The Gold Bug

Sunday, March 3, 2013

Gold in the Time of QE

By Scott Silva

2-27-13

Within the last two weeks, the price of gold dropped sharply to levels not seen since July 2012 and nearly as low as the lows of December 2011. Spot gold lost 112 points in the ten days from February 11^th to February 21^st, a 6.7% slide.

Just prior to the selloff, many analysts identified an onerous chart pattern as well as a popular technical indicator that appeared to be turning bearish enough to reverse gold’s long standing bullish trend. The worrisome chart pattern is the bearish triple top. The indicator that anxious traders carefully watched for proof of a trend reversal to the downside is aptly named the “Death Cross”.

The price of gold did fall in those ten days. But, did the bearish chart pattern predict a fall in the price of gold, or did traders create the patterns that confirmed the decline?

A look at the market conditions surrounding the sudden selloff in gold shows the bearish chart pattern actually failed, and traders may have had more to do with the selloff than many observers might think.

First let’s examine the bearish triple top pattern, also known as the triple top reversal pattern.

We know the triple top chart pattern can lead to some powerful downdrafts, especially if the successive tops are separated greatly from support levels and the tops are spread over a long period of time. The triple top pattern occurs when price action meets resistance, falls, and retests resistance then falls, twice more. The resistance level of gold recently is clearly established at 1805. The support level is also clearly evident; it appears as the bottom of a trading range. The support level is 1527. The three tops and the support level are evident in the daily chart for gold below. The depth of the trading range between resistance and support in this pattern is 278 points. A reversal occurs when price drops below support with relatively high volume.

But there are two elements missing in the bearish triple top pattern that are required to make the pattern valid. First and most obvious is the fact that price action has not dropped below the support level of 1527, although the drop came close. On February 19^th, gold traded as low as 1554.30 but closed at 1559.60, quite a bit higher than the support level. Price action has yet to close below the support level of the pattern. Second is a lack of confirming higher relative volume, which may be moot without the breakout. Nevertheless, there is no sign of capitulation, or massive selling pressure. The conclusion is the triple top reversal in gold has not occurred.

But what did occur is a sudden selloff. What caused it?

The answer, in my opinion, is the power of the self-fulfilling prophesy. Traders believed that a selloff was coming and so they sold. Selling begot more selling, which continued until there were no sellers left, leaving the buyers in control. What did the sellers see coming for gold? It was the terrifying “Death Cross”, the bearish signal sent when the 50 day moving average drops below the 200 day moving average. It is highlighted by the circle on the chart below. Traders could see steady convergence in the averages days before the selloff. Then, just before the cross, sellers sold hoping to get ahead of the decline. And by selling, more sellers were alerted, all driving the bid lower. The prophesy of a selloff became a selloff. It is a reliable phenomenon. Traders with long positions set their stops at such junctions. And the shorts kick in at these points as well, hoping the decline will be deep. These sell long and buy short orders are made by humans and machines. Nowadays it’s difficult to tell which moves the market more.

The bullish trend for gold remains intact. We can make this statement because technical support has not been breached. In fact, the recent decline was healthy for gold. It has allowed some profit taking, and new buyers to enter at bargain prices. The major trend remains bullish for gold. Tuesday, Chairman Bernanke dispelled any rumors of gold’s demise, when he affirmed his commitment to continued Quantitative Easing, until such time as US unemployment shrinks to 6.5%. The Chairman is referring to the administration’s favorite measure for the out or work. The true unemployment rate, the U-6 measure, is so much higher that it is deemed politically incorrect (a lofty 14.6% for January). At that rate of job growth over the last four years, the Fed will be buying bonds until 2035!

