Playing Chicken With Deflation

By: Captain Hook | Wed, May 30, 2012
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The following is commentary that originally appeared at Treasure Chests for the benefit of subscribers on Wednesday, May 16th, 2012.


Much discussion and consternation surrounding a silver manipulation conspiracy led by JP Morgan (acting as an agent for the Fed, et al) has been circulating within the 'gold community' for sometime now, but more recently, it, along with everything else the banking cartel does to suppress precious metals, has become more than just 'paranoid hogwash' to increasing factions of the mainstream. The reason for this is because those in the know can sense the price is about to surge higher once again due to accelerating currency debasement policy by the central bank(s)(don't be fooled it's an election year and the printing is accelerating despite strategic rhetoric designed to have you think the opposite), where increasing numbers are repositioning for the coming paradigm shift, which will become apparent as the bull market in precious metals increasingly imprints on the less aware through process and time. At this moment we are at the beginning a period (sending prices higher over the next year) that will be marked by full acceptance of the need for gold (and silver) as money (a store of wealth not just another fiat currency) by governments (central banks) and institutional investors, but not the public -- not yet.

No -- the public will not get it for some time yet (not until the third phase of the bull market running into 2021), with silver being known as 'poor man's gold' for a reason. No, like the tech bubble, which took the public roughly 20 years (from 1980) to jump into fully, sending prices into the stratosphere in the year 2000 (note: my harmonics study points to 2021, a Fibonacci 21-year cycle to mark the top in precious metals), if the precious metals bull market the same time span (and returns of similar degree), gold, silver, and any investments containing these words should be tripping the light fantastic in about 8 years from now. This is when 'the public' will get involved in precious metals if history is a good guide, sending prices 'to the moon' in a mania that could make the tech bubble appear tame in comparison. It's all happened before you should know, but this time around, because this is the 'Big Kahuna' cycle wise, expect the mania in precious metals (especially now beaten down shares) to be particularly spectacular. The more something is hated now the more it will be loved in 2021.

And please, whatever you do, don't listen to commentators who don't know what they are talking about. Don't listen to projections that put a cap on the gold price at $2,500 and silver at $130. These are the comparable inflation adjusted targets dating back to peaks in 1980 and they will likely be hit next year. Then, we will have another deflation scare post the election starting next year (expect money supply growth rates to slow) and running into 2014, followed by a build into the mania discussed above another seven years out. Make no mistake about it, gold and silver are not going away anytime soon. (i.e. its been ultimate money for thousands of years and will continue in this fashion.) In fact, expect just the opposite until a full-blown currency crisis (with the USDollar [$] at center) and mania in the shares have run their respective courses. These requirements still need to be fulfilled within the collective human psyche before an end to the precious metals bull market can be declared, and a new trend in unsubstantiated currencies begins again.

Now some are of the opinion precious metals shares will never be fully engaged in a mania; and, that the only reasonable play moving forward is in physical metals because paper markets are to easily manipulated. And to be sure this view is understandable given the performance of precious metals shares thus far in 2012. As pointed out in previous commentary the shares are plumbing relative nadir's against a plethora of measures dating back to the bear market lows of year 2000. What's more, and as you can see here, our most reliable sentiment measure associated with precious metals shares (open interest put / call ratios on ETF's) is not indicating a bottom yet either (it needs to diverge higher), which means more downside may be needed to finally chase away bullish speculators in the ETF options market. Remember, as pointed out previously, this is the only remaining sentiment measure not followed by these aggressive speculators, which is why it still works. (i.e. read the attached above carefully to discover why if you don't know already.)

This is why wrong-headed speculators are continuously toppled over by the authorities in their efforts to keep precious metals prices subdued. It's not COT conditions, or Market Vane's bullish consensus, or any other widely followed sentiment measures that are going to help us identify a possible lasting bottom in precious metals (the shares must bottom first -- hence the focus on them above). It's watching for a change in extreme gambler behavior that will finally thwart our price managing bureaucracy's algo attacks (the machines) on precious metals paper markets, which with any luck will come this week at options expiry. That's how these things go -- all of a sudden these speculators become exhausted and open interest put / call ratios go shooting higher. Then the short squeeze begins and the precious metals markets, again, led by the shares, will put in key weekly reversals. And there are a great many shorts in the market right now, so when the turn does occur, it should be quite violent.

Side Note: The trademark of a lasting bottom in the precious metals bull of the last 12-years has always been marked by bullish speculator exhaustion (dip buyers give up), where as market conditions have matured, the degree of convincing to have these characters believe the move is over has needed to get increasingly violent. Easily the best example of this was the 78.2% retrace in the shares witnessed in 2008 / 2009, which finally saw bullish speculators give up the ghost and abandon their betting practices. With open interest put / call ratios across the sector still extremely low and riding prices lower, if a marked shift in sentiment is not registered at options expiry on Friday, the signatured 50% retrace in the shares already witnessed will likely need to be exceeded convincingly once again. Make no mistake about it however, this shift will occur at some point in the not too distant future, and like in 2009, the squeeze higher will be something to behold, especially if QE3 is announced given current skepticism concerning the effectiveness of central bank profligacy.

