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March 13, 2007

The Need For Speed
by Captain Hook

Below is a commentary that originally appeared at Treasure Chests for the benefit of subscribers on Tuesday, February 27th, 2007.

The world is awash in dichotomies, misperceptions, and imbalances that make it very difficult indeed for independent investors to safely navigate shark-infested waters of the seven seas today. A good example of this is the spin media types are attempting to pawn off as a rational explanation for the quarter point rate hike in Japan last week. As per the attached, and consistent with central bank community party line 'rhetoric', or 'propaganda' if you will, monetary authorities in Japan are attempting to make it appear the economy is just right, as with Goldilock's porridge, not too hot or cold. Of course anybody with an IQ greater than a grapefruit knows what's really happening behind the scenes would be better reflected by a story involving the Big Bad Wolf actually gobbling up the naïve little girl, but your not likely to get any fairy tails like that out of the propaganda machine these days. Not with the reality of the situation so precarious your not.

Along these lines, governments of the world want to keep commodity prices under control because just about everything is now feeling the effects of inflation, and it's getting harder to hide, threatening to spoil the party one of these days. Our recent discussion involving what we see as a relentless ascent in base metal prices due to supply pull conditions (tight supplies) is particularly poignant in this respect, where here, surface dwellers cannot understand why commodities are rising in the first place, nor do they care. The only thing these guys care about is the fact rising commodities will eventually eat into corporate profits, but so far both inflation and profits seem fine, and the stock market is acting well, so as an acquaintance from California recently espoused in conversation with me on the same subject, 'party on dude'.

Whether the party animals on Wall Street care or not however, the larger eventuality that will matter at some point is that rising input costs will slow profit growth, if only marginally in some areas, much worse within cyclically challenged economies. As I say however, not that anybody cares - yet. Why don't they care? Because like magic, no matter how bad the real economy gets, stocks keep rising because we are in the midst of the strongest inflation cycle in history. From China to Sweden, and from the Fed to the Treasury, never in the history of man has there been such a coordinated and widespread use of fiat currency policy within economic intercourse. What's more, never has there ever been a more speculative environment, with the current example of market participants already beginning to discount Fed-easing par for the course these days.

Are lower official rates necessarily a panacea for rising stock markets? Answer: At first perhaps, at least until everybody begins to expect more and stops shorting the stock market. Here, it appears the Fed may be ready to drop its defense of the dollar ($) before the stock market actually cracks given the extent of our dependence on asset prices now, with financials at the forefront in this regard. And the currency does appear sickly because increasing numbers are expecting the Fed to turn dovish soon, providing the appearance it's slightly ahead of the curve. Add in Presidential Cycle considerations, where if price managers don't watch out they could find themselves having to do some very heavy lifting right when politicos will be expecting stability, and again, one must begin warming up to the idea official policy might be set for a preemptive turn soon. This is of course the larger reason third years in a Presidential Cycle are normally strong in the first place, as incumbents goose the system in an attempt to get re-elected.

Is this what gold is sniffing out right now? Like a hound dog, is gold sniffing out a growing 'need for speed' in money supply circulation rates? If I were a guessing man, whom I prefer not to be, even here one would be compelled to answer 'yes' to the aforementioned questions. That is to say gold's recent strength is largely due to educated men observing accelerating underlying weakness in the economy and reacting rationally by accumulating inflation protection. This is of course why gold is currently out-performing input prices, and why it is indeed discounting 'the need for speed' then. Interestingly though, you may be shocked at this next statement. Gold has not even begun to properly discount the degree of currency debasement in the States because it's being hidden in several covert ways, not the least of which is off-the-books wholesale credit creation. Here, the Fed has already lost control of this boggy, and once the $ loses more of its appeal as global hegemony, even the currencies of well endowed (possessing resources) banana republics will make gains on the $. A look at a plot of the Broad Dollar Index ($$) tells the story here, where by 'hook or by crook' the greenback has enjoyed unwarranted strength against many smaller but more fiscally responsible economies. Again however, this appears set to change. (See Figure 1)

Figure 1

Source: The Chart Store

And when the $ begins to slide against a broader basket of currencies ($$), that's when the fun should really begin for gold. In this respect, as you can see above, the fun has not even begun yet. Old habits die hard though, and for most talk of (select) emerging market debt being sounder than that of the States would qualify you for a trip to the nut house. To these people, the fact the States has no realistic means of ever addressing its mushrooming debts doesn't factor into the formula. Do not kid yourself however, it will when the $ index is trading in the mid - 50's, which is my minimum secular target assuming it doesn't go off the map in present specie. Here, when global financial trends stop growing outward as the world turns towards regionalism, international trade will likely require countries to back external debts in gold again, meaning new currencies will need to be chartered.