There is no doubt that more QE is good for gold, and evidently, stocks. QE is better for gold because gold cannot disappoint analysts and traders with lower quarterly earnings, which is one trap the ultra-easy monetary policy springs for stock market investors. Stock yields appear attractive compared to negative real interest rate fixed income assets. The Fed has distorted not only the yield curve but also the risk/return balance. This has pushed investors into stocks and in the stock indices higher. We are seeing companies manage earnings well while missing top line revenue expectations. This is not a sustainable growth model for equities. The model collapses as interest rates rise, and margins are squeezed further. Lower sales revenues are a symptom of recession in Europe, a slowdown in China and continued sluggishness in the US. QE Infinity is artificially pumping up stock prices. The forward PE for the S&P 500 Index, for example, is 17.90 compared to 15.78 a year ago. If there were true earnings growth, which only can be sustained by true revenue growth, the forward PE would be much higher. Then, there is the $ 2 Trillion cash trove sitting on company balance sheets here and in overseas tax havens. Companies are not investing in growth. They would rather buy back shares and sit on cash.

So, how have investors fared in stocks vs gold during the time of QE? Since Chairman Ben and the Treasury began their ultra-easy monetary regime, gold has gained dramatically compared to

the broad stock index (SPX).

No one can predict the future, including Ben Bernanke. But he seems intent on continuing his dovish ways. And as he does, those who own gold will be better off for it.

Responsible citizens and prudent investors protect themselves and their wealth against the ambitions of over-reaching government authority and debasement of the currency by owning gold. Gold is honest money. Investors from around the world benefit from timely market analysis on gold and silver and portfolio recommendations contained in The Gold Speculator investment newsletter, which is based on the principles of free markets, private property, sound money and Austrian School economics.

The question for you to consider is how are you going to protect yourself from the vagaries of the fiat money and economic uncertainty? We publish The Gold Speculator to help people make better decisions about their money. Our Model Conservative Portfolio has outperformed the DJIA and the S&P 500 by more than 3:1 over the last several years. Follow @TheGoldSpec Subscribe at our web site www.thegoldspeculatorllc.com with credit card or PayPal ($300/yr) or by sending your check for $290 ($10 cash discount) The Gold Speculator, 614 Nashua St. #142 Milford, NH 03055

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editor@thegoldspeculatorllc.com

Wednesday, February 13, 2013

Catching the Bid

By Scott Silva

Editor, The Gold Speculator

2-13-13

Stocks are catching the bid again, trading higher. The S&P 500 has topped 1500, a level not seen since 2007. The Dow has also recovered from its lows to pre-meltdown levels, above 14,000. Stock traders shrugged off fiscal cliff fears, to extend the rally into the new year. Small investors are now joining the professional buyers, who have viewed stocks as undervalued assets for over a year. They are cashing in their bonds and emptying the mattresses to put money into stocks.

What has propelled US equity markets? The answer may surprise you.

We’ll we know the presidential election has not pushed the stock market higher. To the contrary, stocks tumbled when the president was re-elected. Stocks had rallied with pre-election hopes of a new, pro-growth occupant in the Oval Office. But alas, that hope vanished when the final votes were tallied. The president could have won over traders by announcing a change in his economic policy to start his second term, but he didn’t, and his plan has consequences. More on that later.

So if the president’s economic policy did not stimulate the current rally, what did? The answer lies in a fundamental principle of free-market economics (and everyday life), namely, substitution. In his 1978 text Microeconomic Theory, Nicholson defines substitute goods as “those goods which, as a result of changed conditions, may replace each other in use (or consumption).” Investors treat risk-free yield as a desirable economic good. The world gold standard risk-free instrument has been the US Treasury bond, or note. Buyers of AAA-rated

10-year Treasury notes would typically collect 4% annual interest with virtually no risk of default. In contrast, equities as an asset class typically return 7%, commensurate with higher risk.

Companies could go bankrupt, products could fall out of favor, or stock prices could fall for any number of reasons. Throughout history, investors searching for yield have committed capital both to stocks and bonds, overweighting their portfolios in one or the other asset class according to their risk profile and investment objective.

