THE GOLD PRICE AND WAR IN THE MID EAST
by Clif Droke
November 5, 2007

I received an e-mail from a financial professional this week that speaks to our question in this week�s commentary:

�Am concerned there is a real crisis brewing. Oil at $95; gold at $800 (and keep in mind that's a suppressed price!) And Sec Lend [Fed securities lending] 4 days -- is it in the last 10 days � we're OVER TEN BILLION DOLLARS?! Is that a weekly all time all time record??!

�WHY??? Most peaks in gold are covered by a war or capped by a crash, eh?!�

Let's examine the recent spike in the gold price before we attempt to find the answer to this question.

Gold closed at a 27-year high on Friday at $806/oz. That's one of the highest levels seen since the all-time high was made in 1980. What on earth is the runaway gold price rise telling us?

As far as stock market crash, the odds are extremely low against this happening. With the IBES Valuation Model showing a 36% undervaluation of the stock market and with insider buying and securities lending volumes this high, a stock market crash would be unprecedented at this point. There is simply too much in the way of support for this to occur.

Now what about the second alternative, namely, war? This is a more likely scenario. It could be that gold �smells� war in the very near future and is doing what gold normally does when war is in the future. The same thing happened heading in the second war with Iraq in 2003.

This time it seems Iran has come into the crosshairs of the Bush Administration as being the next target of Mid East occupation. In June, the U.S. government issued an official warning to all Americans not to travel to Iran, according to an A.P. report. A more recent headline from the Financial Times reports, �US hits Iran with financial sanctions (Rest of world urged to follow lead).� It seems there are many in Washington who desperately want war with Iran and are going out of their way to get it!

Could the gold and oil price action be foretelling us of military action soon to come?

As an aside, if war is waged in Iran in the upcoming months, this will provide the pretext for the next increase in monetary liquidity. Remember what happened in 2003 when the war in Iraq began? The U.S. was absolutely flooded with money and a series of bull markets all across the stock and commodity arenas provided distractions to keep Americans from being overly concerned with the war.

Any war that is declared in the current economic milieu is sure to be greeted with less than an enthused response. Ergo, �a priming we shall go� will be the tune the Fed sings as the next phase of Middle East war gets underway.

The headlines of the financial newspapers have also given us reason to remain bullish on stocks from an intermediate-term standpoint. Now, after all those weeks of hand-wringing over the �credit crisis,� the press has given investors yet another reason to �be afraid�be very afraid.

The new crisis of the hour? More inflation!

Tuesday Financial Times contained an article by Michael Mackenzie, �Dollar and oil swings prompt fears of inflation.� We've seen this recurrent inflation theme several times in the past few days in the press and it seems to be a widespread fear. This fear is just what the market needs to keep the �Wall of Worry� intact and the bull market going forward.

Mark Dodson has an interesting take on inflation from the standpoint of the global economy. He writes, �For all the talk of so many economists who now recognize and talk about the twin forces of globalization and the technology revolution and the increase in competition that results, they continue to rely on Phillips curve style models that look at things like unemployment and capacity utilization in the US to determine if inflation is coming on the scene. They are using 20th century economic models in the 21st century.

�Even if you believe in a Phillips curve model, global capacity and global unemployment should be what you are looking for, and no one has the slightest clue what those numbers are.�

Indeed, it seems everyone is afraid of a resurgence of inflation following the Fed's interest rate cut and they�ll be even more afraid if the Fed cuts the rate again.

But inflation (properly speaking) is the last thing the stock market and economy have to worry about. The true inflation story is contained in this long-term chart showing the continuous yield on the 10-Year Treasury. The recent spike in bond prices and corresponding drop in yields has the all the marks of money going into the proverbial �bomb shelter� seeking protection from the latest crisis of the hour. It is most certainly not a sign the market is worried about inflation.

Dodson adds, �Commodities (input prices) might be through the roof, but the final goods prices that are included in popular inflation measures show inflation that is well under control. Same old story. We like the way that ISI puts it: what emerging economies (Think China) buy, they inflate; what they sell, they deflate.�

Now what about gold stocks? Here we are in the month of November, a time known for showing seasonal improvement of the mining stock sector. December-January are normally the best months of this seasonal time frame but sometimes November can be positive as well.

The XAU�s track record in the month of November going back the past 15 years is a mixed one. There have been six negative Novembers, seven positive ones and two neutral ones. The past 15-year record shows no strong seasonal tendency one way or another.

When we look at the past four Novembers, however, we see that every November since 2003 has been a winning one for the XAU as measured from the start of the month until the finish. Here's hoping that November 2007 will make it five in a row.

Among the other major mining companies reporting quarterly earnings, Silver Wheaton (SLW, $17.11) announced Wednesday lower net earnings of $19.2 million ($0.09 per share) from the sale of 3.1 million ounces of silver, compared with $22.5 million ($0.10 per share) from the sale of 3.5 million ounces of silver in 2006. Operating cash flows for the latest reporting period were also lower at $27.1 million versus $28.3 million a year ago. SLW�s revenues fell short of consensus. However, Silver Wheaton�s earnings-per-share (EPS) beat analysts� consensus.

The remaining companies due to release third quarter earnings in upcoming days are as follows:

Goldcorp (GG): Nov. 9

Hecla (HL): Nov. 8

Iamgold (IAG): Nov. 8

Pan American (PAAS): Nov. 9

Silver Standard (SSRI): Nov. 5

I'll leave you with this. The following headline article was discovered on the CNNMoney.com newswire yesterday. The article's headline says:

“Gold stocks: Few gems left to unearth (The price of gold may continue heading skyward but analysts say investors need to tread cautiously if thinking of adding mining stocks to their portfolio)”

This headline holds forth bullish implications from a contrarian standpoint and is yet another anecdotal piece of evidence that the uptrend for gold and silver stocks should continue, notwithstanding a few potholes along the way.

© 2007 Clif Droke
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Clif Droke
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