Monday, December 12, 2005

Is Gold Predicting A New "Great Depression?" - Schmidt.

MONEYization #18
Ned W. Schmidt, CFA, CEBS
Dec 09, 2005

The global financial phenomenon of individuals and businesses moving their funds to monies in which they have the highest confidence, or money which has a higher store of faith.

Or, Catching Up & Calming Down

Many recovered more quickly from Hurricane Wilma. Having eight days of no electricity put a bigger hole in our productive activities than expected. More than a couple weeks were required to return the human schedule to some kind of normality. Just last week I was able to say that most of the "holes" had been filled in, and progress could again be made. For that reason, this writing is in part intended to catch up. Additionally, some investors need to calm down and not allow the speculative juices now running through the markets to drive their activities.

Buying motivated by a fear of missing out on a market move has never been productive. Successful investing is built on buying low, when few want something. Such is not the case today in the Gold market. While the longer term positive outlook for Gold to rise above US$1,300 is regularly confirmed by the news, every day is not a "buying day." Some days are just "watching days."

Rarely have so many reasons coexisted at one time to motivate buyers of Gold, and the other metals. The following are a sample of the many factors that have been joined in time to give us $Gold at more than $500. No intention exists to say that any one is a particular problem, but rather that a long list of buyers have come into the Gold market in a short time span to create an over bought situation.

Investment managers are busy window dressing their client accounts. Many have not owned Gold in their managed accounts. Few want to send out December statements without some exposure to the precious metals. The calendar is helping in another manner. The investment community starts winding down for the year in the first weeks of December. Tax loss selling has been completed and the moneys have been repositioned to convince clients how well their money is being managed. In short, the period of maximum flow from this group is now being felt in the Gold market.

Federal Reserve watchers, not all reading the signs the same, are also shifting to Gold. These handicappers of Fed Res policy are divided into two groups. First, some think the Federal Reserve is close to the end of the interest rate raising cycle. To them, lower interest rates are just a matter of time. Such a development would be bearish for the dollar, and makes buying Gold a good idea. Another group reads the minutes of the FOMC and focuses on concerns of higher inflation ahead. This latter group is motivated by those worries to buy Gold.

CNBC discovered Gold. When trading below US$300, we were Gold Nuts. At $500, Gold deserves a panel discussion in the morning. That talk certainly has created some buying by those that let CNBC manage their portfolios. Course these discussions are fitted in between reports on Google. Google vs. Gold, seems almost like a title for a Japanese monster movie of times past. As long as the investment merits of Google at recent prices are still being discussed, Gold is a safe longer term holding. The media attention has certainly attracted some that are afraid of missing the move.

Momentum players have watched as the back testing of their profit matrixes created buy signals on Gold. These traders would not touch Gold below $400, but the move above $475 was a buy signal to these gamblers. Understanding momentum investing is important. A momentum investor sees four red numbers in a row at a roulette wheel as a sure sign that red will keep coming up. Would you bet with them?

The nominee for Chairman of the Federal Reserve, Bernanke, will likely be as good for Gold as the outgoing Chairman. Bernanke's Delusion and Bernanke's Illusion will serve as foundations for monetary policies that will likely enhance the price of $Gold. The new Chairman will build on the view that Federal Reserve policy has not been faulty over the past many years. Bernanke is President Bush's gift to Gold investors. Thank you, Mr. President!

Federal Reserve policies continue to be supportive of higher future inflation. Higher oil prices have been monetized by the Federal Reserve. $60 oil and higher prices for other commodities are slowly working their way through the global economic system. The year-to-year change in the U.S. CPI has broken out of a ten year trading range. The Federal Reserve, though, continues to view all these developments as exogenous factors not influenced by the policies of the central bank. This mistake has been made before.

Gold has demonstrated price strength in many national monies. That development has convinced many of a new bull market in Gold on global basis. This global Gold rally is an exciting example of the moneyization phenomenon, where people shift to money, Gold, in which they have a higher faith. National monies, on a global basis, are losing value as a consequence. Another view might be that the shift, in process since 2000, away from paper assets to real assets has accelerated as real returns have been superior to paper returns.

Central banks around the world, following the lead of the Federal Reserve, have created unprecedented amounts of liquidity over the past decade. When that liquidity was being stored in U.S. government and agency debt the potential to influence prices was minimal. With the tendency to invest money away from the US. dollar, that liquidity is pushing a broad array of prices higher. Gold, oil, commodities, paper stocks, housing and others prices are rising as that liquidity is now being freed from the shackle of U.S. debt. That unleashing of liquidity may be having an inordinate impact at the present time on Gold's price, and the prices of U.S. equities. Such a development increases short-term price risk without disturbing the long-term dynamics.

The U.S. dollar has passed through a period of high relative pessimism which has normally been associated with an overbought Gold market, and a likelihood of a correction within the context of a longer term bull market. This situation can be observed in first graph. The solid line is a stochastic like measure built on the relative ranking of the U.S. dollar versus nine major national monies. This measure is plotted, using the right axis, as an oscillator with 0% representing maximum pessimism and -100% as maximum optimism. Such a plotting convention allows more ready comparison versus the $Gold price. Line of triangles is the $Gold price, using the left axis.

