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The Gamblers Fallacy
By Jon Nadler

After hitting resistance just above the $945 pivot point both yesterday as well as today, gold prices managed to head into slightly calmer waters but retained their small gains trading near $943 amid still rising crude oil prices and a small loss in the greenback. Rising apprehensions about (once again) dwindling jewelry demand (the largest offtake sector in the market) and the increasing amount of short positions being added in the oil markets and related ETFs also contributed to the metal's stall. Core jewelry buyers are apparently holding out for eventual inventory acquisitions at levels in the upper $800's.

However, bullion remains fairly well supported near the $920 and $930 marks at the moment, as participants factor in a small ECB rate hike for tomorrow and little in the way of a Fed response to inflationary pressures in the near-term. Another stab at the $947 to $950 zone or even higher, could still be in the cards, barring a selling bout in oil, or the opposite in the dollar. The shortened trading week may contribute to added tomorrow but action of a larger order of magnitude is really only expected in the coming week.

New York spot gold prices were quoted at $942 up $2.30 per ounce at last check, and participants will now focus on tomorrow's employment data and ECB rate decision. Both factors could (neither of them perceived to be very helpful to the dollar in the near-term) add to a pre-holiday spike in gold, but do not offer sufficient fuel to overcome the coming correction in crude oil. When (and not if) that event comes about, we will not be talking about some fantasy $200 intra-day spike in gold (as some are dreaming about) but rather about a $50 to $75 pullback within the same timeframe. The current price action in gold is deeply intertwined with that in the oil niche and the latter could have its wheels come off at any moment if conditions become right. Therefore, the question of value for a short-term speculative holder is once again at the forefront.

The Dow was expected to gain a bit in today's session but problems such as car sales at a 10-year low, fears of a possible GM bankruptcy and Starbucks closing 600 of its java dispensaries are keeping the equities crowd on full red alert for the time being. Gold could also benefit from the quest by stock sellers for a place to park their funds. It would benefit a whole lot more however, if it was not being seen as within $100 of its all-time high seen in March and possibly offering a $200 risk on either side of its price scale. Silver was ahead by 19 cents on the day, quoted at $18.28 after a brief overnight dip to sub $18 levels. Platinum was down $11 at $2054 and palladium lost $1 at $464 per ounce. US car sales figures are putting a dent into the otherwise strong noble metals complex.

Background geopolitics, while far from showing signs of a detente, simmered down a bit overnight as Iran's foreign minister Mottaki referred to a "new trend" in negotiations with the West regarding its nuclear programme. European nations and the US, China, and Russia are apparently pulling out an arsenal of carrots to block the view of the sticks that Israel (and the US) have waved at Iran recently. Mr. Mottaki remains convinced that the likelihood of military conflict with the Jewish state is -as he puts it- "nil." President Bush said that military action against Iran is 'not his first/preferred option. Let's all hope that the cooler heads prevail. Also in the background, the realization that at $100 per barrel, the proven oil reserves under the sands of the Middle East are worth as much as the aggregate size of public equity markets around the world. We are talking now about kings who could really be king...makers. Were it not, of course, for the notorious corruptive powers of oil-based wealth. History is the best witness.

Since it is mid-year, we bring you a perspective on equity markets as seen through the eyes of history and those of Mark Hulbert over at Marketwatch:

"No doubt about it: It was an awful June, quarter, and first half of the year".

Indeed, the 10.2% loss produced in June by the Dow Jones Industrial Average was the third worst for that month in this index's history, eclipsed only by 1930 and 1896.

The Dow's loss during the second quarter is not ranked quite as close to the bottom as June's, but still low: Only 15 other years out of the last 112 have had second quarters with worse returns.

The picture isn't any prettier when we look at first halves of years: Only nine other years since 1896 have seen the Dow lose more than the 14.4% loss for the first six months of this year.

All this is water under the bridge. What can we learn about the rest of this year from such an awful month, quarter and six-month period? Not much, as it turns out. But what we can learn suggests that the second half of this year is unlikely to be as bad as the first.