But that time-tested strategy not longer holds. That’s because the Federal Reserve has changed the game. In his reverent adherence to Keynesian stimuli, Chairman Bernanke has taken away risk –free yield (or pushed it out to 30 year maturities), by instituting his Zero Interest Rate Policy (ZIRP). This massive credit intervention flattens the yield curve and drives real returns on medium term Treasury instruments (and CD’s) into negative territory. Investors naturally seek other instruments. They look for substitute goods. Many select high-yield dividend stocks, not for their equity value, but for their dividend income. When the buyers come in, stock prices rise.

Many investors have been holding cash since the great financial meltdown. They have lost capital while they held because the Dollar has lost purchasing power since then (and will continue to lose value). This too, is a result of the Federal Reserve’s massive credit intervention.

Big Ben loves to print money. But we know that Gresham’s Law still holds. The Fed debases and devalues the currency each month by printing more money out of thin air in its $1 Trillion/ year Quantitative Easing program.

That’s not all QE is doing. QE is pumping up stocks with hot air. The Fed’s ultra-easy money regime keeps margin rates low, which spurs stocks, and also keeps borrowing rates low for corporate capital investment. Because of investor substitution, incoming stock buyers benefit from low margin rates. But companies are not rushing to but capital equipment at low interest rates. Instead, companies are sitting on roughly $2 Trillion in cash here, and keeping another $2 Trillion offshore and out of reach of Federal taxes. Some companies can think of nothing better to do with their cash than buy back shares. Stock buybacks tend to push stock prices higher (less stock outstanding, higher P/E for the same earnings), but they are a tremendous waste of capital.

Excess corporate cash should rightly go to shareholder dividends or expansion.

In general, US companies are not expanding. They certainly are not hiring. No amount of Federal Reserve QE will force them to do either. Simply put, the Fed cannot create aggregate demand. This is heresy, of course, to the Chairman and the president’s economic team. But the reason that the president’s entire economic team has deserted him is because their Keynesian policies have utterly failed. TARP was a failure. The GM bailout was illegal. The $800 Billion Stimulus Package failed. Cash of Clunkers failed. Mortgage modification failed. The Payroll tax holiday failed. GDP is hovering at low levels, and dipped into negative territory last quarter. Unemployment has not declined since 2009, despite the administration’s spin. It remains stubbornly at 14% (U-6 measure), a level not seen since the 1930’s. We simply cannot print money, tax, spend and regulate our way to prosperity.

So should investors join the buying spree in stocks? Well, the speculator and the aggressive investor may find some gains in equities now. We have been realizing good profits each week in our Model Aggressive Portfolio (MAP), where we focus on near term trade (weekly) setups in stocks, options and futures. In MAP, we have been focused on stocks since November 2011 and our recommendations have made money each week. But the market holds risks for more conservative investors that enter at these levels. That’s because earnings, the mother’s milk of stocks, are beginning to top out for many large cap companies. We are seeing companies meet or beat 4^th quarter earnings expectations and miss revenue expectations. Revenue growth is essential to earnings growth. Many companies are guiding analysts lower going forward. These companies are reflecting lower global demand and the realities of continued recession in Europe, a slowdown in China and slowing demand in the US.

Slowing, low demand in the US won’t be reversed by raising taxes. But raising taxes yet again is exactly what the president intends to do. What is puzzling about the president’s tax obsession is history shows cutting taxes stimulates the economy. The economy jumps when consumers have more discretionary income to spend. What’s more, the Federal government gets more revenue when marginal tax rates are reduced. This happened as a result of the Kennedy tax cuts, the Reagan tax cuts, the Clinton tax cuts and the Bush tax cuts. Reducing federal regulation also stimulates the economy, as we saw most prominently in the Reagan years, the longest period of prosperity and economic growth in our time.

