Unbiased research and analysis of the financial markets that is not influenced
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FINANCIAL MARKET UPDATE By Edward Gofsky - february, 2004
Gold and silver staring in the bubble strikes back

As I look at the markets today (DJIA, S&P, NASDAQ) it is quit shocking to witness the kind of optimism and euphoria on Wall Street. Remember it was only 4 years ago around this same time (Feb-March-2000) that the markets were at mania levels by any standards (P.E level, dividend yield).

And after a brutal bear market that turned trillions of investor's dollars into smoke it is utterly amazing that investors would be so eager to jump back into general stocks let alone the same stocks that burnt them only 4 years ago. As you look at the chart below of ground zero for the new mania (Russell 2000) the small cap index, look at the almost straight line of accent since Oct 2002.

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This chart simply leaves me speechless, remember it is a historical fact that the old high flying stocks that lead the last bull market (82-2000) never lead the new one which is why this recent rally(Oct 02-present) is nothing more than a wave 2 rally in Elliott wave terms or a secondary reaction/bounce created by the Bush/Greenspan tax cuts, government spending, 50 year low interest rates that created the housing bubble, continual printing of paper fiat dollars, and the willingness of foreign governments to buy U.S bonds to finance the out of control deficits.

Everyone reading this essay please understand that even with a fed funds rate of 1% and mortgage rates at 50 year lows the BANKRUPCY AND FORCOLSURE rates are at historic levels just go to goggle and type in record foreclosures or record bankruptcy and you will get dozens of recent news stories around America telling this very grim story. Now people just what is going to happen when the fed raises rates just a little or what if god forbid they move the fed funds rate to the long term average of 3-4% a 300% increase!!!!

What are the numbers going to look like at that point? Please understand that with most American and Canadians refinancing there mortgages or getting sucked into buying there first home a 50 year low interest rates (in Canada you can get a 5 year mortgage for under 5%) what is going to happen in the next 5-10 years when millions of home owners have to renew there mortgages at much higher rates.

Even if mortgage rates move back to there long term average of 7-8% that's a 25-40% increase in monthly mortgage payments. With most new home owners putting very little down (some lenders in California willing to lend up to 100%), where is the safety for the banks and lenders?

I mean much of the residential housing boom of the last few years was a result of nearly free housing with 15% of all home buyers depositing only 5% or less on their homes, which means that after only a 5% decline in real estate prices those home buyers would have no equity and there for be unafraid to walk away while sticking the banks and lenders for the remainder.

This is not a pretty picture! it won't be that much different I think than the early 80's when home mortgages went from around 10% to 14-15% even peaking at over 20% for a short time that's a 100% increase in monthly mortgage payments. It would only take a rise up to the 10% in mortgage rates to recreate that situation which would utterly destroy the economy the housing market and the stock market.

What is happening in the home mortgage market reminds me a lot of the late 90's dot com financing bubble when anyone with an idea about b2b or b2c or just adding .com to the end of there company got financed with billions of dollars with no idea about safety or long term business viability, everyone got sucked into believing that tech would rise forever just like everyone thinks that real estate will rise forever and anyone with just 5% down can own a home with a 5% mortgage.

I believe that the banks are making another big mistake lending billions to sub par borrowers who will default on there mortgages once rates go up, heck they are already defaulting with fed funds at 1% and mortgages at 5% what about feds 4% and mortgages 9% in a few years?.

Remember the famous saying, When ever a real estate agent says, "buy real estate, they're not making any more of it," you should always tell them that "They never have made anymore land, but there are still real estate cycles. This bear market rally is totally credit and debt induced and once wave 3 down in Elliott wave terms starts (The worst part of the bear market) or in plain English the bear will wake from it's long 18 month hibernation and viciously attack the perma bulls and disillusioned economists (Larry Kudlow) who have been blindly optimistic just so they can keep there jobs and pay there own mortgages.

In fact I have two charts below that tell me maybe the whole bull run of 82-2000 was nothing more than a credit and debt orgy forced onto the American public who was blind to it all the way up!!. Take a look at these two charts and make up your own mind; I think the charts speak for themselves.

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When the debt accumulation hits the wall and it will, that is when the fangs of deflation will really bit the economy and the stock market and ravage the housing market. The text book definition of deflation is a contraction in the supply of money and credit so when the debt line on the 2nd chart above starts to decline watch out.

This is where gold and silver come in…. as I have been saying in my past essays gold and silver are both in new secular bull markets that began in 2001. Gold and silver stocks have been rising since Sept 2001 just after 9/11 as you can see from the ultra long term chart of the XAU.

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I love to show this chart in every essay I write to help fellow gold/silver investors keep a good perspective on the big picture. Just look at the long base pattern what a text book perfect head and shoulders bottom reversal. Any future books on technical analysis need to include this chart in there explanation of bottom reversal H+S patterns.