Impossible? Consider this - what if bird flu starts to mutate faster, and within just a few short years from now is passing from human to human such that international travel all but shuts down completely. What effect would such an occurrence have the $? Well, for one thing, which will happen eventually if not for this reason, for others, the $'s role as global hegemony would become irrelevant. In fact, except for debt servicing obligations that would be done over a wire in order to avoid default, if both people and goods are not crossing borders, which would literally collapse the current global banking model, the sustainability of all fiat currencies will come into question. Do you think maybe once people see that writing on the wall this might be good for gold?

But, we are not even at that point yet. We are still a few years away from this kind of thing. No, we are still in party mode, where price managers think they are so smart now they can thwart any slowdown before it happens. Yup - they are going to paper over any and all problems that come their way. Well, excuse me, but I cannot help but conclude that this too is a very good reason to diversify my fiat currency into gold and silver, especially considering the States is well on its way to qualifying as a banana republic in its own right. Again however, we are not at this point just yet, which believe it or not is demonstrated in the fact the Silver / Gold Ratio is poised to make further gains at present. And as you can see on the attached monthly plot from the Chart Room, silver has a long ways to go against gold, meaning if history is a good guide we should expect sufficient inflation in coming days to continue masking the hidden recession / depression real world inhabitants face every day. Here, one cannot look at the world in which Wall Streeters exist to get an indication of what's happening in the real world because they are in fact the primary benefactors of all this inflation. No, please do not make that mistake, especially if you are one of the beneficiaries because it won't last.

Back on topic now, when silver is appreciating against gold this normally signals the economy and stock market(s) are in an upswing, and a 'healthy' (an officially stated rate of around 2%) inflationary environment exists. What's more, this is also when precious metals will make the lion's share of larger cycle gains as the fiat currency of the day attempts to escape increasingly visible inflation. You see it's not that a period of gold outperforming silver is necessarily bearish for precious metals, it's just that precious metals shares need a predominantly buoyant stock market environment to flourish as well, where as you may know, precious metal share to precious metal ratios have historically been the primary definers of a healthy larger sector. To go past this, where gold will likely hold a shine to just about everything, we are talking about gold's monetary role coming to the forefront, meaning financial assets are usually under considerable pricing pressure (think financial crisis), which also spills over into absolute pricing patterns of the metals in full measure. Of course this time could be different if governments begin revaluing gold for their own purposes, but such a circumstance may not arise until it's too late for your stock portfolio, or until after your gold bullion has been confiscated. This is why some precious metals investors stick to buying coins (legal tender), as the risk of confiscation is minimized.

Again however, we are certainly not at such a juncture yet. Nor should we be for some time if the historical comparisons on these analog charts prove accurate, which as you may have noticed is exactly what is happening. Of course some dismiss this whole vein of thinking because it's thought both people and circumstances are different today. In this respect I can assure nothing could be further from the truth, where not only is the same blood that was coursing through people's veins at similar junctures in the past still red today, so are peoples emotional tendencies, fear and greed both alike. Here, silver outperforms when greed is in charge, and gold when fear is at the forefront. So, on this basis alone, the fact silver still has quite a ways to go before it hits previous historical strength highs against gold tells us the entire Super-Cycle Degree move for the sector has a great deal more work to do. And of course conceptualization of the possibilities are endless, but I would like to show you a set of possible outcomes that should not be too far off the mark if the sector is truly in the midst of making another Super - Cycle Degree advance at present. Here is the first picture in this regard showing one possibility of how gold could theoretically react as it approaches Grand Super-Cycle sine resistance, currently at approximately US$750. (See Figure 2)

Figure 2

Source: The Chart Store

As you can see above, under this scenario gold would head up to sine resistance in coming days to mark a minor degree b wave before heading back down into the $500's to complete a Primary Degree II Wave bottom. And don't kid yourself; such a scenario, or worse, could in fact become reality if the equity complex begins to unravel soon. The price action in China's stock markets overnight, down some 9-percent in just one session, could be marking the beginning of such a test assuming this is not a temporary product of more warnings. What's more, on a structural basis, such a pattern would have to be considered 'normal' (a standard A - B - C corrective sequence), especially considering the importance of Grand Super-Cycle sine resistance, and how it has contained gold's pricing for hundreds of years with the exception of 1980's spike.

