February 21, 2007

"It's early days yet, but my gut is telling me that February 21st 2007 may turn out to be the date that the sea change started to manifest. Right now I am in the minority, if not alone in my views. However, if and when the Gold Price rises to new all-time highs, and just keeps on going, people will increasingly begin to recognise this possibility." (Bloom, Gold-Eagle 22/2/07)

In the past week I've received several (circular) emails from nervous gold- philes, so perhaps it will be constructive to explain what I mean by "sea change".

I see the markets as a barometer for society's general state of mind. Frankly, the state of mind holds far more interest for me than the barometer. I have a roof over my head, food on my plate, two cars, a wife of 36 years who still loves me and three kids who regard me as their friend. They actively seek me out at least once a week to share their thoughts and dreams. I'm rich in a meaningful way.

There are 6.5 billion people living on this planet. The "Developed" world is home to less than one billion and, within the developed world ten percent of the population own 90% of the wealth. The rest are "consumers".

The consumption habits of these (now) 900 odd million people have driven the world economy since the mid 1700s and, in the process, our environment has become seriously damaged - some believe terminally, I don't. It seems to me that the environment has the capacity to wipe us out before we destroy it. The other 5.5 billion people have been watching - some in envy - and at least 3 billion more are now reaching out to become like the first 900 million.

It does not take a genius to conclude that, if the environment could not sustain 900 million consumers it most certainly will not sustain a similar lifestyle for four billion consumers. The average annual per capita income of the Chinese and the Indians will never get to where it got to for the Americans and the Europeans. Never! That 'throwaway' lifestyle was an anomaly of history. One day - as a unified group - we're going to experience a realization of this fact

The question in my mind has been: 'when'?"

My gut instinct on February 22nd 2007 was that the previous day was the day that the process of realization began to commence. Today is March 15th. All I've seen in the past three weeks is an escalation of the levels of anxiety and an escalation of 'noise'.

If I am reading it correctly (of course, nothing is ever cast in concrete, but common sense is probably more useful than rocket science here) the realization process will finally give rise to a dawning of understanding that the concept of a Central Bank that could "control" the minds of men is just plain old common-or-garden bullshit. Recognition of this fact will represent 'Step 1' of the macro realization and adjustment process.

Yes, it's possible to corral the community of sheep, influence their behaviour, shepherd them as a flock, and drive them right to the brink of the abyss, but they would have to be mindless lemmings to jump off the edge of the cliff and into the abyss.

I have a higher opinion of humanity than that it is composed merely of lemmings. On average, by definition, we have an IQ of 100. Nowadays, that's pretty smart. We've come along way in the past 11,500 years. We're able to think, and we've accumulated a massive body of knowledge - most of which seems to have been 'handed' to us around 5,500 years ago, and some of which was 'codified' around 3,500 years ago, then again 2,000 years ago, and then again 1,400 years ago.

So, how is this all going to unfold? Are we going to be flushed down the toilet, or are we going to come out of this better people - more evolved in our attitudes?

The former seems pretty pointless to me, so let's proceed from the base assumption that we're going to work through the problems and come out the other side with a more balanced set of aspirations and values.

Step 2 - after we have acknowledged that the Central Banking system as it is currently structured was a folly of some men's egos - will be to recognise that life still holds practical challenges. It's all very well going off with the pixies, but we have to ensure that food keeps arriving on our dinner plates and we still have roofs over our heads. If one has to prioritise where our attentions should be focussed, the highest priority, paradoxically, is not (yet) on restructuring the Central Banking system. It is to recognise that whilst Al Gore is well meaning, for various reasons he is probably wrong. The biggest risk we are facing is Global Cooling, not 'warming'. The Northern Hemisphere is warming, at present, but the Antarctic shelf is growing. Moving to address the implications of that particular issue across the globe will require such a huge investment that this, by itself, will likely drive the world economy whilst we reorganise.

Step 2a - will be to reorganise the way in which we generate energy in all spheres of life - ranging from electricity production to fuel for transportation.

Step 3 - somewhere along the way, and in parallel - it will advisable to reorganise our Banking System from the top down. Perhaps - even probably - gold will have a role to play here, but it will be a 'necessary but not sufficient' condition.

Step 3a - sometime along the way and in parallel - it will be desirable to kick out the testosterone addled and/or egomaniacal politicians and restructure our systems of government to be managed by leaders of wisdom. (This will be the most difficult and complex of problems, and it will require massive pain and suffering on the part of the population at large before the old style leaders will lose their iron grip of control.)

No one knows where the markets are going to go from here. Not me, not you, not the man in the moon. But we can apply some common sense.

If the Central Banks continue to pump money into the world's economies, we will have asset hyperinflation. Given that Sir Alan Greenspan himself came out the other day and stated unequivocally that he thought a recession was on the cards, we can safely conclude that asset hyperinflation - which was a looming danger until a few weeks ago - is no longer the risk it was.

Will the industrial markets fall in a heap?

In 1929 there was a run on the banks. That was what ultimately caused the loss of confidence. People don't keep money under their mattresses anymore. It's stored in electronic ledgers. Even in 'normal' times, if a private individual makes an unusually large cash withdrawal from his bank, the Central Bank wants to know about it as a matter of routine. The 'excuse' is 'drug money laundering', or 'tax evasion' or whatever. The reality is 'control'. It defies common sense that there will ever be another run on the banks in the Developed World. We are too sophisticated to allow that to happen, and it doesn't matter if there is one in the Developing World. In the absence of a run on the banks, the public will probably sit there numbly watching their lives disintegrating rather than 'force' a realization of their assets.

