Fed Response to Stumbling Markets

Whilst looking at the gold chart below, (source: http://quotes.ino.com/chart/?s=FOREX_XAUUSDO&v=d12) I was struck by the repetitive similarity of the angles of decline in the down moves. This raised the possibility in my mind that the Fed may still be operating under the assumption that it can "manage" a soft landing.

• May-June: 720-550
• July: 670-620
• September: 640-580
• Oct: 600-570; 600-580
• Jan: 640-610
• Feb: 685-640

All falls occurred at a similar "steepness"

Given that (physical) excess of supply over demand fell from 250 tons in 2005 to 90 tonsin 2006, the cause of these falls comes into question,

Of particular interest is:

• There was 403 tons of "de-hedging" in 2006 - ie Unwinding of hedge positions by mines took 403 tons of gold off the market. This was effectively "supplied" by .a reduction in buying for Jewellery fabrication·
• Old gold scrap supplies amounted to 50% of net new gold mined. This is an extraordinarily high number, and raises a question mark regarding the accuracy of the statistics

Gold supply and demand (WGC presentation)

Source: www.gold.org/value/stats/statistics/gold_demand/index.html

Assuming accuracy of the scrap supplies (it will of interest to discover how such a numberwas quantified in the first place) with ETFs now in place, and with official sector sales abating, the question arises whether Jewellery demand will grow at current prices, or whether there will be a diversion of investment funds into Gold ETFs.

Fundamentally, if jewellery demand does not rise (unlikely), and/or if mine hedging re-emerges (unlikely) then the swing factor to cause the gold price to rise will be a shrinkage in gold scrap availability, unless ETFs become more active.

Technically, the inflation adjusted price of gold has also broken to the upside of a three line fan formation, and gold is also in a bull trend in deflated dollars - but with significantly less short term upside resistance.

Source: http://upload.wikimedia.org/wikipedia/commons/d/df/Gold_price.png

Of course, this raises a question about what is likely to happen to the US Dollar, and that is where the Fed's "management" plans become important.

In terms of the following chart, the US Dollar seems to have a lot of support at the 80 level

www.decisionpoint.com/prime/dailycharts/23ltindx_20yr.html

Like the gold price, the goldollar index looks like it is experiencing a technical reaction having broken up from a short term three line fan formation:

From the above two charts, it appears that the downside potential of the US Dollar may be limited, from a technical perspective.

All the above therefore begs the question. If, technically, the gold price is going to rise BOTH in absolute dollars AND in deflated dollars, what - fundamentally - is going to cause this?

It's impossible to crystal ball gaze the answer to that one. As mentioned, one possibility is the switching of money by the public out of the Industrial Markets into Precious Metals via the ETFs, so let's look at the possibility that money might be taken out of the industrial markets

The chart below of the Dow Jones Industrial Index (courtesy decisionpoint.com) is showing sell signal on the oscillator which, in turn, is showing a non confirmation in that its most recent high was lower than its earlier high in February 2004

In turn, this would imply that the possibility of an exponential blow-off in the industrial markets is receding. Paradoxically, this may not be such a bad outcome. At least it leaves the door open to an orderly migration to more appropriate Thought Paradigms regarding the Energy markets.

But when one looks at the following chart of the 30 year Bond Yield, a mental disconnect manifests:

If the yield falls from here (because of the sell signal on the oscillator), whilst it may protect the property markets it may, at the same, time threaten the US Dollar.

But the US Dollar can be protected by other means - namely by concerted actions on the part of the Central Banks.

Problem is that, in terms of the following long term chart of the yields, a break below 4.5% may take the yields all the way down to 4.25% and perhaps lower.

This might be bullish for Treasuries - ie money may be diverted from the Equity Markets into Treasuries. But it might also imply a slowing in the velocity of money, and recession - which Greenspan was possibly attempting to "ensure" via his comments. (From this analyst's perspective, that would be a far more responsible approach than pumping yet more money into the economy)

Conclusions

Based on currently available information, it appears that:

1. Yields may come under pressure (whether engineered or not is yet to be determined)
2. There may be some Central Bank interference in the Currency markets to keep the US Dollar from falling below 80
3. The Dow Jones might fall as low as 10,500 within an "orderly" decline, and still remain in a modestly rising trend.
4. If that level is penetrated on the downside, a significantly more bearish picture might begin to emerge
5. The steeply falling gold price from time-to-time over the past few months might very well imply active intervention on the part of the Central Banks or their agents
6. Offsetting this, it seems possible that some investment money "may" be diverted via the ETFs for Investment in Precious Metals, because, although money may be diverted to Treasuries, falling interest rates might be perceived by some as a threat to the US Dollar, and gold might become more desirable flowing from portfolio management and balancing decisions
7. The above scenario would be consistent with a gold price that may rise to new heights without an accompanying panic in other markets

The key to all of the above is therefore: interests rates. Is the Fed going to Engineer these down, or could they start to fall because of a slowing velocity of money?

Overall Conclusion

If the velocity of money slows, the likely outcome is deflation, and a collapse of the debt mountain. It would appear that the most "desirable" outcome is that the Fed's attention will soon switch from "money supply inflation" to "Price of money Reduction".

Comment

Unless there is a structural change in our approach to finding a new "Driver" of the world economy, viz a Next Generation Energy source to replace fossil fuels (that is NOT Nuclear Fission) , all such an approach will achieve is a prolonging of the pain - which will become chronic as opposed to acute.

That we may be dangerously close to a slowing in the velocity of money is apparent from the oil index chart below. 40-42 seems to represent support which, if it does not hold, will give way to a new support level at 30

The Fed is doing the best it can under the circumstances, but failure of the politicians to appropriately address the Energy issue is the ultimate issue. If this is not addressed - and in a meaningful way, as opposed to just paying lip service - the markets will probably continue to unwind.

There are solutions. There are at least three, and possibly five, Energy technologies that might facilitate a migration from fossil fuels.

The most pressing problem is that we are running out of time. By now, anyone who lives in either New York State (temperatures below freezing) or California (frost decimated citrus crop) will be starting to question how we could possibly be experiencing global "warming". And the Chinese are also starting to wonder about this global warming. See: www.shanghaidaily.com/sp/article/2007/200703/20070306/article_308050_1.htm

There are now THREE unrelated models that have come to my attention which are pointing to 2012 - 2040 as the unravelling period.