The technical indicators are signaling stocks are reaching major resistance. For the S&P 500 index (SPX), a good measure of the broad equity market, prices has climbed to just over 1500, a key resistance level. Price action of the SPX has formed a bullish inverted head-and-shoulders pattern on the daily charts with a neckline at 1458. The measured move on a bullish breakout above the neckline is 105, which brings a target level of 1563. The SPX made its breakout of the bullish pattern on January 10^th, and has been climbing steadily since. Yesterday, the SPX closed at 1522.29.

This move up can also be seen in the Fibonacci extensions of the previous run up (June -Sept 2012) and pullback (Sept-Election swoon of November 2012). Since the November lows, price action has powered up to the 50% Fib (1448) at circle #1 on the chart below, then fell back to just above the 23.6% Fibo (1398 at circle #2), and quickly jumped past the 38.2% Fibo and surged right up to the 61.8 Fibo at 1472 (circle #3). After five days of consolidation at the 61.8 Fib, the SPX climbed steadily to the 78.6% Fibo at 1507 (circle #4) and appears to be headed higher still.

It is gratifying to see separate technical analyses in such lockstep agreement.

The speculator or aggressive investor that followed our Model Aggressive Portfolio (MAP) Recommendations has done very well with selected stocks, stock options and futures contracts over the last several months. Weekly returns have ranged from 30% to 77%. What choices are available to the conservative investor in today’s investment environment?

The answer certainly is not bonds, especially Treasurys. Treasury bonds yield negative real interest returns. Investment grade corporate bonds don’t offer much more for the added risk.

Conservative and prudent investors choose gold.

The case for choosing gold today is as strong as it has ever been. It can be made efficiently in the form of a parliamentary inquiry, so often used in my own sovereign state of New Hampshire’s General Court:

If you know, as I know, that stocks are full of Fed hot air, and the Fed has fenced off reasonable yields in fixed income instruments by intervening in the credit markets, and,

If you know, as I know, that corporate bonds offer yields only at a significant risk of default, and,

If you know, as I know, that the Federal Reserve is continuing to print money under its Quantitative Easing program, and has stated it will not stop until the unemployment rate is lower than 6.5%, and

If you know, as I know, that unlimited QE has no effect on the unemployment rate, and that

QE debases the currency and its purchasing power, and

If you know, as I know, that gold increases in value as the Dollar decreases in value, and that gold is recognized as the ultimate global currency,

Would you not agree with me that owning gold today will protect your wealth against the ravishing of fiat currency and tyrannical federal overreach?

That’s right. The answer for conservative investors is gold. In fact, aggressive investors should also own some gold to diversify their portfolios. Here’s why any investor should own gold now.

The great bull market for gold is continuing. The fundamentals are in force to push gold prices higher, and the technical analysis supports higher gold prices from here.

First, the fundamental case. It all boils down to central bank policy. The Fed, the ECB and BOJ are all maintaining accommodative monetary policies. That is, they will keep interest rates artificially low and continue to add liquidity by various forms of Quantitative Easing. QE itself debases the currency and drives commodity prices higher. Loss of confidence in the Dollar, the world’s reserve currency, is also reflected in the price of gold. Political instability in sensitive regions of the world affects the price of gold (and oil). We are seeing the war premium boosting oil prices as tensions rise over nuclear weapons development in Iran and North Korea. Even central banks are buying gold. That’s because unlike fiat currency, gold has intrinsic value. Gold is recognized as the ultimate global currency and store of value.

Second, the technical case. QE is weakening the Dollar. As the Dollar weakens the price of gold increases. The traditional inverse relationship between the Dollar and gold is present in today’s market. Global QE and US economic policy is keeping the Dollar weak. The weak Dollar supports higher commodity prices in general and higher gold prices in particular.

We can see this dynamic play out in the chart of gold vs Dollar below. Technical indicators on the daily and weekly basis charts are bearish for the Dollar. On the weekly basis charts, resistance is now 80.74 with support at 77.44. The Dollar is headed lower form here. A move down to the 78 level would command a gold price of 1800, a key resistance level.

