The noose tightens for gold bears
A very interesting thing happened last week: in Europe
we woke up on Tuesday morning to a strong gold price.
This was noticeably different from the established
pattern of not much overnight change from the New York
close. This strength exacerbated physical shortages of
both gold and silver, propelling gold to nearly $1,350
and silver to $23. Put another way, buying in the Far
East dictated the price, taking the initiative away from
Western markets.
The underlying momentum is extremely strong, as shown in
the chart below where gold is following a neat parabolic
course. This means that any pull-backs will be limited
in both duration and extent.
From a technical point of view, the major pull-back
everyone is still waiting for occurred in 2008. This is
a market that will not be bought by the cautious, who
will feel they have missed the rise. Interestingly, the
most likely Elliott Wave count shows running corrections
in different wave magnitudes, which complete above where
they started – a peculiar concept for the uninitiated,
but a portent of strong price gains to come.
There are important positives for gold and silver.
Besides the strong technical analysis reading, price
actions are confirming acute shortages of physical
bullion, which are getting worse by the day. And
importantly, there have been dramatic monetary
developments early this week in both the US and Japan.
Forthcoming elections to hand more power to the Fed
Last Monday Ben Bernanke gave a speech before the Rhode
Island Public Expenditure Committee, where he expressed
concern about the course of public spending, warning
that it would either be curbed by “a careful and
deliberate process”, or by a “rapid and painful response
to a looming or actual fiscal crisis”. Put another way,
he is saying the Keynesian lever of fiscal deficits is
expended, leaving monetary policy as the only tool to
save the economy. He is anticipating perhaps the
results of the upcoming elections, where the Democrats
are likely to lose legislative control to Republicans
less tolerant of government profligacy. The result of a
legislative stalemate will be to hand more power to the
Fed, which will implement QE on a larger scale to
compensate for any cuts in public spending, while
keeping interest rates at zero for a considerable time.
The Fed therefore joins the Bank of England in pursuing
this strategy. The currency markets are waking up to
the implications of the next wave of American QE, and
all other currency-issuing central banks are considering
their monetary policies accordingly. What makes this so
dangerous is that an important element of input prices,
raw materials, is rising rapidly, with the Reuters CRB
Index up over 60% since November 2008. The rapid
expansion of raw money is also exacerbating the shortage
of physical gold and silver bullion for the bullion
banks and the shorts on Comex. They have all been
caught, in effect, betting the house on deflation. But
that approach does not allow for Asian buying by both
the central banks and hundreds of millions of the new
middle classes. This leads us to the second major
development, which is in Japan.
Japanese QE is desperation
On Monday night the Bank of Japan announced a new round
of QE with interest rates to be held even closer to
zero. There is little doubt it was this development that
generated Far Eastern demand for gold on Monday night,
and for good reason. The BoJ is going further than any
other central bank, and will buy in their words:
“Long-term government bonds, treasury discount bills,
commercial paper (CP), asset-backed CP (ABCP), corporate
bonds, exchange-traded funds(ETFs), and Japan real
estate investment trusts (J-REITs). As a fund
provisioning method other than the purchase of assets,
the Bank will utilize the fixed-rate funds-supplying
operation against pooled collateral. -- The purchases of
the ETFs and J-REITs are conditional on receiving
approval pursuant to the Bank of Japan Act”.
This is the widest application of QE by any central bank
so far. The stated reason for it is to prevent the
economy from entering a deflationary slump. But there
are two other important reasons for this policy: it is
an attempt to manage the currency downwards against a
falling dollar, so it is in effect a response to
anticipated Fed QE; and the Japanese government is
desperate for the money.
More or less all governments in the developed world are
borrowing more than their domestic bond markets can
provide, and Japan is now in the same boat. Over time,
she has through Keynesian policies almost destroyed her
savings culture, and her increasing ranks of the elderly
are depleting the savings pool. Therefore, the Japanese
government faces a choice for the next year or two:
raise interest rates to attract foreign capital to make
up for the savings shortfall, or print money. The
former can be ruled out, since it would drive the yen
up, bring on the collapse of domestic bond markets, and
expose government finances to elevated funding costs.
So printing is the only acceptable option.
Indeed, for the Fed, the Bank of England and the Bank of
Japan the primary reason for QE is not to rescue their
respective economies, but to fund government deficits.
Without QE, there would be savage competition for
international capital which could only be resolved by
substantially higher interest rates; and if this
happened, governments with high debt to GDP ratios would
rapidly go to the wall.
These are precisely the conditions that lead to
stagflation followed by a hyperinflationary slump, so it
is no wonder bullion prices are at record levels and
following that parabolic course.
7 October 2010