Is such an outcome necessarily 'baked in the cake'? Answer: Definitely not, but by and large, the above scenario is definitely within the realm of possibilities. Of course on the opposite end of the scale, if monetary authorities were to panic, a more polarized alternative could trace out something along the lines seen in the chart below, so really there is no telling what will happen other than to recognize long - term the future appears bright for gold no matter which scenario prevails. Here however, if a rush of capital flows into the sector gold could push up through Grand Super-Cycle resistance and continue on to the large round number at $1,000 directly in not only discounting the need for speed, but also growing fear and respect associated with the implications of accelerating inflation. Again though, such a condition will arrive at some point, but if history is a good guide in terms of human behavior, the lights won't come on for the masses until they become disenchanted with the 'bubble de jour', of which there are still apparently many more attractive than precious metals given the low participation rates across the sector. Correspondingly then, from a socio-historical-behavioral perspective, an outcome such as the one depicted below must be considered most unlikely given the totality of possibilities. (i.e. the others must largely blow up before the public will make a new bubble in gold.) (See Figure 3)

Figure 3

Source: The Chart Store

Speaking of historical precedents, human behavior, and more natural outcomes, you should know that an outcome more along the lines of what was experienced back in the 70's should in fact be seen here in fully correcting the previous advance of the larger degree sequence, which would involve a 'Golden Ratio' (61.8 %) retrace all the way down to $433 in marking the top last May as Primary Degree I of the current Super-Cycle Degree affair. And in moving past all this technical jargon, traditional thinkers would categorize such an outcome as a 'mid-term' correction, which in the end essentially proved to be the case back in the 70's, lasting approximately 20-months in total. What's more, duplicating such an outcome today would mean gold corrects until December and falls almost $250 from here. Personally, I do not foresee such an outcome until the Grand Super-Cycle deflation commences sometime after decade's end, as the current economy is simply too dependent on asset inflation for price managers to allow such a signal to be put in view if avoidable.

Here, once prices fall enough in coming months to take some of the shine off commodities, which is the primary aim of authorities these days given prices were threatening to escape the bottle once again, they will be quick to re-inflate the system because unlike the 70's our asset based economy could not handle the kind of medicine that was being dished out back then. This is of course where the need for speed comes in, the need for speed in money supply growth rates by any means, which because the consumer has all but maxed out his credit card involves monetization practices these days. So you see this is why gold will remain relatively buoyant for the remainder of the current Super-Cycle sequence. It's because the need for speed is ever-present, constantly growing, and of such a mass it must now be fed day and night by essentially every living being on the planet. And who wouldn't want to escape this brand of insanity once understood and presented with a means of surviving the calamity such conditions are sure to bring. Again, this is why increasing numbers are choosing to hold gold. (See Figure 4)

Figure 4

Source: The Chart Store

And wouldn't you know it, it appears price managers were at it again overnight with European stock markets down some 1.5-percent this morning. And as mentioned above, Chinese stocks fared far worse; signaling to those exposed to excessive margin trouble could be brewing for real this time. And if the record high levels of margin debt were unwound moving forward from this point, anything is possible in terms of correction severities, so as mentioned on these pages many times over the past several months, please ensure your portfolios are 'comfortably structured' for what could prove to be a bumpy ride. In the strictest terms this means ensure your use of margin debt is kept to a minimum, if not eliminated completely. Quite frankly there are simply too many investors out there leveraged to the eyeballs to adopt an alternative approach in my opinion, because it's under these circumstances accidents occur no matter how many warnings are issued.

So, Greenspan warns of recession and China continues to warn about stock market bubbles, but one does have to wonder what the true agenda of central authorities can be when only one alternative exists for them in maintaining the status quo, which is inflate or die. Of course history has demonstrated all the monetary largesse in the world will not work to support prices unless a willing population of bearish speculators is on hand to squeeze prices higher, which is a growing concern considering the overextended nature of the current sequence.

If history is a good guide again however, knowing price managers need to throw a little fear into people in order to properly motivate them to buy more insurance, as suggested by the patterning in the analog chart comparisons attached above (here too), we can expect an approximate 10 to 15-perent correction in stocks to start anytime. In the larger sense however, this would only be a pause as long as speculators become / remain bearish. Right now, based on collapsing put / call ratios on the Dow and NASDAQ, it appears some re-convincing might be in order.

If this is the kind of analysis you are looking for, we invite you to visit our new and improved web site and discover more about how our service can further aid you in achieving your financial goals. For your information, our new site includes such improvements as automated subscriptions, improvements to trend identifying / professionally annotated charts, to the more detailed quote pages exclusively designed for independent investors who like to stay on top of things. Here, in addition to improving our advisory service, our aim is to also provide a resource center, one where you have access to well presented 'key' information concerning the markets we cover.

And if you have any questions, comments, or criticisms regarding the above, please feel free to drop us a line. We very much enjoy hearing from you on these matters.

Good investing all.

Captain Hook
TreasureChests.info

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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