What would cause the gold price to drop significantly? Well, if the Federal Reserve were to cease buying bonds (QE), the price of gold would drop. But Chairman Ben has reiterated his commitment to buying bonds at the rate of $85 Billion per month until unemployment is reduced to 6.5%. The January 2013 unemployment rate is 14.4% and the current regime has no pro-growth economic plan. The price of gold would drop if peace broke out in the Middle East and Iran, North Korea and China dismantled their nuclear weapons. Recent events in these tinderbox areas demonstrate there’s not much chance of that happening, particularly when the US is reducing its military strength to the point it can no longer fight in two theaters of operation at once. Gold would fall if real estate became a safe investment asset again. But it will take 10 years to work through the housing overhang of 5 million foreclosed properties that is weighing down home prices. And gold would fall, as it did in the Reagan years, if pro-growth tax reform, and a plan to balance the budget within ten years, which would include entitlement reform, were adopted now. As we saw in yesterday’s State of the Union address, the president is campaigning for higher taxes, more spending and more Federal regulation. No pro-growth agenda there.

So now is a good time to buy and hold gold. Buy gold to protect your wealth against the corrosive effect of ultra-easy monetary policy. Buy gold to maintain a store of value that is recognized universally. Buy gold to diversify your investment portfolio. Buy gold for peace of mind in uncertain times. Buy gold to secure yourself and your family.

www.thegoldspeculatorllc.com

editor@thegoldspeculatorllc.com

Wednesday, October 24, 2012

Triple Top in Gold?

By Scott Silva

Editor, The Gold Speculator

10-24-12

Gold is amazing stuff. Gold has launched wars, destroyed and created whole societies. For thousands of years gold has been the trusted medium of exchange, and for hundreds of years had been the reserve currency of developed nations. Today, there is revived interest in gold. Central banks are net buyers of gold bullion, and more and more individuals are buying gold and silver bullion. That’s because gold has intrinsic value as money anywhere on the globe. Gold maintains its value as fiat currency is debased as central banks print Trillions more paper notes on the pretext of stimulating ailing economies. In fact, these robber-baron governments are implementing their secret agenda to monetize massive national debts, that is, paying interest (rarely principle) with paper currency of ever-diminishing value. Where are the RICO laws for that criminal practice?

Gold has been good for investors to own. Owning gold is an excellent way to diversify almost any portfolio. Hedge funds, banks, and other institutional investors have been buying gold, particularly in the last few years. The price of gold shows the bulls have been in control for years, pushing the price of gold up four-fold over the past ten years.

Some analysts see a triple top pattern in the weekly charts for gold. The triple top pattern typically marks a reversal. Since gold has been in a strong bullish trend for years now, a trend reversal would be strong and steep. The commodity bull cemetery is full of gravestones bearing the inscription, “killed by a triple top”. Are the charts telling us the price of gold is headed for a lethal fall? Has gold formed the bearish triple top that some analysts see? Or are there other technical signs that we can see from the charts that can help us decide to buy, sell or hold gold right now?

Well, we know from technical analysis that a triple top chart pattern is indeed a bearish pattern that typically marks a reversal. We can spot the pattern by its three successive peaks near major resistance, formed over time by successive moves up from the same support level. The three tops should be spaced roughly equally apart. Trading volume should show a declining trend over the three-peak formation period. The weekly basis chart for spot gold displays such features.

So should we sell gold now before its inevitable fall? Well, it might be more prudent to

determine if the bearish triple top pattern displays a break below its support level. At present, weekly price action is 200 points higher than the support level of 1527, so we would need to see a major decline from today’s price. If the price of gold does decline and drops below 1527, the measured move for this pattern shows gold could drop down to 1251. Ouch!

