"The face of the coin has been debased as fast as its value. First the faces of gods were on the coins. Then the faces of kings. Then of presidents. Today it's only paper. The miracle is that you can still buy things with it." ~ Ian Fleming, From Russia With Love
If the recent meltdown in precious metals took you by surprise, you obviously haven't been reading this update. Since at least late 2007 this update has said the principal risk to precious metals was a dollar rally based on euro weakness. After calling the top in gold in March, targets in the low $800s and lower were immediately published. Since then, precious metals advances have been called a "sucker's rally", and on June first I went as far as to suggest that gold could be "the short of the year." For a more detailed look at excerpts from past updates, view the Precious Points Retrospective.
Metals had been relatively resilient for the past few months, but what that has ultimately served to do is to raise moving average and trendline support levels higher where they could be more decisively broken. As shown in the chart below, this week alone, gold violated the 50-week moving average, which had been major support in previous declines, and it's long term uptrend from late 2005. It seems only the trajectory from the summer 2006 low and the previous resistance just below $750 remain to which precious metals bulls can cling.
Silver, as shown below, has already descended to the trajectory from the summer '06 lows.
But more importantly, the significant tailwinds for metals over the past five years have now become headwinds. Inflation, global growth, euro - traders are now going against these in a big way and commodities across the board have been repriced. The same industrial exposure that helped silver outperform since 2005 has now become a liability as anything exposed to global infrastructure or industry is thrown overboard. The fact is that the impact of the housing market IS being felt in the broader economy as disinflation or even, gasp, deflation!
It wasn't very long ago that financial stocks were being treated in exactly the same fashion and, if anything, the rally off the July 15 lows in stocks have shown the market tends to overreact in these situations. And in this case, the cause for the selloff is rather tenuous at best, and based on some uncertain assumptions, namely that the US is near a bottom in housing and the economy will recover first, if not soon, relative to other countries, that the US has likely seen the worst of the banking crisis and that, even if there are some continued writedowns, the government has effectively backstopped the system and catastrophic failure is off the table.
Many analysts and commentators have done excellent work showing how evidence to support this assumption is far from conclusive, but even to the casual observer it should be suspicious that most of those now calling a bottom in stocks, a top in inflation and a recovery around the corner are the very pundits who initially denied there would be a housing recession, financial crisis or spillover into the larger economy in the first place. Even the rosy-eyed Allan Greenspan, who is finally and appropriately starting to receive some of the blame for the crisis, now defers a bottom in housing until next year while more disinterested parties without their legacy to defend believe even this is an overly optimistic scenario.
The second major assumption is that the ECB must cut rates but the Fed will not. Remember the recent and most precipitous selling in metals came after the Trichet suggested a pause in its inflation-fighting campaign due to slower than expected growth in the Eurozone. The ECB is famous for its single mandate and inflation hawkishness, and though this could prove to be an important precedent, Trichet stopped well short of signaling an actual rate cut. Meanwhile, support for another Fed rate cut could take hold now that inflation appears to have at least tapered off for the current quarter. Of course the victory over inflation is beaten is a sort of pyrrhic one where wage growth is stagnant and receding high commodity prices become unsustainable - hardly sounds like the stuff prosperity is made of. It may be a step in the right direction, but the bottom line is that while the ECB may be allowed to remain on hold due to slowing inflation, the Fed may still need to cut rates further to stimulate growth, a possibility that entirely undermines the logic of the current dollar rally.
And, of course, there's always the return to crisis and panic to get the metals bull going, as largely undesirable as that may be. But if recovery is not around the corner, then systemic crisis can hardly be categorically "off the table." Yes, the Treasury Dept. now has express authority to intervene in equity markets to prop up GSE equity, and GSE debt paper also shares the guarantee of the US taxpayer. But what unintended side effects could too much bailout have? With credit the very lifeblood of the American consumer and banks showing no signs of loosening lending standards, can the possibility of a deep recession really be ignored? And is the FDIC, which unbeknownst to most is a leveraged institution without enough capital to simultaneously fund all its potential liabilities, ready to handle a widespread bank crisis if it develops?
Unfortunately, there's no denying the technical damage done to the precious metals. The extent of the recent declines will now call into question any subsequent advances. Even if we see gold approaching all time highs in either 2009 or 2010, a long term bullish count could include another sickeningly steep and sudden correction before it's all through.
And the long term, systemic changes that Secretary Paulson and Chairman Bernanke have shepherded seem ridiculous and inadequate for dealing with the current crisis, but they could have significant implications for the long term appreciation of precious metals. While current selling may be overdone, it's far from certain gold and silver will ever see the same kinds of year-over-year gains that were the true legacy of the Greenspan era. But to the extent that any economy based on fiat currency will be committed to some measure of inflation, precious metals will continue to be an effective hedge if bought properly, and a measure of security against financial crises and other potential disasters. Bull or bear, call it what you will, the fate of precious metals seems to rest with the U.S. and European economies and the extent to which the monetary base will have to be inflated to prevent a deflationary spiral. More and more it appears that real catastrophe may be the most bullish force for gold and that could ultimately be worse than being long precious metals from significantly higher. If you've been reading this update, however, that shouldn't be you.
TTC has been quite busy trading since we closed our doors to new retail membership and paused the regular free weekly updates. But coming soon, and for a limited time only, TTC will reopen for new members while space is available. Beginning Saturday August 30 until September 8, or until available spaces are filled, TTC will be accepting new members.
Because we take the quality of our service very seriously, we strictly limit membership and work to develop members' trading skills. Having noticed an improvement in our current membership, most of which are professional, institutional traders, we will accept a limited number of new retail members for one week only. TTC does not issue trade signals because we teach you how to trade. We don't spoon feed you because we teach you how to take care of yourself. So, whether you're a novice trader who wants to get better, or a more experienced pro that's wants to share what they've learned and go to an even higher level in multiple markets and timeframes, TTC is the place for you. Stay tuned for further updates with information on how to join.