Honest Money Gold and Silver Report: Market Wrap
Week Ending 9/12/08
Because our economy uses a paper fiat debt-money system, it is pre-ordained that the monetary system must inflate or die. It can be no other way. Money, credit, and debt are the same three faces of Eve in paper fiat land - you can't have one without the other. They are like the three sisters of fate.
Paper monetary systems either implode by deflation or explode by hyperinflation. There is no example in history of a currency ending by deflation. There are numerous examples of currencies being wiped out by hyperinflation.
The Federal Reserve is responsible for the most excessive orgy of money, credit, and debt creation known to man. What we are witnessing today in the financial markets is a result from that which came before. The only way to stave off deflation or hyperinflation is to stop the inflation that precedes it. But that is much easier said than done. A paper fiat money system guarantees that inflation is the order of the day. Once the imbalances grow to the proportions they have today - the system has one of two ways to relieve the pressure: implosion or explosion - deflation or hyperinflation.
Until recently inflation was ruling the roost. That didn't mean that deflation wasn't at play in some segments of the economy - it was. Real estate, housing, mortgages, and related businesses have been deflating for a while now. At the same time, commodities, medical costs, college tuitions, energy, and food prices have been rising through the roof.
In the last few weeks the tide has turned - now it seems that deflation is ruling the roost, at least for the time being. The question is - is it really and for how long; and what precipitated this change? Can it change just as quickly back the other way?
Yen Carry Trade
The Fed and other Central Banks have been creating money and credit with reckless abandonment: inundating the world with Federal Reserve Notes and other paper fiat currencies. Our greatest export is inflation.
Japan has been lending money at ½ of 1% interest - the lowest rate in the world. This low rate of interest created the yen carry trade. Investors and financiers borrow money at Japan's ridiculously low rates. They turn around and lend the money out at higher rates. The spread between the two rates is pocketed as profit.
One of the big trades that the yen carry trade fostered was the short dollar trade, which involved many sub-trades: shorting the dollar, going long oil or precious metals, and going long other commodities as well.
Short Yen - Long Commodities
Suddenly the multi-faceted short dollar/long commodity trade has turned and is no longer working. Huge positions built up over months and years have to be unwound. The recent drop has been violent and relentless. The pendulum has swung too far to one side. Deleveraging and liquidity is now the order of the day.
A major hedge fund that was highly leveraged went under the other day. All its leveraged trades went down with it. There will be further repercussions, as well, as other funds go under. The world of finance is too interconnected - similar to bookies that lay off risk to one another. There is an emergency meeting this weekend to discuss Lehman's fate.
Anyone caught on the wrong side of this trade had to unwind and get out. This caused a cascading waterfall that tripped off one sell order after another. Then analysts and retail investors picked up on the news, and a new wave of selling hit the markets. It has now reached a panic cry of just get me out at any price - I want out.
The important point in all this is that the precipitating factor that appears to have caused the recent sell-off is the deleveraging and unwinding of all short yen and long commodity trades. Once it started it became a self-fulfilling prophecy.
A chart similar to the one below was shown in last week's report. It shows that the 10 year note has had big moves down in rates followed by big moves up in rates. It's almost as if deflation scares led way to inflation reality or credit creation. The Fed must inflate or die.
Back in the 8/15/08 market wrap I had two sections titled: Has Anything Changed; and Deleveraging. The topic of deleveraging has already been covered above.
The fundamental outlook for the economy and markets are summed up in the expression: Has Anything Changed? The answer is no, nothing has changed. Our economy continues to produce more debt than anything and one financial fiasco and bailout follows another.
Wall Street rallied on the recent bailout of Fannie and Freddie, as did the U.S. dollar. Don't worry - the Fed and the government will bail us out. Excuse me - who will bail who out?
Isn't it the taxpayers and all holders of Federal Reserve Notes that are paying for all these bailouts? Where else can the full faith and credit of the U.S. come from except from the backs of We the People?
All of which means the fundamentals point to continued destruction of the purchasing power of the U.S. dollar, which tends to point to higher costs not lower. Gold will respond in kind - it's not a question of if, but when.
Real interest rates (nominal rates minus inflation) are negative, a gun to the head of one who would dare think of saving as a form of wealth creation.
This can only put a wind to the back of gold's long term trend and most other commodities as well. Expect more bailouts: Lehman, GM and others are waiting in the wings.
If anything the fundamentals have become more bullish for gold, at least in the long term. But Mr. Market can stay irrational much longer than we can remain solvent. His pockets run deep - ours do not.
When the market moves, either be aligned with the move or get out of the way. Life stops for no man - it continues on undaunted. Quarter is seldom given. Remember, however, when the Fates finally speak - even the market bows in reverence.