There is another pattern in the weekly gold chart worth considering. It is a large, long term bullish ascending triangle pattern that began to form way back in February. The ascending triangle pattern is a continuation pattern, which at breakout, can result in a powerful move up. We identified a smaller ascending triangle pattern in gold for readers of these pages (“Charting Gold, 8-14-12), which predicted the breakout from 1635 to 1724. The measured move calculated in the larger, longer term ascending triangle pattern if the gold price were to break above 1803 is 221 points, which would bring the bullish breakout target price to $2024/oz for spot gold.

Will gold break above 1803 on its way to 2024? We shall see. Price action is finding support at current levels, and 1803 is just 4% away from last week’s closing price of 1730.40.

The ascending triangle pattern is in the weekly basis chart for gold. There is yet another bullish pattern evident in the weekly chart, namely, the bullish cup and handle pattern. This is a powerful, long term formation that dates back to February. The bullish cup and handle pattern traces out the “cup” by the gradual price decline, then bottoming out, and then gradually returning to the “lip” of the cup. We can see this feature in the chart from February to September for spot gold. We can also discern the formation of the “handle” feature, which is the sideways to slightly declining price action. The measured move for the bullish cup and handle pattern is calculated by adding the value of the depth of the cup portion to the breakout level, which is the upper trend line of the handle feature. The measured move for spot gold in this pattern is 274, which would bring the price target to $2077/oz were gold to close above the 1803 on the weekly chart, the breakout level at the “lip”.

There is good potential for a more upward pressure on the gold price. The Fed meets again this week. Chairman Bernanke could announce he is expanding the scope of his monthly bond-buying program (QE Infinity) in response to yet more disappointing US economic data. More QE will likely push gold higher. Gold could also receive a boost from progress across the pond. If the EU gets closer to a solution to Spain and Italy’s debt troubles, the Euro would gain against the Dollar, which would send gold priced in Dollars higher. Also, renewed violence or the threat of violence in the Middle East or Africa would be reflected in higher gold prices. Finally, the US election outcome will impact the price of gold. A pro-growth president would put pressure on gold prices, as was the case under President Reagan. If the incumbent survives the election process, gold is likely to stay high in price, consistent with ultra-easy monetary policy and massive deficit spending.

So, we will be watching which way goeth gold in the short term, up 4% or down 11%, before the next big moves predicted by the charts take place. At present we do not expect gold to plummet from a bearish triple top pattern. The fundamentals support high gold prices for the foreseeable future. However, we shall stay vigilant as we tip toe past the triple top cemetery.

www.thegoldspeculatorllc.com

editor@thegoldspeculatorllc.com

Tuesday, August 21, 2012

Breakout in Precious Metals

By Scott Silva

Editor, The Gold Speculator

8-21-12

Gold bugs are paying attention to the breakout in the gold and silver today. Could this be the breakout that propels the precious metals to new highs? Or is the bullish buying of the shiny metals a passing summer fling?

Some respected analysts characterize the current bullish interest in gold and silver, as well as the summer rally in stocks is invalid, citing the lack of trading volume, which “is the only way to confirm a bullish trend”. That opinion has led many to short stocks and some commodities. Others have elected to stay on the sidelines, satisfied to stash their capital in Treasurys.

Technical analysis sheds some light on the nature of traded assets. Readers of these pages last week (“Charting Gold”) saw our forecast of the potential breakout in gold based its bullish ascending triangle chart pattern. In that analysis, we identified the breakout level to be $1634/oz.

Soon after the New York open today, spot gold jumped to just over 1640, clearly above the trend line breakout level on high trading volume. To be considered a valid breakout, gold needs to close above 1634 over the next few trading sessions with volume above 110,000. The target price for a valid breakout from the bullish ascending triangle pattern in gold is 1725.

