The following is commentary that originally appeared at Treasure Chests for the benefit of subscribers on Tuesday, January 28th, 2010.

Have you noticed the M's have been contracting noticeably over the past month or so, with M1 now joining the party as well. I did not pose that last sentence as a question because I am telling you this is happening, and that it's important, and until it stops equities will continue to fall. Here comes a question though. Why is it happening? Answer: Because the bozos over at the Fed are attempting to show everyone all is 'OK' by attempting to drain liquidity from the system, which is necessary for continued confidence in their policies (credibility). There is of course a huge problem for them in this regard however, as they are caught in a self-induced liquidity trap, in that until 2012 they will actually need to increase monetization efforts on mortgages once again because of the mountain of option ARM's deals coming due (see Figure 1) over the next few years, never mind the increasing amounts of Treasuries it will have to buy to fund ballooning deficits in all levels of government. (i.e. the Fed will never be able to unwind the more than doubling of the monetary base in an orderly fashion.)

So don't believe them when they tell you everything is OK, as they did yesterday, because it's not - not by a long shot. In fact, what the Fed is doing in it's efforts to drain liquidity out of the system right now, when the economy is like a burned out junkie on life support, is essentially playing craps with the fiat currency / credit based economy they have created. They are playing craps in the hope they will get lucky for a little while longer and fool a few more poor souls into squandering their life savings away in the stock market, or in corporate bonds, which as you know from our work are on the verge of plunging in meaningful fashion. So again, please, don't believe anything the Fed says or does, because like Ben Sanderson in the classic Leaving Las Vegas, the only way they will leaving Las Vegas (the quantitative easing [QE] game) is in a pine box, as they are caught in the biggest liquidity trap in history.

Now, we don't know what color that pine box will be ultimately yet, colored with hyperinflation or deflation, however as you should know, for our purposes it doesn't matter. Here again, you know from our work, the only thing that matters is how the gamblers are betting, and that we are on the other side of that bet. In doing so, we effectively become the house, like in Vegas, who always wins in the end. What's more, in doing so one ensures you don't leave Vegas (the markets) in a pine box, like Ben, who simply could not figure out his game and wanted out at any cost. And don't kid yourself, to an extent everybody must play the game, whether it be voluntary or not, as we must all strive to survive. To do nothing is financial suicide, because at the extreme, whether it be inflation or deflation that finally marks the end of the Fed, either outcome should be guarded against ahead of time.

And that's exactly what we are doing right now, calculating exactly what we should be doing with our savings based on probable / perceived changes in macro economic conditions that will materially affect our finances. That's right - and make no mistake about it. While it's true we are gambling too (you are also gambling in doing nothing), the difference between what we are doing and most people is it's on a calculated basis, where it's understood it's better to be the house than the uneducated rube. The reason for this is obvious, because like the vast majority who enter the casinos in Las Vegas, most who enter (speculate in) the stock and commodity markets will not leave with what they started either. The house will not pay the majority, but only the few that are smart enough to take profits at the right times. Gold and silver, in re-establishing themselves as reserve currencies through time, will operate outside this framework in the end.

This is why we school significant diversification into physical metals by all, no matter how sophisticated you may think you are. Because in the end, all gamblers get caught when least expected. That's because whether it be a hyperinflationary blow-off or deflationary collapse that finally finishes off the Fed, it will not matter in terms of gold and silver re-establishing themselves as reserve currencies, where their relative wealth preserving attributes will go unchallenged. No other assets or competing currencies will provide this kind of insurance in terms of wealth protection, and when people finally realize they actually risk losing all through either hyperinflationary or deflationary confiscation, they will run to precious metals like never before. Don't be fooled by the relative calmness in this market right now. Paper market price managers in the United States are still suppressing the price attempting to preserve the dollar's ($) reserve currency status.

Eventually however, these efforts will be overwhelmed whether it be due to inflation or deflation of monetary aggregate measures, because for example in the latter, when deflation eventually grips macro-conditions, there is so much money that will flee failing banks set against tiny available precious metals supplies, that even when most people see nothing but down for all assets, gold and silver will stand out from the crowd, and a mania will begin. This will be the bain of present day bankers and why you should not worry if precious metals take a hit with the initial waves of selling of other equity groups, as is occurring as we speak. In terms of gold, and as mentioned the other day, while it may be dragged down to $1,000 or lower before it finds traction on the basis described above, this should be welcomed by most to make additional purchases with savings they have ear-tagged for preservation, which is something you should be thinking about now, not when its too late and physical metals are no longer available.

You should know it would only take about a dozen billionaires to clean out all available gold and silver supplies right now. So one day, whether it's hitting the fan or not, and much to the surprise of many, you will wake up to find physical precious metals unavailable permanently, as nations will need all new supplies to back their fiat currencies as global trade alliances break down due to economic depression. Laws will be passed, and as usual, the little guy will be locked out of the lucrative trade. Of course such an outcome would then shine a new light on precious metals shares as the only means for most to participate in the market, which is when one can expect to see a mania develop here too. Right now it looks like precious metals shares might feel the effects of the next round of deleveraging, but again, afterwards, look out. (See Figure 1)

Figure 1

As you can see above, it appears the Amex Gold Bugs Index (HUI) is destined to test channel support in the 375 area in coming days, where unfortunately for the bulls, it may not hold. I say this for several reasons, not the least of which being because the HUI / Gold Ratio appears destined for lower trajectories as well, with indicator breaks to the downside portending further meaningful weakness. All we need is for the HUI to break the 200-day moving average with some gumption and the process would begin, which is exactly where prices are perched now. In terms of the HUI / Gold Ratio, what the bulls don't want to see is Bollinger Band (BB) widths continue to widen with further weakness, as this would confirm the trend change from up to down with an accelerating move. Additionally, the bulls don't want to see the RSI diamond broken to the downside again either, which is a possibility now that the bullish test has failed coincident with what could possibly be a bearish time line turn. Notice the possibility for the time line turn in the HUI (Figure 1) as well. (See Figure 2)

Figure 2

But the thing that is most disconcerting in this regard, and that which has me bearishly predisposed when the majority of others are not, is the fact that the Dow / TSE (Toronto Stock Exchange) Ratio is poised to finally breakout, which means commodity speculators and those looking to Canadian markets as a safe haven are about to get a rude awakening. Expect to see Canadian banks get into noticeable trouble this time around, with mergers the likely result as the government is compelled to rationalize the already dependent sector as the wheels come off the global economy. This will shake the very foundation of the global economy / banking system as the uniformed think Canadian banks are untouchable when the opposite is true. So, watch for a breakout on the Dow / TSE Ratio to mark acceleration in the larger global deleveraging process, which should transpire any day now. (See Figure 3)

Figure 3

Unfortunately we cannot carry on past this point, as the remainder of this analysis is reserved for our subscribers. Of course if the above is the kind of analysis you are looking for this is easily remedied by visiting our continually improved web site to discover more about how our service can help you in not only this regard, but also in achieving your financial goals. For your information, our newly reconstructed 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.

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Good investing all.