programs look for ways to come between the buy and the sell and skim pennies. It sounds like nothing, but it is happening with thousands of stocks daily. Computer trading is also active in the higher priced juniors with more volume, trading between $0.50 and a few dollars a share; you will also see this with the huge amount of 100-share trades.

Something else happens with computers, but is attributed less often to automatic trading: that is severely shorting the junior gold stocks. In the past, we have seen short trading on the senior and midtier gold stocks, but now we see a lot of shorting on junior producers, too. Strangely, most of the short positions came at the bottom of the market in May /June, so it won't take much to put them underwater, and short covering could add fuel to a rally.

There has been a big increase in computer trading; there are more professional traders in the market and fewer retail investors. There are also more exchange-traded funds that hedge in a lot of these stocks. With the extensive shorting, we are either seeing intervention in the gold stocks or the reflection of strong beliefs that the gold bull market is over. However, in the latter case, they will be proven wrong, and that is why short covering could be substantial.

TGR: Last year you were liquidating your portfolio, based in part on the jump in the price in silver, and by extension, gold. Silver is now at $28/ounce (oz) and gold is still around $1,600/oz. How are you adjusting your portfolio to fit this new reality?

RS: Gold and silver often rally together and both are in short physical supply and highly leveraged-the same ounce of gold or silver has been sold 50-100 times. We are in a currency war. Countries are fighting to keep the fast-moving money in their currency to prop up their huge debt loads; gold and silver are competing currencies.

The U.S. has intervened to keep interest rates low, trying to keep the system afloat and intervening to keep the stock market up, but commodities and gold lower. Europe is doing the same thing. Meanwhile, a lot of Eastern countries, with huge U.S. dollar and euro reserves, are trying to diversify out of these debt-ridden currencies into other currencies, including gold. Every month we see news of mostly Eastern central banks-including India, China, Russia, and Korea, etc.-buying gold. Physical gold is in short supply, but they know the price is being held down with intervention in the paper commodities market. We are seeing a continuous flow of gold from the West to the East, the same thing that sparked the big rally in the late 1970s to 1980. This will happen again; it just depends on when the West does not want to give up any more physical gold to the East, at least at these prices. In that case, we will soon see gold move easily above $2,000/oz, taking silver higher with it.

TGR: How high could silver go?

RS: It will hit resistance at $50/oz again, but eventually it will break through. If that does not happen on this next rally, it will on the next one. We are speaking in dollar-inflated terms; $50/oz was the high from 1980, and we still are not above that, but gold has gone up well above the 1980 high of about $850/oz.

TGR: What percentage of your portfolio do you have in cash versus stocks, and juniors versus mid and large caps?

RS: It has been about the same since 2008, adjusted a bit here and there, but we keep about 20% in physical gold and silver, keep cash up around 30% because of uncertain times, and then keep about another 15-20% in good dividend stocks. With the low interest rates, some good dividend interest is great. These dividend companies have served as pillars of strength in our portfolio during this period. I devised what I call a Millennium index of dividend stocks we use to invest here. The last 30% or so we invest in gold stocks, mining and energy stocks.

TGR: Are you looking mainly at gold juniors or producers?

RS: I have a mixture. I have about 20% in the senior and midtier golds. There is a lot of leverage in the junior producers and advanced juniors, so I have about 25% in small and emerging producers and another 20% in advanced. We put about 15% into the small exploration plays that seem promising and 20% into some of the energy stocks-I call them energy and cleantech, but they can involve some of the other areas, like graphite.

TGR: So what advice would you give an investor who wonders what to do going into the fall?

RS: Always diversify. Returning to my portfolio weightings: keep a good cash cushion because if you don't have cash, you don't want to sell at potentially depressed prices to raise it. Keep 20% in physical gold and silver-you know you have it in your possession-or something like the Central Fund of Canada, which has been around a while and is audited, so you know the gold it is actually there. Many exchange-traded funds and gold are so leveraged that I am worried a lot of people have ended up paying for the same gold ounce, and you don't want to be one of them if the financial system falls apart further.

Dividend stocks are also a good idea; it is nice to have income coming into your portfolio. The rest should be in some gold stocks, the juniors, but again-diversify. It is good to own 10-15 stocks in that sector, since it can be volatile, especially on the exploration side. You can lose money in some, but if you hit it big in just one or two others, your portfolio's still up substantially.

TGR: Thanks for your insights.

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