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Weekly Gold Market Outlook ECB, or Threat of USd Reversal Weigh on Gold Prices
Confirmation of the break down is a lower low through US$7.41 on the front month and the implied objective of this short term pattern is down to around US$7.00. The market signaled the end of a two month uptrend in gold prices as well - on October 19th - following a bullish failure earlier in the month. Gold prices have since developed a pattern that looks more bearish than bullish (either a one month triple top or head & shoulders), which implies a correction to around US$440 on confirmation - which is a break below support at around US$461 on the December contract. These of course are short term chalk marks and my experience has been that the technical implications of the short term behavior of prices and volumes are less reliable than those that occur on the longer term charts. This is mainly because short term trends are more sensitive to the noise of the day, which is not always so easy to anticipate. On top of that, the bears have painted the charts on gold all the way up - i.e. most every consolidation has "looked" bearish, including the last one, yet has resolved bullishly. I've interpreted it bullishly on the grounds that it simply reflects the reality that the bull market is still garnering a lot of skepticism… which is healthy as it indicates how young confidence in it still is. At some point in the bull market I anticipate the consolidations to look more and more bullish as the market intends to draw in the weakest hands… right now I believe the character of the tape is still such that it is trying to keep 'em out. That's how I see it. Furthermore, the intermediate trends and chalk marks suggest that the entire range of values down to US$440 is well supported. I also get the sense that if a retracement move was going to occur to test the conviction of September's breakout, which is what such a pull back to $440 would be, it should've already happened. But whether we see a small correction here or not, the intermediate trends remain bullish as long as the market stays above US$430. Recovery Trade Resurfaces on News, FOMC Financial markets welcomed bullish news on the economy this week (productivity, consumption and manufacturing data came in better than expected) by bidding up the USd, bond yields and stock prices almost simultaneously. We dub this sort of action the 'recovery trade' because that's the sentiment we believe such action reflects. The FOMC raised interest rates by the usual 25 basis points Tuesday. Maybe they can get to 20% like this without anyone noticing! The statement said nothing new - some future inflation risk was attributed to energy prices but on the whole "core inflation" is apparently contained while the economy is as strong as heck. Easing Speculation Ebbs The news probably disappointed speculation that the Fed was going to end its tightening campaign, at least not before a genuine catalyst that truly threatened to hammer confidence in the economy (like a collapsing stock market) and while everyone expected them to move. Afterwards, current Fed chairman Alan Greenspan played up the recovery trade with a dash of inflation concern, further putting off speculation over a new easing cycle. Naturally, Greenspan's best course of action is to maintain a steady hand if possible - he doesn't want to upset the markets before he leaves office but neither can he afford to let the inflation genie get too far out of the bag on his watch. My speculation about a new easing cycle at the Fed rests with a stock market accident, and the evidence for its arrival has been building both technically and fundamentally (with growth rates in profits slowing generally, key sectors (airlines, carmakers, mortgages) feeling the pinch, and with bond yields soaring..). And of course, for those of you who know that an inflation induced stock market boom requires the inflation (in money supplies) to sustain at ever greater rates if it is to continue, betting on a new easing cycle is merely a matter of identifying the opportune moment to liquidify, from the Fed's perspective. But when gold bulls are lined up and drooling with anticipation it is never opportune… the Fed would probably prefer not to inflate if it feels that the impact of that inflation will feed right through to gold prices because then it gets no benefit… at the moment, gold bulls are set to front run the entire benefit, and so the Fed has to figure out a way to throw them off its trail. The US government's growing hurricane clean up bill is real, and puts political pressure on the Fed to accommodate its budget requirements, as does the administration's other interventionist agendas both foreign and domestic. The effects of withholding accommodation have become apparent in the bond market and can be explained in terms of the crowding out effect (the government has to go to market to borrow which pushes up bond yields). Now, I'm speculating, but this may be deliberated in order to steepen the yield curve, which in turn would make lending out on the yield curve attractive despite higher short term interest rates, thereby creating new incentives for the expansion of credit/money. So Greenspan's tough talk on inflation and smokescreen on the economy scares off gold bulls but sets up another round of inflation right under our noses!? It's just a thought. Either way, I believe the fact is that while a new easing cycle is inevitable it is not likely to occur on Greenspan's watch in the absence of a financial calamity (or whatever alleged externality causes one).
ECB/BOE Key Elements in Speculating on Current Leg (Gold) Although the USd is the most important currency with respect to its implications for all 'round gold values, the current leg in gold prices started in Europe as we have pointed out in prior issues, and as you can see in the graphs to the right. We anticipated it long ago in our coverage of ECB and BOE inflation rates where we pointed out that the foreign currency price of gold was not reflecting these phenomena… that it was obscured by the allure and strength of foreign currency financial assets, but that the foreign currency price of gold was so pent up as a result that it would outrun the foreign exchange rate of the US dollar and give us our long awaited climax in USd gold prices. We anticipated that this move in gold would occur despite a recovery in the USd, and even found some empirical evidence (the pattern of the 1970's gold bull market) to legitimize the hypothesis, beforehand. While that may not guarantee we are going to be right about the next call it should serve to illustrate my main point here - that this leg is driven more by the effects of recent monetary policies overseas than the Fed.