The previous major warning from this measure was this past summer when over optimism on the dollar was indicated. That condition suggested a shift toward less optimism, or more pessimism. Higher $Gold prices were expected in that situation, and higher prices did occur. At the present, while short of a maximum negative reading, the measure is suggesting that $Gold will weaken. While the U.S. dollar remains in a longer term bear market, pessimism has passed trough an extreme level which pushed Gold prices to today's higher price. Based on this measure some consolidation is likely. Too much optimism on Gold is built on too much pessimism on the dollar, in the short-term.

The attitude of the world toward the longer term prospects for the U.S. dollar remains negative. Concern here is that the dollar is now at the lower edge of the bear market channel and is likely to bounce to the upper boundary of that downward sloping channel. That development could create some short-term price consolidation in the Gold market. Longer term the growing negative view of the world toward dollar investments should support optimistic forecasts for $Gold's price. This trend toward a collective negative on the U.S. dollar can be observed in the second graph.

Each week the Federal Reserve releases data that includes holdings at the Federal Reserve of U.S. government and agency debt in accounts for foreign official institutions. This report provides the most timely data on the investment of dollars back into U.S. debt. Last week these holdings amounted to $1.5 trillion. Plotted in the second graph is the slope of a regression line on that data on foreign official institution holdings of U.S. government and agency debt. For those with a mathematical leaning, it is the "b" in y = a + bx regression line where y = holdings of U.S. debt. In short, this measure gives an indication of the trend in these holdings.

While some may have forgotten that topic from long past courses in math and statistics, the interpretation is fairly easy. If this measure is positive, foreign official institutions are still increasing their holdings of U.S. government and agency debt. If the measure is declining, becoming less positive in this case, the rate of acquisition is slowing. This plot should give us an early indication of when the selling might start. That day when global investors tire of losing money in the U.S. dollar is coming if this trend continues to deteriorate.

At present the plot remains positive. Foreign official institutions are still buying, but at a slower rate. Since the hemorrhaging of dollars by the U.S. in the form of the trade deficit continues, excess dollars are being spent or sold rather than reinvested. That tendency to shed dollars puts pressure on the dollar's value and pushes up the price of $Gold. Such a development has contributed to the recent $Gold rally, and is the foundation for the long-term dollar bear market and bull market in $Gold. However, these foreign official institutions have not started selling dollars. That action, when it develops, will be what propels $Gold to over US$1,300.

The longer term case for Gold remains well intact. Concern here is with the tactical moves of investors, or how they should deal with the daily and weekly price movements. As shown in the third chart by the oscillator at the bottom, $Gold has risen to an over bought extreme. Timing your purchases to make greater profits simply makes sense. And note, we are referring to the timing of purchases. One should not sell in a bull market.

The indicator in the $Gold graph suggests that $Gold may be preparing to start a consolidation. An overbought reading on this oscillator continues to persist. Speculative juices now running rampant will exhaust themselves at some point, and prepare the way for another profitable buying opportunity. Those wishing to buy $Gold should be accumulating cash, selling U.S. equities for example, in preparation for the next buy signal on this indicator.

While Gold has done well in dollars, $Gold is not the only price that has come alive. Gold in both Euros and Canadian dollars has been strong. This development can be seen in the last two charts. These charts also include the oscillator for over bought/sold to help investors denominated in those monies to make more timely purchases. These charts are new to THE VALUE VIEW GOLD REPORT so historical buys that might have occurred are not plotted beyond the last signal.

As shown in the €Gold graph, the movement of €Gold above €400 really lit the belly fires of speculators. Breaking above US$300, way back when, did nothing, but this did. Investors in a host of national monies took notice. Gold's brilliant fire suddenly burned bright for a far larger spectrum of investors. Some had expected $Gold to rally, but the €Gold move was not foreseen. Politics in the EU, French riots and the Jordan bombings reminded Euro investors of the need for real money in their portfolios.

As shown in the Canadian $ Gold graph, CN$Gold joined in the move. Gold moving above CN$560 was like a flame to a moth. Canadian investors have a long history of moving out of their national money. They should continue to use the over valued Canadian dollar to buy Gold when conditions are right. While the Canadian dollar has appreciated against the U.S. dollar as one economic consequence of the Patriot Act, the trend in CN$Gold clearly showed another picture. Canadian investors should be wary of the paper money illusion, and move to Gold when profitable buying opportunities develop.

However as can be seen in these graphs, Gold in both national monies has moved well into an over bought condition. Investors in both nations should be restraining purchases at this time. A better purchase price will develop. Always has! Both CN$Gold and €Gold will again move to over sold prices. Investors denominated in these national monies should also be preparing for future buying opportunities, rather than "chasing the rabbit."

A caveat in all this seeming rationale thinking does exist. Markets discount the future, not what we know today. The world has a massive investment in U.S. dollar denominated assets. Much of the global economic machine is dependent on the U.S. consumer spending binge. U.S. consumption exceeds income. Negative savings is the term applied to that situation. To date, that deficit has been financed by converting equity in homes to cash. Should U.S. consumers not have access to that source of cash, spending would fall by more than $500 billion. The U.S. dollar would plunge. 1930 would by contrast look like a spring picnic. Is the Gold market telling us something?

Ned W. Schmidt

Copyright ©2003-2005 Ned W. Schmidt. All Rights Reserved.