GOLDDRIVERS 2008

• Physical shortages become evident
  
• Massive CB intervention will be proven short lived
  
• GATA proven right again!

Confused about the latest sell-off in gold? Confused about the contradicting explanations coming your way through all kinds of financial media? Will this latest correction be proven temporary? Or did we just witnessed the end of the gold bull market? Has deflation arrived as many analysts want you to believe? Or are we heading for a hyper inflationary recession? Was the brutal sell-off the result of a massive coordinated intervention in order to prop up the dollar? Or was it just the speculators running for the hills? You don't know what to believe anymore? You don't know what to do with your gold holdings? Well, strange things did happen in the financial markets during last month indeed thereby generating too much noise blurring the minds of the average gold investor.

It doesn't help much by staring at daily doses noise, all what should be done in turbulent times like these is to filter out that noise by taking a few steps back and take a look at the big picture and wonder what critical drivers launched the gold prices in the first place from a 22 year low of $250 in 2001 to current prices of $800+ in 2008. You might wonder if a 7 year bull market would be enough to wipe out the excesses created by the 22 year bear market which took the gold price down from $850 towards $250, you might wonder if a few years of increased exploration spending would be sufficient in order to announce enough new world class gold discoveries being brought into production in order to replace the gold ounces being produced these days, you might wonder if the dollar can appreciate from here on the back of an ever increasing US spending attitude (financing of two ongoing wars and bail out of failing banks too big too fail), you might wonder if demand for gold will be decreasing despite the ever growing investment appetite (physical shortages are becoming evident)..

Well, I can go on for a while here but my point is that looking at gold's critical drivers one could clearly see the way for gold is up, not down. The gold bears will have a difficult time explaining gold exceeding $1500 before the end of this decade since their misleading arguments of increased gold supply, reduced demand and deflation didn't work for the last 6 years, it won't work for the next years either. They sound like a broken record indeed and yes, one day they might be right, most probably early next decade or so. Some popular bear tunes over the years have been:

• Gold prices are at an historic high and will likely come down (March 2005, gold trading at $430)
  
• World gold production levels are going up and will bring down the price of gold should it rise. (March 2005, gold trading at $430)
  
• Gold has nowhere to go but down due to deflation pressures around the corner (November 2002, gold trading at $320).
  

Sounds familiar right? Now this latest tune of upcoming deflation has been picking up steam again fueled by record write downs, failing banks, crashing housing markets etc.. The tune goes that these forces will slow down the economy thereby dragging inflation down. The root of higher inflation however is the government's willingness to prop up the economy through means of high money supplies. Current annual growth in M3 is running at levels exceeding 15%. The unfolding banking crisis will only accelerate the surging money growth (bail out failing banks that are too big too fail) which in turn will fuel higher inflation. So the banking crisis caused federal spending to spike while at the same time tax revenues are on the wane due to the economic slow-down. This is of course all very dollar negative. A government destroying its own currency paves the way for inflation taking off. Zimbabwe's president Robert Mugabe knows exactly what I'm trying to say here since he tried to do the very same thing: printing money to prop up the economy. The result? Well, sure enough inflation took off (11 million percent) despite a complete economic halt.

Zimbabwe inflation rockets higher
BBC News - August 19

The rate of inflation in Zimbabwe jumped to just over 11,250,000% in June, official figures show.

"It gained 9,035,045.5 percentage points from the May rate of 2,233,713.4%," said state media quoting the Central Statistical Office (CSO).

However, experts believe the actual rate of inflation may be much higher.

Zimbabwe is in the midst of a dire economic crisis with unemployment at almost 80%, most manufacturing at a halt and basic foods in short supply.

High money supplies have also been fuelling hyperinflation. Critics have accused President Robert Mugabe's government of printing money to finance his election campaign and prop up the economy. Month-on-month inflation in the country accelerated to 839.3% from 433.4%.

END.

