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Paul Volcker Enters the Phone Booth
By Jon Nadler

Gold prices maintained their downward bias throughout the pre-holiday session and settled into a lackluster afternoon as traders cleaned workstations and prepared to head home. A decent rally in oil prices ahead of the holiday was unable to lend much support to gold at this juncture. The dollar kept on the offensive, rising 0.68 on the index, to 85.65. Stocks tacked on another 220 points, capping a fourth day of gains. Obviously, it was not the consumer spending numbers, or the drop in durable goods that attracted buyers to the equity pits.

The most likely explanation lies in what we have already noted throughout the course of this week; that the Obama appointments are lifting market and investor optimism as soon as they are named. Today, it was revealed that none other than Paul Volcker will play a crucial role on an economic advisory board tasked with getting the US economy back into the groove it left more than a year ago. The former Fed chief's hands are clean of any contaminating trace of the current crisis, and his future contributions will bear close watching.

Gold bugs have always taken note of Mr. Volcker's reputation as an anti-inflationist - a hawk who spared no time in raising rates to 19% (and real rates to 9%) and stopping the early 80's era of feverish gold speculation dead in its tracks. For 19 years.

Consumer spending data fell- and, it fell in line with expectations - by 1% that is, and weekly jobless claims declined by 14,000 last week. Still, when adding in the plunge in durable goods orders (they fell by 6.2%) the amalgam of economic stats reveals more of what we have been getting accustomed to, of late.

Oil prices rose by more than $3.25 on perceptions that interest rate cuts in China might buoy demand. Platinum-group metals on the other hand, took a haircut on Toyota's announcement that production will be cut 20% in at least one of its overseas plant, and that its credit rating is no longer AAA. Our last price check had gold off by $10 at $809.40, silver was down by 3 cents at $10.27, platinum was also lower at $862, and palladium was down $6 at $191 per ounce.

Topping the overnight news, was the move by China to slash interest rates by an amount not seen in over a decade. Cognizant of the fact that growth could fall into the 7 percent range (the lowest in two decades), the central bank took out a big blade and shaved 1.08% off its key lending rate. The move comes on the heels of a near-$600 billion stimulus package which was also an offering designed to stave off what appears as the inevitable.

The country's manufacturing contracted by a record amount last month. The outlook for 2009 is not very encouraging when we consider that an 8 percent growth rate is tantamount to a recession. The country needs to support swelling ranks of urban dwellers that have left their farms behind. Sporadic social unrest episodes have been noted in parts of the country, as fired workers took to the streets and raised havoc.

Why is the China news critical? Consider the ANZ Bank analysis of commodities issued just this morning. The word ‘China’ is certainly not absent from the statement:

“Commodity prices may fall a further 10 percent to 15 percent before nearing the end of their decline next year as a faltering world economy stifles demand for raw materials, Australia & New Zealand Banking Group forecast.

Crude oil is the “most vulnerable” and may fall as low as “late $40s” a barrel, Geoff Clear, executive director and head of commodities, said today. Copper may “disappoint” despite tight supply, while zinc and lead may fare better, he said. Commodities markets are heading for the biggest annual drop in more than two decades as the U.S., U.K., Japan, Germany and the 15 European nations that use the euro slip into a recession. Oil has plunged 65 percent since reaching a record $147.27 in July and copper has fallen by half this year.

“Although most of the price declines have already occurred, with funds quickly factoring in the downside, prices could drop further before hitting the bottom of the cycle,” Clear said in Seoul. Commodities may “bottom out” in first half of 2009, probably in June, he said. Prices may fall 40 percent on average next year, he said, as demand slows in China, the world’s biggest buyer of base metals including copper, aluminum and nickel.

“Base metals have been downgraded to reflect slowing demand in China, and other major economies moving into recessionary conditions in 2009,” Clear said.”

None of the above is stopping the perma-bulls from being...permanently bullish on gold's prospects. We go back to Mark Hulbert and Marketwatch in another installment of market sentiment and contrarian overview. Sounds familiar:

"When I last wrote about gold market sentiment, some six weeks ago, I reported that "there's been an excess of bullish sentiment in recent weeks and months, in effect forming the veritable golden slope of hope that makes it easier for the market to decline than advance."

In the subsequent couple of weeks, gold bullion dropped by nearly $100 per ounce, with the December COMEX gold contract hitting a low of $699 per ounce on Nov. 13. In the two weeks since, bullion has recovered a significant chunk of what it lost during October and early November.

And, yet, the editors of gold timing newsletters are just as bullish today as they were in early October, when bullion was markedly higher than where it stands today. As a result, it's difficult to see how contrarians can reach any less bearish a forecast today than then. See Oct. 16 column

Consider the current level of the Hulbert Gold Newsletter Sentiment Index (HGNSI), which represents 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 30.7%.

That turns out to be the same level at which the HGNSI stood on Oct. 9, when bullion was trading around $890 per ounce, some $70 per ounce more than where it closed on Monday. That's not an encouraging development, since the usual pattern is for timers to become more bearish as the market declines. It must mean that there is a significant amount of stubbornly held bullishness among the editors of gold-timing newsletters, which is a bad omen. Major market bottoms typically are accompanied by stubbornly-held bearishness, not stubbornly held bullishness.

Another data point that also does not point to a sustainable rally is that the HGNSI never fell into negative territory in mid-November. In fact, the lowest to which this sentiment index fell was 2.1%. That means that, even when gold's prospects appeared bleakest in mid-November, the editor of the average gold timing newsletter still was not betting on additional declines.

The gold market's correction of recent months failed to persuade enough of the gold bulls that they should throw in the towel. As a result, the sentiment winds continue not to blow in the gold market's sails. This, in turn, makes it unlikely that gold's current two-week-old rally will meet any better fate than other rallies of recent months."

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