Countdown to More Uncertainty

By Jon Nadler

Senior Metals Market Analyst

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Jon Nadler

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30 December 2008 @ 10:25 am ET

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Good Morning,

The year's penultimate day started off on a rare synchronous down note for gold, silver, the dollar, and oil values. Seemingly less perturbed by the fourth day of Gaza attacks, oil prices quietly slipped under $40 and lost nearly one dollar. The greenback fell 0.53 on the index, to trade at 80.53 this morning. Within the half-hour preceding its NY opening, gold was off by $16, quoted at $863 per ounce, after having failed to once again surmount the $890 area. Geopolitics continue to be unsettled, with Israel warning that its Gaza incursion is but in its initial stages, and with India pressing troops closer to the border with Pakistan, even as that country urged dialogue in an effort to defuse tensions.

Stock futures appeared to presage a good day for the Dow, following the $5 billion belated Christmas present that the financing arm of GM received late yesterday from an uncle named Sam. The pressure -despite the cash injection- is on however, as the auto giant has a limited amount of time to turn things around and get going in the right direction. Pressure of another kind was being felt in Europe, where the ECB is being seen as behind the curve on cutting rates, given the deep contraction being experienced across the region. Still, the Old World appears to be in better shape than the Land of the Rising Sun, where the economy is set to shrink at an annualized pace of 12.1% to 14,1% and deflation is staging an unwelcome comeback as the new year rolls in.

Bullion trading opened in New York with gold off by $12 at $868.60 per ounce, as the trade gets set to square logbooks and close out the year with an early departure tomorrow. The tally for the year-on-year gain in gold stands at 3.29% as of today. Silver fell 16 cents to $10.70 per ounce, while platinum and palladium turned lower ( by $17 and $5 per ounce respectively) despite the promising news from the world of cars. US economic conditions continue to be extremely difficult following a disaster in holiday sales, and as economists see perhaps as many as half of the nation's retailers being in serious trouble.

Something else in trouble, is our own loonie. As half of Canada's exports rely on commodities, and as that sector took a direct hit since July, the dollar fell 18% this year - its worst decline ever. Currency experts see further losses in the cards and expect the loonie to hit lows anywhere from $1.28 to $1.33 next year. O(h) Canada. It is still hard to see where the demand might come from, but some oil traders expect black gold to rebound to $60 in 2009. We'll see.

Time now for the periodic temperature reading of bulls and contrarians offered by Mark Hulbert at Marketwatch. Few surprises here (okay, maybe one), as you might have guessed. Writes Mark:

"The editor of the average gold-timing newsletter is more bullish today than he has been in nearly six months.

That is not encouraging from a contrarian point of view.

In fact, the last time the average gold-timing newsletter was more bullish was July, when gold bullion was trading for nearly $1,000 an ounce. Gold or less promptly commenced a two-month correction in which it lost about $200 per ounce.

Consider the latest readings of the Hulbert Gold Newsletter Sentiment Index (HGNSI), which reflects the average recommended gold market exposure among a subset of short-term gold-timing newsletters tracked by the Hulbert Financial Digest. As of Monday night, the HGNSI stood at 60.9%.

When gold bullion approached the $1,000 level in mid July, in contrast, the HGNSI was barely higher, at 64.3%.

To be sure, a contrarian analysis of gold sentiment over the past year wasn't always as successful as it was this past July. But it's been right more often than wrong, not only in 2008 but over the last two decades that I have been carefully tracking gold market sentiment.

Consider the results of a recent Hulbert Financial Digest study. In it, I took the HGNSI's daily readings since 1985, some 23 years ago, and fed them into my PC's statistical package. I then asked the software to calculate the correlations between the different levels of this sentiment index and subsequent movements in the PHLX Gold-Silver index.

I found statistically significant evidence of an inverse correlation. That is, higher HGNSI readings were more often than not followed by below-average returns for the gold silver index, and vice versa. I did find one surprise in the data, however: A marked compression in reaction times. Prior to the last five years, for example, the strongest correlations with the HGNSI were at the three-month horizon. The correlations with subsequent one-month performance, though statistically significant, were somewhat weaker. At the two-week horizon there was no statistically significant correlation at all -- which meant that, in the period between 1985 and 2003, we could draw no conclusions from gold sentiment about what the XAU would do over the subsequent two weeks.

In the past five years, in contrast, the situation has reversed itself dramatically. Now there is no statistically significant correlation with the three-month horizon. And not only have correlations at the two-week horizon become statistically significant, they now even exceed those that prevail at the one-month horizon.

This suggests that contrarian analysis, to the extent it is valuable in the gold market, is for an even shorter-term horizon than it was already.

So even though my analysis of gold market sentiment leads -- at least for the moment -- to a bearish conclusion, that bearishness is most likely to last a matter of weeks rather than months.

After that, the contrarian crystal ball is too hazy."

Our own crystal ball is being polished and de-hazed in preparation for tomorrow's 2009 projections for precious metals. In the interim, there is always today to focus upon.

Mr. Nadler\'s gold market commentaries on the gold market are quoted on a regular basis by the mainstream U.S., Canadian, and global financial media including MarketWatch, Forbes.com, and Associated Press to name a few. His expertise is in the area of consumer education in precious metals.

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