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December 19, 2006

BOJ Is The Key
by Captain Hook

Below is an excerpt from a commentary that originally appeared at Treasure Chests for the benefit of subscribers on Tuesday, December 5th, 2006.

With both Bernanke and Paulson heading to China soon, one should definitely not be surprised if the dollar ($) bounces higher in coming days considering they will want to make it appear the world likes a close relationship with the States. And let's face it, we are talking about the China connection here, the one with America that keeps the global debt bubble afloat, which in turn feeds all the assets bubbles, making it the cornerstone of the 'globalization model' bankers around the world envision as our destiny. It's the 'new world order' you see, seamless in terms of freely flowing capital and resources independent of both geographical and political constraints. Of course when oil goes to $150 per barrel at some point in the future, and politics brings geography back into a former light, this view of the world will be well tested, and likely fail with fiat currency regimes within process. But this is a discussion for another day.

Today we will focus on the $, because as Cliff Droke points out in his latest, it might bounce soon considering sentiment is pervasively bearish now. And although I cannot agree with Cliff on the $'s fortunes past the observation sentiment might be a bit too bearish right now for a continued slide, what you will be happy to know is it does not matter what it does moving forward in relation to influencing gold pricing. No, in fact it's not the $'s movements that has a tight and direct correlation with the gold price, but Japanese equities believe it or not. And in spite of what some will have you believe, Japanese equities are depend on pressure the global economy's pipe remaining strong, where when we circle back around to the primary point made in our opening remarks, in terms of fiat currency pricing, gold needs to see the US and China getting along trade wise, which will allow asset bubbles to continue growing within the current global trade model.

Did you catch that? Let's go over this understanding again so that you don't miss this point because it's important. In terms of EXISTING FIAT CURRENCY REGIME PRICING ($'s, Euros, etc.), where one must realize precious metals can be priced in relation to just about anything, including new currencies that may replace existing ones not far off, in order for prices to continue rising, not only do all the asset bubbles floating around need to remain buoyant, but the mother of all bubbles, the credit bubble, must also remain healthy. This is so precious metals markets can be made into bubbles in terms of current pricing measures as well, where in relation to other asset classes more recently in favor, real purchasing power attains better historical comparisons. Of course the best known example of this is the DOW / GOLD relationship (the Dow / Gold Ratio), where at an extreme in the revaluation process, gold and the Dow should cross paths at unity in nominal terms once again to mark a Super-cycle top.

Placing such considerations aside for the moment however, and returning to the point we were making above, it should be understood then, the primary mechanism that will keep gold moving forward in bull mode is a buoyant Japanese equity profile, which in turn is not only dependent on Japan's willingness to add liquidity to the global financial system, but more, and specifically in its own case, its willingness to expand its own monetary base. You will see the implications of this understanding below in chart form with gold overlaid on a Nikki plot. And of course the implication here is global equities (led by gold) inflate best when Japan is growing its own economy via expansionary 'quantitative easing policy' (growing its monetary base), married the low interest rate (free money) yen carry trade that is key to providing marginally required liquidity within the big casino. The folks over at Contrary Investor had much to say on this subject over the past week, as follows:

"Is the BOJ done in terms of the bulk of removing their prior quantitative easing efforts of the last few years at least? It sure could be. We fully expect more interest rate increases to come from the fun folks at the BOJ, but they will be gradual, if not glacial. So as we watch this change in the rate of decline in the Japanese monetary base, we need to ask ourselves whether Japan will once again heat up as a global liquidity factory, so to speak? And if so, how can we benefit, if at all? First, we need to remember that the carry trade (borrowing at low interest rates in Japan, hedging currency cross rates, and investing elsewhere in much higher rate of return assets) has not stopped in the least. The fact that the Japanese yen has been declining steadily since really early summer is darn indicative of the fact that the carry trade has anything but dissipated in aggregate. Just a few weeks back, Japanese monetary authorities made some noise about the need to more strictly monitor carry trade activities looking ahead. Perhaps someday they will really mean it. But at this point we have to continue to take a "we'll believe it when we see it" attitude toward any BOJ effort to reign in the carry trade action given their historical implicit don't ask, don't tell policy. Moreover, it very well could be that the action of contracting the Japanese monetary base is at least temporarily over due to recent Japanese economic stats/indicators turning down a touch. In the last few weeks we've seen year over year rate of change declines in Japanese M2, vehicle sales, machinery orders, CPI (core - ex food and energy), the leading indicator, and now the second consecutive monthly decline in retail sales. With this has come the stabilization, at least for now, in the monetary base as BOJ authorities have clearly taken their collective foot off of the monetary brakes.

Again, why do we bring this up? At least in our minds, for a global financial marketplace, and economy for that matter, that has been relatively heavily dependent on excess liquidity availability, we need to continue to try to monitor all available sources of meaningful global liquidity generation. If the actions of the BOJ are not a critical part of this larger exercise, then we're missing something. As we've mentioned probably too many times now, pre-election liquidity 'availability' has been a key characteristic of the US environment courtesy of the Fed/Treasury/Administration. And that excess availability, if you will, has found its expression in financial asset prices, completely bypassing residential real estate markets. The thought among certain segments of the investment community has been that as the election period passes, so too the need for the domestic monetary powers to be so 'generous' in their temporary and open market operations activities. So far, we have not seen any diminution in Fed/Treasury temporary or permanent open market activities. Although the forward level and intensity of Fed/Treasury actions ahead remains to be seen, could the BOJ become an important source of forward short term global liquidity generation once again, at perhaps the exact time US authorities take a 'time out'? For now, the stabilization in the Japanese monetary base says 'watch me'."

