Gold Market Update

Gold ended last week very close to new highs against the dollar, which was a remarkable achievement given that the dollar soared and that the stockmarket fell heavily. The NYSE tried to explain away the near 1000 point drop in the DJIA intraday on Thursday as being due to some sort of technical glitch, but the more plausible explanation for us is that it was occasioned by temporary blind panic, which should it recur would have rather unfortunate consequences, to put it mildly. The implications of this formidable strength in gold are immense, for what this means is that it has arrived at the point where it no longer matters much what the dollar and stockmarkets do - it's going up anyway. The reason for this is that we are now advancing rapidly into the endgame of the global href="http://en.wikipedia.org/wiki/Fiat_money">fiat experiment, which is concluding as it inevitably must with mess and mayhem.

The abolition of the gold standard back in the time of Nixon was a charter for profligacy and recklessness that allowed polticians to balloon money supply exponentially and we have now arrived at the point where it is rising vertically, totally out of control - and uncontrollable - since any serious attempt to rein it in at this "one minute to 12" juncture would result in a massive spike in interest rates and an instant deflationary implosion. Since we know that the one thing politicians and world leaders fear more than inflation and hyperinflation is having their heads adorning the railings of presidential palaces and government buildings, we can reasonably deduce that they will attempt to resolve every serious economic challenge with massive infusions of electronically created cash. Hence we are looking at continued massive inflation of the global money supply.

Now, you might think that the ability to just keep ramping up the money supply would mean that the resulting inflation would continue to drive up the prices of everything. This is simply not true and you only have to look at the US property market over the past several years as an example. There is already an absurd disconnect between government commitments and their ability to meet those commitments going forward, particularly in the US where it has entered the realms of pure fantasy, that will result in economies being lamed and a massive burden being imposed on individual taxpayers that must feed through to reduced corporate profits, and thus a collapse in asset values even while currencies are continuing to inflate. The projections for the US are so insanely dire that if The Marx Brothers or The Three Stooges or even Monty Python had been running the country for the past 10 or 15 years, they couldn't have created a more apocalyptic scenario.

Now let`s define what we mean by the endgame of the of the global fiat experiment. When economies leave behind the discipline of the gold standard and embrace fiat, the expansion of the money supply initially takes place comparatively gradually, but as politicians increasingly like what they see - the ability to grow the economy, to fund ambitious and munificent projects, to keep the majority of the population happy and of course to jack up their own salaries, all with the magic wand of increased money supply, they get more and more used to it, more and more dependant on it. The possibilies opened up by this wonderful world of fiat start to seem boundless, endless, and they eventually succumb to the temptation "to see what this thing can do". Nothing makes politicians more popular than granting the populous instant gratification - after all why should they save up for things like their grandparents did? - how quiant, how old-fashioned - and not necessary at all in this new golden age of fiat. They can have whatever they want immediately and pay for it later, and this instant demand is surely good for the economy - and if consumers need not wait until they have the resources to buy something, then why should the government itself, or corporations? The result of this philosophy put into action across a broad front is debt, massive debt. Eventually, however, this debt expands to reach its servicable limits, an inconvenience which spawned derivatives that allow debt to be pyramided. Having tested debt to its limits, why not test derivatives to their limits? This is what is currently happening as derivatives have risen to levels something like 6 times global GDP. According to the Big Bang Theory even the universe has limits, or rather it used to have before it exploded. Who knows where the limit is with derivatives? - maybe there isn't any. One thing's certain though, you sure don't want to be around if the day ever dawns when the collective realization sets in that this stuff is worthless.

The fiat money system is like driving across the Utah salt flats trying to set a new land speed record, but rather than slowing down as you approach the vertical cliff at the other side (don't laugh - this actually happened to some poor fellow recently) you keep accelerating and moving up the gears until you slam into the cliff so hard the investigators have trouble even finding your DNA. The difference between 2008 and now is that we have just moved up a gear - into top gear. You may recall how in 2008 many large corporations and institutions, particularly in the US, that previously greedily hoarded their massive profits largely for distribution to their senior staff suddenly fell upon hard times and instantly declared themselves to be too big and important too fail, and threw themselves upon the mercy of the government, which, never having had a problem spending other peoples' money, i.e. the taxpayers, did "the decent thing" and bailed them out to stop the system from collapsing. Even the average Joe in the suburbs, completing his higher education by watching The Simpsons , was dimly aware that he would be the sucker who would be stuck with the bill for it all, and after scrawling a message of protest on a torn out face of a cardboard box he feistily made his way down to the State capitol with hundreds of like minded grumpy citizens, observed from a distance by helicopters with high powered lenses.

