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January 09, 2005

What Will Kill the Current Commodity Boom?
by David Petch

There are three central ideas that will each play and independent yet have a cumulative effect on stopping the commodity bull market dead some time between 2011-2012. Each point is addressed with its own bullet.

• Government debt is different that people debt

When governments go into debt and default, the losers are foreign lenders. Business can continue as usual. The people represent the tax base for the government; their essence of being, the heart of the matter. Failure for debt payment from people results in higher bank failures and a contraction in spending. A reduction in the health of the financial status of people of a given nation affects the health of the government for being able to continue with their programs, whether social, defense or ensuring a stable supply of commodities (that is in essence what starts wars). Currently baby boomers in the US are nearing retirement. Come 2008, the first wave of baby boomers will retire en masse. 50-60% of the population is invested directly or indirectly in the stock market via mutual funds, stocks etc. etc. When people retire, they will draw down on their life savings. This in turn will cause pension funds to require liquidation of a portion of their asset base to meet financial obligations. I firmly believe that pension funds will begin selling their broad base index funds and hold off on gold stocks until around 2008-2010. After that point, pension funds will be strapped and selling of gold stocks will commence the "distribution phase" to the public. Some people will take note, but the gold stocks will continue to rise. People will flock to gold as they fear hyperinflation will destroy their entire net worth. Once the pension funds have liquidated their gold shares to the public, the game of musical chairs begins.......some chairs are taken away and there are only so many people that can sit while the rest are left standing (or holding the bag). When the last buyer steps in at the top to buy the highly priced gold stocks, a top will be in and set for a ripe decline (I think 2011-2013 is the range, obviously the time horizon is too far to accurately quantify a top).

• Peak Oil

Peak oil is often referred to as "Hubberts Peak", a geophysicist who observed that oil well production followed a bell curve. Peak oil is set to occur around 2006-2008. When peak oil occurs, production will decline approximately 3% per year at a time where global demand is increasing at 3% per year. This translates into strong commodity based inflation. I presented a chart around one month ago that suggested oil was in the final phase of its fractal pattern, topping out around $160/barrel. This would cause a severe contraction in the economy, since no one would be able to afford most items. It will come down to buying bread, fruit, and meat (where available) and other staple food items. This will trigger a deflationary collapse that will be devastating on many fronts. High oil prices around $160/barrel would collapse to around $30/barrel. In 2012, should that occur, it would have a positive effect on agriculture, since food would be able to be produced cheaper. However, a decline in oil prices would signal a collapse in exploration, which would only add to energy crises in the future. A decline in oil to such a level would not be a permanent thing. It would likely return to the former level of $160/barrel and remain there, rising in price as it becomes more scarce. The wild fluctuations will hurt most, since it translates into oscillating inflation/deflation cycles.

• Currency Faux Paus's

The US dollar index is poised to go to 60 in the next 18 months and will likely cause trading blocks to develop. A lower USD translates into imported goods costing more. This will compound the government's financial situation, causing them to turn on the printing press. This will generate hyperinflation due to currency expansion. All great hyperinflations ALWAYS end in deflation. Other countries will lower their interest rates to try and make their currency more competitive. At some point, higher interest rates across the board will occur to prevent currency meltdowns and unless currencies are backed by gold, they could fail. This is one reason to be extremely bullish on gold. Governments around the world are going to have to add gold to their coffers somehow to have economic stability. During a period of deflation, it makes sense to have a gold-backed currency, because that is what usually will trigger a gold-backed currency to develop in the first place. Periods of economic growth require a dollar de-coupled from gold so economic expansion is not hindered. With a collapse in global populations, money supply etc., there will be no expansion mode required, so a gold backed currency situation will work, in fact it is all that will work. Economic trading blocks must be established for countries with little or no natural resources, or they will be destitute. England and several European countries come to mind. I think the US will become self-sufficient with what they have, but only because a massive reduction in their standard of living is coming.

US Dollar Index (USD)

The lower 55 MA Bollinger band has been riding beneath the index for some time, suggestive a bottom was looming. I felt the index would test the lower 80 level for longer than it did, but that proved wrong. Refer to Figures 4 and 5 for the Elliott Wave count of the USD. There is a temporary bottom in place that will be tested in 2-3 months time. The full stochastics below are on a longer-term setting and have an apparent lag for when bottoms and tops are hit. The %K is a given now to cross above the %D. There is a massive short-covering of USD positions driving it higher as we speak. The mass speculation is causing the violent swings in all markets, so until it is quashed, volatility will remain.

The 50-day moving average is current around 83. The USD index will take out this value within the next week. The decline from October was approximately 2 ½ months, so the corrective pattern in the USD is likely to stay in its bounce up for one month minimally. There is at least three more week's strength in the USD. One point to not is the rapid ascent of the short-term stochastics. The USD has had a remarkable 3-day rise. Flagpole moves usually burn out short-term stochastics quickly. I am looking for a short-term top in the US dollar on Thursday followed by a retrace. The corrective pattern is still going to progress as described above.

The weekly USD is shown below. The upper Bollinger bands are starting to fan out, suggestive the next ribbon formation is starting to get ready to slowly form. I have drawn sloping red lines to indicate the slope of the rising stochastics. Accompanying this are vertical lines to show the point corresponding to bottoms in the USD and subsequent rises. Most of the slopes are generally sharp. Note the recent slope that has been developing and compare the two red circles. Failure to produce a strong up-trend is a sign of a lack of strength. The USD is likely to hit 83 in the next week, followed by a partial retracement that could last a week or two. Time will tell, but it is best to tread carefully, because a prior article I posted suggested the USD index was going to 60 in the coming 18 months.

The Elliott Wave count of the mid-term USD index is shown below. I had to modify the last portion of the count due to the rapid ascent in the index. I think the wave 1.(5).[1].c is ugly, but that is life. The completion of the impulse down has a high probability of now being complete and is set to rally to one of the Fibonacci retracements. A move to 85.34 represents a 61.8% retracement of the decline. The time horizon for this move is minimally one month.

The short-term Elliott Wave count of the USD index is shown below. The count required changing due to the rapid ascent of the USD index during the past 4 days. Wave 5.(5) below was a terminal impulse (3-3-3-3-3). This implies that 82.6 will be hit, most likely by Thursday this week. The move up in the USD has a corrective signature.

David Petch
TreasureChests.info

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