Gold And The Phillips Curve

For the past few years, the citizens of China and India have been in the “gold buying spotlight”.  I’ve hinted that the citizens of Japan could soon become another source of sizable demand.

In contrast to their “debt-a-holic” government, Japanese citizens tend to shun the use of debt.  Over the past year, the actions of Shinzo Abe and Haruhiko Kuroda have resulted in a tumbling yen, and the official inflation rate has started to rise.

The citizens of Japan have started to increase the amount of gold they are buying, to protect themselves.  Over the next six months, I expect that trend to accelerate significantly.

“Gold demand in Japan jumped threefold in 2013 as prices slumped and investors sought refuge from Prime Minister Shinzo Abe’s campaign to stoke inflation and weaken the yen, the World Gold Council said.  Demand for jewelry, bars and coins increased to 21.3 metric tons last year from 6.6 tons in 2012….” – Bloomberg News, February 18, 2014.

I’ve argued that gold entered a jewellery-oriented “bull era” in 2013.  I’ve predicted that consistent monthly demand for gold in the form of jewellery, just from China, Japan, and India, will surpass the entire monthly global gold supply. 

On that note, about 17 tons of the reported 21.3 tons of Japanese total demand was in the form of jewellery.

Compared to the demand from China and India, Japanese gold demand is tiny, but Abenomics has barely started, and the Japanese inflation rate is still very low. 

The per capita GDP in Japan is about $35,000 a year, and the Japanese economy is the third largest in the world.  That translates into massive gold buying power.  

The QE experiment in Japan is extremely dangerous because the government debt versus GDP ratio is much higher there than in America.  Cost-push inflation could begin much more quickly than most analysts are anticipating. 

The combination of a debt-obsessed Japanese government and debt-averse citizens could soon produce an almost maniacal charge into gold, by millions of frightened Japanese savers.

In America, the appointment of Janet Yellen to head the US central bank could also prove to be a “golden game changer”.   Gold investors should focus on a subtle difference between the economic philosophies of Dr. Yellen and Dr. Bernanke. 

Dr. Bernanke believed that the financial crisis of 2008 produced the need for strong but temporary action to be taken by the Fed.  His focus was on providing liquidity to the financial system, as a substantial but temporary strategy.

In contrast, Dr. Yellen believes in the Phillips Curve.   In the 1950s, William Phillips suggested that there is an inverse relationship between inflation and unemployment, and his ideas are used extensively by Keynesian economists.  To learn more about the Phillips Curve please click here now. 

In 2007, as head of the San Francisco Fed, Dr. Yellen authored a significant essay that was titled, “Implications of Behavioral Economics for Monetary Policy”.  It focused on the Phillips Curve and the use of it by the central bank as a “workhorse”.  If you want a copy of that essay, send a request to [email protected] and I’ll send it to you.

The bottom line is that Dr. Yellen is a strong Keynesian who is in charge of America’s central bank.  She believes that real unemployment will fall significantly, if she raises the inflation rate.  That has the attention of powerful institutional money managers, and it should have the attention of everyone in the gold community.

In the short term gold is massively overbought, from a technical perspective.  Many gold enthusiasts became almost giddy with the prospect of an “ultimate bottom” being completed in the $1180 area.  Gold could suffer a sharp and frightening sell-off right now, from this key sell-side HSR (horizontal support and resistance) zone.  That decline would help create a large and bullish inverse head and shoulders bottom pattern.

That’s the daily gold chart.  Note the “nosebleed” on my stokeillator at the bottom of the chart.  The lead line sits at about 93, which is where many violent sell-offs have occurred in the past.

The entire $1335 - $1360 price zone represents significant sell-side HSR.  If gold is going to challenge the August highs in the $1432 area, it would attract a lot of technical buyers if a head and shoulders pattern is clearly apparent on the chart.

This daily silver chart shows that silver has started to outperform gold on days when gold rises.  That tends to happen near the end of a minor trend move.  When the stokeillator moves down and gives the next buy signal, I expect silver to continue to outperform gold, which is good news for silver bugs who have shown tremendous patience with this mighty metal!

When a financial crisis is the focus of institutional money managers, they tend to buy gold bullion.  Recently, gold stocks have done much better than gold.  That’s likely because institutional money managers are aware of Dr. Yellen’s tendency to endorse a higher inflation rate. 

Gold stocks have arrived at some minor sell-side HSR in the $27 area.  While I’m cheering for gold stocks to continue to rally, it’s prudent to book some light profits here.  Like pruning a fruit tree produces more fruit, investors should prune profits from their gold stocks! 

A pullback to the $24 area might be disappointing, but it would only add to the bullish look of the chart.  That would attract more technical buying.

Since the year began, junior gold and silver stocks have outperformed every asset class.  This daily GDXJ chart suggests that institutional money managers are aware of the need to find much more gold, to supply the buyers in the gold jewellery era! 

Note the inverse head and shoulders bottom pattern in play.  That’s very bullish.  In the short term, the stokeillator is very high, so a decline is to be expected.  On a pullback to the $38 area, I’d like to see strong buying from the gold community!

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Stewart Thomson 

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