And if you go on to read the full text of their latest monthly offering, you will notice they point out that Japan's economy is showing signs of stress, and that this could foreshadow a possible return to an accelerated monetary easing, meaning a return to an expansionary quantitative easing agenda. What's more, and again pointed out in the attached, we will know this is the case when Japanese stocks begin to rise again, which as you know from our discussion above, would be good for gold.

This is why we thought it was a good idea to examine technicals associated with Japanese stocks at present, to see if any clues exist within this realm as to expectations concerning their fate. And wouldn't you know it, in fact it does appear the Nikki is about to vault higher again very soon based on a predisposition within key indicators that have proven reliable in terms of predicting future price movements. Take a look for yourself, just below. (See Figure 1)

Figure 1

In looking above, undoubtedly the most startling element of this chart, and as alluded to earlier, is the remarkably tight correlation gold has with the Nikki, moving higher hand in hand since 2003. You may remember, this was the time world monetary authorities were pulling out all the stops to keep the 'system' afloat, where Japan's efforts in stimulating its own economy through quantitative easing, along with the liquidity provided to the world through the yen carry trade, combined into what we can now identify as the centerpiece to global re-inflation efforts at the time. We know this is the case because since the Bank Of Japan (BOJ) withdrew much of the liquidity associated with quantitative easing earlier this year, shrinking its monetary base, both gold and the Nikki have stalled.

As mentioned to a new subscriber the other day in correspondence, where we were discussing identifying good stocks, finding diamonds in the rough is the game, meaning finding those that posses excellent value yet to be discovered by the investing world is our primary objective here at Treasure Chests. And as this concept applies to the Nikki at present, along with bringing your attention to the diamonds within the patterning of indictors in Figure 1, it becomes apparent via extrapolation that Japanese stocks are preparing to move higher, which not only implies expansionary quantitative easing policy is likely on the agenda then, but of course more importantly to us, gold is also likely preparing to advance in meaningful fashion once again soon, as well. Please remember, if you are ever wondering about our most current views on targeting, simply head over to the Chart Room and look at the annotated daily and weekly plots maintained with this information for your benefit. As you can see in the attached, our next target for gold is a Fibonacci resonance based projection up to the $800 area.

Before we move on to further chart related observations pertaining to growth trajectories for both Japanese stocks and gold, we would be amiss not further explaining annotated comments concerning the yen in Figure 1, so let's do so now. Here, and simply expanding on the core of our observations presented above, it should be understood that a low and stable yen is reflective of the condition foreign carry trade borrowers (think hedge funds) are happy with global growth prospects because they are not paying back the debt, meaning they see solid growth prospects in the future. Further to this, and as mentioned above, it's only when the yen plows through 90 against the $ should we worry in this regard, which is definitely not the case at present. What's more, and in circling back up to our discussion in the third paragraph above, it should then dawn on you that while a collapsing $ will definitely attract gold buying as an alternative currency, this might not translate into nominal gains immediately if other asset classes are suffering outsized losses at various times.

This of course does not mean gold will not go where its suppose to eventually (re-establishing itself as the basis of money once again), or that it will not continue to gain against other asset classes on a relative basis, not to mention its intrinsic value which can be expressed in any currency regime, old or new. No, its just that if a debt based crisis were to grip the macro, such an event could have a temporary deflationary / destabilizing influence on gold until reorganizations or stabilizing measures are implemented. What does this all mean? Well, one thing is for sure, you don't want to see a $ crisis, because this will mean the yen is appreciating, meaning the yen carry trade is being unwound. (i.e. borrowed funds are being returned to Japan causing the currency to appreciate.) And as we know from Figure 1, this would be bad for both Japanese stocks (along with all other equities around the world), and as mentioned, until it becomes the basis of money again, gold as well. Now wouldn't that cause a bit of confusion to see both the $ and gold collapsing at the same time. Of course this would only be in fiat currency terms (if that makes you feel better), and only when deflation finally arrives.

Not knowing when this will occur however, but of course monitoring the situation for clues, we did not want to leave this discussion without imparting just how excited we are about more near-term prospects for gold, where if the BOJ rejoins the 'full steam ahead' inflation party once again soon, which most assuredly the West will insist on at some point knowing proclivities, both it and Japanese stocks should fly any day now. So, the question then begs, 'when will we know equities are about to bust a move higher?' In borrowing another well founded observation from the good people at Contrary Investor, we just so happened to have looked at a more detailed chart of Japanese small caps, as measured by the Japan Smaller Capitalization Fund (JOF), and noticed that here too, the technicals point to substantially higher prices, where if for example the channel denoted in the plot below were to be re-entered, all hell would break loose to the upside for both it, and undoubtedly gold as well. (See Figure 2)

Figure 2

To continue our analysis past this point today would be a disservice to our existing subscribers considering they pay for this information. For this reason then, we must cut things off here. But, we invite you to visit our site and discover more about how an enlightened approach to market analysis and investing could potentially aid you in protecting your finances into the future. In addition to macro-analysis like that above to aid in top down opinion shaping and investment policy, we also offer opinions on specific opportunities in the precious metals and energy sectors believed to possess exceptional value. So again, pay us a visit and discover why a small investment could pay you handsome rewards in the not too distant future.

And of course if you have any questions, comments, or criticisms regarding the above, please feel free to drop us a line. We very much enjoy hearing from you on these matters.

Good investing all.

Captain Hook
TreasureChests.info

Treasure Chests is a market timing service specializing in value-based position trading in the precious metals and equity markets with an orientation geared to identifying intermediate-term swing trading opportunities. Specific opportunities are identified utilizing a combination of fundamental, technical, and inter-market analysis. This style of investing has proven very successful for wealthy and sophisticated investors, as it reduces risk and enhances returns when the methodology is applied effectively. Those interested in discovering more about how the strategies described above can enhance your wealth should visit our web site at Treasure Chests.

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