Ichimoku Kinko Hyo indicators show that the 1725 target price has been a strong support/resistance level in the past. We can see from the weekly basis chart the projected cloud is showing 1723.80 as resistance. We saw gold trades close to this level before the run up last August and for several weeks of sideways trading from April through May this year. Another significant feature on weekly chart below is the bullish cross of MACD oscillator. Several traders use MACD crosses to execute trades because it clearly identifies shifts in momentum. Whether or not MACD is used as a trigger for a trade, it is a useful measure for confirming other technical indicators, such as a bullish cross of Tenkan Sen from below the Kijun Sen, which remains intact since it appeared on the July 26 daily Ichimoku charts for gold.

Some traders rely on the TrendSpotter indicator, a popular computerized trend analysis available on most trading platforms and on Barchart.com. The indicator combines elements of wave theory, market momentum and volatility to display the general trend for a given traded asset. Traders read the TrendSpotter “dots” which are graphic codes for more technical analysis going on in the background by computer algorithms. A single dot above the price indicates resistance and a bearish trend. A dot below the price shows support and a bullish trend. When two dots appear, one above and one below the price, the trend is neutral indicating “hold”.

We can see that TrendSpotter dots have followed the upward trend in gold building from late July, and accelerating in the last three trading sessions including sessions.

The study at the bottom of the TrendSpotter chart is a momentum indicator, which shows relative price differences between the current price and the price 10 and 20 sessions ago. The waves above and below the zero line show bullish and bearish price momentum. The height (amplitude) of the wave signifies the strength of the momentum. These data are showing an accelerating bullish TrendSpotter trend for gold, with modest momentum at the moment.

There are a multitude of technical indicators and systems that support informed trading decisions. The important thing to remember about technical analysis is that it works. What works best for one trader or another comes down to personal preference. Ichimoku works well for us at The Gold Speculator. We use it as the basis for selecting gold and silver stocks and futures for the Model Conservative Portfolio (MCP). Ichimoku support and resistance levels tend to correlate closely to Fibonacci retracements, which we find to be very reliable forecasting tools when used in combination. We use Ichimoku along with some “trigger” indicators for our weekly recommendations for traders who trade more frequently across all markets using our Model Aggressive Portfolio (MAD), which returned 77.3% for the week ending 8-17-12. Recommendations for each risk profile are available online to subscribers.

Each set of these popular technical indicators are showing a new bullish trend is building for gold. These same technical analysis tools show that silver has broken out above resistance and may be on the way to new highs this year. Silver has the potential to make much greater percentage gains than gold over the next few months.

The charts are telling us it’s time to buy and hold gold and silver. Sometimes, a summer fling

can turn into “The One”.

www.thegoldspeculatorllc.com

editor@thegoldspeculatorllc.com

Tuesday, August 7, 2012

To QE or not to QE

By Scott Silva

Editor, The Gold Speculator

8-7-12

To QE or not to QE. That is the question. The markets waited for the Fed Chairman to announce it is time to jump in with another round of restorative stimulus, and had bid up nicely before Big Ben disappointed once again at the conclusion of last week’s FOMC meeting, stating,

“The Committee will closely monitor incoming information on economic and financial developments and will provide additional accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.”

Hardly stimulating. The markets responded by selling off, but not as sharply as usual following a Bernanke punt. Traders held out hope that the ECB might do something bold. But alas, Mario Draghi seemed content to sit on the edge of the bed as well. Apparently, now is not the time for the central banks to begin a new bond-buying binge. The bankers must have insight other do not. Could it be that that they expect economic conditions to deteriorate further, or do they see signs of a sudden turnaround? Most analysts are pessimistic on the prospect that the Eurozone debt crisis can be contained. And many do not see the US recovery happening until a pro-growth president takes the oath of office.

The reason that the Fed policy has failed to stimulate the US economy is that monetary policy cannot stimulate demand. And despite what the Keynesians in charge of Washington believe, government spending does not create demand (except, or course for defense spending). Even if I accept the Keynesian approach, then also I must believe that the US is in JMK’s liquidity trap, that eerie nether region of extended ultra-low interest rates in which no amount of additional money produces any increase in output. Uncle Ben must secretly know that QE3 would ultimately fail, as did QE1 and QE2. And so too, his legacy as an effective Fed Chairman would never materialize.

