Yearly Forecast

This year we are not going to do a separate Yearly Forecast as we've done in previous years. This is because a) we provide 12-month forecasts as part of the regular commentaries, and b) we want to downplay the importance of forecasting (as explained in the 14th January Interim Update it is real-time risk/reward analysis that determines how much money we make, not how accurate we happen to be with our longer-term forecasts). However, just to make sure everyone is on the same page we are including, below, a summary of our current expectations for the markets over the remainder of this year. These forecasts are, of course, subject to revision at any time as new information becomes available. 

The US Stock Market

Our expectations for the stock market as far as the next 2 years are concerned were outlined in the 14th January Interim Update under the heading "The Big Picture". In a nutshell, we expect to see a topping process during the first half of this year -- perhaps a January peak followed by a higher peak in March or April -- and then a decline lasting 12 months or longer. The below chart, which was originally included in the aforementioned commentary, roughly illustrates the expected pattern. The red line on the chart shows what we think could happen if the US government attempts Japanese-style intervention while the green line represents what we think the market would do if left to its own devices.

Interest Rates

Our view is that long-term interest rates made a secular low last June and will move substantially higher over the coming 12 months following a secondary low during the first half of this year. We expect that the Fed will begin to hike the official short-term interest rate aggressively soon after long-term interest rates move above their August-2003 high, regardless of the state of the economy at the time or the closeness of the presidential election. 

Commodities

When the CRB Index recently moved above its 1996 high (see chart below) it provided belated confirmation that a long-term bull market was in progress. We say "belated confirmation" because this breakout is not a reason for us to become bullish on commodities; it simply confirms the bullish view we've held over the past 18 months. The next obstacles will be the 1988 peak of around 270 and the 1980 peak of around 340.

The CRB rose in almost straight-line fashion from 230 to its recent high of around 270, so we'd be surprised if the breakout above the 1996 high were followed, in the short-term, by additional large gains. In fact, many of the commodities that led the CRB Index higher over the past two years are likely to experience pullbacks over the next few months, resulting in a multi-month period of consolidation for the CRB. However, we expect that the Fed's determination to keep short-term interest rates at a very low level for as long as possible will help the CRB Index move up to near its 1980 peak within the next 12-18 months.

The Dollar

We expect that the Dollar Index will drop to test long-term support in the 78-80 range (equivalent to about 135 for the euro) during the first half of this year and that this test will be successful (the support will hold). 

The reason we anticipate a drop to near the long-term support is that the Fed probably isn't going to tighten monetary policy and thus remove one of the most important drivers of US$ weakness until US bonds break decisively lower; and we could still be a few months away from a breakdown in the bond market.

The reasons we don't expect a breach of long-term support THIS year are:

a) Significant additional weakness in the US$ would most likely prompt other central banks -- particularly the ECB -- to join with the Japanese central bank in a coordinated effort to support the dollar. This dollar support could take the form of direct intervention in the currency market or, in the ECB's case, reductions in official interest rates.

b) Over the past two years the US bond market has benefited from US$ weakness due, primarily, to Japanese buying of US bonds in response to every dollar decline. However, this is a situation that can only continue for as long as dollar weakness does not generate inflation fears. Our guess, though, is that if the Dollar Index dropped to near 80 then the possibility of this support giving way would cause inflation fears to rise and precipitate large-scale selling of US bonds. The resultant surge in long-term interest rates would, in turn, force the Fed into action.

So, our Dollar forecast is for a bottom during the next several months followed by a rebound over the remainder of the year.

Gold

Our forecast for gold is illustrated on the below chart and is necessarily the approximate opposite of our forecast for the Dollar. In summary, we expect that the current correction will bottom some time between now and the end of February and be followed by a multi-month rally. A lengthy (6 months or longer) consolidation would then follow. 

Our upside price target for the aforementioned rally is $460, but we wouldn't be surprised to see gold overshoot by $30-$50. 

We expect the silver price to move in roughly the same direction as the gold price, but with much greater volatility. 

Gold Stocks

A low for the current correction in the gold stocks is likely to precede a correction low for the gold price. For example, if gold bottoms towards the end of February then we'd expect that a correction low would be in place for the gold stocks by mid February. Furthermore, gold stocks are likely to reach their next peak prior to a peak in the gold price and after a peak in the Dow Industrials Index. Therefore, based on what we know right now the sequence that makes the most sense is:

 - A Dow peak in March/April
 - A gold stock peak in April/May
 - A gold peak in May/June