From Chart 1, it can be seen that the gold price's stochastic is giving a clear sell signal at present, and that the MACD is in significantly overbought territory . I have chosen to track the Cumulative Differential between the 40 day MA and the 200 day MA, and there is now a "gap" of over $30 between these two MA lines.
Based on the elastic band principle, the further the two MA lines drift apart, the greater the tension, the greater the instability of the status quo, and the greater the predisposition of price to move in such a manner (in this case "down") in order to ensure a closing of this gap - ie, the gold price "could" be facing a $30 fall from here.
From Chart 2, the opposite scenario appears to be unfolding - ie, the US Dollar's stochastic is giving a trading buy signal as it reverses from a deeply oversold position, and the MACD is not only also in oversold territory, but appears to be reflecting a bullish pattern of rising bottoms.
Traders would argue that the above represents a "slam dunk" trade, namely - Buy US Dollars and Sell Gold.
Unfortunately, if it was that easy, we would all be basking in the sun on our yachts in the Mediterranean, or on the Great Barrier Reef.
One of the characteristics of a Primary Bull Market (where prices are "generally" rising) is that the stochastic tends to spend more time in the overbought range (above 80%) than in the oversold range (below 20%). For this reason, sell signals tend to be less credible than buy signals. Conversely, stochastic buy signals tend to be less reliable in Primary Bear Markets.
To illustrate this, reference to Chart 3 shows that the stochastic of the Commodities index has been giving a series of "false" sell signals even as the index has been rising (Although the MACD is not yet in as seriously overbought territory as the MACD of the Gold Price appears to be).
But this raises the question of "just how far above long term average is too overbought?"
Reference to Chart 4 shows that the MACD of silver "appeared" to be overbought when the differential was at $0.25, and yet it is now approaching $0.75.
The possibility of a $30 pull back is also reflected in the long term chart of the gold price below:
Although we do not have volume to validate the formation, there appears to be a perfect textbook example of a bullish saucer formation which, according to textbook theory, should be followed by a sort of sideways to downwards consolidation movement (handle) following the breakout (maybe to as low as $375/oz) and preceding the next up-move (which seems likely to encounter resistance at $500/oz)
So what's a trader to do? Should we sell gold and silver following these sell signals; and buy the US dollar following the buy signal? And what are the chances that we will quickly discover ourselves knocked flat on the canvass (and counted out for the match) from what might turn out to have be a "sucker punch"?.
From my younger days, when I followed these things, I seem to remember that you want to stand aside or duck when someone throws a sucker punch. You don't want to lead into it.
The short answer to the above questions is that it's a mugs game to try to trade in and out of near term swings - particularly if the fundamentals indicate that the price is far out of whack with underlying value.
Here are some reasons why - with particular reference to gold:
I have just spent three weeks reading a book entitled "The Gold War", written by Gordon Weil & Ian Davidson, and published by Secker and Warburg in London in 1970. Without meaning any disrespect to the authors - who were clearly writing about what was topically important in those days (nearly 35 years ago) - the contents of that book were as boring as bat shit in 2004 - which is why it took me three weeks to read it over my vacation. However, the principles that were covered in that book were, in my view, exceptionally important, and it was well worth the effort to grimly wade through the book whilst sitting on a deck chair on the beach with the seagulls and pelicans gliding on the thermals, high above the glittering ocean surface.
The main principles that I gleaned from the book were:
- The balance of foreign exchange movements in and out of the United States between 1944 (Bretton Woods) and 1969 had been chronically negative flowing from the US's predisposition to spend vast amounts of money on "defence" outside its borders (mainly in Europe at that time, and later Vietnam).
- It was this chronic outflow of US dollars which led to a rise in the Gold Price from $35/oz to $40/oz in October 1960, when the rest of the world started to fear that the US$ would no longer be convertible into gold (In those days, the US dollar and the British pound were 100% convertible to gold, and the world had fixed exchange rates)
- At page 127: "But in the late 1950's, when the American balance of payments started to move into deficit, the operators on the gold market started to have doubts about the capacity of the United States to maintain the thirty-five dollar price, and the free price started to move up in London. At this early stage, movements in the London price were very modest, but when it went up to $40 in October 1960, the United States and Britain together decided to move in to stabilise the price. A year later, they had persuaded six other countries - France, Germany, Italy, Switzerland, Holland and Belgium - to join them; these eight countries together formed the so-called Gold Pool, which operated from the autumn of 1961 to the Spring of 1968. The principle of the Gold Pool was that the Bank of England, as the agent for the other seven central banks, would buy when the price fell and sell when it rose, and that the eight countries together would share in the profits or losses of the operation according to previously fixed proportions. (Bloom comment: There is no "conspiracy". A conspiracy implies secrecy and clandestine behaviour. The guiding principle of actively suppressing the gold price has been out in the open and has been cast in concrete since the 1950s).