So there it is, a complete collapse of the economy is no guarantee for low inflation. Now let's go back to the US government spending attitude. As mentioned above the government has no other choice as to bail out failing banks that are too big too fail. A failing bank here, a failing bank there, a $50 billion dollar rescue gift to GM and the list goes on and on. You don't have to be a rocket scientist in order to understand what impact these bail outs have on the administration's budget deficit. Sure enough it'll explode. How the government responds to exploding deficits is predictable. They just raise the federal debt limit. That's what they've done recently, they raised the federal debt limit to $10.5 trillion allowing them to take on another trillion dollars of debt from current levels. Current reading of federal government debt stands at $9.6 trillion which is an increase of more than $4 trillion over the last 6 years, see chart below:
 

This chart leaves no doubt, the federal government debt is going up in a straight line which is very dollar negative. In order to prevent a free fall of the dollar the rest of the world has simply no other option as to buy this debt. The chart below does speak for itself, foreign countries have been financing US spending/consumption but needless to say this trend cannot last forever.
 

What we see here is an ever increasing amount of debt hold by foreign countries. This is clearly not sustainable and simple logic tells us that all what is not sustainable simply stops. In other words, without foreign support the US$ is in deep trouble.

Now if the $9.6T federal debt wasn't already bad enough, the picture only worsens when looking at total US debt which clocked an alarming $53 trillion last year. The chart below speaks for itself:

As you can see here total US debt is growing faster than its national income. Ever tried to run a business which its debt grows faster than its income? Well, needless to say you would be heading straight into bankruptcy. And that's exactly what's happening with the US, they're heading straight into bankruptcy which is of course extremely dollar negative. The only way to work its way out of debt is through inflation.

Now sure enough foreign countries don't have an interest to see a dollar collapse since it would hurt their export to the US and massive dollar reserves. In order to prevent a dollar collapse joint intervention becomes necessary at critical times. In March this year joint intervention was seriously considered in order to rescue the crashing dollar:

U.S., Europe, Japan Planned March Dollar Rescue: Nikkei

By Gertrude Chavez-Dreyfuss
Reuters
via The Guardian, London
Wednesday, August 27, 2008

NEW YORK -- The United States, Europe, and Japan had planned to intervene and rescue a weak U.S. dollar in March, business newspaper Nikkei reported on Wednesday.

Officials from the U.S. Treasury Department, Japan's Finance Ministry, and the European Central Bank reportedly drew up a currency contingency plan to be undertaken over the March 15-16 weekend, Nikkei reported, citing sources familiar with the situation.

The monetary officials also agreed on a framework for coordinating dollar-buying intervention, the report said.

The officials did not specify an exchange rate for initiating the dollar rescue plan, but in the event of a free-fall, they all agreed to aggressively buy the greenback and sell yen and euros, according to Nikkei.

END.

Obviously the planned intervention never took place in March since the dollar started to recover on its own after the Bear Stearns rescue. But 4 months later (mid July) the dollar started blasting off like a rocket leaving analysts clueless for the reason why. The thing is that no fundamental news for the dollar could explain such a dramatic move so what did move the dollar so fast? Was it intervention this time? Let's first take a peek at the dollar chart and see what happened since mid July:
 

This chart clearly reveals the dollar rocket launch since mid July. Again, not one single fundamental could explain such a dramatic move, could it be intervention this time around?

James Turk of GoldMoney.com was the first one to report on this matter and concluded this must have been the result of intervention indeed:

James Turk - GoldMoney.com August 7, 2008

So what happened to cause the dollar to rally over the past three weeks? In a word, intervention. Central banks have propped up the dollar, and here's the proof.

When central banks intervene in the currency markets, they exchange their currency for dollars. Central banks then use the dollars they acquire to buy US government debt instruments so that they can earn interest on their money. The debt instruments central banks acquire are held in custody for them at the Federal Reserve, which reports this amount weekly.

On July 16, 2008 (the closest date of the weekly reports to the July 15th low in the Dollar Index), the Federal Reserve reported holding $2,349 billion of US government paper in custody for central banks. In its report released today, this amount had grown over the past three weeks to $2,401 billion, a 38.4% annual rate of growth. To put this phenomenally high growth rate into perspective, for the twelve months ending this past July 16th, assets in the Federal Reserve's custody account grew by 17.3%, which is less than one-half the growth rate experienced over the past three weeks.

