From August 2007 when the world passed the tipping point it has been
in the grip of massive deflationary forces that have already ravaged
portfolios and pension plans and resulted in millions losing their jobs. This
deflationary implosion had become structurally inevitable and it was only
ever a question of when, rather than if, it occurred. It had to happen
because debt and debt financed activities had ballooned to unsustainable
The wilful obstruction of the necessary corrective forces of recession
over many years and the continued expansion of this huge debt bubble to
unprecedented extremes via what is called financial engineering, in
particular derivatives, led to it becoming critically unstable, so that when
it burst a disastrous cascading deleveraging process set in. As we know, the
event or crisis which burst the bubble was the sub-prime mortgage debacle.
Instead of accepting the deflationary implosion as the necessary price
to be paid for years of excess, and something essential for eventual renewed
growth from a firm foundation in the future, politicians and governments
around the world, unable or unwilling to face up to the economic pain and
probable political instability that would result, have been and are trying to
obstruct the contraction through enormous ramping of the money supply in many
countries and propping up defunct entities that according to the laws of
economics and capitalism itself should be allowed to fall by the wayside.
This is creating a highly anomalous situation where massive and ultimately
unstoppable deflationary forces are colliding with an outright and reckless
attempt to block them through means of massive reliquification.
Because of the enormity of the debts and the scale of deleveraging
necessary to purge the system, they can only delay or temporarily mitigate
the forces of contraction, and that is probably all they are trying to do
with the intention of further lining their pockets before they head for the
hills. However, their continued efforts to obstruct these forces by means of
the very profligacy and fiscal abuse that created the monstrous bubble in the
first place, will lead to an even more catastrophic collapse later on. Their
immediate solution to the crisis is to create blizzards of new money out of
nowhere to throw at it and to drop interest rates to zero, in a desperate
effort to stir up economic activity and to retard the compounding of already
hopelessly out-of-control levels of debt. Many individuals and companies and
even states and countries are in no fit state to take up the offer of cheap
money, and have no reason to with demand having fallen off a cliff.
Thus we face a situation where many asset values are likely to
continue to collapse even while the air is filled with clouds of confetti
money - you could call it super stagflation. The value of most debt must
collapse towards zero, only in this way can
individuals and companies be rid of its suffocating and paralysing influence,
which is inhibiting their ability to generate demand within the economy. This
means that the holders of debt instruments across the board are going to see
the value of these investments shrivel towards zero over time. This will, of
course, include the holders of US Treasuries and the holders of US dollar
denominated assets in general.
Over the past two months we have witnessed a big recovery in world stockmarkets, that has been fuelled by the widespread
perception that the global economy has "hit bottom" or is close to
doing so, and that world governments have essentially bought their way out of
trouble and beaten back deflationary forces by means of their massive money
creation - politely referred to as quantitative easing.
This fantasy has been played up by the media, who are in most
instances an arm of government, but as we have just stated, the deflationary
forces can only be exhausted once the imbalances giving rise to them have
been corrected - and this will only be achieved once the massive debt
overhang has been unwound, and this doesn't mean marking debt to model, it
means being realistic and marking it to market, which in the case of most
debt means marking it to a big round 0. The crisis will end when we have
arrived at this point and we are clearly a long way from it yet.
Thus, it looks likely that we will witness another downblast
of deleveraging before before much longer, and it
will probably take several such downwaves perhaps
over the space of years to finally purge the system, just as in the time of
The Great Depression, and the recent buffoonery of massive money creation
will only exacerbate the crisis. As we witnessed last year, the collateral
damage that is inflicted during a phase of rapid deleveraging can be very
heavy as forced sellers indiscriminately dump everything over the side,
regardless of its intrinsic merits. Therefore we should not rationalize that
because something has sound fundamentals it will be immune. We are well aware
of this risk and expect the oil sector to get taken down hard should another
wave of heavy selling in the broad stockmarket develop
as expected, which is why we dumped the oil sector at the peak
a week ago.
Precious Metals stocks may well suffer too, and we will mechanically
exit most PM stock positions, which we scaled back a week ago, in the event
of the current uptrends in the PM stock indices
failing. However, this time around we cannot be so sure, for gold, which held
up remarkably well during last year's carnage, could rise as it continues in
the direction of being "the only game in town", and is given added
impetus by the watering down of currencies worldwide. For a while we could
see gold going up and gold stocks dropping at the same time during an acute
selloff phase, before rebounding strongly. The US government has good reason
to want to see another wave of deleveraging as it would serve to channel
funds into the dollar again to buy Treasuries, like last year, although not
to the extent that they would hope for, as this time round the rally in both
the dollar and Treasuries is likely to be much more muted as more players
realize that both are living on borrowed time, especially as the growing risk
of holding Treasuries has in the recent past been highlighted by the Fed
stepping in to monetize them to plug a threatening shortfall in demand, a
sign of growing desperation. Once this late flight into the dollar and
Treasuries has run its course, they are very likely to collapse.
At this point gold and silver, the physical supply of which is already
acutely thin, will go through the roof.
It is because of this risk of another wave of deleveraging setting in
that we have been rather circumspect in recommending Precious Metals stocks
in the recent past, especially the big index driven stocks. Certainly the
fundamentals for the sector are very positive with the outlook for gold
getting better and better with each passing month - the massive increases in
the global money supply not only to finance bailouts etc but also to support
burgeoning deficits guarantees strong inflation in the future, and the supply
of physical gold and silver is getting ever tighter, creating the conditions
that are at some point are likely to lead to an explosive advance.
In addition, mining costs have dropped considerably, especially as a
result of last year's big drop in the price of oil. However, if the expected
inflation is preceded by another bout of deleveraging, as looks likely, then
Precious Metals stocks could be taken down temporarily along with most
everything else, although this time gold is likely to hold up better and
perhaps even rise. This is why we have been lightening positions as the PM
stock indices approached the top of their current intermediate uptrend
channel and stand ready to take evasive action or protect positions with
options should this uptrend fail. If it does and we see another plunge it
will be viewed as an outstanding opportunity to take positions across the
sector for what promises to be an exceptionally powerful recovery and
uptrend. Selected strong juniors have been recommended in the recent past on
the site that have the capacity to make strong gains
over a short time horizon.
In conclusion, this is a very tricky time for investors with the
battle on between the forces of inflation and deflation. Because of the highly
unusual combination of enormous debt that must unwind with rapid expansion of
the money supply, we are likely to see extreme stagflation involving economic
contraction, sometimes involving heavy and destructive bouts of deleveraging,
accompanied by eventual high inflation that could morph into hyperinflation.
With Treasuries and other government paper becoming less and less attractive
and more and more dangerous, investors seeking to preserve their capital will
turn increasingly to gold.
With acknowledgements to whoever created the pictures used in this
Diploma Technical Analysis
All articles by Clive Maund
Trading the precious metals and Energy
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