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Yellow Metal Retreats


Price drop yields buying opportunity.

Corrections are part of every bull market - nothing goes straight up.

So why is gold down? I think we're seeing a combination of disappointment the Fed didn't ease more yesterday, hope by the herd that the financial markets have been magically healed by the Fed's recent moves, and a general pullback in commodities all hitting at the same time.

For the gold shares though, they never discounted $1000 gold to begin with. Thus, one wouldn't expect much more near-term downside in them. We can also see this in the XAU/Gold ratio, which is currently 0.192, close to its recent nadir back in August.

As you can see from the chart below, selling gold shares with this ratio below 0.20 over the past 25 years has been a big mistake. Buying gold shares when this ratio was below 0.20, however, has tended to be highly profitable.

Click to enlarge image

Also, many out there seem to be getting excited about a big "rally" in the dollar. I've noted before that the US dollar index (DXY) is basically a proxy for the euro due to its heavy weighting in the index. The yen is the next biggest weighting in the index. Yesterday, these two currencies fell against the dollar, causing the U.S. dollar index to bounce. This marked a reversal after the euro and yen literally crashed to the upside over the past couple weeks.

At the same time, nearly every other piece of paper on the planet rose against the dollar in the wake of the Fed's 75 basis point rate cut. Hence, the trade-weighted dollar actually made a new multi-year low yesterday, although you might not know it for all the hoopla on Heehaw about the return of "goldilocks."

Click to enlarge image

Let's once again review the facts. The Fed eased 75 bps yesterday and promised more easing to come, which brings real interest rates down to -1.75%, even when using a flawed inflation measurement like the CPI (which is designed to understate inflation). It's no coincidence that prior periods of negative real interest rates were extremely bullish periods for gold, as we can see in the following chart of real interest rates.

Why are these periods bullish for gold? They're bullish because negative real interest rates are by definition inflationary!

Click to enlarge image

The fact remains that in the wake of the housing bust the financial system is still broken, and the Fed will be forced to continue to "print" just to keep the markets functioning. That's going to lead to more inflation, and it won't do much for the asset-inflation dependent U.S. economy.

The result is going to be some form of stagflation. That's the reality.
Position in GLD, Gold Shares

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