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Caveat Venditor


We all know the meaning of "let the buyer beware" and its Latin version Caveat Emptor. Caveat Venditor has been our unscholarly version of "let the seller beware".

The first seems applicable to important highs for gold and the other at important lows for the Precious Metals Sector.

Like now, or at least soon.

To be clinical, it is worth reviewing the orthodox views of the gold community. This is highly critical of intrusive central banking and particularly so of reckless central banking. It is important to condemn this, but it has been painful to position gold or silver to "get even" with Fed stupidity and bureaucratic ritual.

Supply/demand research has been widely used, but as history shows it is not up to the changes in metal prices in a world of financial asset inflation, volatility and then financial asset deflation. What's more, such "fundamental" research did not work at the end of the huge speculation in tangible assets that blew out in 1980. Our research service got its start in 1976 when retained by two global mining companies located in Vancouver. This is when it was learned that supply/demand analysis was part of the culture of mining but hopeless in actual forecasting of significant price reversals.

This has been the case in both base and precious metals and the failure of such research in silver, for example, has been remarkable. Silver, we are breathlessly advised, is always in short supply. Then upon disappointment in method, we are told that governments are competent enough to rig bullion prices down.

But Mother Nature regularly shows that as a speculative boom culminates, the behaviour of silver relative to gold acts like a credit spread. The gold/silver ratio goes down in a boom and turns up as the boom fades.

And then there is the notion that the ancient ratio of 16 will come back. Three hundred years of evidence firmly says "No!".

Our research has always focused upon prices in the senior currency. The gold/silver ratio traded close to 15 through to the bubble that completed in 1772. On the subsequent long post-bubble contraction that completed in 1792, the ratio rose from 14.7 to 15.4.

On the next era of bubbles the ratio was at 15.5 when commodities and CPI inflation blew out in 1816. That long post-bubble contraction ended in 1844 when the ratio had increased to 17.2. No big deal in amount but it defined a trend.

The next secular commodity boom completed in 1865 with the gold/silver ratio at 16.6. It was at 17.3 when the 1873 financial bubble completed. On the Great Depression that ended in 1895 the ratio increased to 34.1.

From the incredible financial dislocations of the French Revolution and the Napoleonic dictatorship to the banking discipline of Victorian England the ratio increased from 15.5 to 34. Actually it had little to do with the remarkable change in politics and culture. It was that on the long post-bubble contractions the gold/silver ratio increased - significantly.

At the height of the secular commodity boom in 1920 the ratio had declined to 22. In 1929 it reached 42 and it set a secular high at 91 in 1940.

At the peak of the 1980 buying frenzy in gold and silver the ratio briefly reached 16. As the contraction progressed our target for the gold/silver ratio became around 90. This was exceeded in the banking crisis at the end of 1990. The high was 104 in early 1991.

The "ancient" pattern has continued with the ratio declining to 45 in 2007 and soaring to 93 in the 2008 Crash.

The low with the mania in precious metals in 2011 was 31. The high this week has been 74 and as this post-bubble contraction fully develops our target for the gold/silver ratio is around 100.

The behaviour of the silver/gold ratio has been a reliable guide to important swings in the Precious Metals Sector. We have been using it since 1987 when we noticed that in the 1980 blow-off the ratio changed some weeks before the rise in both metals ended.

On each bull market silver outperforms gold and the key to calling the high has been in the momentum peak in the silver/gold ratio. When the RSI soars to above 78 it indicates that speculation is becoming excessive.

This reached 92 in 2011 and we noted that that level had not been accomplished since January 1980 and that speculation had reached a "dangerous" level. We also thought that the bear would not be as bad as post-1980.

On the way down there were some big swings. The first of which drove the RSI to 86 in September 2012 and the second drove it to 84 in June of this year. Both were noted as dangerous levels and were followed by significant declines.

Some months ago we thought that the next buying opportunity in gold stocks would appear late in October. A couple of weeks ago we advised "not yet".

Gold share weakness continued to month-end. The HUI set its high for the year at 252 in July and closed the month with a low of 152. This is at the Crash low of 150 set in late 2008. The latest plunge drove the Daily RSI down to 22, which is low enough to limit the decline.

