(Please read on below.)
Meanwhile, the Dow Jones Industrial Average looks deadly wounded when compared with gold. While the downside in the Dow:Gold ratio has come to a large extent from the Dow's sinking recently, we don't think gold will linger for much longer and we expect the price pair to move closer towards the target area (upper triangle) that is shown in the chart below.
DON'T BE AFRAID. Because what happened today is not exactly unexpected. As gold guru Jim Sinclair of JSMineset has repeatedly written on his blog: gold's volatility will reach spiritual levels during this bull run.
One rumour about the plunge that could be found in the news was that it
possibly stemmed from forced selling:
"Sources attribute rising margin requirements in energy futures are responsible for the sell-off in gold. They are selling gold to meet fresh requirements in oil, in all likelihood."
http://www.reutersfxhub.com/fxhub/blog-detail.jsf?title=talk_of_forced_liquidation_in
In our opinion, possible reason(s) for the action today could be the following:
A closer examination of the chart pattern back in the 1990s shows that gold:silver first entered a counter movement (upwards) to the main trend (downwards) -- (1). After briefly touching the upper boundary of the main downward channel, the ratio made a first attempt to new lows -- (2). After this move had been stopped and the ratio had bounced back, it went in to a coiling pattern -- (3). It stayed approximately constant over several weeks (70:1 to 73:1), before quickly touching the upper channel boundaries again and then turning downwards in a major explosion to below 40:1 -- (4).
(Please read on below.)
So, what next?
Reappearance of weakness in the US Dollar combined with the Indian wedding season could first send gold back through $1,000. If silver lagged behind this movement, the gold:silver ratio could test the upper channel boundary, before the shorts would finally have to give in to physical buying pressure in silver. Interesting times ahead?
Stay tuned.
The Fed can never go bust. The market knows this intuitively. In terms of the Fed's balance sheet, market forces therefore sooner or later shape prices such that the Fed is solvent and has equity greater than or equal to zero. So, what does it mean for gold when the Fed monetizes almost worthless asset-backed paper at face value?
Assume BEFORE MONETIZATION a Fed balance of:
| Assets | Liabilities |
|---|---|
| 1,000 oz gold | 1,300,000 Federal Reserve Notes |
| $550,000 T-bills (market value) |
T-bills are risk-free, i.e. essentially $1 in T-bills is as good as one Federal Reserve Note (FRN 1). Assuming Assets=Liabilities, we must have 1,000 oz gold equivalent to FRN 750,000, since 750,000 = 1,300,000 - 550,000. The equilibrium price the market wants is therefore 1 oz gold = FRN 750 = $750.
Assume now that the asset-backed paper market takes a hit, and the Fed is forced to monetize mortgage-backed securities (MBS) that have lost 75% of their value. The Fed buys them at their face value of $1,200,000 (market value $300,000) with freshly printed FRN 1,200,000.
The new Fed balance AFTER MONETIZATION is:
| Assets | Liabilities |
|---|---|
| 1,000 oz gold | 2,500,000 Federal Reserve Notes (old FRN 1,300,000, plus freshly printed FRN 1,200,000) |
| $550,000 T-bills (market value) | |
| $300,000 MBSs (market value) |
Under the old gold price of $750, assets sum up to $1,600,000, and the Fed is bankrupt since liabilities are at FRN 2,500,000. HOWEVER, the market knows that this can not or should not happen! Therefore, the market revalues gold to establish equilibrium. The new gold price is then such that once more Assets=Liabilities, i.e.
1,000 oz gold = $2,500,000 - $550,000 - $300,000 = $165,000.
The result is 1 oz gold at $1,650.
(Please read on below.)
(Please read on below.)
(Please read on below.)
There have been several occasions around the $900 as well as around the $800 mark where gold could have been taken down a la May/June 2006. But nothing happened. Instead, strong buying occured - for a reason!
(Please read on below.)
(Please read on below.)
As pointed out before, silver could peak at $25-$30 if this was to happen. (See also Technical Analysis (February 09, 2008).)
Our analysis stems from the well-established channel in the ratio that can be seen in the chart below. At the moment the ratio is at the upper range of the channel, however, the price history shows that there are periodical breakdowns in the ratio. Given the recent very bullish developments in the precious metals and given the historically high percentage of silver short contracts on the COMEX, we think the chances are good of seeing the ratio hitting the lower range of the channel within a comparatively short period of time.
(Please read on below.)