One example of the failure of Washington central planning policy is the unemployment rate, which has now reached 15% (U-6 rate) for July. We have not had so many out-of-work citizens since the 1930’s. If defense funding sequestration occurs, there will be another 700,000 or so joining the jobless ranks. Despite what some may say, the private sector is not “doing fine”.

The US stock market seems to have discounted the feckless Fed, re-election campaign rhetoric, and the lousy July jobs number to closing above 13,000 last week and continuing its move up this week. The markets seem propelled by some special knowledge that there may be a bridge across the fiscal cliff. Could reason and responsibility succeed where rhetoric and redistribution has failed? We shall see. In the meantime, individuals must remain vigilant and protect themselves against attack by those who would steal their wealth and give it to others more “deserving”. Да, Comrade!

Many know that buying and owning gold is an excellent way of protecting wealth. Gold has been a recognized store of value for thousands of years. Gold has intrinsic value. Gold maintains its value especially in uncertain economic times. The price of gold increases when governments intervene in the credit markets and create more fiat currency than economies demand. This has been the case in the US and the EU for the last several years as central bankers have tripled the money supply through Quantitative Easing and other easy money measures.

Over the past five years, US central planners have distributed more than $4 Trillion of stimulus funding, raising the government share of GDP to 42.3% in 2009 from 35% in late 2007. The Federal spending binge includes add-ons to the agricultural and housing bills in 2007, the $600 per capita tax rebate in 2008, the TARP and Fannie Mae and Freddie Mac bailouts, "Cash for Clunkers," additional mortgage relief subsidies and the president’s $860 billion stimulus plan that promised to deliver unemployment rates below 6% by now.

Since the beginning of the Federal stimulus spending spree, US GDP has fallen 61% and the price of gold has increased 101%. The price of gold is likely to climb higher if Chairman Bernanke ignores his better angels and succumbs to another sip from the punchbowl.

And the price of gold is telling us now that odds are good that the Chairman will fall off the wagon, again, soon. Today, gold is trading above $1600/oz.

There are signs that gold will continue its upward trend for some time yet. Technical indicators for commodities in general are bullish. The CRB index is in an upward swing, climbing to 12% to over 561 since June. Many noted commodity traders are adding to their long positions. In particular, large speculators (the smart money) are accumulating gold. In the most recent Commitment of Traders (COT) report, Large Speculator bullish sentiment jumped 3 points to 79%. The large traders added 5,246 new long contracts and shed 7, 841 short positions on slightly lower open interest of 403,403 contracts. These professional traders are usually ahead of the herd. As subscribers to The Gold Speculator know, we are bullish on the precious metals.

What will happen to the price of gold if Helicopter Ben does not dump more bushels of greenbacks from the sky? Well, the price of gold will still rise. A major reason is the fact that money is seeping in to the economy from a massive store held as “excess reserves” by member banks of the Federal Reserve system. These funds are released into the economy when the banks lend or create new demand accounts. Normally, adding money into circulation stimulates economic activity. But we also know that increasing the supply of money when the demand for money is low, as is the case today at 1.5% GDP growth, leads to higher prices.

Of course, a new round of Fed bond-buying would be a massive dose; the last two rounds were woefully inadequate, according to the Keynesians in charge. “If only the stimulus were larger, say $1.5 Trillion or so, we would have come out of the woods by now.” Or, maybe $3 Trillion, as Paul Krugman has suggested.

Here’s an idea that might work. Take Paul Krugman’s $3Trillion number and rather than spending it on shovel-ready stimulus programs, spend it all on running the Federal government for a year, and declare a 1-year tax holiday for all US citizens and all US businesses. Now that would jump start the economy and end the jobless recession.

'Tis a consummation devoutly to be wished.