- The "Group of 10" Central Bankers (United States, Britain, West Germany. France, Italy, Japan, the Netherlands, Canada, Belgium and Sweden), sometimes known as the "Paris Club", were even then (in the 1960s) dedicated to "managing" the international Monetary System. At Page 51 :"The Group of Ten was formed out of fear. In 1960, persistent drain of dollars and sterling led to widespread concern that confidence in these reserve currencies would completely disappear and a major upheaval take place". At Page 72: "It [the Group of 10] is a highly political group, in contrast with the Bank for International Settlements, being composed of top Treasury or Finance Ministry Officials. Speaking on behalf of their governments, these men often make decisions on the functioning and future of the monetary system".
- France was the loudest voice of resistance at all turns as it attempted to influence a united European front to thwart what President Charles De Gaulle perceived as an unholy "Anglo-Saxon" alliance. It galled De Gaulle that Europe could not share the power that was being wielded by the US/UK axis - which was essentially why France vetoed the then proposed membership of the UK in the European Common Market (which at that time consisted of six countries). France wanted Europe to band together in a united front to stand up to what he saw as the irresponsible financial behaviour of the US and UK. However, West Germany was not prepared to make waves so soon after WWII, and Italy, which was on the receiving end of US largesse, also did not wish to rock the US/UK boat. The Benelux countries fell in step with Germany and Italy, and the ECM as a group took the line of least resistance - which frustrated France no end. (President De Gaulle had a conscious policy of accumulating gold, and he used every opportunity to undermine the UK Pound and the US Dollar by converting these currencies into gold).
- The chronic strength of the French Franc in the mid 1960s eventually gave second devaluation (the first soon after De Gaulle assumed power in the 1950s), and Germany's mark became badly undervalued (much like the Chinese Yuan today) and there was a fear that the entire international financial system would become dysfunctional - particularly given that "blind Freddy" could see that the British Pound had no right to be regarded as an international exchange currency backed by gold.
From the Gold Wars (at page 39):
"Soon after he came into office in 1961. President John F. Kennedy became preoccupied with the alarming outflow of gold which was already well under way. He believed that many programs which led to a dollar and gold outflow were essential and it would be unwise to affront American business by slowing investment abroad. He decided instead to promote a program designed to increase American exports and thus earn more dollars back through straight commercial means."
This led to the Trade Expansion Act in 1962 which, in turn, led to the Kennedy Round of trade talks which was "based on the assumption that Britain and other European nations would be admitted to the European Common Market". (In 1963 the French vetoed Britain's entry, and caused a severe setback to Kennedy's initiative)
The French tactics were really nothing more than interference, and International Trade did increase, with France lagging somewhat. However, US imports started to rise faster than her exports. "From 1964, when the American trade balance showed a surplus of some 6.6 billion dollars, the black ink in the trade ledger dwindled to about one billion dollars in 1968, with no signs of improvement". The authors pointed out elsewhere that the Trade Balance was only one area of funds flow, with the other's being "invisible" services, capital and interest flows, military expenditure abroad, and Foreign Aid. ("Quite apart from the financial, logistical, and instructional assistance the United States distributes in the form of military aid, it also provides foreign economic help to a host of countries from Afghanistan to Zambia" - at page 31. Further: "One of the main American exports in the last quarter century [since 1944] has been money")
On balance, therefore, Kennedy's tinkering achieved nothing of consequence, and overall, dollars kept flowing out of the USA.
"In 1959 the United States held 19.5 billion dollars worth of gold out of a world total of 37.9 billion. Ten years later the American share had decreased to 10.8 billion out of a total of 38.9 billion. In the same period, the gold holdings of the industrial nations of Europe (excluding Britain) rose from 10.5 billion to 18.3 billion dollars. Dollars held abroad which could be turned into gold amounted to 10.1 billion in 1959 and 17.5 just ten years later. This means that the United States could have paid off all the short term claims against the American Treasury in 1959, but could not have done so, if it had been asked to, in 1969" (at page 42)
Then from page 43:
"Undoubtedly the United States has gotten itself into serious debt and serious trouble. The welfare of its currency is at least partly in the hands of foreigners. The U.S. Government can bank on their need for dollars to finance trade and investment as some guarantee that they will not suddenly make a run on the Treasury. But this belief is based on economic rather than political considerations. What if a nation were ready to take the economic risks inherent in an attack on the U.S. Dollar because it wanted to "punish" the United States for taking "unfair advantage" of the international monetary system that permits the Americans to be constantly in debt to their neighbours?"
All of the above led to two "creative" departures from the heretofore conventional historical approach.