In nominal terms and for a period of one year, we would expect prices to reach at least $1000 for gold and $25 for an ounce of silver, with a gold:silver ratio of 40:1. We see the possibility of briefly reaching gold $1050 and silver $30, bringing the gold:silver ratio down to 35:1.
Our analysis here stems from the gold-silver scatter plot below, in which each point represents the price of gold and the price of silver for one day of the given time period. The current bull market in gold and silver seems to be prone to repetitive patterns.
(Please read on below.)
Repetitiveness is also a theme for the nominal price of silver itself. The chart below demonstrates this, showing two flag or step like patterns that have developed over the past few years. For silver, explosive moves followed by longer consolidation phases seem to be the way to go forward.
From previous moves, we can imagine that silver could go to $25-$30 per ounce within a comparatively brief period of time, again followed by a consolidiation phase. The breakout for this next move seems to have already happened.
Gold Price Prediction Predicting the gold price is quite obviously a very difficult if not impossible task. Some investors who apply Fundamental Analysis think that the theoretical gold price can be calculated by comparing on an international scale money measures like M3 (added up in USD) with the amount of gold (or investment gold) held. The idea is to basically calculate the value of the Dollar in gold (or vice versa) given it would still be backed by gold. In fact, Paul van Eeden has shown that except for exuberant speculation in the early 1980's, the gold price fluctuated for several years (after 1971 when Nixon uncoupled the USD from gold) in a comparatively small corridor around its theoretical price. However, from 1996 on, the gold price started to decline due to financial and politicial crises at different places on the globe that somewhat artificially increased the demand for Dollars (see also Gold's theoretical value of Paul van Eeeden). Van Eeden concludes that the gold price over the next 5 years or so (this was written in 2004) should reach a theoretical level of around USD 1,000.
Some charting In my opinion, van Eeden's price range is reasonable. My own gold price extrapolation of the current bull market suggests a median level of around USD 1,200 in 5 years time (see the chart Gold price in USD with 5 year exponential extrapolation (What's this?)). However, since a bull market could first exaggerate the price before falling back to lower levels, this prognosis seems not out of range with van Eeden's calculations. In fact, the suggested maximum level of around USD 2,000 in the above chart is also not at all unrealistic. A hard landing of the US econonomy combined with possibly yet another military crisis in an oil-producing country could easily lead to a similar scenario as in the early 1980's. Back then maximum daily fixings went to levels of USD 875. However, adjusted for inflation (see Real and nominal gold price (1968-2006) from Wikipedia) this was in a similar range as the maximum level of USD 2,000 predicted in 5 years time.
Outlook for gold in other currencies (EUR, GBP)
For many investors outside the US the gold price in USD is relevant since the market
mainly trades in Dollars. However, their investment incentives are rather driven by
increasing their purchasing power in their home countries. As a German living in the UK,
I am personally more interested in the gold price in terms of EUR and GBP. The charts
Gold price in GBP with 2 year exponential extrapolation
Gold price in EUR with 2 year exponential extrapolation
have been constructed for this purpose. Obviously, the interpretation of these charts is
always similar. However, the interesting facts can be seen when comparing the charts
with each other. For instance, if we have a look at the upper green line in the USD-chart
Gold price in USD with 2 year exponential extrapolation
we can see that on a 2-year time horizon the maximal predicted return on the maximum
that has been reached so far would be 1,203.86/725.75=1.659. The same numbers for other
currencies are 1.421 for the British Pound and 1.335 for the Euro. In other words, the return
in Dollars could potentially be the highest, with the Pound being second and the Euro last.
However, this does not mean that Europeans should start panicking. The different return levels
rather reflect the possible appreciation of these currencies against each other.
Where most market obeservers still think that the USD is overvalued, many think the
Pound is too. However, the problems of the US still seem worse than those of the UK. This
is reflected in the extrapolation lines that indirectly make a statement about possible
future exchange rates. The charts imply that the USD will loose most in value, with the
Pound second, and the Euro performing best. It is worth mentioning that this fact is actually
not only predicted by the green lines, but also by the red lines that depict the minimal
expected gold prices.
For people who live in the UK, the following charts might be interesting as well:
Real and nominal gold prices in GBP (1979-2006)
UK house prices in ounces of gold (1979-2006)
The first one gives us an impression what potential gold might have in terms of
British Pounds in
a possible future economic crisis. In the face of an inflation adjusted gold price of nearly
900 pounds only 27 years ago, the 5-year chart for GBP
Gold price in GBP with 5 year exponential extrapolation
suddenly looks conservative, even if we consider the most extreme scenario (to the
upside) represented by the green line. The second link above shows the purchasing power
of gold for houses in the UK and Scotland (I live in Edinburgh). The interesting fact we
can see is that, at least in terms of gold, the house price bubble in the UK has burst
already in 2005. I think it is quite obvious what an investor investing only in gold and
property would have to do these days.
