first majestic silver


December 4, 2004

There is an old saying that has both wisdom and humour: "Just because I'm paranoid, doesn't mean that they are not out to get me".

As a rule of thumb, the more hysterically bullish an "investor" is about the prospects for the gold price, the more paranoid he/she is likely to be that there is some heinous plot and/or conspiracy to sabotage the financial well-being of the average individual, world-wide, when the gold price fails to deliver against expectations.

There is no question that the world's Central Banks are dedicated to ensuring an orderly management of their individual country's economies and of their individual country's currencies in the world markets. That is their stated purpose; their very raison d'etre.

If we go back into history, the underlying principle on which the Federal Reserve - as an example - was formed, was to facilitate a managed expansion and/or contraction of a fiat money supply as a means of smoothing out economic cycles.

Of course, there is a question regarding the Constitutional legality of the Fed, given that the Constitution specifically bars what the Fed is doing, but the USA electorate has had roughly 90 years to do something about this unconstitutionality of the Fed, and nothing has yet been done. Of course, the paranoid amongst us could argue that the "powers that be" have blocked any such action, but the reality is that the US is the world's greatest Democracy. The voting plebiscite has been free for 90 years to do something, and the FACT is that the voting plebiscite has not been sufficiently uncomfortable to want to change the status quo.

Thus, those who have proven - using sophisticated statistical techniques - that the gold price is being "manipulated", have really proved that the Central Banks are doing precisely what they were set up to do. As Homer Simpson might have put it: "D'oh?!"

The real question is not whether the gold price is being manipulated (I prefer the term "managed", because it reflects reality). It is whether the ability of the Central Banks to fulfil their stated purpose is waning. Is the world economy spiralling out of control?

As an aside, those of us who would believe that we live in a world with free markets should note that word "control". The stated purpose of Central Banks is specifically to "control". There is no such thing as a market that is free of any outside management interference whatsoever.

With the US Dollar Index approaching a long term support level of around 80, the question regarding whether or not the world economy is spiralling out of control is possibly PARTIALLY answerable by addressing the following question: "Will the US Dollar break below its historical support levels?" Presumably, a collapse of the US Dollar would be a necessary but not sufficient condition for a loss of control. (Of course, there will be other factors).

The following are daily, weekly and monthly charts of the US Dollar Index (courtesy

Note on the daily chart how the PMO is severely oversold which typically represents trading (short term) support, whilst on the weekly chart the PMO still has some downside potential. Of course, in a Bear Market, the PMO can remain oversold, but the probabilities show that on the short term there may be some frittering around whilst in the medium term the Dollar Index still has "some" downside potential.

The key issue is whether the 80 level will hold on the long term chart (see below)

Interestingly, not only is there remarkably strong "price" support at current levels (around 80-81) but there is also PMO support.

Technically, if the US Dollar Index does indeed break below the support level at 80, we will undoubtedly be entering a new economic era. The question regarding whether or not this will lead to a "spiralling out of control" of the world economy will still be left unanswered.

Just how important is the USA in the broader scheme of the World Economy? This particular question is answered by the following Table:

% Contributions of Major Economies to the
World Economy
(US$ Billion)

(2002 GDPs expressed in 1995 $ and exchange rates)

Note that actual GDP of the USA in 2003 was approximately $11 trillion, which implies a total World GDP in 2003 of $42.3 Trillion (Source:

The answer is that in 2002/3, the USA accounted for roughly 26% of the World's economy. Clearly, what is at issue if the US Dollar were to break below 80 is as follows:

  • How will the World's Central Banks excluding the US Fed (who hold most of the foreign dollar claims) react?
  • Will the other 74% of the world survive in the event that the USA ceases to be the primary "driver" of world exports (assuming that it is, given its huge trading account deficits and the ROW trading account surpluses)?

An important point to focus on is that Central Banks typically do not behave like individuals. They do not "panic out" of their holdings. To the contrary, their brief is to prevent financial crises, not create financial crises. It is therefore a virtual certainty that non US Central banks will not just "dump" their dollar denominated assets - be they actual greenbacks or dollar denominated treasury instruments.

So it follows that any US Dollar crisis - were it to happen - will be caused by US Citizens and/or Corporations scrambling to get out of US Dollars, and into …. What?

It is unlikely that this money will ALL go into foreign stock markets - given that these stock markets are not looking particularly exciting. The following charts (courtesy reflect what has been happening to the Japanese, German and French Markets over the past five years.

Japan has been rising slightly since Q1 2003, but looks like it may be struggling to maintain this rise

The German market has also been rising since Q1 2003, and is currently pointing up

The French market has also been pointing up since Q1 2003.

