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The following is commentary that originally appeared at Treasure Chests for the benefit of subscribers on Thursday, January 3rd, 2012.
Rapa Nui, which is also know as Easter Island, is a living exemplar of why our bloated modern day society should be concerned about the future, where it appears we have failed to learn from the past - yet again. Because just like the early Rapanui people, who in a mass mania to have ever-grander Moai Statues self-extinguished both their habitat and society, we too, have fallen pray to false gods and materialism, only on a far greater and obviously more profound scale. In the case of the Rapanui people they almost completely deforested the island just to transport the Moai Statues to desired locations, which ultimately caused the population to crash from 30,000 to just 111, some 200-years after the peak. If our present global population were to follow suit moving forward, we go from 7 billion to just over 2.5 million, which is food for thought for all those who think affluence and accumulating unneeded material things is 'good'.
Certainly such things are good for those who consider themselves as 'winners' in our material world, but for everybody else, extravagance and excess only accelerate process, using credit, which borrows valuable and scarce resources from the future, lost to our children forever. Here again, lavish monuments are erected in outsized cities designed to re-enforce our reverence for materialism and the mainstream prophets it creates, none more profound than the larger credit pyramid itself, the ultimate enabler of false god worship within society today. As with the obsession on Rapa Nui however, this is all set to change as well. The credit bubble, as with the serial asset bubbles that were manifested as a result, are all deflating now save one, the next bubble, which will be in precious metals.
Because gold and silver represent sound money - money of the ages - money that cannot be inflated away at the whim of an increasingly debased society. Precious metals are the anti-thesis of the enablers, the perfect vessels with which to anchor a sound and measured commodity money system that can be trusted, and will become increasingly important as modern day fiat currency economies continue to unravel. This process is already underway in periphery economies that have grown under the Western banking model, however it's just a matter of time before the core begins to destabilize noticeably as well, where we are of course referring to the US at center.
Yes, 2013 will likely go down in the annals as the year the credit bubble officially burst in the States led by consumer credit in being the weak link of the chain. (i.e. governments will continue to debase their currencies as the general population attempts to deleverage.) Authorities have been doing a miraculous job of delaying the inevitable in this regard, continuing to enslave (in debt) both young and old alike. As with all fraudulent endeavors (usury) however, all good things must come to an end, with yet another serial credit bubble popping recently. But it's the derivatives bubble that's the elephant in the room, where credit related product still reigns supreme, meaning it's an accident waiting to happen. This time around, as opposed to 2008, it will be the bond market(s) that take it on the chin because they have been the primary beneficiaries of fund flows for some time now.
Supporting this view, and as you can see in the attached, it appears the rate at which the consumer will shed credit in 2013 is set to pick-up, which again, is why this coming year will likely see the debt bubble officially burst in the States. This is seen as why the Fed is pre-emptily printing money at an increasing rate, because they fear that fiscal cliff related drag could push too many consumers over their own respective cliffs, meaning 70% of the economy (consumers) is about to come under intensifying pressure. Of course with most Americans only semi-conscious at best, there senses dulled to political bickering such as is the case concerning fiscal cliff squabbling, one must wonder if the Democrats wish to use these circumstances for a good old fashioned 'tax grab', using the media to blame Republicans. (i.e. such a move would be a defacto power grab, increasing the size of government in effect.)
If this is the case, then it's not difficult to see why the bond bubbles might be in serious jeopardy here because while it's true Federal coffers might benefit from such a move (lower debt related ratios), in order to make up for the macro spending distortions such policy would create (forced austerity on the general populous), the Fed would need to work even harder, which would play havoc on money supply measures eventually. What's more, and as you may know, the debt ceiling is also set to be pushed over $21 trillion sometime in the not too distant future (rumors are by mid-January as part of the final fiscal cliff deal), which is inflationary on its own, and would push the gold price over $2000 if this relationship has any predictive value, which of course it does. Once gold takes out $1800, bonds should respond quite unfavorably, especially at the long-end of the curve, with prices at all time highs and the long-term channel top pictured below. (See Figure 1)
Because real cliff is not the fiscal cliff, but the larger debt cliff, as alluded to above. So, once increasing inflation in the US is signaled by both growing debt (think debt ceiling increase) and the resulting increase in the gold price, the bond market should find such conditions difficult to say the least, especially if ratings agencies follow-through on their threats to downgrade Treasuries if lawmakers don't cut spending sufficiently. Such an eventuality looks probable, however the timing is questionable. (i.e. such downgrades usually come after the markets have already done their work.) One must wonder then, just how long pressure can be maintained in the pipe if a US led global bond market route develops, especially if equities cannot get rolling in a sustainable fashion. The wedge in the CBOE Volatility Index (VIX) pictured below brings this concern to the forefront considering prices are attempting to breakout now. (See Figure 2)