As you can see on the chart above the high point in the XAU over the last 20 years has been around the 150 level (175 intra day all time high 96) this happened in 87 and 96 but remember that physical gold and silver were still in there secular bear markets in both of those years so once the 150 level was hit it fell of rapidly. If you listen to some of the gold/silver bears out there or just turn on CNBC they will tell you that gold stocks (do you notice how they never seem to talk about silver stocks?) are way over priced or have already run up way too far.

But looking at the chart above will tell you another story, today the XAU stands at only 102 the 150 level is still 50% away. So are gold/silver stocks overvalued? Absolutely not, is the bull market in the metals over? Hardly the 150 level in the XAU hit in 87/96 was when gold/silver where in a long term bear market, this time both metals are in secular bulls so the 150 level should be hit later this year and if not then definitely in 05 and after that happens you can look for much higher levels after that.

Just remember that in 87/96 the 150 level was hit very fast almost in a straight line, this time there has been a 5 year base pattern (the H+S pattern) this is the most bullish thing that has happened to the XAU in its 20 year history.

I believe that some very smart people can see what is coming in the stock market and the economy in 05/06 and are getting into gold/silver investments now ahead of the herd, below are some ultra long term charts of a few gold and silver stocks. As you can see from a long term perspective these stocks have hardly moved at all and look at the volume over the last few years on these stocks!!! Somebody wants a piece of this action very badly.

These are the biggest accumulations in the history of these stocks:

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In my analysis the bull market in gold and silver has just started, as you can see from these 4 charts there is still a massive opportunity to own these and other gold/silver stocks for a fraction of there former price, the opportunity in gold/silver stocks is simply mind blowing.

As wave 3 down in the stock market begins and the bear is awakened gold and silver stocks might take a short term hit as massive margin calls are given out by the big brokerage houses on wall street but it will be short lived.

I believe that once the bear comes out and starts to roam down wall street clawing the defenseless bulls that this will be the catalyst for the next big leg up in gold and silver as people run scared on wall street griped by mass fear looking for a place to put there money and gold/silver will be there like a bright light shining in a dark forest.

And when the Oct 2002 lows are taken out that will be a very special day for us gold/silver investors as a nation of investors told by wall street and CNBC that those 2002 lows where the final bottom of the bear market will have there reality smashed and a whole generation of investors expectations will be wiped out.

As Bill Bonner of the Daily Reckoning recently said:

"Investors believe that another important bottom was hit in Oct 02- at a P.E of 33 and a dividend yield of 1.8%! We think rather it was a ledge."

This is the point at were the really big money will come flooding into gold/silver investments as they will be the only rational choice.

This next decade is unfolding perfectly for gold/silver and I am so glad to be so young (26) to be taking part in something so historic (The biggest bull in gold/silver of all time). Through my meticulous studying I have learned that every generation of investors has a chance to be apart of a massive bull market somewhere on wall street, in the 60's it was the nifty 50 and tech stocks in the 70's it was oil and gas and gold and silver stocks (read my last essay if you want to learn about what happened to gold and silver stocks in the 70's) and in the 80's it was Japanese stocks and in the 90's it was American stocks and more ideally the NASDAQ. And now in the 00's it appears that gold/silver will be the place to be once again as it was a full generation ago.

I was only 3 years old when gold hit $850+ in 1980 so for people around my age or for people that started working on wall street around that time all we have ever known our whole lives is that gold and silver only go down in price and for all of our lives people have told us that gold and silver are a bad investment or are (barbaric relics).

But that situation is simply untrue, for all a serious life long dedicated market student has to do id read about market history and it will tell you that there are good times to own gold/silver and there are bad times just look at the DJIA/GOLD ratio at it clearly tell you that there have been only 3 times in the last 100 years that anyone should of owned gold, in the 30's in the 70's and RIGHT NOW.

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The chart above is from Steven J. Williams, CyclePro Outlook. I highly recommend his web site as it is filled with some fantastic info.

And to quote one of my favorite newsletter writers that I subscribe to and that I highly recommend to everyone is Adam Hamilton of Zeal.com, Adam says:

"Gold is a timeless bastion of financial strength, a rare monetary asset with indisputable intrinsic worth in and of itself through six millennia of human history. Unlike paper currencies, which are merely promises to pay in the future backed by nothing but faith in some fallible human government, gold is true money. Gold always has been valuable and always will be valuable, and investors and savers across the globe instinctively know this".

I totally agree and will never forget it!

As some of you are already familiar with my work I am a ferocious reader of books on investing, financial planning, market history, and gold and silver. One of the books that I would like to share with you is a book that was written in 1993 and then revised in 95 it is a book called "Silver Bonanza" and it was written by James U. Blanchard. I have personally read the book numerous times and will forever cherish the priceless wisdom inside this magical book. For anyone wanting to invest in silver or anyone who wants to know why silver is the biggest investing opportunity of our life time needs to read this book. Let me share with all of you some of the priceless information inside this masterful piece of literature:

Introduction: "A once in a lifetime opportunity" This book could literally change your life. Why? Because only once, maybe twice in a lifetime are you given the opportunity to participate in an investment bull market of such magnitude that you cannot only realize huge profits, but actually become independently wealthy. I believe silver will be THE investment for the rest of the 1990s, and in the following pages I will explain how you can profit from the coming boom in silver prices.

