In cased you missed it gold is coming down
lately. Today (June 26) it fell by another $10 and touched its 200 dma for the
first time since early 2007. Sure enough bearish sentiment has been propelled
to new extremes as a result of this sudden drop and spooked out many
investors out of their gold positions. Time to worry? No! Why not? Well,
gold touching its 200 dma is a phenomena we’ve been witnessing once or
twice a year since the start of this gold bull market in 2001 and sure enough
we’ll be witnessing it many more times in the years ahead. It’s
just part of the game. When examining previous bottoms we’ll see that
whenever gold touched its 200 dma it entered a ‘BUY’ zone in
which it can stay for up to two months before taking off towards higher levels.
Does it mean that gold can’t drop any
further from here on?
No, that’s not what I mean, what I want to
say is that we find ourselves near bottom levels.
Even if gold would drop further from here there is no reason for worry since
the worst corrections in gold (since 2001) have been characterized by
relative gold values (gold vs its own 200 dma) of
0.95 and needless to say we are nowhere near such depressed levels yet. In
order to do so gold would have to drop all the way down to $605. Now
I’m not predicting a further drop towards $605, all I want to say is
that corrections towards gold’s own 200 dma and slightly below are a
normal phenomena in any on going bull market .
So what to do now then?
Well, the only appropriate thing to do right now
is to do nothing at all. This bottom process will most
probably end in this price area and as I pointed out in my piece ‘GoldDrivers
2007 – Gold’s Fundamentals still pointing towards $2000+’
there is still plenty of reason to be bullish on the outlook for gold coming
years. Always consider yourself what fundamentals launched the gold price
from its 22 year low of $250 in 2001 to current price levels
around $650 today. What fundamentals changed in order to justify the end of
this bull run? The answer is simple. None! In part I we shone a light on
gold’s historical average and the US$ and needless to say we
couldn’t find any bear argument over there, in contrary, in order to
reach new historical ‘REAL’ highs gold should be trading above
$2000 levels these days.
In this piece we will shine a light on gold
related to inflation:
IMPORTANT
NOTE: It’s not my aim to build a case for higher gold prices just on
higher rates/inflation alone. Inflation is just ONE of several critical
drivers for gold. In part I we discussed gold related to the dollar and its
historical norm, today we will shine light on gold related to inflation and next
essays will shine a light on other critical drivers like supply/demand/oil
and manipulation.
Gold
& Inflation
In part I (gold &US$) I quoted a popular bear
tune which wants you to believe that rising rates are being the death knell
for gold. The
fact however is that rising rates as a result of a dropping dollar is a
strong critical driver for gold which was the case during the seventies
indeed when the 10 year yield rose from a mere 5% in the early seventies
towards 15% in the early eighties. Gold performed extremely well in that
environment since it rose from $35 towards $850. That’s the big picture, please commit this to memory since daily market
commentary on gold will get you nowhere. Reading daily market commentary is
like staring at noise which troubles the big picture
behind it. What I mean is this, gold can move in
opposite direction on certain news as one would normally expect. It’s
no secret that the big financial power houses (read commercial bullion banks)
aren’t very pleased with rising gold prices so they knock gold down on
gold bullish news. They do it it such a blatant way that it has become a joke. Gold
experts who endorse GATA’s
claims like eg John Embry, Frank Veneroso, James Turk, Peter Grandich,
Doug Casey and Peter George are reporing the counter intuitive moves
for years but unfortunately most of the main stream gold analysts still
don’t get it..(We will discuss Gold & GATA more in detail in a separate essay). But if you have a good sence of humor you
can enjoy yourself by reading daily comments like:
- Gold going down on lower oil prices since lower
oil prices are a boost for the economy therefore reducing gold’s
appeal as an alternative for the DOW.
- Gold going down on higher oil prices since higher
oil prices are bad for the economy thereby reducing demand for gold
jewelry. This will lead to lower gold prices.
- Gold going down on a higher dollar since a higher
dollar reduces the need to for investors to protect themselves (by means
of gold) against a loss of purchasing power.
- Gold going down on a lower dollar since a lower
dollar leads to rising rates which in turn could have a devastating
effect for home owners thereby impacting the economy on a negative note
thereby reducing demand for gold à lower gold prices.
- Gold going down on inflation fears since a rising
inflation would force the FED to raise rates which would strenghten the
dollar thereby encouraging investors to sell their gold in favor of the
dollar.