Having said this, the flip side of this coin is debt. If the banks start calling in their loans, there will most certainly be forced selling. So one risk of a market melt-down, paradoxically, lies in the possibility that there might be a 'run on the public', by lenders wanting their money back.

Where do most people have their debt?

There are two kinds of people - those who try to plan for tomorrow (who will own homes and will have mortgages); and those who live only for today (who will have credit card debt, hire purchase debt, supplier debt).

Paradoxically, common sense dictates that the risk does not lie with the home owner/mortgagee. Why would a bank repossess a home in an environment where that home is unsaleable at a price that will cover the mortgage? The answer, from the banks perspective will be to 'restructure the debt' and, with the aid of the Central Bank which can probably be relied upon to push rates down, this is largely achievable.

The real risk lies is in consumer borrowing. If credit cards are maxed out; if hire purchase contracts become more difficult to come by; if suppliers have more difficulty in financing their selling on credit, then the velocity of money will slow as consumption slows.

The world's economy will start to unravel, unless Governments start to invest in infrastructure once again.

Where will the most logical place be?

Energy - but in energies that will replace fossil fuels.

Right now, the politicians - commencing with a decision on the part of Margaret Thatcher - are positioning for that investment to be in nuclear fission plants. Big Mistake! BIG mistake. Wrong technology. This is not the time or place to discuss why.

Okay. So let's test this logic.

Are there signs that interest rates may come under downward pressure?

The following chart - courtesy Decisionpoint.com - is showing a potentially interesting development in the oscillator

Whilst there has been a 'non-confirmation' of rising highs between 04 and 06, the oscillator is at present pointing down and is fairly close to its rising moving average and the zero line. There are no "rules" in Technical Analysis, only "clues".

One clue is that the oscillator on the weekly chart is giving an actual sell signal

Normally, from a "trading" perspective, a sell signal in the oscillator is really only meaningful if it is given at a point where it is turning down from a high. However, when it turns down from the zero line, it might mean the imminent resumption of an already existing bear market. It may be important that both the 17 week and 43 week MA are pointing down, and that the yield is below both of these.

The following daily chart of the oil index (a proxy for energy consumption, in my view) is showing a non-confirmation of the price and the oscillator

Note how the high in price did not reach a higher high than in December, but that the oscillator did. Does this mean that a rising oil price is imminent?

In my view, the weekly chart below is saying "no, the oil index is unlikely to rise from this level, but it seems unlikely to fall either". Perhaps we will see a stabilisation at these levels.

But it would be intellectually dishonest to ignore the crossover of the daily oscillator down through its moving average; or that the price itself is below its moving averages, or that the short term moving average has crossed over to a level below its longer term moving average. This is a warning sign that "energy consumption" might fall from here and this, in turn, would lead to a slowing in the velocity of money and the economy. It will also put pressure on people's ability to repay loans - which is why we might expect interest rates to fall.

Given that the long term yield chart had previously been pointing to a "market" that wanted yields to at least bottom out or rise, the logical conclusion is that the Fed is moving to "manage" interest rates down - which might also account for the negative yield curve.

And the gold price?

The Point and Figure Chart below is fascinating to me (Courtesy Stockcharts.com)

Based on a horizontal count target method, the breakdown below $660 called for a target of $635 - which has been reached. In this analyst's experience, a vertical count target is only meaningful if the vertical count is in the same direction as the Primary Trend. If the Primary Trend is "up" then a theoretical downside count based on vertical target methodology is probably meaningless.

Alternatively, put another way, if the gold price does not bounce up from here, and if it falls below $635, then the odds are that the Primary Bull market in gold is over.

My view is that it is not over.

The P&F chart above of the Gold Price - plotted on log scale - shows that the upward pointing trendline is still intact, and that the gold price has been trending sideways, essentially consolidating from an overbought situation. This is healthy action.

What about the Industrial Markets?

Again, based on the above monthly chart of the S&P, the market looks more likely to consolidate from an overbought level than "collapse"

Conclusion

The Fed appears to have pulled it off for the time being. Greenspan's timely announcement headed off the Hyperinflation risk, and downward pressure on rates seems to be taking the 'fear' out of the markets. But the Gold Price is saying "Sorry, Mr Bernanke, sleepless nights ahead for you. The issue of an engine of the world economy has yet to be addressed, and that's out of your hands".

All of this begs the question regarding dollar confidence

The US Dollar Index is not looking strong. The weekly chart is travelling below its two moving averages, but the oscillator looks like it's in a trading range.

That the dollar is unlikely to fall below 80 is validated by the Goldollar Chart below

Both the Gold Price and the Goldollar Index appear to be approaching a rising trendline from which they will need to bounce up. There are only two ways it could bounce up:

• If the gold price rises and the dollar remains constant or rises
• If the dollar rises and the gold price remains constant or rises

A breakdown would imply a fall in both the gold price and the US Dollar, or a fall in only the gold price, and there is no objectively logical fundamental reason why this should happen. i.e. It looks more likely that the trendline will hold.

Overall Conclusion

Once again, the Fed has managed to buy a bit more time.

It seems that money will, slowly, move from the Industrial Markets into US Treasuries, and that some of this money may be shifted into gold.

All of which amounts to shifting deck chairs on the Titanic. From this analyst's vantage point, the sea change is starting to spread. The tide of fossil fuel driven industrialisation is turning.