Gold Market Update

Gold is behaving well technically and is, thus far, on course to break out to new highs soon. On its 3-year chart we can see how the upside breakout from the Triangle led to a run at the highs, where it stalled out and reversed as it arrived near the highs in an overbought condition and with its COT figures at an extreme level. The reaction following the breakout is quite normal and we will be able to see more clearly on the shorter-term chart lower down the page just where this reaction should terminate and be followed by a breakout to new highs.

The main point to observe on the 3-year chart is that the breakout from the Triangle has put gold in a very good position to break out to new highs and embark on a substantial upleg. The giant consolidation pattern from March of last year is all but complete and with the price and all moving averages in bullish alignment, gold is "ready to go", although it may consolidate/react for a few weeks more before it takes off, which the latest COT figures suggest is likely. Could the entire pattern abort and end up being a giant top area? - yes it could, but if this proved to be the case it would mean that the world would tip into the economic cataclysm of a deflationary implosion, and virtually everything would "go down the gurgler" - commodities, stocks, Real Estate, you name it. Panic money would flee initially into Treasuries and the dollar as happened last year, and even though gold too would drop nominally, it would fall in price slower than most other investments. This is the dire scenario highlighted by Karl Denninger in his recent postings. If this worst-case scenario hits it will be signalled by gold breaking below the apex of the Triangle.

Much has been written on the deflation/inflation conundrum in the recent past and the arguments continue to rage. The key point to grasp in relation to this is that the fiat money system has already met its nemesis and is in its death throes. The natural and necessary recessionary and deflationary forces that bankers and politicians have managed to keep at bay for so long have now built up to apocalyptic proportions. Without the discipline of a gold standard to restrain them they have indulged in an orgy of money creation and debt and credit pyramiding over many years that now threatens to bury them. Since the global financial crisis started to erupt in August 2007 with the sub-prime mortgage scandal, NOTHING HAS BEEN DONE TO ADDRESS THE ROOT CAUSES OF THE CRISIS. Instead, all efforts have been directed to patching things up and keeping the system somehow limping along, which have required extreme measures such as massive bailouts and increasing monetisation of the Treasury market, all of which has required a further ramping up of the money creation and debt pyramiding that created the crisis in the first place. In other words they are procrastinating, and the end result of all this must be an even worse implosion when they finally run out of rope.

Faced with a choice between deflation and inflation, politicians will almost always choose inflation. This is because deflation means huge unemployment and privation, possible insurrection and the resulting chance that politicians' heads will wind up adorning the railings outside government offices and palaces etc. Inflation on the other hand creeps up on the population by stealth, and like the frog in the pot that slowly heats up, which doesn't quite arrive at the decision to jump out and so dies, the masses similarly can't quite bring themselves to organise storming their government offices and kicking out their leaders. They end up just as poor as in the deflation scenario, and often more so, but it is a more seamless process. This explains why Robert Mugabe, the President of Zimbabwe, remained in power throughout the hyperinflationary ruin of his country and is still in power. Thus we can expect politicians in the US and other countries such as Britain to plump for the inflationary/hyperinflationary route to try to stave off the deflationary implosion for as long as possible. The end result will be the same, however - ruin. Once the hyperinflation has run its course and the currency is worthless and the population are destitute and normal business activity has ceased you have to start over from the ground up - just the same as with a deflationary implosion. A crucial point to note, particularly in regard to the most profligate countries such as Britain and the US, is that we are now so far advanced into the endgame that they now have only one button left to push - hyperinflation, to maintain liquidity and eliminate debt by devaluing the currency and defrauding creditors, which is the route taken by the Weimar Republic in Germany - and we know how that ended. Any attempt at restraint at this very late stage will result in interest rates skyrocketing and almost immediate debt default. There is another option, however, which was explored in the essay The Death of the American Empire ,which is to surrender to the mercy of creditors, who would effectively become the owners of the country and dictate its future policy.

While it is logical to assume that politicians will take the inflationary/hyperinflationary route, it is not 100% sure that this option is open to them. Over the past year, as we know, they have have been printing up truckloads of money to pass to their pals in the banks and other favored Wall St institutions, but a big problem which has potentially deflationary implications is that the banks have been greedily hoarding this windfall cash in their coffers (apart from that which has been dipped into to pay massive bonuses, which is arguably an economic stimulus in its own right) and either not lending it out at all, or lending it out at exhorbitant rates of interest, given that official rates are close to zero. The guy on the street or small business owner who goes cap in hand for a loan to his local bank is very often told to "take a long walk on a short pier". Needless this say, this hardly constitutes a grassroots stimulus to the economy, which explains the grim employment situation that now exists in the US. This kind of behaviour is clearly deflationary and is severely impacting tax revenues in the US. Thus it is by no means certain that politicians will be able to keep the deflation "grim reaper" at bay for much longer with their inflationary antics and if they don't succeed in doing so we will have a second round crash in the commodity and stockmarkets, which could be imminent. This is why a clear break below the apex or nose of the gold Triangle would be viewed as a general sell signal for both gold and silver. Still another scenario is an imminent rout of commodity and stockmarkets caused by another deflation scare, that proves to be false and is followed by inflation/hyperinflation. This is the scenario implied by Ron Rosen`s recent scary postings. In this scenario gold and silver tumble and then take off strongly higher again later.

Returning to the charts, the year-to-date chart for gold shows recent action in detail. On this chart we can see how the breakout from the Triangle is being followed by the expected reaction. The latest COT figures suggest that further consolidation/reaction is likely before a sustainable advance can get underway, and it may react back towards $960, a likely scenario being shown by the blue arrowed line. Such a reaction should provide an important late buying opportunity ahead of gold proceeding to break out to new highs. A clear break below the support at the apex or nose of the Triangle however would constitute a sell signal as it would create a dangerous situation where a devastating "end run" collapse could occur - hence it is important to maintain stops below this level. Although not considered likely, the chance of this has been increased by the somewhat unconvincing late breakout from the Triangle.

The gold COT eased somewhat last week from its recent extreme readings. It suggests that consolidation/reaction is likely to continue for at least a week or two yet and probably until gold drops back towards $960.

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

Copiapo, Chile, 4 October 2009