So central banks were accumulating dollars over the past three weeks at a rate far above what one would expect as a result of the US trade deficit. The logical conclusion is that they were intervening in currency markets. They were buying dollars for the purpose of propping it up, to keep the dollar from falling off the edge of the cliff and doing so ignited a short covering rally, which is not too difficult to do given the leverage employed in the markets these days by hedge funds and others. So central banks pushed in one direction and funds and traders then stepped on board. In other words, central banks ignited the fuse of a bear market rally.

END.

JsMineset contributor Dan Norcini is convinced of foreign central bank intervention either:

Dan Norcini - JsMineset.com - August 28, 2008

As a side note – the huge amount of US Treasury purchases which has sent that chart nearly vertical helps to explain the continued rally in the US Dollar. It is a near certainty that something has been transpiring behind the scenes involving various Central Banks in regards to the US Dollar. Should any of this Foreign CB buying abate for any reason whatsoever, the Dollar will lose all of its support immediately. With yields on US Treasuries headed firmly lower only a foolish investor would see bonds or notes as a safe haven given what we all know about the real rate of inflation here in the US in contrast to the absurd and mentally insulting numbers that the knavish Feds are dishing out.

I repeat my main assertion - Foreign Central Banks are behind the rally in US Treasuries and as a consequence, the rally in the US Dollar. How much longer they remain willing to ply this gambit is unclear but one is not at all murky, someone is going to get stuck holding the bag.

END.

So if this was a coordinated intervention then who participated?

Off course no official will ever admit that currency intervention have been taken place but it seems that China is just doing that in order to hold down the yuan:

Beijing Swells Dollar Reserves Through Stealth

By Ambrose Evans-Pritchard
The Telegraph, London
Tuesday, August 26, 2008

China has resorted to stealth intervention in the currency markets to amass US dollars, using indirect means to hold down the yuan and ease the pain for its struggling exporters as the global slowdown engulfs the economy.

A study by HSBC's currency team in Asia has concluded that China's central bank is in effect forcing commercial banks to build up large dollar reserves, using them as arm's-length proxies in a renewed campaign of exchange rate intervention.

Beijing has raised the reserve requirement for banks five times since March, quickening the pace with two half-point rises in late June.

This is having major spill-over effects into the currency markets because banks in China have been required over the last year to hold extra reserves in dollars rather than yuan. The latest moves have lifted the mandatory deposit from 15 to 17.5 percent of total lending since March.

END.

In order to make intervention more successful it's necessary to restore the dollar's credibility. Now how do you prop up the dollar's credibility? Well, the answer is simple, all what needs to be done is to burry the price of gold. Former FED president Paul Volcker said in his memoirs (referring to the dollar crisis of the 70's):

Paul Volcker, Former FED president:

Joint intervention in gold sales to prevent a steep rise in the price of gold, however, was not undertaken. That was a mistake. Through March, the price of gold rose rapidly, and that knocked the psychological props out from under the dollar." END.

It seems that Volcker's comments have been taken heart since gold has been attacked since mid July in a blatant manner never ever seen before. Three US banks increased their gold short position an eleven fold which resulted not only in the largest short position ever by US banks but of course in a massive market price collapse as well. Gold tumbled down by $150.

Market analyst Rob Kirby reported on this subject in his column Wake Up Call:

Rob Kirby - Wake Up Call
August 26, 2008

For gold, 3 U.S. banks held a sho rt position of 7,787 contracts (778,700 ounces) in July, and 3 U.S. banks held a short position of 86,398 contracts (8,639,800 ounces) in August, an eleven-fold increase and coinciding with a gold price decline of more than $150 per ounce. As was the case with silver, this is the largest short position ever by US banks in the data listed on the CFTC’s site. This position was put on and resulted in massive market price collapse.

END.

Kirby notes that such a short position can be only the work of a central bank, "because no public entity -- bank or otherwise -- has the balance sheet maneuverability in an impaired credit environment to conduct such business.