But further supporting the hypothesis that this particular move is driven largely by overseas monetary trends is the generally positive correlation between gold prices and the USd index that has materialized since August. I don't just mean gold's resilience to the US dollar's comeback which as you can see has been apparent all year long, but rather I mean that between August and late October the gold and US dollar charts practically mirrored each other (shaded region in the chart); the correlation has broken since the week of October 24th. If the last bull market is indicative this behavior is quite rational and normal, provided that it is a bull market (as if there could be a doubt!). My read is that it means the currencies that the USd trades against are losing gold value faster than the USd and that each loss in gold (real) value shows up as a loss in the foreign exchange rate to a lesser extent… it confirms to me that it is the foreign currency price of gold which is in charge of the current trend. Therefore, the increasing noise about an ECB rate hike may be more significant for gold prices in the short term than speculation about when the Fed will stop hiking its rates. So, while the US recovery play is pressuring gold prices this week, a genuine intermediate correction in gold should occur alongside a decline in the FX value of the USd reflecting an ebbing in the overseas leadership of the current leg in gold prices, on growing bets that the ECB, BOE and/or BOC, etc. are set to increase their policy-setting interest rates in order to slow down the accelerating growth rates in their own money supplies, which the decline in the foreign exchange value of the USd over the past few years accommodated (i.e. obscured its effects). In other words, although it sounds counterintuitive, perhaps the USd should track gold if this is going to be a genuine intermediate correction rather than just a dip. The inflation trends are particularly alarming in Europe where the currency is new and confidence in the Union's Stability & Growth Pact is waning, so the threat of a tightening campaign by the ECB looms larger by the day if prudence were the right theory by which to forecast central bank policy run by mercantilist governments (who aim at currency devaluations in order to spur trade). Although the correlation between the US dollar and gold prices has broken in recent weeks (in the light of the recovery trade in my opinion) it is not a sustainable enough trend to warrant more than a pullback in gold - the USd is vulnerable if the ECB decides to raise rates in the first place but more on that later. The factor that could cause an intermediate correction - that is, push gold prices down through all that support between US$440 and US$460 - is the possibility that the foreign central banks begin increasing rates as well as the Fed, in unison. So, I am saying that the threat of a tighter ECB to gold prices is greater than the supposed threat of another growth spurt in the US economy (especially without the Fed / Government's help). However, while from the perspective of prudence it may be urgent for the ECB to act, so far there are scant signs of it. In any event that would be the most bearish scenario in my mind. I can't see substance to the recovery trade until after the market has weeded out the effects (malinvestments) of the last inflationary boom (2001-2004). Either USd Breaks Out, OR ECB Acts, Both Not Possible The USd index is taking another run at intermediate bear market resistance (@ 92), but the only way I believe it can sustain a bullish reversal is under the condition that the foreign central banks fail to act themselves (i.e. in tightening policy), which is bullish for gold in the current run and would probably extend the correlation between gold and the US dollar, generally speaking, once the psychological effects of the foreign exchange reversal took gold down another 10 points or so first. The most bearish intermediate fact for gold therefore, in my outlook, would be any sign of actual tightening by the ECB or BOE, reinforced by the Fed. In the meantime, any sign that foreign central bank monetary policy lacks the scruples to tighten here, or of fresh slack in the US economy, should provide gold prices with support; and beyond that, if they take the tightening road, the extent of their success in tightening without causing a financial crisis will determine the extent of the gold price correction. In other words, if the actions led to a meaningful slow down in the growth of their own monetary aggregates (as well as the Fed's) without causing stock prices to fall or unemployment to rise, the operation could be called relatively successful while it lasted and would pressure the gold market more than if their interest rate actions had no effect on the rapid growth of money and credit. My guess is that the ECB will adopt the gradualist path that the Fed has paved, and that whatever policy it adopts won't have a noticeable effect on the growth of its monetary variables for months to come, if at all. A break out in the USd index would be sustainable only if other key central banks failed to adopt a relatively serious tightening campaign (leaving the differential in real rates to widen in the USd's favor, for instance), and so long as events didn't provide the Fed with another easing-op. …or until Bernanke is in office! But Could the Economy Stand It? Returns in US capital markets have been lower than elsewhere for several years running, and a widening yield differential is not going to improve those conditions. Should I be wrong about the substance of the US economy (i.e. my judgment is that the boom is far more inflationary than induced by productivity/savings) then I'll probably be wrong about that statement too, and there could be more downside in gold prices than I foresee today. In other words… My bullish hypothesis rests on the supposition that the underlying structure of the global economy - weakened over the years by excessive inflation and intervention - could not withstand any serious withdrawal of cheap money, and that Greenspan is unlikely to orchestrate a deflation scare in his last days as Fed chief because it holds the risk that his successor can shift the blame in his direction. A steady hand, stern voice, and hope are all that Greenspan is capable of, in my view. Barring any evidence to upset that hypothesis, the current correction in gold prices is unlikely to herald the end of the nearly five year long trend, and should be confined to a further 20 point slide at worst, and that only if the US$460 handle is decisively breached in coming days which is likely if the USd breaks out past the 92 handle. Ed Bugos November 5, 2005 The Goldenbar Report: is not a registered advisory service and does not give investment advice. Our comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. While we believe our statements to be true, they always depend on the reliability of our own credible sources. Of course, we recommend that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and barring that, we encourage you to confirm the facts on your own before making important investment commitments. |
04-Nov-05: Silver prices fell through the neckline of a one month double top on Tuesday (@ US$7.53), but the bulls have clawed their way back up just above that level since Tuesday's FOMC.
So my forecast continues to be for the FOMC to push rates up at 25
basis point intervals until Wall Street starts crying; if they push rates
up by 50 basis points it could signal a temporary end to the
campaign… since the inflation problem can only get worse (for rates)
with the world's increasing dependency on the policy.
The ECB has kept its policy setting interest rate at a record low (2%)
for about two years now while the year over year rate of growth in EU M1 has increased steadily from about 9 percent to 20 percent as of August. The BOE has also
grown its monetary aggregates by more than 10 percent annually for
two years running [see the last issue of The GoldenBar Report:
October 26th for more details on inflation rates in the G7].