The quote that begins this book, "The major monetary metal in history is silver, not gold," was told to me by the worlds greatest living economist, noble laureate Milton Friedman. This statement is significant not only because it comes from one of the great minds on the 20th century, but also because it offers the prime reason why the roaring bull market now beginning in silver is not just a short term phenomenon.

It is not a bull market that will last for only a few months or even a year or two. It is a bull market with the power of history behind it-one of truly epic proportions that promises to last well into the next century. We are already in the very early stages of a massive sea change in monetary, economic, and investment trends, all of which are converging to propel silver prices to levels that even I may be unable to imagine.

All around us, we see evidence of new mega trends that are changing the world as we know it: the collapse of the Soviet Union, the worldwide rush toward free-market economic systems, the shift of economic power and wealth from Europe and North America to Asia, and technological revolution destined to carry far more impact than even the industrial revolution of the 19th century.

Investment analysts have talked endlessly of how these mega trends will affect world stock, bond, and currency, real estate, and commodity markets. But there is one little-known investment that will be the prime beneficiary of this great transition during the rest of the 90s and into the next century. That investment is silver."

A common question asked by many people regarding silver is "which is a better environment for investing in silver?" An inflationary environment or a deflationary environment here is what Mr. Blanchard says:

"The government deficit sharpens the problem. Why? As the currency's purchasing power decreases, loanable capital (in real terms) decreases along with it. This is a deathblow to an economy in which all produces are chronic borrowers. In the face of this shrinking capital supply, government borrowing must nevertheless increase because interest on the deficit must be served.

If the central bank simply monetizes the government debt (inflates more), then the situation becomes hyperbolically worse, because as inflation rises, interest rates rise (after a certain point in the inflation rate-initial doses of money lower interest rates when inflation is in the lower ranges).

Rising interest rates then increase the amount of money the government must borrow to service its debt, crowding out private borrowers out of an already overcrowded capital market.

The point is this: Nominal monetary inflation can occur simultaneously in an economy with deflationary depression conditions. In fact, inflation will always bring on a deflationary depression because eventually it shrinks total money supply by shrinking its purchasing power.

As silver investors we don't care whether there's inflation or deflation, because the underlying condition of either is deflationary, which favors silver even more than inflation. Our fundamental case for silver, which depends on rising demand, limited supply, and rising monetary demand, remains Bullish."

One of the reasons that some people think the silver situation is more bullish than gold is that unlike gold that is mostly horded and stored away in vaults, silver is used up in many different applications around the world in many different industries. This is what Mr. Blanchard has to say about this fascinating topic:

"Some silver is irrecoverably lost through fabrication demand, constantly decreasing the total pool of silver. Silver is forever consumed and lost through photography, electrical usage, dentistry, brazing and soldering, electroplating, mirrors, and medical uses. CRA estimates that in the seven decades from 1921 through 1990, a total of 10 billion ounces were irrecoverably lost in north America alone, and 12.6 billion ounces for the entire world. About 1.4 billion ounces were lost in the past decade. Although this loss has declined in the past 3 decades, it nevertheless puts unrelenting pressure on the worlds silver supply as year by year more silver is lost or tied up in new goods.

That's not all. As the economies of china, India, the newly freed East European bloc, and the rest of the world grow, these irrecoverable losses can only grow. Newly mined silver must replenish supply, but a geological problem stands in the way: Epithermal Deposition or condensation near the earth's surface. Simply put, the richest silver deposits are nearest to the surface of the earth. The deeper mines go the less silver they tend to produce. The deeper the mine, the more expensive the silver. This also means that almost all the primary silver mines in the world have already been discovered. Remember that silver is so scarce that it only forms about 73 parts per billion of the earth's crust."

And finally I will leave you with this last paragraph on Mr. Blanchard's take on the silver supply. Many people ask how much silver is really left in the world:

"Fabrication demand for silver is rising faster than supply. Silver supply has been in deficit for the past for years (and has continued into 2004), and in 1993 the short fall more than doubled. No ready economical substitute for silver exists in most applications. Some silver is irrecoverably lost and thus taken off the market every year. Long lead times are required before mine production can be increased.

Long lead times will also be required to reduce silver usage further. The 1970s and 1980s were decades of squeezing silver out of industrial applications. To achieve greater economies of silver usage now will require relatively more expensive research efforts, yielding diminishing returns.

There appears to be a lot of silver in the world, until you look closer. In fact, very little is available at prices under $20. In the words of Charles River Associates, "The common perception in the market that silver stocks are very large and thus readily available is wrong. The stocks are large but are not readily available."

As you can tell, the case for silver is very bullish and this wonderful book explains all the facts and answers all the questions. This book truly is the bible of the silver investor!

Edward Gofsky
I welcome all comments and views on my essay. Contact me to discuss this posting.
Elliott Wave Theory, Classical Technical Analysis and Financial Planning
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