Strong Buy Signal For Gold
Heinrich Leopold
All people are smart: the one before and the other afterwards. This Chinese proverb comes always to my mind when I am studying the different charting methods trying to forecast short term movements or turning points in commodity prices.
While I find charting tools very effective to study a long term trend, it is very difficult for me to make short term investing decisions based on these tools. For this reason I have tried to develop an indicator, which can predict price movements for commodities one or two months in advance.
The concept is based on changes of the monetary environment for the underlying commodity. In the case for gold - which is effectively a leading indicator for other commodities - this is the monetary liquidity derived from inflation, short and long term interest rates, production as well as currency movements.
In the above chart, the developed indicator for gold (LIC = Liquidity Indicator) has been very low end of the decade of last century. No wonder the gold price underperformed during this period.
Around 1999 the picture changed and the first wave of monetary liquidity started during this time. The indicator declined beginning 2000, which correlated then with a fall in the gold price during this time. Nevertheless, beginning of 2001 the indicator showed strong growth and predicted an upward cycle for gold, which also occurred from 2001 until end of 2003.
At the start of 2004, the indicator declined steeply and gold followed promptly in April 2004. In 2005 the indicator recovered and so did gold. Once again the indicator declined in March 2006 indicating the steep fall in May 2006.
While it is difficult to assess the extension of a decline or rise in the gold price, it has been for me very helpful to determine the turning points of a rise or decline.
Throughout the summer 2006 the LIC recovered somewhat and during the last weeks it showed a steep rise, which is for me the signal for a new wave of monetary liquidity, which will be followed very likely by a steep rise in the gold price - possibly going into record territory - over the next few months.
The current burst of liquidity comes from the recent steep fall of inflation which dragged down worldwide interest rates. Long term interest rates fell by nearly one percent in many countries and are poised to fall further over the coming weeks due to a more abrupt fall in inflation. The latest inflation numbers for Germany (down to 1,1 percent year over year) show clearly the trend for the next weeks.
It is also important to distinguish between the current driving forces for a rise in commodity prices and the increase of raw material prices in the seventies. Today the liquidity is caused by a liquidity trap in Europe, Japan and North America. Central Banks in developed countries have painted themselves into a corner, which will take years to resolve. However this is good news for the rest of the world as low interest rates in developed countries will divert a deluge of capital into emerging countries, which offer much higher interest rates. This will trigger enormous demand for commodities.
The escalation of commodities during the seventies has been an inflation scare induced liquidity. During the seventies Central Banks printed a lot of cash (M1 monetary aggregate) which has been spent in panic mode by money savers when inflation went up. This triggered two major spikes in commodities.
Today the situation is completely different as liquidity is not derived from cash but from new debt (M3 monetary aggregate). Debt is not inflationary but deflationary and leads to a liquidity trap. For this reason, the price appreciation for commodities will go for much longer than in the seventies as it takes a long time for unwinding the current monetary deadlock in industrial countries. The example of Japan, which is a harbinger for Europe and the US, shows already how long it can take to undo a liquidity trap.
Nevertheless, there is still a message in the rise of gold. It indicates the need for monetisation of the worldwide debt pile. The monetisation of debt will eventually occur through inflation as an orderly pay back is very unlikely. Yet we are years away from this point and when it happens it will go very fast and will be the last stage of gold's rise.
I look forward to receiving your comments.
Heinrich Leopold
hgleopold@yahoo.com
29 September 2006
Certain statements included herein may constitute "forward-looking statements" with the meaning of certain securities legislative measures. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the above mentioned companies, or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements.
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