As you most likely know, the S&P rating agency downgraded US credit rating from AAA to AA+, which is an unprecedented event so the effects are unclear as far as stock market is concerned. In the long term they are unclear because on one hand it's obvious that the credit downgrade will make US securities more risky and thus less attractive for foreign investors, but on the other hand we know that when Canada lost its AAA rating in April 1993, Canadian stocks rallied more than 15% in the subsequent year. Japanese stocks moved over 25% higher in the 12 months after Moody's downgraded Japan in November 1998.

In the short term the situation is complicated because some of this information might have already been factored in Friday's price levels and we could have the "buy the rumor, sell the fact" type of event, which in this case would mean "sell the rumor, buy the fact".

Speaking of facts, let's start with them. The US has been downgraded from AAA to AA+.

From S&P website we get the following definitions:

• 'AAA' — Extremely strong capacity to meet financial commitments. Highest Rating.
• 'AA' — Very strong capacity to meet financial commitments.

Note: Ratings from 'AA' to 'CCC' may be modified by the addition of a plus (+) or minus (-) sign to show relative standing within the major rating categories.

Additional facts are:

• Moody's and Fitch did not change their top credit rating for the US.
• Credit ratings are used for calculating required rate of return (lower rating -> bigger risk -> bigger payoff required for taking this additional risk called risk premium) and this means that they directly related to US debt securities and indirectly to other US securities as well.

So, the US has not been downgraded to "junk" status (like Greece), it's been downgraded from extremely strong to very strong. This will have a small impact on the risk premiums - perhaps 0.38% (compare country risk premium between Aaa and Aa1 countries on http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/ctryprem.htm...). So, the logical approach suggests that not much should change - after all, this is a slight change only one of the rating agencies' view on the US credit.

On the other hand, it's the world's biggest economic superpower that's no longer top notch and it seems that this action will make many investors sell their "riskless Treasuries" and buy other countries' notes/bonds or precious metals instead. There's a lot of fear in the marketplace as the traditional safe bet (Treasuries) doesn't appear as safe as it used to. This creates a positive environment for gold.

Here's what we view as most likely outcome from here:

IMMEDIATE TERM (next week):

1. The general stock market moves lower sharply - it seems that S&P decision was not priced in on Friday and gold's pre-market action confirms that.

2. Gold shoots up, probably to $1,800. This would not be likely at all without the downgrade, however now we will likely see more fresh buying power entering the gold market. Some people will switch from Treasuries to gold and some will buy it as a hedge against the uncertainty.

3. Silver and mining stocks move up but they lag gold - not necessarily on a daily basis, but any quick corrections would likely be bigger in silver and miners than in gold. For instance, if gold moves higher, we could see silver and miners move 1.5 times as high, but when it corrects, we could see 5x more severe correction in silver and metals. These multipliers are just examples to illustrate the point which is that gold has better upside potential than silver and miners right now.

It seems that it's a good idea to open a speculative long position in gold with the target at $1,800 (based on the long-term chart featured in the latest Premium Update).

At this point it’s not clear how low will the general stock market, silver and mining stocks move based on the downgrade. The above point 3 provides the most likely outcome in our view, but it is much less certain than what happens with gold and main stock indices. The move is unprecedented, so we will monitor signals like volume, indicators and cycles as the price changes and will let you know as soon as something crystalizes.

SHORT TERM (next few weeks):

After the first shock, the world realizes that AA+ is still a very good rating and that the initial reaction was overdone and the corrective move will take place. Fed may try to calm the markets with the QE3 which would contribute to a rally in stocks, gold, silver and mining stocks.

If the QE3 is announced, then it may be a good idea to get back into silver and mining stocks with one's long-term capital. If it's not announced, it seems waiting for a correction will be a better option.

Without QE3, it seems that after a quick move to $1,800, gold would fall and stocks rise (or at least stop declining), but the fate of silver and mining stocks is unclear at this moment. Our best bet that they would fall along with gold and in the end gold would end the correction relatively high (above $1,600), and silver / mining stocks would end it relatively low (below current levels with silver around $32). This is where it might be a good idea to get back in the market with the remaining part of one's long-term capital dedicated to silver and mining stocks.

LONG TERM:

Bull market in precious metals continues.

As always, we'll keep you updated.

Sincerely,

Przemyslaw Radomski