Precious Points: Cut, Bernanke, One More Time!
So, we didn't get our liftoff last week exactly as expected, or perhaps it's still playing out, but the issue for the bigger picture in gold remains. Remember, what has to be decided is whether this is the middle part of a corrective pattern from the 2006 highs or the start of a new impulsive bull leg. Ultimately, silver will probably take its general direction from whichever outcome is decided for gold, leaving a very bullish future with the possibility of one more correction first. $14 ... remains a psychological resistance level. The Street seemed to shrug off the much higher than expected PPI data last week, but it is unlikely to do so again if CPI comes in above expectations. Expectations for further rate cuts in the US, though decreasing, persist. The greatest risk to the rally in gold ... falling expectations for another cut. ~ Precious Points: Liftoff? October 13, 2007
It was the liftoff indeed as gold's bounce off the triangle trendline described here last week extended over $770 in the front month futures contract. Any question as to the short term direction for precious metals was settled Monday night with Chairman Bernanke's recounting of recent financial turmoil to the Economics Club of New York, wherein he asserted that inflation readings would continue to be "favorable" as housing drags on the overall economy through at least the first half of 2008.
As if echoing this portion of Bernanke's remarks, Sectary of the Treasury Henry Paulson said in a high profile speech the following day housing would drag on the economy longer than expected. Though falling housing prices and the writedowns suffered by owners of asset-backed derivatives suggest a deflationary spiral, these comments seemed to renew Bernanke's pre-chairmanship promise that any deflationary period would be mild and short lived, and his speech had the overall effect of opening the door to the idea of further rate cuts on October 31 and, of course, to further weakness in the dollar and further strength in precious metals.
This was somewhat of a reversal from last week, which saw decreasing likelihood for a another rate cut which threatened to spark a rally in the dollar. Instead, as comments in the TTC forums indicate, the dovish posture from the U.S.'s top economic and monetary policy makers clearly tipped the scales in favor of further advances for gold and silver - enough so that we at last entered the target area for this advance according to the corrective pattern from the May 2006 high scenario. Remember that theory would have a seemingly impulsive move make new highs, fail, and retrace the advance well below $700. As this update has maintained for weeks, the current advance in metals, and gold in particular, has been almost entirely based on currency rates, and these hinge on relative economic strength as well as the degree to which the Fed remains dovish and the ECB hawkish.
The only real scare came as Bernanke spoke about "uncertainty" Friday morning, seeming to suggesting at first glance that any premium built upon rate cutting expectations were unfounded. But, upon further inspection, however, it could be reasonably argued Bernanke was actually further establishing the foundation for another cut in October. Though he had acknowledged the Fed's success at on Monday in stabilizing financial markets, a fact that is supported by recent indicators, his attention began to shift towards the larger economy on Monday and this shift was fully realized in Friday's address to the St. Louis conference.
In complex, technical jargon, Bernanke's speech essentially traced the history of a certain line of thinking related to economic uncertainty as it pertained to the Fed's choice of policy instrument. Previous editions of this update spotlighted the current interest-rate targeting regime, calling it Bernanke's beautiful machine, and noted its relative benefits for inflation-sensitive commodities like precious metals compared to the alternative approach of dictating money supply growth. If Bernanke is in fact, acknowledging the inherent difficulties of maintaining an interest rate target in uncertain economic terrain and therefore contemplating abandoning a fixed Fed funds target rate in favor of a controlled rate for money supply growth, this will have uncertain effects on gold, but will probably be negative in the balance.
However, the much more likely interpretation, at this juncture, of the chairman's admission that "intuition suggests that stronger action by the central bank may be warranted to prevent particularly costly outcomes" is that Gentle Ben is preparing the ground for another rate cut. Though the market is becoming increasingly dubious of the Fed's ability to smooth out the business cycle and save a receding economy, it's difficult to imagine anything but an enthusiastic response from precious metals markets to further policy accommodations.
And then, of course, there's inflation. Bernanke explicitly affirmed the assertion here last week it was utter foolishness to assume the Fed no longer cared about inflation. To the contrary, Bernanke explicitly said uncertain times like these make the Fed's ability to anchor inflation expectations, that is to create a sense of trust in the general public as to the Fed's inflation fighting abilities, central to designing effective monetary policy. And how is that accomplished in the face of steadily rising oil and gold and a sinking dollar? The Fed is able to point to declines in its core CPI, where declines in the average cost of college tuition, landline telephones and automobiles outweigh rises in housing costs as an overall reduction in the expenses of the typical American consumer. And of course the higher costs of gas and food don't factor at all. So, to the Fed, you can own a new or used car, but you can't drive it enough for the cost of gas to factor into your monthly expenditures. Sound like anybody you know? Me either.
Still, the Fed can probably depend on falling housing prices and the consequently weakening economy to keep a lid on aggregate demand and inflation for the time being, making their "favorable" inflation expectations at least credible. But in the face of such a fragile situation, and with at least one presidential candidate calling for the outright dismantling of the Federal Reserve System, the role of Federal Reserve chairman will not be easy and Bernanke is probably wise to remain the humble academic. And as his fate and that of his institution unfolds, the dollar price of precious metals will be a key factor in shaping public perception and political exigency.
For several months, this update has held the 5-week simple moving average in gold as a sort of barometer for the short term health of the gold bull market. In most cases, two consecutive weekly closes above this level have a high correlation with extended rallies of $40-$60 or more. This level has been explicitly mentioned in the TTC forums and chatroom as the bare minimum for confirmation of a reversal, even now that we're in the target range for the corrective pattern. It's therefore a bit surprising that so many continue to take short positions in gold. After Friday's developments, near term volatility is virtually guaranteed, but without even a retest of the 5-week moving average, it's impossible to expect anything but a consolidation leading to new highs. Before long, if this proves to be the case, the corrective pattern will be invalidated altogether. But it isn't yet.