Just for fun, let's look at the German market relative to the Dow Jones:

Whoops! The Dow Jones has actually been outperforming the European markets since Q2 2002.

So it hardly seems likely that money is going to "pour" out of the USA and into foreign equity markets.

Now here's an interesting thought:

If US Investors piled into (say) German Government Bonds, would that not cause bond yields in Germany to fall? Let's look at the mechanics of the transaction:

Step 1: Order is placed to purchase German Government Bonds denominated in Deutschmarks
Step 2: Purchase is made - causing downward pressure on German Bond Yields
Step 3: Payment in US Dollars needs to be converted into Dmarks
Step 4: German Bundesbank buys dollars and sells Dmarks

Question: What does the German Bundesbank do with the dollars?

Well, maybe it uses the dollars to buy US Government Treasuries - thereby putting downward pressure on US yields, and neutralising the downward pressure on the US Dollar.

Alternatively, it holds the dollars in its Foreign Exchange Reserves. USA yields remain static whilst German yields fall, thereby placing upward pressure on the US Dollar and downward pressure on the D Mark.

It is only if the Bundesbank actively moves to sell the dollars in the market place that the US Dollar will fall.

What has been occupying most of my spare mind space over the past few weeks is US yields. They "should" be rising to protect the Dollar.

But, in terms of the above logic, provided the overseas Central Banks do not "panic out" of dollars, selling pressure in the FOREX markets is likely to come mainly from speculators - who have been arguing for months and have been positioning themselves for months to capitalise on a collapsing dollar.

In terms of this logic, the selling pressure on the US dollar has already occurred. The speculators are already positioned. Who is left to create a dollar collapse? Remember, the Central Banks mandates are to PREVENT financial dislocations

So, the bottom line is that if yields in overseas countries fall because US based investors are pouring their money into foreign treasuries, and US yields remain flat, this will effectively put UPWARD pressure on the US Dollar.

So the key question is: What will happen to US Interest rates?

Look what happened to the long bond yield on Friday December 3rd. It fell from 5.048% to 4.942% and, in the process, fell back below its 200 day Moving Average.

From the non confirmation showing in the falling monthly yield and the rising monthly PMO, and from the break up from the diamond pattern in the chart below, there is no question in my mind that yields in the USA have stopped falling.

But the question is: Will they rise from here?

There are a few "straws in the wind" which are pointing to the possibility that they may not rise significantly from these levels:

The first is this P&F 2.5% three box reversal chart (courtesy which shows that IF THE YIELD BREAKS UP OUT OF ITS CURRENT CONSOLIDATION, it could rise to 5.8% based on a horizontal count, and as high as 7.2% based on vertical count.

But the thing is: There is nothing in this chart that says whether or when the yield is likely to break up. All it is saying is that yields are now in a rising (no longer in a falling) trend.

What will cause yields to rise?

It is clear that the US Government will still need to fund its deficits.

But if the cycle that I described above continues, then money leaving the USA to be invested offshore will have a high likelihood of returning almost immediately as foreign Central Banks recycle the dollars into US Treasuries - thereby neutralising the downward pressure on the US Dollar. The US Fed could continue to fund US Government needs just as they have been doing.

Of course, there will be those afflicted with Paranoia who will argue that the sudden fall in yields on Friday was the result of "manipulation". How about "enlightened self interest" on the part of the foreign Central Banks who need to recycle their dollars anyway? That sounds a bit less paranoid and bit more reasonable.

The next straw in the wind has been the underperformance of the $XAU and $HUI relative to the gold price. This has been pointing to a reasonable probability that the US Dollar Index of 80 is likely to hold (given the mirror image relationship between gold and the US Dollar).

The following P&F chart of the $HUI divided by the gold price puts some perspective on this

It has actually reached its horizontal count target of 50 and could consolidate from here relative to gold. i.e. They could move in tandem from this point forward or the $HUI could soon start to outperform gold again.

Then there are the charts of the dollar denominated Commodities Index and the Oil Index

The $CRB almost reached its upside target - based on horizontal count - and is now consolidating again. Surely, if the US Dollar was about to collapse, the price of commodities in US Dollars would be rising?

But, if the US Dollar Index level of 80 is going to hold - and maybe the USA Dollar index will rise strongly as the speculators get themselves badly burned - what will happen to the gold price?

Ah! That's the 64,000 Euro question.

Let's have a look at gold.