- The seeds of "globalization" were sown. At page 65: "On July 4th, 1962, President Kennedy, speaking at Independence Hall in Philadelphia, called for a declaration of interdependence which would recognise the partnership that was being created between the nations on both sides of the Atlantic. He did not speak so much of an Atlantic community, which had come to mean for some a prolonged American rule in this vast area. Instead, he looked forward to the day when a stronger and more united Europe could take its place as an equal partner of the United States" But: "The French veto of British membership in the European Common Market in 1963, just six months after Kennedy spoke, seemed to delay further the day when equal partnership could be a reality" (Bloom comment: It appears that De Gaulle was suspicious of the UK's motives for joining the ECM because he was fixated on the Anglo-Saxon alliance)
- Special Drawing Rights (SDR's) or "Paper Gold" were created because it was argued that the primary cause of an excessive reliance on US dollars was a general shortage of international capital that was caused by inadequate gold bullion inventories. The argument was that if the gold price would be allowed to rise in an environment of fixed exchange rates and convertibility of the dollar and sterling into gold, the pain of inflation would be unbearable. It was therefore decided to create a new type of paper currency - that would be "as good as gold" - and that would increase the overall inventory of foreign exchange balances held by the central banks. (Bloom comment: What this was supposed to achieve is not 100% clear. It seems to me that SDR's are merely an alternative fiction to fiat currencies)
And here we are, nearly 35 years later, facing almost identical problems to those described above. The US is still in chronic deficit, and the rest of the world is starting to focus - again - as evidenced by a rising gold price. I have deliberately selected the above passages from the book to highlight the fact that in the last 35 years, the Central Bankers of the world have failed to address any of the fundamental causes of the world's economic imbalances. Arising from the creation of a fiction called "Fiat Currencies" the US has essentially prospered from the generosity of the Rest of the World, and the Rest of the World has gone along because to call in the debts would be to bring to a grinding halt the engine of growth that has been causing their own economies to grow.
Against this background it is not difficult to understand the "real" reason why the US has declared war - supposedly on terrorism, but essentially on those oil countries in the Middle East who represent the greatest "political" risk to the US Dollar.
Against this background, it is not difficult to understand why France and the US - still to this day - do not see eye to eye.
Against this background, it is not difficult to understand why the US Dollar and Gold movements seem likely to be facing a period of unusual volatility (like a bucking bronco?) - with the eventual outcome being virtually certain to be an (eventual) total loss of credibility of the US Dollar, and SIGNIFICANT pain to many inexperienced investment cowboys who attempt to ride the bucking bronco.
One important question (yet unanswered) is whether the Central Bankers are going to attempt to perpetuate the economic fiction of fiat currencies, by shifting the mantel of rulership over the International Media of Exchange to the Euro. If so, it seems unbelievable that, since 1944, we appear to have learned nothing of consequence that will likely lead to a "permanent" solution.
Alternatively, will the Central Bankers finally admit that the experiment with fiat currencies has given rise to a Mountain of Debt that now has no hope of being repaid. Subject to the consequences discussed below, this seems a logical outcome if it is born in mind that the machinations of the 1960s and 1970s ultimately gave rise to a decoupling of the US Dollar from Gold, and that that option is therefore now no longer available to the Central Bankers.
Yet another important question is whether the Yuan (like the German Mark before it in another era) will be re-valued upwards. This in itself is likely to cause as much damage inside China - which needs large volumes of low priced orders to keep its economic engines running - as it will inside the USA, which will suddenly find itself facing inflationary dislocation within its borders.
The problems seem insurmountable when looked at through conventional eyes.
In short, the debtor (the USA) has been making promises since the 1950s and has not only failed to deliver on those promises, but has actually exacerbated the problem to the point of chronic (terminal?) illness. In a "normal" world, the only logical way of managing a recalcitrant debtor would be to move to foreclosure and liquidation. In the global world in which we now live, unfortunately, foreclosure will give rise to as much pain for the creditors as it will to the debtors.
Logic dictates, therefore, that we need to find a "new" way of greasing the economic wheel. This might or might not involve gold, but - referring to the above charts - and against the above background, anyone who seeks to "trade" in and out of gold to take advantage of short term swings seems more likely to suffer irreparable damage than to make significant profits.
Gold is a "buy and hold" insurance policy to which "spare" capital should be applied - nothing more and nothing less. It is critically important to focus on the time factor. In July 1962 President Kennedy publicly sowed the seeds of Globalization. It took around FORTY years for these seeds to germinate. When we are talking about global shifts in behaviour, we are by definition talking about a LONG TERM play in which heavyweights with stamina are going to be the only ones who survive the full 15 rounds. I, for one, do not want to be taking a sucker punch in the early rounds.
Brian Bloom
Australia, 28 January 2004
In the late 1980s, Brian Bloom became an Assistant Vice President and, later a Vice President of one of the world's largest Venture Capital Investment Banks. In that capacity he worked on more than one multi-billion dollar Leveraged Buyout transaction. Since the early 1990s he has been providing strategic, marketing, capital raising and management advice to emerging businesses with multinational growth potential and, since 1998 has been focussing specifically on Franchising in the Fast Food and Indulgence Industries. For over 25 years he has been motivated by wanting to "do something practical" about the parlous state of economic affairs we now find ourselves facing - the evolution of which he has been watching with fascination since the late 1970s.