Paper or Gold
Although the fundamentals speak in gold's favor, the technicals are deteriorating daily. Friday, gold had a reprieve from its recent correction. Was this just a dead cat bounce, or the start of a change in trend? It is too early to tell, although a change in trend right now is doubtful.
The fib level at 730.40 is being tested. If broken the next level is 644. Gold needs to soon turn up and stay up, or the cyclical gold bull will be over.
A secular gold bull will still maintain, but that's a horse of a different color, as written about in previous reports. The fib level at 644 is the 50% level of the entire bull move to date.
Cyclical trends in larger secular trends can have 50% or greater corrections, as history shows. In 1971 gold went from $35 an ounce to just under $197 an ounce by 1974. Gold then broke down to $103 in 1976, and then put in its biggest move to $850 in 1980.
The entire secular move encompassed 9 years with some serious cycles in between. Needless to say, it was a gut-wrenching ride to stay on the bull through all the twists and turns. History does not always repeat, but it does rhyme.
Gold's short and intermediate term trends have broken down. The August low was taken out and a new low formed in September.
Price needs to reclaim the bottom horizontal trend line, which it is attempting to do.
With so much downward momentum, the Sept. low will most likely require testing before gold can begin a sustained rise of any significance.
GLD's daily chart shows the steep fall that has occurred. It will take a lot of work to repair the damage done. Some positive divergences are beginning to form. Money flow (CMF) still remains negative, however.
Silver has been much weaker than gold. As the chart below shows, silver has already given back almost 61.8% of its bull market gains.
Price needs to turn around quickly or the cyclical bull market will no longer be in effect. Some have already proclaimed its end.
Gold stocks have been hit even harder than physical gold. Today (Friday) they had a good rally; however, it remains to be seen if it was a dead cat bounce, with further testing of the lows needed; or if it was the start of a change in trend.
The long term chart of the XAU shows it is just barely hanging on and remains within the lower confines of its positively sloped channel.
The daily and weekly charts for the XAU look worse than the monthly chart, and suggest that further weakness may yet occur. Only time will tell.
The fact that prices broke below their August lows is not a good omen. However, the gold stocks are very thinly traded and it doesn't take much money to move them significantly - in either direction.
If gold stocks fall much further it appears the cyclical bull market is over. I have not yet made that decision - others have.
The HUI Index is performing better than the XAU or the GDX, both of which have closed below their August lows. The HUI broke below its August low, but rallied to close back above it (at least for the time being).
Once again the question remains as to whether this was an oversold bounce or something more. It felt like a lot of short covering was taking place.
Follow through confirmation is obviously needed, and we will not know that until next week. RSI does appear to be putting in a double bottom, including a higher low. But that too can change quite quickly as we have seen.
The Fed's primary goal is to keep the Treasury bond market stable. They take no prisoners in this quest: be it the dollar, stocks, gold and silver or other commodities. All is considered fair game and grist for the mill.
Although extremely powerful, they are not omnipotent. They cannot control the market. They may be able to influence it to a large degree, but that ultimately creates imbalances that must be rebalanced. When the fates declare the balance is due - all pay, regardless of their station.
The chart below hints that the dollar may be bumping up against significant overhead resistance at the 80 level. In past reports I have mentioned this significant zone.
Notice that RSI has made a double top with a lower high. Once again, confirmation and follow through are needed.
The tide has turned and most players are dollar bullish and commodity bearish. Recently, this has been the correct position to take. However, there are divergences and subtle nuances that are hinting a short term bottom may be building. This does not mean that one should back up the truck or mortgage the farm - simply watching what unfolds with a shopping list handy may, however, be in order. Last week was the first time we have bought a gold stock since the decline began. We bought AEM on Wed. and sold it on Friday. We got lucky - we'll take it.
The fundamentals remain positive for gold. A few of the more important are:
- Debt levels
- Savings levels
- Excessive Credit Creation
- Negative real interest rates
- All world currencies are paper fiat
- World currencies are continually devaluing
The technical data on gold is questionable.
- Long term trend still in effect
- Short term trend has broken down
- Intermediate term trend has broken down
Recall that paper fiat currencies eventually morph into either deflation or hyperinflation. Deflation does not end a currency - hyperinflation does. Deflation cannot follow hyperinflation.
As the 10 year T-note chart showed, interest rates have been a jagged affair: up for a while and then down for a while. It's almost as if room has continually been made for the inflation that must inevitably come.
Bernanke fears deflation. He has vowed to fight it tooth and nail; and he will. How - by inflating. But such action is walking the highest of high wire acts ever dared. One slip and hyperinflation takes hold.
That is when gold (unfortunately) shines the brightest. Gold is the ultimate insurance against currency debasement and ultimate currency destruction. It has been for thousands of years. Like most insurance - hopefully it will not be needed.
Good luck. Good trading. Good health, and that's a wrap.
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