- Gold going down on a rising DOW since rising
stocks provide a better alternative for the investor than gold.
- Gold down on a crasing DOW since investors need to
cash in their gold position in order to provide the investor with enough
liquidity fast (eg in order to meet margin calls etc....)
Now please don’t think these remarks are
exaggerated, just check it out yourself in
this video interview posted
on thestreet.com. Gold bearish themes as a result of higher rates to come
followed by gold bearish tunes as a result of lower inflation rates to come
all within 6 minutes, in summary this is being said:
First part of
interview: Higher rates à weighing on the
economy à weighing on the stock
market à downdraft on the
commodity markets à 20% downturn in gold
Second part of
interview: Experts see a very healthy US economy with low inflation (low
inflation is lower rates) 6 months down the road à healthy for the dollar à pressure on the gold price.
END.
There it is, no matter what the US stock market
does, gold should go down, no matter which way rates are heading, gold should
go down, at least that’s what many gold analysts want you to believe.
You get it? My point is that daily market
analysis is almost completely useless and confusing since it troubles the big
picture behind it. Daily market analysis is like
discussing weekly weather temperature swings and extrapolating the weekly
temperature trend 6 months ahead. But as one can imagine staring at weekly
temperature trends is staring at noise which will get you nowhere. In order
to get an impression of what weather temperatures could be 6 months ahead it
might be a better idea to analyse last years temperature cycle and try to
determine where you find yourself this year into that cycle. The same
analogy applies for the gold market as well. Staring at weekly/daily
movements doesn’t make sence at all since it doesn’t tell you
anything. In order to get a grasp of what could lie ahead it’s better
to understand the implications of a massive scale of monetary inflation, one
almost never witnessed before.
Sure enough enough one could argue about the true
rate of inflation but I would say if you still believe your government
inflation statistics then please forget about gold. The simple fact is that
central banks around the world are printing their currencies into oblivion
which simply leads to a lower confidence in their corresponding currencies
which in turn undermines investor’s willingness purchasing bonds at an
ever increasing pace neccesary to keep the system going. So printing money at
an ever increasing pace inevitably leads to the only single conclusion possible:
Inflation
will roar it ugly head in the years to come.
Please make no misstake about it, the central
banks are printing money like if there’s no tomorrow. The Russian central bank is
inflating its money supply at an astounding 57% annualized, the US by 14%,
Australia by almost 14% …In fact you won’t find any big
powerhouse around the world which is inflating its money supply at less than
10%!!
You really think this is all deflationary? You
really think that all this fresh printed money represents real value? You
really think the government is telling the truth when they say there is no
inflation?
Well, the simple fact is that US inflation rates
are running at approximately 10% these days. The official hedonic adjusted
inflation rates which the government wants you to eat are a blatant joke.
PIMCO’s Bill Gross once called the government CPI numbers a
‘haute con job’ and so does 90% of the
american public.
But how on earth do they (government) manage to
report low inflation figures while inflation is on the rise? Well, reporting
low inflation numbers is easy. All one has to do is to remove all items contributing to higher CPI figures. If someone
starts questioning for reasons doing so then tell them these items are too volatile to be included. Sure, as long as
you don’t have to eat and drive all is well...As said above there
aren’t that many people around trusting the government official
inflation numbers. When using methodology as during the pre-Clinton era in
order to calculate CPI figures
then CPI numbers today would be clocking
figures exceeding 6%, not the bogus 2%+ reported
today. John Williams, a specialist in government economic reporting says
on his Shadow Government Statistics website (www.shadowstats.com) that current
inflation levels do exceed the 10% mark already.
Well, whether you believe
the governments stats or not the bottom line is:
A country that prints its
currency into oblivion will see its value declining towards its intrinsic
value which is zero! As mentioned above with countries like Russia accelerating their
printing presses by an astonishing 57% annualized, the US
by 14% etc …it ain’t hard to understand which way the value of
paper money is heading. The answer is lower! Paper money losing its value
simply translates itself into higher inflation numbers.
Now let’s turn to the
charts and see what history says about gold vs in flation:
The chart above clearly
demonstrates the strong correlation between rising inflation figures and
gold. Sure, the official CPI number shows us a comfortable 2%+ inflation rate
and the FED has assured us that inflation is well contained. Well, never mind
sky-rocketing food prices, never mind sky-rocketing energy prices, all is
well as long as you believe the official government stats.