It seemed like a lot of money, didn't it, to bail out those corporations and institutions back in 2008, but that was chicken feed compared to the bailouts now in prospect. Those were companies - now try countries. This is 2010 and we have now moved up a gear to bailing out countries, starting with Greece. The term used in polite society for countries going off the rails is "Sovereign Defaults", but we prefer to use the more readily understood "Countries Going Bust", just as we find "Currency Dilution" more appealing than "Quantitative Easing" which could be mistaken for an affliction of the bowels, and "Trash Collector" more descriptive than "Garbage Disposal Technician". Greece is just the start, other countries in the EU are already lining up for help, and even if they don't look too shaky right now, speculators may well force the issue and bring about a self-fulfilling prophecy by forcing up interest rates. According to the logic of fiat as already set out above, countries on the rocks should be bailed out whatever the cost, as all you have to do is hit a few keystrokes and manufacture the necessary cash - problem solved, although as you probably don't need explaining, this solution is somewhat inflationary to put it mildly. But what about the US? - with its careening astronomic deficits and impossible commitments, who is big enough to bail it out? The answer to that is simple - it can bail itself out - just magic into existence a few more tens of trillions and buy itself out of trouble. OK - this is a joke, although not entirely, as this is what is already happening, a course that looks set to continue, but it is rather like that guy riding along in a car in the old silent film who when a wheel falls off leans out of the car (he is not the one driving) and holds it up by the axle. This is why those fleeing from the Euro into the perceived safety of the dollar, the "global reserve currency", reserved that is for those who want to go bust, had better watch out, because once the pillars of the European empire have fallen in, the dollar will be very quickly in the crosshairs. This is the reason why gold rose with the dollar last week, as more perceptive investors and speculators are only too well aware that the dollar is now no more than a stepping stone to the only really safe investment left in the twilight days of the latest fiat experiment - gold.

That's enough background, now we will review the charts.

Starting with gold we can see on its 1-year chart that it came within a whisker of breaking out to new highs, an almost astonishing feat given the strong advance in the dollar last week and the sizeable drop in the stockmarket. It is believed to be on the point of "going ballistic", which is a perfectly reasonable thing for it to do in the current circumstances, and if the now critically overbought dollar goes into reverse, it should have the wind at its back.

For anyone who hasn't seen it the gold in euros chart is truly astounding. No-one can call gold weak looking at this chart, although admittedly the euro can't exactly be described as strong this past week. Actually this chart shows a wildly overbought condition calling for a reversal, suggesting that the dollar and euro will reverse directions soon, if only briefly, in which case although gold may be falling against the euro, it should rise against the dollar.

The dollar rose very sharply indeed last week on the deepening crisis in the euro to become critically overbought. The force of this move implies that it may continue even higher, perhaps after a brief pause to alleviate the overbought condition. At this unusual time gold may continue to advance with the dollar, and it should accelerate once it breaks out to clear new highs. This is due to funds fleeing from the euro into both the dollar and gold as safe havens, although as mentioned above the dollar is viewed as only a temporary bolthole.

A most encouraging development for Precious Metals stock investors last week was that when the broad stockmarket nosedived, the sector was not just left unscathed, but actually rose. This is an indication that the sector is likely to break ranks with the broad stockmarket in the event that the latter goes into decline. As we can see on the 3-year chart for the HUI index, it is at a critical juncture as it is either forming a Double Top with its 2008 highs, or it is about to break out to new highs and embark on a vigorous uptrend. This is what we expect to happen, and is what many individual stock charts are pointing to, and of course this development would be expected to come hard on the heels of a gold breakout to new highs.

You have to feel a little sorry for silver. It has been suffering from an identity crisis - it can't make up its mind whether it's an industrial metal or a Precious Metal. You could see this on Thursday when as gold surged and the stockmarket tanked, it hardly moved. It was like a bewildered child at a country crossroads not knowing whether to follow its big brother gold and take the high road, or to follow the man with the candy and take the low road. There is an old saying that blood is thicker than water, so after a sigh silver ran to catch up with its brother on Friday. It's nice to have a story with a happy ending, although actually what we are looking at here is a beginning, the beginning of the next stage of a journey to lofty heights.

On its 3-year chart we can see that after its recovery last year from the panic lows of 2008, silver's advance slowed as it approached and ran into a wall of overhanging supply near its early 2008 highs and it has effectively been in a large trading range since as far back as last October. It's 3-year chart is very similar to the 3-year charts for the PM stocks indices, and for both silver and the stock indices the resistance approaching and at the 2008 highs is a major hurdle, which if overcome should lead to a strong uptrend. While the risk that it is Double Topping remains until this resistance is overcome, the strongly bullish action in gold and the completing base patterns in many individual quality junior silver stocks strongly suggest that it will be, and soon. The current tight bunching of the price and the bullishly aligned moving averages certainly puts silver in position to break out upside soon, and we should note that such a breakout is likely to be rapid and dramatic, and will take a lot of traders by surprise.

The 6-month chart shows recent action in more detail. On this chart we can see how silver has been repeatedly backing off from the resistance in the $19 + area. We can also see the rather alarming drop last Tuesday, Thursday`s indecisive rally when gold soared and how it played catch up on Friday with a bullish strong rise from the vicinity of its 50-day moving average.

Clive Maund, Diploma Technical Analysis
[email protected]
www.clivemaund.com

Copiapo, Chile, 9 May 2010