Publisher of the Wellington Letter, Bert Dohmen, offers his insights about the stock market, economy and safety assets like gold and the US Dollar in his December 2009 issue.

Many of the major indices are now where they were in the middle of October, and others are back to their levels of mid-September. Yet, we hear many analysts in the media talking about the “relentless upmove” in the stock market. It’s fiction.

Whereas the small cap stocks, especially the worst stocks on a fundamentals basis, outperformed the big cap stocks by a factor of 10:1 in the first 6 months of the rally, lately they have been underperforming. This means that the large cap stocks, which have the greatest impact on the cap-weighted indices, are now being pushed upward to present the illusion of strength. This is reminiscent of the early October 2007 rally to the bull market high in the middle of that month.

The Dubai crisis this week shows that the markets are very nervous. The emerging markets will now see an outflow of funds as risk gets priced into the markets.

The big traders still have lots of stocks thinking they will be the first ones out of the exit when the music stops. It’s just like 2007. At that time they found out they couldn’t get out the door fast enough. We should see a repeat this time.

However, before the plug is pulled, it’s possible that the major indices can be supported going into late December. We shall see. These markets are not driven by logic or fundamentals. It’s manipulation and excess money. New mini-bubbles have been created by the Fed. The money is not going into economic activity, but into speculation. Such rallies usually don’t end happily.

Mr. Dohmen points out that while Dubai was in a catastrophic economic climate, the Dubai Financial Index rose 28% in 2009. Regardless of what Dubai stock market investors thought about economic recovery, Dohmen says, the stock market rise “predicted nothing,” and that “there is a lot of stupid money in the world.”

Does a similar fate await the “stupid money” in the US and emerging markets?

Flight to Safety

In our recent article Why Gold Can Still Go Down, we opined that the Dubai crisis was a prelude to how the world markets would react in the event of a panic. Our view of the situation is that the credit delinquency by Dubai World scared investors so much that they actually fled to the US Dollar for safety, as every other asset class declined.

Bert Dohmen suggests that this is exactly what happened, as is evidenced by the massive amount of money flowing into US short-term Treasury Bills, which has been in excess of $300 Billion a week recently, even when the interest rates on those T-Bills dropped below zero on several days.

As a result of capital fleeing to the US Dollar for safety because of Dubai concerns, we saw an intense decline into the morning after Thanksgiving, which saw stock markets around the world shave of around 3% in value and gold dropp $55 as soon as markets opened.

Dohmen opines about gold:

What does it mean for gold? It dropped over $55 per ounce but rebounded strongly. The initial drop was a knee-jerk reaction. Now we will see that smart money stepping in. Debt defaults, when they trigger large bailouts, create demand for the only genuine money, and that is gold.

In our aforementioned article we said:

Contrary to popular opinion, gold may not yet have become the last, safest asset on Earth. Investors may have simply been speculating on the price of gold moving up. For some, it may have been an inflation hedge, but according to the government’s CPI numbers, there is nominal inflation. And, if gold was really a safehaven asset now, then it should have been moving up, not down, on today’s Dubai news.

So, is gold a safe haven asset? In the long-term, we believe gold will be one of the very few safehaven assets to protect wealth. But in the near-term, it is hard to predict. As Mr. Dohmen points out, the gold price may falter for a short time in the event of global panic and stock market collapses, but smart money looking for safety will start buying it up.

How low can gold go if capital starts flowing into the dollar because of panic? Any answer would be pure speculation, though Dr. Marc Faber has Clarified his gold outlook in the near-term and we think it is probably a good way to gauge which direction the price might go in the event of a ‘panic-like’ event:

If the gold price breakout move above $ 1000 is real then gold should not decline again below the $950 – $1000 zone. Before, this range was resistance and now it should be a support range.

However, if gold dropped below this range than I would be very concerned that a decline to around $ 800 could take place.

There should be no doubt that the smart money around the world has been fleeing to gold for protection for several years now, as evidenced by its price rise in a variety of currencies including the USD, EUR, and JPY. This trend should continue for several more years, especially considering the instability of governments around the world as they attempt to weather the economic crisis. Therefore, as we’ve mentioned before, the short-term movements of gold may be erratic, irrational and violent, but the long-term trend is in the upward direction, as we are still in the middle of a gold bull market.

We’d recommend to our readers that they heed Bert Dohmen’s warning about today’s economic, geo-political and market uncertainty:

Don’t be over-exposed to risky assets. Don’t use high leverage. And realize that anything can happen in today’s fragile environment.

Nothing is outside of the realm of possibility, so plan for SHTF accordingly.

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