May tends to be an important trend change month for precious metals (especially the shares), so it's quite possible, if not likely some sort of speculator exhaustion will be witnessed post options expiry this month. And we will be sure to keep you abreast of the situation. With precious metals shares now hitting a signatured 50% retracement from the 2009 low no significant further downside is necessary to sponsor a lasting rally if earlier historical harmonic signatures in the trade are still a good guide. Unfortunately however, because the markets are now heavily controlled (think the machines) betting parlors like never before; again, to arrive at this psychological condition it may take more convincing. (i.e. lower prices.) It's encouraging to see the open interest put / call ratios for GLD and SLV beginning to diverge higher, however in total we are still not there yet attitude wise considering their ratios are still essentially half of 1, and speculators in the shares, as measured by the GDX contract (the largest ETF by far), is still plumbing the lows at .5 as well.

Turning to some key charts from the Chart Room to illuminate on current circumstances, we return (highlighted in my last public commentary) to the monthly plot of the Dow / TSX Ratio because it has triggered the much feared 'deflation signal' (with a breakout above 2008 highs), which is undoubtedly the chief factor why precious metals (and their related equities) are falling at present. Certainly falling and generally low open interest put / call ratios on the key ETF's also have an influence on pricing (along with everything else algo, shorting, etc.), and it will be interesting to see what happens next week post expiry, especially if Bernanke doesn't say anything by then. Even if he doesn't precious metals will likely bounce post expiry, but it won't last. (i.e. even if the lows are put in this week, which is a distinct possibility, they would likely be tested by a higher low sometime in July or August.) (See Figure 1)

Figure 1
$INDU:$TSX Chart
$INDU:$TSX Chart

Does all this mean a lasting deflationary episode is about to grip global macro-economic conditions? Answer: Given deflationary conditions are always with us (think continuous capital destruction and currency burn-off), and that during times of 'inflation' this simply means monetary authorities are printing more new currency that is leaving the bubbles, the answer to this question is no. What this does mean however is that if the Bernanke keeps playing chicken with deflation, and he leaves this condition open too long, capital destruction could domino uncontrollably, causing the need for hyperinflation sooner rather than later. This of course assumes the decision to re-inflate will always be the default program chosen by central bankers. History tells us this is the safe bet, so it will be interesting to see if the powers that be (think Bennie) will allow the monthly breakout here to occur. Even if he does, the chart below tells us to expect a reversal in coming months, perhaps as gasoline prices breakdown (his debt to Obama paid), and he figures out the macro is now deflating at an accelerating rate. (See Figure 2)

Figure 2

Because in terms of central banker logic this is not suppose to happen. What is supposed to happen is money (it's really only currency) creation should be expanding at an accelerating rate. What an actual deflation scare will do is simply increase volatility as macro-conditions slip in and out of deflation / inflation, giving us a schizophrenic economy / markets where volatility (and instability) is the key operational condition in play. Again, what Figure 2 is telling us then is while we may continue to get a deflation scare in coming weeks, hopefully the Bernanke figures out just how dangerous present policy is and reverses course on the premise his buddy won't get re-elected if the economy crashes either. This of course assumes he is capable of figuring this out, which is questionable at best given his track record. One thing is for sure, precious metals speculators will be far more wary moving forward after this correction, which is likely why silver is on a major timeline turn interval, meaning a reversal should be witnessed soon. (See Figure 3)

Figure 3

And while it should be noted silver could see additional downside before a bottom is put in place given present technical conditions (which can be seen on the monthly plot next as well), looking in the other direction, once Bennie and company print enough new currency to bail the world out (most noticeably the banks) once again, an inflationary tone (which will progress to hyperinflation eventually when the feds panic) will return to macro-conditions, sending silver through key resistance at $33. Once silver is through $33 it won't take long for it to get back to previous all-time highs at $50, and then off to trajectories unknown. (See Figure 4)

Figure 4
$Silver Spot Price
$Silver Spot Price

The key understanding to grasp here is because human frailties and decision making are involved, process will be 'sloppy', for lack of a better word. This is why, as a long-term buyer/holder/whatever of precious metals you must keep the faith Bennie and his buddies will repeat previous behavior. But again, the ride will undoubtedly be a rocky one, which means silver might need to fall into the $27 area, or lower if technicals in Figure 4 (monthly chart) descend to delineated supports. (Note: RSI might need to fall to channel support at 40, which would take silver back to the sub-$25 range.) This would rattle some cages and change speculator betting practices for a very long time most assuredly, which might cause the more optimistic count denoted in Figure 4 (that the last wave up to $50 was only wave 1 of C or that wave E extends beyond belief) to become a reality. This is certainly possible from the perspective participation rates in silver are still in their infancy, which is reflected in ongoing depressed levels in Figure 5, measuring macro-investor propensities for holding silver as opposed to stocks. (See Figure 5)

Figure 5

Further to this, and in relation to previous commentary on the subject, it appears the world is now inside the pickle jar with Bernanke and Obama, where the Bernanke is willing to risk all out deflation in order to knock commodity prices (think gasoline) down in order to have his buddy (Obama) re-elected. Because were Romney or Paul are elected besides Obama, the Bernanke will be sure to receive an exit visa for his prized position either way. What is happening is while Bernanke and company are indeed printing money (monetizing), the rate at which this is occurring has crashed in relation to levels in 2008 / 2009, which is having an aggregate negative drag on the world's always deflating fiat currency economy(s). (i.e. the world's fiat currency economy, which rides like a cloud above the real economy and can block any sunlight until lifted, is like a big balloon with a multitude of little holes in it leaking because of the inadequacies and burn off resulting from the human experience, which constantly needs to be re-inflated (currency / money printing of greater diversity and amounts) in order not to implode.)