Resource Investor's Gene Arensberg is suspicious as well, he seems convinced in his latest "Gold Gold Report" that the recent enormous shorting of gold and silver by a few banks was a market manipulation and likely a currency intervention inspired by the U.S. government.

Firestorm Erupts Over U.S. Banks' Gold, Silver Shorting

By Gene Arensberg 01 Sep 2008

A very few and very large banks seemed to have positioned very well ahead of the plunge in prices for gold and silver, but in the process they may have bought more than they bargained for – possible class-action lawsuits.

Is it a coincidence that these two or three U.S. banks took such huge short positions in gold and silver not very long after Federal Reserve Chairman Ben S. Bernanke spoke publicly about the weak dollar?  (A very rare event, but it occurred in the same week in June that Treasury Secretary Paulson and President Bush both came out and jawboned the dollar higher.)
http://www.resourceinvestor.com/pebble.asp?relid=45789

END.

The result of these massive short positions established in July is a no brainer. Sure enough the price of gold collapsed but a strange thing happened here. The gold price kept falling despite a record run on physical gold. Demand for gold eagle coins became so strong that the US mint had to suspend sales of the popular coins:

U.S. Mint Suspends Red-Hot Gold Eagle Coins

By Frank Tang
Reuters
Thursday, August 21, 2008

NEW YORK -- A shortage of American Eagle bullion coins due to soaring demand following a recent sharp retreat in gold prices has forced the U.S. Mint to temporarily suspend sales of the popular coins.

"Due to the unprecedented demand for American Eagle gold one-ounce bullion coins, our inventories have been depleted. We are therefore temporarily suspending all sales of these coins," the U.S. Mint told authorized coin dealers in a memorandum dated on Friday.

END.

It didn't stop here with the gold eagle coins:

World's Largest Gold Refiner Runs Out of Krugerrands
By Claudia Carpenter

Aug. 28 (Bloomberg) -- Rand Refinery Ltd., the world's largest gold refinery, ran out of South African Krugerrands after an "unusually large'' order from a buyer in Switzerland.

The order was for 5,000 ounces and it will take until Sept. 3 for inventories to be replenished, said Johan Botha, a spokesman for Rand Refinery in Germiston, east of Johannesburg. He declined to identify the buyer.

Coins and bars of precious metals are attracting investors as a haven against a sliding dollar and conflict between Russia and its neighbor Georgia. The U.S. Mint suspended sales of one- ounce "American Eagle'' gold coins, Johnson Matthey Plc stopped taking orders for 100-ounce silver bars at its Salt Lake City refinery and Heraeus Holding GmbH has a delivery waiting list of as long as two weeks for orders of gold bars in Europe.

A lot of people are worried about the dollar, they're worried about inflation and now we have geopolitical risk with what's happening in Russia,'' said Mark O'Byrne, managing director of brokerage Gold and Silver Investments Ltd. in Dublin. O'Byrne said his company's sales are up fourfold this year, heading for a record since its founding in 2003.

END.

Then last week John Reade from UBS reported an unprecedented physical gold demand from India, some European consumers and other Asian clients.

"...over the past three weeks we have noted unprecedented physical gold demand from India, some European consumers and other Asian clients. Demand is also very strong from Turkey and the Middle East and should pick up from Italy next week after the vacation… The last time we issued a strong tactical buy recommendation in gold was in August 2007 at $660/oz. Gold eventually topped out more than $350/oz higher than that level, demonstrating the potential for the metal when these three factors align."

END.

