Originally published December 17th, 2007
We don't normally look at fundamentals in these Gold Market updates, but it is worth stopping for a moment to consider the implications of the latest stroke of genius announced last week by the Fed in its desperate attempts to prevent a credit crunch, as it has important implications for the price of gold.
Like a magician pulling a rabbit out of a hat, the Fed and foreign central banks announced that they will conjure up $50 billion to inject into the system, which they will generate by selling low interest rate loans for those who like throwing good money after bad, or have no choice but to. The point to grasp though is this - the Fed will ultimately be liable for these loans - and we all know what the Fed does when it needs money, with a few simple keystrokes it creates it out of thin air - so why stop at a paltry $50 billion, which with respect to the liquidity problem is like approaching a guy who has just had his arm chopped off and is gushing blood all over the place with a drugstore plaster for a minor cut - why not really get serious and create $100 billion, a trillion, or, inspired by early 20's Weimar Germany, ten or a hundred trillion?
While it only takes a few keystrokes to create endless trillions, so that the guys at the Fed can lay down in a sea of money and make whooping noises as they throw handfuls of it into the air, in the real world outside the perimeter fence, there is, as ever, a finite supply of goods and services that this money, so easily created, is going to end up chasing and competing for. So the result of this endlessly expanding creation of liquidity must be more and more inflation - if they succeed in staving off a credit crunch and deflationary implosion, that is, and because a deflationary implosion would be catastrophic, they MUST succeed. So you see how they have finally painted themselves into a corner where they have to continue to ramp the money supply exponentially, a "catch 22" situation which could easily runaway into hyperinflation. Once you understand this, you will immediately realize why they stopped reporting the M3 money supply figures several years ago, which have since gone off the scale. The only caveat to all of this is the possibility that they actually want to see a credit crunch and deflationary implosion, for reasons set out in the No Way Back article last week.
So, faced with accelerating inflation what do investors do to preserve their wealth? They do what they did in the 70's, buy tangibles - hard assets, gold and silver, paintings, coins, stamps etc - anything with a scarcity value which those desperate to get out of cash will flock to buy. Last weeks' announcement by the Fed of another liquidity boost was just another staging post on the road to hyperinflation and has provided yet another reason to buy gold, as if there aren't enough already. Now we will examine gold on the charts to see how it is shaping up.
On the 3-year chart we can see that gold has actually held up well since the last update about 2 weeks ago, given the dollar strength which was predicted at that time. We were looking for it to react back to the $765 area, give or take $10, which would have involved a minor break of the 50-day moving average, and this is still regarded as a possibility in coming days, or perhaps over the next week or two. Even if we see such a reaction, however, as was the case in the last update, the current trading range continues to be regarded as a consolidation pattern - a Pennant - and therefore any short-term dip will be viewed as a buying opportunity. The situation is of course rather different with Precious Metals stocks, which are subject to the vagaries of the stockmarket.
The following paragraph is lifted from the last update, as with gold still in the trading range it remains relevant...
"The first and most important point to make is that the strong advance by gold throughout September and October and into early November involved a breakout from a consolidation pattern lasting approximately 15 months, and is regarded as the FIRST UPLEG of a major uptrend. This being so the current retreat is viewed as a reaction, not a top, so the only question is how far it runs before gold takes off again to the upside. As with the major uptrend of late 2005 - early 2006, the price should at intervals test support in the vicinity of its 50-day moving, as it is doing now, and this average can be expected to maintain a fairly large gap with the 200-day until the advance has run its course, which is believed to be a long way out yet. So, bearing in mind what was written about the dollar above, and gold's propensity to "telegraph" action in the dollar, how much further is it likely to react before the advance resumes? The answer is about $765, with $10 leeway either way, and it will have to be watched closely because once it reverses to the upside it is likely to be fast. If gold does drop back to the $765 area there is likely to be a sharp but brief shakeout in Precious Metals stocks, which should prove to be a significant buying opportunity."
With respect to the last sentence of the above paragraph, the HUI index broke down from an intermediate Head-and-Shoulders top late last week, which may be telegraphing a short, sharp drop by gold in the near future back to the $765 area, which, as stated above, will be viewed as presenting a buying opportunity.
On the 6-month gold chart we can see that with the triangular Pennant that has formed in recent weeks appearing to be close to completion, we are likely to see a sharp break one way or the other soon. The most likely scenario as made clear above is thought to be a drop to the $765 area that spooks a lot of traders, followed by a resumption of the larger uptrend.
On the 6-month dollar index chart we can see that the dollar has continued its powerful snapback rally, exactly as predicted in the last update, and it had its strongest day for a long time on Friday, no doubt fuelled by those who were impressed by the Fed's largesse last week. The following paragraph, related to how far the dollar rally is likely to get, is also taken from the last update...
"However, we can be reasonably sure that any rally won't get above 79 - 81 on the index, which is the important multi-year support level that the dollar broke decisively below 2 to 3 months ago, and which is now a strong resistance level. Furthermore, all rally attempts so far this year have stalled out in the vicinity of the 100-day moving average, which is now below 79, so taking both these key factors into consideration, it seems most unlikely that the current rally will get any higher than 79. It is important to remember that this is viewed as the MAXIMUM that the dollar can achieve over the short to medium-term, and that the overall picture remains very bearish, with all moving averages falling, and key multi-year support having failed. Thus this rally, which in any case will only be due to a bout of panic short-covering following a period of extreme bearishness, can be expected to be followed by renewed decline which should take the dollar to new lows."
With regard to the above paragraph, the one modification that we need to make is that as the 100-day moving average has now dropped to about 78.3, we should lower our upside target for the dollar from approximately 79 to about 78.5.