Sure enough you can
eliminate oil prices from the CPI calculations but in the end rising oil
prices will find its way into higher CPI figures anyhow. Since the era of
cheap oil can only be found in financial history books as of today higher
energy prices will worm itself into the entire system which will eventually
be reflected in higher PPI/CPI stats.
Now let’s take a peek
at the oil vs inflation chart:
This chart shows us a very
strong correlation between oil and inflation indeed except for the last few
years. The reason is quite obvious since the government is understating real
inflation numbers tremendously. As said earlier, the true rate of inflation
is about 10%.
Now we do have a very
dangerous mix here which concerns an explosion in US
money supply and ever increasing energy prices which in turn could lead to an
inflation tsunami sending gold prices to levels unimaginable today. Please be
aware that the US
money supply increased by more than 100% over the last 10 years. When the US
money supply doubled from 1965 to 1974 it led to an average inflation rate of
9.2% per year from 1973 to 1981. When it comes to ever rising energy prices
please take into account that the world’s biggest oil fields producing 80% of world demand find
themselves in an unstoppable decline therefore energy prices aren’t
likely to come down. (We will deal on this subject in detail in a separate
essay ‘Gold & Oil’).
The
bottom line is:
Inflation and higher rates
are here to come which will benefit gold prices since gold remains the
ultimate hedge against inflation.
OK you’ll say, gold
as a hedge against inflation but what about the argument of a collapsing commodity market
sucking money out of the gold market?
Well, let me ask you this:
the commodity market bottomed out in 2001 and is in a bull trend ever since
then, just like gold. Please be aware that commodities today are still dirt
cheap compared to their ‘REAL’ highs clocked in the early
seventies. In order to reach new ‘REAL’ highs the CRB index
should be clocking 1000+, not the 400+ showing off today. You get it?
Commodity prices were coming down for more than 30 years and now most
analysts are freaking out of so called extreme high valuations after a tiny
little 5 year bull move. The chart below shows the CRB index adjusted for
inflation and it’s quite obvious that commodities still have a long way
to go in order to catch up with previous record highs clocked in the early
seventies.
This chart clearly says
that both gold and commodities still have a long way to go before they reach
new ‘REAL’ highs. A CRB index clocking 1000+ and gold prices
clocking $2000+ would be required in order to do so!
Now please forget about the
argument that a reduced economic growth in China would hurt the commodity
sector since a reduced demand for commodities could only be achieved by a
negative economic growth. The point is I don’t care even if the Chinese
economy would slow down to a moderate growth of 8% since it WON’T
reduce demand for commodities. It’s the pace of growth in demand that
would decline, but still demand would grow! The bottom line is:
Economic growth = increase
demand for commodities no matter whether economic growth is 1, 2, 3 or
17%. Same applies of course for India et all….
Highlights:
- Inflation took off after the US money
supply had doubled from 1965 to 1974 leading to an averaged inflation
rate of 9.2% per year from 1973 to 1981.
- US money
supply increased by more than 100% again over the last ten years. Signs
of accelerated inflation in sky-rocketing food and energy prices are
clearly visible.
- Higher energy prices will worm itself into the
entire system which will eventually be reflected in higher PPI/CPI
statistics.
- Higher energy prices are not the result of an
oil crisis but of a demand driven bull market in oil.
- The end of cheap energy has arrived.
- Higher energy prices à higher inflation numbers à higher gold prices.
- Ever increasing energy prices on top of an
explosion in the US
money supply (increase by more than 100% in last 10 years) is a
dangerous mix. An Inflation tsunami could be the result which could send
gold prices to levels unimaginable today.
Despite the fact that the
long term outlook for gold remains as bullish as it can get it should be
noted that gold’s bearish sentiment these days won’t disappear
over night and yes, many analysts are still calling for a further drop as
from here. But if you are a believer in gold’s future then these are
the time to increase your gold share positions since the gold shares are
selling at fire sale prices due to this extreme bearish sentiment. In other
words, downside risk is low. Higher gold prices the years ahead will lift the
entire gold share sector but the most exciting rewards will come from junior
mining companies making new discoveries.
By :
Eric
Hommelberg
Editor, the Gold Discovery Letter, the Gold Drivers Report
www.golddrivers.com
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