Gold Market Update
Originally published November 20th, 2008.
Gold has remained in a narrowing trading range since the last update late in October, which is looking increasingly like an intermediate base area that will lead to a significant advance. In the last update a relief rally was predicted on the basis that the preceding steep downtrend had exhausted itself, and this is what we saw, although it didn't get very far. About a week ago gold looked like it may be forming a Pennant, implying a drop to new lows, but the lack of follow through on last week's decline and subsequent partial recovery has resulted in the pattern opening out into a Triangle, which is increasing the chances of an upside breakout. On the 6-month chart we can see the pattern in detail, and how the rising MACD indicator, shown at the bottom of the chart, which is now well above its rising moving average, is conducive to an upside breakout soon. Although now looking set to break out upside from the range the chart shows that gold still has falling moving averages to contend with and is still within a larger downtrend that gives us a provisional target for an advance, which is the upper channel boundary currently at about $890, and if it should succeed in getting above that, the strong resistance in the $930 area.
A crucial factor determining whether gold breaks out upside is of course the dollar. About a week ago it looked as if the dollar was completing a Pennant pattern. It broke out upside from the suspected Pennant but instead of advancing strongly to a new high, it stalled out beneath the highs where it is now hesitating, and may be forming a Double Top. It now needs to break out swiftly to new highs - if it doesn't a reaction is to be expected which could be severe. The extremely large gap between the dollar and its 200-day moving average and between the 20 and 50-day moving averages shown on our 6-month dollar index chart indicate a high probability that the dollar will react heavily soon. Note, however, that this won't necessarily mark the immediate death of the dollar spike, as what could happen is that the dollar reacts back to either the support or the trendline shown, before turning higher and possibly advancing to new highs. This scenario would fit with gold advancing strongly soon, only to react back from the upper boundary of the larger downtrend shown on our chart above.
The latest COT chart for gold is most encouraging as it shows that the heavily bearish combination of a high Commercial short position and high Large and Small Spec long positions has now largely unwound. The COT chart is now at its most bullish for a very long time, and is supportive of a MAJOR uptrend in gold beginning before much longer. Once it does the extraordinarily oversold Precious Metals stocks sector is likely to stage a spectacular rally.
A major development of recent weeks is that the desperate attempt to kickstart the global economy by means of reducing interest rates effectively to zero appears to be failing. This strategy worked in 2003 and averted the impending deep recession at that time, but also fired up the housing boom and massive carry trade speculation. We had thought some weeks ago that it might have some effect this time round to the extent that it might engender an anemic recovery or at least arrest the deterioration and buy some time at the cost of inflation - but the strategy is clearly not working at all, as made obvious by the frightening IRX (13 week T-Bill) chart below, which shows that investors are prepared to accept effectively no rate of return in these instruments, implying a very low inflation expectation going forward.
What it all boils down to is this - after years of exponentially expanding profligacy based on unbridled expansion of the money supply and debt, the Fiat Money system has run out of track and is disappearing straight over the edge of the cliff. Most politicians and World leaders can't grasp this simple fact, their thought processes are rooted in an era that is now coming to an end - so their futile attempt to return to "business as usual" by means of zero interest rates and unbridled money supply expansion is having no effect - this is because in the same way that you can take a horse to water but you can't make it drink, you can drop interest rates to zero but you can't force people to borrow. The only hope for business leaders now is that aliens from another planet where interest rates are 10% or more land and they can get a carry trade going with them. Apart from that remote prospect we are staring straight down the barrel of a deflationary depression. Mr Barack Obama is about to inherit the biggest mess in history. One of the ultimate consequences of all this is a probable return to a gold standard, or at least something that re-establishes a linkage with the Precious Metals as an anchoring store of value. This is the last thing politicians want - discipline and restraint are not their cup of tea at all - and they can be expected to resist this with all the means at their disposal, but the implosion of the Fiat money system, which is now so overextended it is dissipating and collapsing back in upon itself, will ultimately leave them no choice. Thus, while gold would clearly benefit from an inflationary environment, it will probably end up doing even better in a deflationary one, especially where interest rates are close to zero, and we should not overlook that in a deflationary environment even if gold falls in nominal price, provided that it is falling less fast than everything else it is actually gaining in value. Finally GOLD IS MONEY - paper currencies come and go and when they are abused, as is inevitable in a Fiat system, they end up worthless, which has happened many times in history. This is why those gold holders who truly understand its value couldn't give two hoots about its price in paper money.