That at least is what I concluded after feeding into my PC's statistical package the monthly, quarterly, and six-month returns of the Dow back to its creation in 1896. I searched for any correlations that might exist between losses in June, the second quarter, and the first half of the year and how the market performs in the second half of the year.

In almost all cases, either no correlations emerged or, if they did, were not statistically significant.

That's hardly surprising, of course. Successive monthly or quarterly stock market returns may not be exactly like flips of the coin, but the analogy is quite close: What happens from one of the next is largely, if not completely, independent of what happened previously.

In fact, statisticians have a name for thinking the contrary: Gamblers' fallacy. Ask people what they think the odds of a coin flipping heads after 10 flips that come up tails, and most will think the odds are overwhelmingly high. In fact, of course, the odds of that 11th flip coming up heads are 50-50, just as they would be if the previous 10n flips had been all heads.

Whether you take solace from this discussion depends on your perspective. On the one hand, you might consider it good news that the stock market is not doomed to perform terribly in the second half of this year just because its recent performance has been so dismal.

On the other hand, you might consider this discussion to contain bad news: A rebound in the second half of this year is not assured. There is one pattern about the second half of this year that I think is worth mentioning. However, it has nothing to do with the stock market's losses during the first half of the year.

Instead, this pattern has to do with the upcoming presidential election: In the second halves of all presidential election years over the past 110 years, the Dow has gained an average of 9.7%. In the second halves of all other years, in contrast, the Dow's second-half gain has been 2.7%, or barely more than a quarter as much.

This difference turns out to be marginally significant from a statistical point of view.

And it makes a certain amount of sense: The political party holding the White House will try to do everything it can to make the economy to look as rosy as possible on Election Day. As Bob Brinker, editor of Bob Brinker's Marketimer, put it in the July issue of his newsletter: "Never underestimate the ability of politicians to send money to their constituents in an election year."

Start the coin tossing now. It is an election year. It is also a very different flavored year in many other respects. Indeed, commodities outperformed stocks by 40% in the first half. What will the second half bring?

Stay tuned for more of the same (oil, dollar, stocks, news) and watch for resistance holding or not.

And now, our 2008 platinum price projections for the second half:

*** We caution up-front that as we are not a commodity trading firm, we do not issue such opinion with any underlying buy or sell signal intent, and that a projection is not a soothsaying undertaking designed to prove anyone right or wrong or to motivate investors to act one way or another. So, if the numbers trouble you or not, save the analysis (and related e-mails) of their validity until the last trading day of the year is over, and all the results are in. In the interim, our expectations -as do yours- remain in the realm of opinions (to which, everyone is entitled).***

Bolstered by an approximately 550,000 ounce supply shortfall, the platinum market should continue to orbit around its first half average price of $1950 and might gain in that metric to a possible second half average of $2050. While the first half's trading range was quite wide (from a low of $1531 to a high of $2273) we see a narrowing of the price channel to an estimated $1850 to $2350 as we wind down 2008. Platinum ETF and automotive offtake must remain strong as we go forward in order to achieve such results. The latter has started to look wobbly in the wake of record oil prices. However, since we expect a correction in energy markets and continuing electricity problems in South Africa, the demand/supply equation should continue to play favorably on behalf of the noble metal.

In contrast to platinum, palladium finds itself in a surplus situation of approximately 1.4 million ounces, which, albeit smaller than seen at the beginning of 2008 will keep a lid on major price advances in the near-term. The two 'wild cards' in palladium's future price equation are its substitution attributes and (as usual) Russian sales (or lack thereof). If gold and (especially) platinum prices were to surge far higher, the metal becomes a very attractive substitute for both jewelry as well as automotive users. Russia, on the other hand, has been mum about inventories (nothing new there) but appears to be selling less than it could/should. We expect palladium to average $450 in the second half of 2008 but also envision a narrowing of its price range from the first half's roughly $220 spread (from $364 to $582) down to about $100 - in a channel of from $390 to $490 per ounce.

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