Traditionally, gold shares lead the swings in the bullion price. At the top in 2011 the HUI/Gold rose to .42 in April-May and turned down. Gold set its high in early September. A meaningful rally for precious metals could be led by this turning up from the low of .13 reached on Friday.

The sell-off in the HUI relative to gold has been severe, driving the Weekly RSI down to 20.9, which is very oversold. However, stocks have been outperforming bullion for a few days and it will need further technical work to gain conviction.

There are a number of ways to review the action preliminary to a cyclical bull market for gold stocks. One is the popular focus upon what the dollar price of gold is doing. This is speculation based upon currency changes that may not relate to improving operating margins for gold producers. Another very popular method is to keep track of monsoons, the Indian wedding season and the number of camel-loads of gold going into the Arab souks.

Sadly, this has much to do with supply and demand analysis and has not been reliable during great inflations in financial assets.

Investors should look to to gold's real price which for at least 300 years has been an indicator of adversity or prosperity for the gold industry. But before expanding the outlook for the latter it is worthwhile to look at another popular diversion. This is the focus upon consumption, of which jewelry sales are followed very closely. But as seen in 1929 and in 2008, such consumption declined sharply with the contraction. Fortunately, as with every severe post-bubble contraction since the first in 1720, the investment demand for gold soars as bauble consumption declines.

Our proxy for gold's real price is not the price as deflated by the CPI. The calculation has been unreliable since Clinton's first term. We use our Gold/Commodities Index (GCI) which seems close to The Economist's All Items Commodity Index. Gold is money and not a commodity so it is not in our index, or in The Economist's.

Gold's real price has set an important low in the year a great bubble climaxed. That is on all six examples from 1720 to 2007. On the last one, the GCI turned up in May 2007 signaling the start of the great collapse that became visible in June of that fateful year.

It increased until February 2009 and in turning down it anticipated the end of the financial panic in March.

This has been the first business recovery and financial boom out of a classic crash. Gold's real price bottomed and turned up in June of this year when the credit markets began to deteriorate. The latter has yet to become dramatic, but the GCI continues its advance, which reflects improving prosperity for the Precious Metals Sector. This is likely early in a cyclical bull market for the real price and stock prices could eventually follow.

In the old days, senior gold producers would be the first to recover, then the middlingsized companies with eventually speculative juniors joined late in the party. Nowadays they all come out of a bottom at the same time.

Traders could cover shorts. Investors and traders could begin to accumulate the sector, preparing for the development of a cyclical bull market. Depending upon the size of the portfolio, positions can include the seniors or juniors directly. Many may find the ETFs convenient.

The melancholy conditions prevailing at the bottom of a bear market in precious metals provide outstanding opportunity. This page uses some usually reliable methods to guide decisions. However, there was a bad one a number of decades ago (it could have been back in the days when traders comment on stock analysts was "In a bull market who needs them, and in a bear market who wants them."). Many companies were dead or dying but a broker, sensing opportunity wanted to accumulate. Not willing to afford a secretary, he got the phone numbers and dialed each company. If someone answered he hung up and bought the stock. This was in the days before answering services.

It is an apocryphal story and it worked out. This one will as well.

Also after decades, we looked up Caveat Venditor and it is real.

Deflated Price of Gold During the Dramatic Climax of all Great Financial Manias

Over the past 300 years, gold's real price has shown some fairly reliable patterns. One is that it sets a significant low as a great financial bubble blows out and then recovers during the post-bubble contraction. The first was with the South Sea Bubble in 1720 and the latest classic bubble completed in 2007. It was number six.

Typically, the contractions run for some twenty years with the nearer-term business cycle setting weak expansions and concerning contractions. Gold's real price turned down in February 2009, the panic completed in March and the first expansion out of the 2008 Crash started in June 2009.

Gold's real price declined with the expansion and set a significant low in June. The rising trend since is well established and quite likely in the early stages of another cyclical bull market. Eventually precious metal stocks will follow.

Interesting Chart Pattern: The dreaded Vomiting Camel Pattern (VCP) in Gold

dreaded Vomiting Camel Pattern (VCP) in Gold
Larger Image: Source: Brian Kelly, Brian Kelly Capital LLC


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