Along these lines then, what is happening right now is because the world's fiat currency economy(s) is losing air faster than it's being replaced by the world's central banks, where some key players are actually allowing deflation at present (something the Fed will need to make up to maintain the dollar ($) as world's reserve fiat currency), informed precious metals investors (these are not necessarily smart / seasoned long-term investors who expect this kind of thing from time to time in a bull market cycle) and speculators (greedy / algo dependent hedge funds) are selling (many now actually shorting) precious metals because of a deflation risk if this condition (insufficient money printing) were to persist. This is of course will never be allowed to happen (again, especially in an election year), because even though Obama needs to knock the stuffing out of the commodity complex (again, especially gasoline) (see previous commentary for greater perspective in this regard), Bernanke is essentially playing chicken with deflation in effect, where we are in fact standing at the doorway to the abyss at this very moment. (i.e. see Figure 5 in directly above attached commentary.)

In this regard I find it incredible it takes an actual deflation scare to get precious metals paper market pricing mechanisms aligned to allow for higher prices this far into the bull, where a 'wall of worry' must be reflected in gambler betting practices (see explanation above) in order to squeeze prices higher, but that happens to be the case apparently, so we will just have to live with this condition. This will change at some point when physical bullion supplies run out, but there's no telling how long it will take for such a condition to develop. In the meantime, we will continue to be subjected to the vulgarities of our banker controlled fiat currency based economies and markets, where all that matters is how fast the balloon(s) are inflated, and speculator perceptions / betting practices.

So, as for the possibility of the Bernanke and friends allowing the larger economy to slip into a lasting deflationary environment by mistake; consider this a low probability, which means fade the present trade with a sense of purpose. Because once they figure out this is the risk you will hear words emanating from their general direction to the effect that QE3 is a go, and market participants will know the Fed (and friends) were indeed only playing chicken with deflation, and no matter how much stimulus is needed to drag the economy from the bowels of recession is necessary it will be conjured up via the printing presses. QE announcements are code language for this, and QE3 will be no exception to this rule considering this is an election year, I can assure you. QE3 is code language (Fed Speak) for it's serious this time boys, which will turn leading hedge fund players and plugged in large speculators from being sellers to buyers.

And I can also assure you to expect growth rates on both M2 and the monetary base (seen here) to accelerate higher from present levels, where further monetization (QE) should send the later skyrocketing once implemented, and the former into historical highs, and beyond. The degree of swing lower (extreme) in precious metals shares may have you wondering in this regard, however again, I can assure you this should not effect potentials and ultimate outcomes once the negative sentiment feedback loop (persistent excessive bullish betting in paper markets / derivatives) works its way through the markets, sending prices dramatically higher than most think possible today as they climb a true wall of worry. (i.e. once gold / shares go above certain levels, like the stock market today, speculators will sell all rallies, and the perpetual short squeeze that aides stocks in trading far above their fundamentals will also help precious metals (and especially their related equities) trade up to their fundamental values, and far beyond.

Please, take a good look at the potential and well-reasoned moves Mark Lundeen is talking about in this attached commentary. This is not fairy tale material we are talking here; simply a repeat of history (in terms of investor psychology), which with any luck (and lack of official interference) -- will at least rhyme. Here, it's difficult to imagine paper currency prices not rising if like Ron Paul says, no gold may be left in Fort Knox, which is why an audit should take place. What's more, it's difficult for me to imagine gold shares not rising if the public (and institutions) are essentially locked out of the bullion market (because Western governments need to outlaw future public purchases of physical metals in order to replenish their own depleted reserves) -- very difficult indeed. (i.e. with no other alternatives.)

There are multitudes of uniformed (uninterested), disbelievers, and official participants / sympathizers who will necessarily need to buy precious metals one day who remain uninvolved to this day despite a decade (plus) long bull market in precious metals. One day our society's collective denial about our future prospects (economically, financially, etc.) will shift into a paradigm that more closely resembles reality, and all this will change.

One day this collective denial will shift rapidly to a buying panic as increasing numbers realize, like this 12-year old girl (it's shameful adults have difficulty in this regard), official / central bank related confiscation of the common wealth will not end until our society is completely enslaved, where for all intents and purposes, it already is. (i.e. enslaved by debt.)

So, ignore these realities and eventualities at you own risk, where the stakes are increasing every day.

Good investing all.



Captain Hook

Author: Captain Hook

Captain Hook

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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