Things will remain much the same until something breaks or some event breaks them. What happens then could be dramatic or could be manageable, that is difficult to predict yet. So far the US Fed, in particular, combined with cooperative and blinkered markets have proven very capable at managing things smoothly. One must remember that such a course is also to the benefit of the major market players, for example, stocks become a safer bet if one knows the Fed will step in to help avoid a serious plunge.

But massive global and US imbalances remain. Can they be managed away before some exogenous events trigger less controllable adjustment? Do the imbalances generate sufficient tension to make drastic adjustment inevitable without exogenous events. I am pessimistic that the status quo is viable much longer and expect at least the first signs of catastrophic change to show in 2006. But the US and global economies have been more stable and resilient in 2005 than I expected so I may be premature on this.

The big winners of the year will continue to be commodities and especially gold. Inflation is seen as a growing problem, much more so than in the last decade, that is a major driving force for gold to increase in value. There has been a significant increase in liquidity (central banks printing excessive money) in the last 4 years particularly but also, especially in the US, over the last decade. So far that has popped up mostly as booms in things like stocks, property, now commodities. Excess money from oil revenues and Chinese trade surpluses must go somewhere and gold looks safer than currency denominated assets. Some central banks have also been diversifying into gold and the central banks which have been selling it in recent years (most developed countries who have held major gold reserves) haven't so much now.

I expect gold to make a jump to near $600 by April before pausing, and to climb above $650 later in 2006 - it could exceed $750 but that would be more dependent on response to unexpected events. The risk of gold dropping below $400 are very, very minimal (say 1%), below $450 is unlikely (10%). With current gold price about $500 I think the bet is straightforward: 10% risk of 10% loss but a 10% chance of 50% gain and 50% chance of 20% to 30% gain (30% probability it remains in $450 to $600 range throughout 2006).

Oil is close to a cusp, I think. It has increased in price by over 30% in each of the last 3 years. That has spurred just about all possible rapidly available production to come onstream. Some biggish new projects are due to come online in 2006 so there is a possibility that there will be a slight oversupply in the near term. The two critical factors are: will decline rates in the current major fields in production (FIP) be higher than current fairly optimistic predictions; will there be a significant reduction in demand (currently expected to be 1.9% increased demand) due to a global slowdown? A few months back I coined "Agric's law of oil price" which is: the average price of oil in a calendar year will be within 5% of the maximum price for the previous calendar year (Nymex light sweet, next month quote). This has been true the last 3 years, I expect it will continue to be so until prices go haywire. That gives an average price in 2006 of $70.

I expect the oil price to creep up to $70 by mid march. Thereafter I predict a spike to about $95 in response to some external event, it could happen by mid April. Will $100 oil happen in 2006? Maybe not based on current supply and demand but there is a significant probability that geopolitical or supply disruption events do cause a $100+ spike. I do not expect the oil price to drop to $40, even $50 is unlikely since a key support level at $56 has held well in recent months.

Silver price is likely to follow gold. Copper is much more difficult to predict. It has doubled in price the last couple of years and is due for a 25% downwards correction. However, there are conflicting reports on whether supply will be above or below demand (much driven by the Chinese building and infrastructure boom). Three to six months ago most industry watchers were saying that supply would be above demand in 2006 and a drop in price inevitable. Since then the price has risen 20+% and people are less sanguine about supply. I think a correction is likely but the general strength in metal prices may make that fairly short lived until an economic slowdown (especially if in China) happens. I expect the price to drop from current level of about $2.00 to below $1.60, probably by March to May, then climb back to above $1.80.

I need to digress about the US Homeland Investment Act, 2004 (HIA).  It gave US corporations a two year window to pay only 5.25% tax on profits repatriated from overseas operations rather than the normal 35%. This provison ends with a company's financial yearend preceding 22nd October 2006 and should be mostly unwound before mid 2006 (dependent on individual companies' financial years, most end 31st December). It is estimated to have created an inflow of $300+ billion into the US economy. In retrospect I think this will be seen to have given a significant boost to US economy and stocks, and its ending may bode ill for them. It may also have helped a little to support the US$.

Currencies. Well, I got this wrong in 2005. In part I think this was due to the HIA and increased price of oil which is traded (almost exclusively) in US$. Also I expected the US economy to be weaker and probably limit the Fed rate hikes. The Fed are expected to have a further 2 or 3 rate hikes, ending in March or May, these should continue to support the US$. But, by mid year, supporting pressures on the US$ are likely to be dissapating, the US economy weakening, and a downwards correction probable. Until then, barring major geopolitical / market events, the US$ should remain in the 88 to 92% range of its index. Thereafter it should decline to about 85%. However, I expect events to intervene and cause some quite sudden drops in US$: down to about 82% in April and, later in the year, (after a recovery to possibly 85%) I expect a dip to 80%.

Can the US economy continue to grow at around 4%? No. OK, how about 3%? Possibly, but the odds are against it. For US growth to stay at or above 3% almost everything has to go right. US consumers must continue to spend money they don't have and further increase borrowing beyond current record levels despite interest rate increases. There must be no significant drop in US property prices. Foreigners must continue to increase investment in US treasuries. There must be no major financial market problems like hedge fund or derivatives domino style collapse. US stock prices need to remain near present levels. I find it difficult to believe that all of these will come true.

I expect US GDP (as currently measured) to drop to 2% growth for the first half of 2006 and be flat in the second half of 2006.

Stocks are likely to take a small battering. I predict a steady mild decline for the DJIA to about 10,000 by mid March, a sudden drop to perhaps 9,000 in April. A deeper low of between 7,500 and 8,500 is probable, most likely in October.  Of course there will be bounces back up a bit, but if the DJIA is much above 8,500 at yearend they will have done well. That would be a 20% drop on the year. Retailers, automotive, financial sectors are likely to be hard hit. Utilities and commodity stocks least hurt.

I've avoided reading much of others' predictions while doing mine, here are a couple  of links, the Morgan Stanley one looks well worth reading even though it is much more optimistic than mine:
http://www.morganstanley.com/GEFdata/digests/20051216-fri.html

http://www.marketwatch.com/news/story.asp?dist=&param=archive&siteid=mktw&guid=%7B140F77 59%2DCACD%2D427A%2D8BE3%2DF32C0ABCDE3F%7D&garden=&minisite

http://www.marketwatch.com/news/story.asp?dist=&param=archive&siteid=mktw&guid=%7B6746D5 F4%2D8611%2D4742%2DAEE7%2D80AFD9A56FE3%7D&garden&minisite=

and a more speculative one for 2008, penned before the 2004 presidential election, which may be more accurate than many expect:
http://www.washingtontimes.com/upi-breaking/20041022-011948-1479r.htm