From the chart below, it certainly looks like it needs to/wants to consolidate at around the $428 level for some time, but a closer look at the semi log chart shows that Gold still has some unrealised upside potential

From this chart it looks like a level of around $470 is still possible before consolidation sets in

Now this is very interesting.

If the dollar index holds at around the 80 level and maybe even rises from that point, how is it possible that the gold price could either consolidate or rise? Aren't those two a mirror image of each other? I mean doesn't EVERYBODY know that?

In fact, the chart below of the gold price divided by the dollar index is showing that the break up of gold relative to the dollar actually reached its horizontal count target and is set to consolidate within the context of a continuing bull market

But the key, in my view, is that there is a bull market in place on a relative strength basis. Ie. The chart is showing that the gold price is in a rising trend relative to the US Dollar.

Could it be that, following this coming consolidation, the gold price will rise relative to a US Dollar Index that will hold at its 80 level? If so, this will also indicate a "new era" is upon us.

Unfortunately, the answer is not immediately apparent from the following semi log Point and Figure chart showing a 5% three box reversal of the $HUI relative to the gold price. The $HUI could just as easily break down relative to gold as break up from this point. However, if it does break down it is important to focus on the fact that it is unlikely to enter a new bear trend, because the horizontal count target of the ratio following a break down would only be 38.11 - which is still far above the rising blue line.

No, from where I am sitting, whilst the gold bugs are in for a nail bighting time, it is my view flowing from all of the above that gold is going to emerge from this coming consolidation as an investment counter that is going to divorce itself from the US Dollar mirror image.

In my last article I expressed the view that perhaps my model was wrong because interest rates were not behaving as I was expecting. After thinking about the various issues for the past couple of weeks I have concluded that the model was indeed probably flawed. It is not necessary for interest rates to rise strongly from this point in order to protect the dollar; and the reason is that the Central Banks do not act with emotion. They are not about to "dump" their dollar denominated assets.

And if the rates do not have to rise from this point, then that would explain why the Dow Jones is not "collapsing".

Nevertheless, Dow Theory is still saying that we are experiencing a Secondary upward reaction within a Primary Bear Trend; and it is probably ultimately for this reason that gold is going to divorce itself from the US Dollar mirror image linkage.

In the end analysis, Gold is still the ultimate insurance policy. If yields are going to dicker around giving rise to a "fear" of capital losses on the bond markets should rates rise thereafter. And if the equity markets are going to head south (or maybe just not go north). And if the arbitrage potential in FOREX markets goes away because the Central Banks keep their cool. Then, gold will be seen as a reasonable risk management diversification tool. Particularly in light of the fact that the ETF's are going to tip the demand/supply equation even further in gold's favour.

But how high will gold rise?

Frankly, if you are not predisposed to Paranoia (and I am not), and you are predisposed to believe that the Central Banks will do everything in their power to keep the World Economy under control (which I am), then you will probably conclude that a level of $500 - $550 is "reasonable" from the chart below (courtesy Maybe it could even overshoot somewhat until such time as new gold mine production finds its way onto the market. (Bear in mind that this is a 34 year chart we are looking at)

From where I am sitting, the 74% of the world that is outside the USA is no longer totally dependent on the USA as its "engine for growth"

By way of example, the Chinese are now starting to develop markets in Asia following their having opened markets in Europe; and the Shanghai stock market has already been falling - probably in anticipation of a waning of US demand. (See below). But it is certainly not collapsing.

What could very well happen is that the USA economy goes into a holding pattern - which might lead to a sideways movement of the Dow as the earnings grow into the P/E ratios, or the Dow (and other US equities markets) could fall strongly from here.

Either way, the Dow Theory Primary Bear market will probably remain intact until P/E ratios once again reach bargain levels.

With the co-operation of foreign Central Banks, we could still avoid an economic implosion, but it really looks to me that the US days as world economic leader are drawing to a close.

And if the gold price divorces itself from the US Dollar, we will have proof positive that this argument is more likely to be true than false.

Whew!! Thank goodness. I'm back within my comfort zone of understanding. For a minute there I thought that they were out to get me.

Unfortunately, there's just one teensy-weensy loose end. The oil price doesn't look like it's about to enter a bear trend any time soon - although it could come back as far as $35 a barrel; which is still significantly higher than the $25 - $30 level of 2002-2003

So with personal costs of living still rising in the USA (higher transport costs and now higher property taxes coming through) it really looks like the US economy is going to have to weather tough times internally. It's very difficult for a rational person to believe the hype that the Dow has entered a new Primary Bull Trend.

Gold is perfect for use in coins and jewelry as it does not react with air or water like many other metals.
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