Even if US price managers are able to stuff the VIX back in it's wedge for a bit longer (think volatility repression), which is happening via fiscal cliff related gaming (after the breakout Friday), as you can see above such efforts are not likely to last much longer in any event, which in swinging back to our discussion above, puts a very short timeline (a few months tops) on any rally hopes for the inflation trade, as measured by the S&P 500 (SPX). A rally in precious metals (and possibly their related equities) might last longer considering how oversold they are, however once the VIX breaks out on a monthly basis for real (again averted last month by fiscal cliff games and Fed's prop desk) one would need to become far more defensive even if this were true using history as a guide. Because some profound divergences could get closed in negative fashion given the games US price managers have been playing for some time now, which could literally bring the house down a la year 2000 or 2008 style. (See Figure 3)
In fact, if we see consolidation in stocks over the next few days weeks as more fiscal farce related BS is bandied about, the sequencing will be reminiscent of year 2000 timing wise, which was another instance of the Fed overdoing it for fear of an event (Y2K), which might be the case again, meaning stocks and the inflation trade would not last much past options expiry in March, at best. (i.e. notice this would push the VIX into the extreme nose of the wedge pictured above.) Such an outcome would be bullish for stocks, but the ramp job into March will not be anywhere near as robust as in 2000. And as you can see above, if the Amex Gold Bugs Index (HUI) can't get above 525 in meaningful fashion, the patterning suggests a trip back down to test the 2008 lows, which you should realize is a distinct possibility.
Such an outcome can be averted if the powers that be allow gold to so some serious catching up to global money supply measures, however one must remember they also do not wish runaway prices, so gold being allowed to rise much above $2000 is questionable. And if that turns out to be the case, profitability at mining companies (think HUI components) will remain challenged, again, bringing the head and shoulders pattern denoted above back into focus. Right now US price managers have reduced margins on gold futures and reduced short positions because they know the debt ceiling will be raised soon, and they are not about to stand in front of that train; however, this will likely be a buy the rumor and sell the news event to degree, so again, anything is possible. The pigs (think Animal Farm) will suck up most of the new money into the bureaucracy and larger machine, leaving relatively little for independent investment (they will buy junk bonds not gold), allowing the repression trade in precious metals to go back on when it suits them.
So, by all means be bullish on precious metals shares as the HUI ascends to the 525 area (perhaps spiking up to 550); however, past this point, one must be careful in knowing the above. And this is especially true if the gamblers keep betting incessantly bullish as has been the case as measured by open interest put / call ratios for NUGT and SLV (and AGQ), the latter being the more aggressive play of the metals. Remember, the bureaucracy, Beltway Boys, plutocracy's dogs (again, think Animal Farm), will stop at nothing to protect their supposedly cushy jobs, so throwing copious amounts of freshly printed currency at paper gold and silver pricing mechanisms at the appropriate times is a natural in order to preserve the illusion. (i.e. of low inflation) But of course as with the 2008 fiasco, the big risk here is when all the fiscal farce finagling blows up on their faces and financial assets take another bath, led by the bond market this time.
How are precious metals going to hold up when both stocks and bonds are falling at the same time because baby boomers have decided to deleverage in earnest? I guess we'll find out when the HUI gets up to the 525 - 550 range - won't we. We will find out whether they remain victims of the Keynesian nincompoops (crony capitalists, etc.) running the system; or whether the tables are turned, even if only for a brief moment. (i.e. precious metals outperform.)
That's the best answer to that question I can give you right now. Past this, it will be interesting to see just how much higher Da Boyz can jam stocks going into options expiry on the 18th with no shorts to squeeze. Something tells me that although a breakout will not be tolerated prior to the debt ceiling announcement (expect another day like today in stocks at that point, followed by an epic failure), the VIX will be vexing wedge resistance at that time, meaning the SPX will probably be back in the 1420 area.) This is why nothing of consequence is likely to happen in precious metals prior to index / ETF option expiry on the 18th. Again, if the sequencing is anything like the year 2000, after that, once the influence of these options is at its least potency, precious metals shares should briefly spike higher into early February.
And in attempting to rationalize the cause of the ramp-job in stocks over the past few days, the catch-phrase 'relief rally' does not cover it given it's ferocity. (i.e. note we witnessed the largest drop in the VIX on record.) No, as alluded to above, because of increasing desperation (as measured by increasingly complex games) on the part of the ruling class to maintain the illusion(s), with buoyant stocks at the top of the list, the VIX had to be stuffed back into it's box, or in this case, it's triangle. And in order to do this, key broad indexes are being monetized just like the bond market now, which will eventually have very negative implications for stocks eventually, all thanks to the various prop desks (think hedge funds too) that populate New York City. (i.e. what will they do when the VIX can't be stuffed back into it's wedge?)
We will all find out at some point in coming days, and it likely won't be good.