After a long period of, for want of a better word, inertia in the volatility of the US and other Western stock markets, this week (W/E 2^nd March) has seen the bucking of the ever upward trend and a return to uncertainty illustrated by the increase in volatility.

 
Take a look at the VIX index

 

Whether the markets return to the complacency shown over these last many months and remain driven by an ever increasing flow of liquidity or this week’s developments herald a lasting downturn or even a market crash remains to be seen.

 

The complexity of the issues that are surrounding the unfolding events in the world markets are immense but this does not seem to deter many market analysts from giving their opinions and forecasts with no sign of any general unanimity in their perceived outcomes.

 

On the other hand those of us who follow the markets but are not paid to pass judgements or who do not have the over confidence to believe they know all the answers and feel they must pass on their opinions to an unsuspecting and vulnerable investment public will stay quiet until there is more evidence to indicate which way the markets will pan out.

 

As a point of interest here are some of the influences that will shape the market one way or another.

 

Chinese Government interference with their markets in an effort to clamp down, or at least discourage the frenzy of speculation that is taking place amongst this gambling mad population.

 

The possibility of the unraveling of the carry trade where a currency with a low interest rate such as the Japanese yen is borrowed to purchase a currency or other asset paying out a greater interest.

 

Japanese rates have risen from zero in 2001 to just .25% this month, not a lot for the carry traders to worry about you might think and you may well be right.

 

However it is reported that there is concern that Japanese rates will continue to rise meaning that the yen will strengthen against the other currencies and carry traders who have not unwound there position will becaught on the hop.

 

What matters here is what will be the consequent effect on world liquidity if this scenario comes about?

 

Then there is the bursting bubble of the US property market with any number of contrary opinions being expressed about whether a floor has been reached or not and its consequent effect, together it must be said with other doubtful US economic factors, not least of which is the enormous and ever growing US balance of trade deficit and whether it can be contained.

 

Mr Ben Berbanke, the Federal Reserve Chairman is optimistic on the other hand his predecessor Mr Alan Greenspan has warned of a US recession by the end of 2007.

 

The effect of a US recession will be felt world wide and both other western and emerging nations´ stock markets would have a great deal of difficulty in flourishing if these circumstances come about.

 

To further cloud the picture is the ongoing war in Iraq, possibility of conflict in Iran, the oil supply situation and the possibility of a rapid downturn in the overblown Chinese economy where there are parallels with the Japanese situation from boom to bust in the 80s.

 

Just an aside on the oil supply situation that we find interesting.

 

There is a school of thought that believes oil will go down to circa $30 a barrel as there is no imminent shortage of the black stuff and the world has a plentiful supply just waiting to be tapped.

 

In the meantime OPEC and the other oil producers have been playing games with the US and other oil thirsty nations but are about to become unstuck.

 

We have no opinion but will just comment that despite many temptations in the last 18 months we have refrained from playing the oil market.

 

So where does this leave gold this weekend?

 

At the time of writing gold had dropped to a low of $658.40 and recovered to $664 by midday (Fri).

 

This is just below the resistance seen 2 or 3 weeks ago before breaking out to $680 and above.

 

This is a substantial fall for the commodity that is seen as the ultimate safe haven in times of financial difficulties.

 

The gold price has tracked the movement of the oil price for a considerable time and we note that oil today is over $62 a barrel so why hasn’t gold followed suit?

 

Readers will note from earlier articles that we see no sound justification why there should be a close link between the gold and oil prices and today it seems we could be right.

 

It is our opinion that the current price correction is a reflection of the fear amongst investors caused by the volatility of the stock markets this week.

 

This uncertainty has prompted investors and speculators alike to realise the very decent profits shown in their interest in the various gold indices such as the AMEX Gold Bugs (HUI), the ISE Gold Index (HVY), the PHLX Gold & Silver Index (XAU) as well as the ETFs and physical holdings.

 

Again it is our opinion that this is a correction only if somewhat severe and may have further to go but we believe that the Chinese situation will eventually drive the price to circa $1000 by the end of this year.

 

To those of you who did not read our earlier reflections on the subject and to put it simply, China has vast reserves of US$ and dollar assets but holds only about 1.5% of its total reserves in gold.

 

This compares with an average of around 5% of total reserves held in gold of other industrialised nations.

 

Recent comments made by Chinese officials indicate that they are aware of the possibility of the dollar tanking and their inadequate gold reserves.

 

Should they decide to beef up their reserves to the level of the other industrial nations then they will need to purchase gold in excess of the total production for a year!

 

Now that is something to think about.

 

Just a final thought for those of you who may find the gold scenario a little risky then we still believe that Uranium and the nuclear industry is the market to be in if you are risk averse and consider that there may be a melt down in the stock markets.

 

But these are only our own thoughts and conclusions and are not recommendations to invest or speculate. Please just treat our observations as a guide to your own further research.

 

 

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