first majestic silver

Too Much Speculation

February 10, 2005

The violence of today's move in the gold shares has reminded me that there is too much technically based speculation (gambling) in the market place. Too many people are watching the markets too closely, and this is rendering chart based trading calls extremely dangerous and somewhat unreliable.

In particular I am focussing on the "gap" that manifested at approximately the 90 level on today's chart above. To me there are two possibilities going forward:

  • The previous break down from the upward pointing trendline will prove to be false, and the $XAU price will again rise back above it. In this case, we might experience further upside gaps as emotion creeps back into the gold market.
  • The market calms down, and the price eventually retraces to cover the gap - as typically happens in the overwhelming majority of such cases.

Which of these two will it be?

As anyone who has been reading these Editorials will know, I am not a "rampant bull" on gold. My holdings in gold shares - though proportionally large relative to my total investments - are primarily by way of an insurance policy against a financial dislocation. Nevertheless, there is no question in my mind that the Gold price is in a Primary (albeit relatively shallow) bull trend. Ie With patience, I see no significant probability that I will lose my invested capital, and I see a reasonable probability that it will increase. Conversely, in an environment of economic dislocation, it is highly likely that the capital value of the investment will rise sufficiently to protect the remainder of my capital base. In this context, gold and gold shares represent "sensible" long term investments; and I am free to go about my normal business with peace of mind.

My predisposition is to believe that as we travel forward along the path of Evolution, human ingenuity inevitably triumphs over human shortcomings and, with that attitude, I have been seeking - and have identified - a conceptual way forward through the looming financial/economic/ecological obstacles. To me it is not absolutely necessary that we should experience a "financial collapse" in the washout of the Kondrat'eff winter; and neither is it absolutely necessary that the human race faces extinction due to global warming.

Having said this, it is always prudent to be constantly on the alert for risks - which is ultimately the reason I write these missives: They provide an external disciple which forces me to order my thoughts.

For some time now I have had an intuitive feeling that we are about to experience a severing of the inverse linkage between the gold price and the US Dollar. In my mind, the underlying issue is that the US is running out of capacity to continue as the driver of the world economy, and will - at best - go into holding mode as a new leader emerges.

China, whilst favoured by many as a potential emerging leader, does not represent a sensible option from my perspective. I have heard too many stories regarding the "cowboy" behaviour of the opportunists inside China. For example, there was the story told to me by a Venture Capitalist associate of mine, of the Chinese Local Authority which enticed an offshore investor to establish a fish hatchery in a dam erected in a local river, and then "diverted" the water around the dam because the "farmers downstream" were complaining. Nevertheless, the Authority was able to be convinced to redirect the water flow in return for a tripling of the price of the water to be supplied to the hatchery. The solution, incidentally, was suggested by the local Authority as opposed to the Investor.

In short, it seems to me that the legal (and economic) infrastructure within China is too immature and too fragile to support a predictable (or manageable) set of economic circumstances. To make money in China one needs to be extremely quick on one's feet, or one needs to take an exceptionally long term view.

If China is still evolving - it might become the leader in a couple of generations at the washout of the next long wave - then where will this leadership come from?

About fifteen years ago I hypothesised that it might come from the resource rich countries in Latin America, which had recently shown signs of recovery from the Latin American "crisis". However, having spent several years travelling and doing business throughout the region, I eventually concluded that political corruption was just too deeply ingrained. A Brazilian economist made a rather perspicacious comment when he opined that the 'difference between first world economies and third world economies flows from the concept of land ownership'. In the West, Real Estate ownership entitlement is taken as a given, but this is not so in Third World countries - witness what has been happening in Zimbabwe of late - and it is this single issue that is ultimately holding back the development of Third World countries. In an environment where there is no concept of "permanence" no one is prepared to sink deep roots.

In this context it follows that Europe is the most likely successor to the USA; and Margaret Thatchers (the Establishment's?) "vision" of a United Europe seems to make sense.

Over half a lifetime of watching the machinations of the Establishment, I have concluded that "disinformation" is a very powerful tool in its arsenal. Statements are very often made in public that are calculated to deflect attention away from the real agenda and/or the real story. And so when I hear that at the epicentre of the Establishment - within the UK - there is "public resistance" to a total merging with the EU; I am predisposed to react somewhat cynically. The UK will join, and it will join at a point in time when the momentum is irreversible - regardless of the views of its "great unwashed" citizenry.

So where is all this leading?

The following chart of the Goldollar Index (courtesy DecisionPoint.Com) caught my eye some months ago, and I have been watching its development with fascination.

The line A-B was drawn by joining the first point - which manifested at a downside gap - with point B and two subsequent points thereafter.

With this line in place it became apparent that points 1 and 2 represented peaks flowing from false break-ups. There has been a break down at point 3, and the question I have been grappling with is: "Is this breakdown genuine, or is it - like 1 and 2 - a false break?"

It is most unusual for an ascending right angled triangle to break down. This statement does not flow from drawing lines on a piece of paper. It flows from an understanding of what typically causes these lines to manifest in the first place.

A horizontal line (or resistance level) is typically a result of "conscious" action by a body of investors who typically do not want that level to penetrated on the upside for fear of consequences. Thus, when one sees such a chart pattern on the share price of a corporation, it is possible (but not necessary) that Investment Bankers or Stock Brokers are deliberately keeping the price below a certain critical level because there is a "deal" brewing in the background.

In a Corporate sense, the rising trendline which intersects the horizontal barrier line emerges because there are some investors who may have access to inside information - who are acting in advance of announcement of that information. Alternatively, it might be as a result of generally brewing optimism regarding the fortunes of the company. Alternatively it could be none of the above (we should avoid paranoia at all times J) It is just one piece of an infinitely large jigsaw puzzle.

But the "bottom line" is that ascending right angled triangles typically break to the upside, as the increasing momentum of optimism eventually overcomes the intransigence of sellers, and a "new game" starts to emerge. Typically, the longer the formation takes to manifest, the more violent will be the upside break.

But point 3 represents a break DOWN from the ascending right angled triangle. Why would this happen?

Well, let's look at what the goldollar index represents. It represents a manifestation of the inverse relationship between the gold price and the US Dollar. As the Dollar Falls, so the Gold Price rises and vice versa.

If the relationship breaks down, then the dollar is probably the driver of this relationship and, conversely, if the relationship breaks up, then the gold price is probably the dominant driver of the relationship.

Now, there are only two circumstances which will allow for the latter scenario:

  • The Central Bankers lose control, and "market forces" begin to dominate
  • The Central Bankers conclude that the relationship is no longer important, and withdraw.

Under 1 above, the gold price is likely to scream up as we face economic dislocation

Under 2 above, the urgency of controlling the gold price will have gone away because "Plan B" (the fallback plan) is now in place, and gold can be allowed to find its natural level without threatening the world economy.

My inclination is to go with 2 above, but the breakdown (?) in the goldollar index has alerted me to the possibility that the gold price is still being artificially managed for the time being.

Conclusion

Whilst I am expecting the goldollar index to eventually break up above the Maginot line (yes, I do have a sense of humour), there is probably too much outside interference by the Central Banks to get the timing of this event right. It could be in the short term, or following a protracted period, and patience will be a critical condition precedent to avoid losing capital.

To me the odds favour the shorter time frame because the Central Bankers are running out of ammunition, and the need to have "Plan B" in place is becoming an imperative.

My eyes are turned towards Europe in general and France in particular.


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