So a funny thing did happen indeed. A crashing gold price would suggest that there's too much of this yellow stuff chasing end consumers but the opposite is true. How's that possible? How can an item drop in price while there's a lack of supply? An item should drop in price due to over supply, not due to lack of supply. The only answer is that there's a disconnect between the physical gold market and the paper gold market. The paper gold market is more than 40 times as large as the physical gold market so therefore it's not difficult to understand that price manipulation through paper contracts can easily be achieved. As mentioned above the most logical explanation for this all is blatant intervention. According to GATA the suspension of gold coin sales by the US mint is overwhelming evidence that the future contract price of gold on the commodities exchanges is substantially below the physical market price and that the commodities exchanges are being used as part of a massive scheme of manipulation of the precious metals, currency and bond markets. GATA is gaining credibility fast and the subject of market manipulation is making headlines almost every day now. GATA was right when they said gold was going to $850 back in 2001, now they say gold is heading towards $3000 - $5000. These figures seem exaggerated but believe me, they are not! Despite the fact that the gold cartel has won another battle by taking the gold price down to $800+ levels, it will only be of temporary nature. As mentioned above, demand for physical gold is so extraordinary that current levels will proven to be the bottom and the start of a renewed up-leg in gold targeting $1200+ next year. 

Let's repeat John Reade's comment re gold and physical demand:

"..over the past three weeks we have noted unprecedented physical gold demand from India, some European consumers and other Asian clients"

"The last time we issued a strong tactical buy recommendation in gold was in August 2007 at $660/oz. Gold eventually topped out more than $350/oz higher than that level"

END.

John Reade is clearly suggesting a bottom here for gold. My favorite indicator for spotting major bottoms concerns the relative gold chart. The relative gold chart has nailed all major bottoms of this gold bull market over the last 7 years. This time it flashes a major 'BUY' again. Combined with a strong physical demand for gold the recent lows for gold could very well proven to be the end of the correction indeed.

The r-GOLD chart is gold divided by its own 200 dma .It has proven to be a reliable indicator in spotting major bottoms for gold in the past 7 years.
 

So if the recent lows proves to be to bottom indeed then where are we heading to?

Well, short term the price of gold can do anything, especially since we're heading into an election. Government will do whatever they can to assure its citizens that all is well. Maybe the price of gold will move side ways till election time, who knows, the thing however is that investors can enter the gold market now at rock bottom levels since further down side risk seems to be non existent. All what investors have to keep in mind is the big picture which says that gold is still trading way below its inflation adjusted high of 1980, see chart below:
 

The inflation adjusted long term chart for gold shows that gold still has a long way to go before it reaches 'real' new highs. In a next essay we will examine gold's own historical norm compared to gold itself, Oil, CRB, Inflation, Dow Jones etc. We will see that gold should already be trading at levels exceeding $1500 these days.

So short term anything is possible especially since (as mentioned above) we’re heading into an election. Gold just don’t tend to perform well during election years. James Turk of Goldmoney.com was quoted in Marketwatch.com today and says he’s seen it all before:

Marketwatch.com - September 02, 2008

Radical gold bugs say manipulation will fail
Peter Brimelow

James Turk – GoldMoney.com

"The present situation reminds me of August 1976, just weeks before the Democratic convention confirmed Jimmy Carter as that party's presidential candidate. Gold slid down to $100 per ounce even as the inflation and economic outlooks were worsening. Gold looked dirt-cheap back then even though its price had risen three-fold from just a few years before.

"By the end of 1976, gold had climbed 32.3 percent from its August low. By the end of Carter's presidency four years later, gold climbed more than eight-fold. I wonder where gold will be at the end of the next president's first term in office?"

END.

So yes, maybe we have to be a bit patient here and yes, gold became seriously damaged from a TA point of view but still that doesn’t change a fundamental trend which is up, not down.

So when can we expect gold prices to hit the $1500 - $2000 range then?

It’s hard to say exactly when we can expect $1500 - $2000 gold prices but according to the legendary mining executive Rob McEwen, CEO of US Gold Corp we will see $2000 before end of 2010

Rob McEwen, CEO US Gold Corp
I

nterview with The Gold Report, August 25, 2005

I believe that by the end of 2010, we’ll be seeing $2,000 gold, and before the gold cycle is out, it will go up and touch $5,000, and that will be the end of the mania phase.

I don’t believe that we’re out of the woods on the financial problems, and the economy has quite a bit to shake off before it will start to look good. And there will be more people looking for answers where to put their money so they can protect it. Gold will start shining.

END.

Next week: Gold & Historical Norm

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Eric Hommelberg

Editor, the Gold Discovery Letter, the Gold Drivers Report

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