I am bullish on gold, and I am going to explain why.
Inflation, Government Debt and Demographic Development Since gold cannot be created out of thin air, it is usually seen as possible hedge against inflation of fiat currencies. Beside the fact that several fiat currencies have collapsed over the last century, the present status of some of the world's leading currencies ist not that flattering as well. With consumer price indices usually being in the lower one digit percentages, inflation looks much worse when considered in terms of the money measures M3 or M4. States like the US or the UK are running double digit percentual increases of this measures every year for decades now. However, there is no real way out. With high foreign trade deficits (US, UK), immense public sector debt (US, Euro-zone, UK) and the babyboomer generation at the edge of retirement, there is no way state finances could be consolidated without groundshaking social and financial implications. However, there is always one solution: a silent, but steady and substantial inflation of the legal tender. In the long run, this must be good for gold.
House Price Bubble and Private Debt Consumer debt in the US and the UK has reached unprecedented heights. One reason for this development is remortgaging in the face of the currently overpriced US and UK property markets. The recent level of consumption cannot be sustained for much longer with housing markets in the US already significantly cooling down and expected further interest rate hikes of the Bank of England. The effect of lower consumption on the stock markets will be substantial, and capital will make its way to safe havens like commodities and gold.
Hedge Funds and Yen-carry-trade The economic hickup caused by possibly hard-landing property markets in the US and the UK could be further worsened by the final wipeout of the so-called Yen-carry-trade. If the Japanese central bank further increases interest rates, this will surely be the case. The consequences being that large amounts of money would be drawn out of US-investments, putting immense pressure on the US-markets that would possibly spill over to markets in Europe. The collapse of only a few larger hedge funds due to Japanese interest rate hikes and fluctuating commodity prices could cause a credit default chain reaction and the general collapse of the US stock market. Such an event could drag down other markets in Europe as well. The withdrawn capital might in parts find its way to Europe, pushing the Euro and the Pound up in the beginning. However, economic problems of the US seldom prove good for Europe or the UK. Finally, the conditions in Europe, especially in exporting countries like Germany, would worsen as well, leading to a general decay of the respective stock markets and currencies losing in value towards gold. Heraeus, the German precious metal company, wrote the other day that if only German investors would think of putting 5% of their assets into gold, it would soak up several years of the world's overall gold supply in today's prices. Now, think about that!
Commodities Super-cycles Some pundits say, we are in the beginning or possible the middle of a so-called commodities super-cycle. Some people believe that such cycles can be very sustainable, having durations of up to 15 years and longer. In this particular case, some say, it could be a particularly sustainable one since the further urbanization of countries like China and India, that still have a majority of their people living outside of cities, would demand huge amounts of construction materials in the coming years. With gold being the 'odd' commodity, half commodity, half currency, it could benefit from such a cycle immensely in the long term.
Geopolitics, Oil and the Middle East The geopolitical situation is not good. The US' Iraq engagement is a disaster, with a military withdrawal only pending. Nuclear threats posed by Iran and North Korea remain unsolved, and Iran's and Turkey's strong interest in the Iraq-problem is not really encouraging either. In sum, a region with huge oil-reserves politically deteriorates further and further. What could the outcomes be? An unstable Iraq without US support? An Iraq finally occupied or closely allied with Iran? A war of the US also against Iran? In any possible scenario, I cannot see how that would not push the oil price, put further pressure on the US and the world economics. Again, gold could rise along with oil, being regarded as a financial safe haven.
Petrodollars and Global Warming The other day MoneyWeek asked where all the petrodollars would go, because they would not be invested in the US anymore. The offered solution was that investors would basically build on sand (in the form of artifical islands in the Persian Gulf). Where I can see that this is good for shares of construction companies and in general commodities, do you really think artificial islands and a construction boom are sustainable investment opportunities? With the Iraq further destabilizing and sea levels rising due to global warming, I cannot at all see why the Beckhams of this world should buy a house on an artificial sandbank inches over the sea level in short distance of one of the most notorious military hotspots of the planet. Eventually, the petrodollars, if they still flow, will go into other investments. I could think of gold.
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