Gold & Central Bank Shift

In the last month a tectonic shift has taken place among central bankers. To be sure, the USDollar is aided if foreign central banks end their march to raise official interest rates. The USDollar has been propped up for over two years in large part from powerful credit market carry trades that used to exploit higher USTreasury bond yields, both the short-term and long-term variety. The US Federal Reserve has been forced kicking and screaming to reduce official Fed Funds rates, all the while denying a grotesque contagion from the bond world to the bank world to the economy on Main Street. The USFed looks bound by the bond market to continue to cut interest rates, much like a large dog is led by a spiked choker around its neck, urged to obey its master's orders via vicious tugs.

The gold price has stabilized. The flood of additional open interest to short gold contracts kept the gold price in check. It remains within the neighborhood of the critical 3/8-ths retracement area after the September breakout and the November established peak. Absurd pronouncements like that from Goldman Sachs of a gold decline in 2008 betray how gold is eyeing the 1000 level. GSachs is not a non-profit organization, so they attempt to deceive you into selling your gold, with the power of the press behind them. Some additional time might be necessary for the moving averages to catch up to the gold price, as unstable prices typically result when it extends far above even rising 20-week and 50-week moving averages. The stochastix cyclical gauge hints that gold is unwilling to remain near intraweek low prices, preferring instead to resist downward pressure (real and forced) and close strong each week. Gold remains very stubborn, with friends in Asia and the Middle East who are under siege from massive US$-based hoards of reserves at risk. They hedge with gold bullion quietly. They prevent gold price from moving too far below 800.

Today in fact, the gold price might have responded favorably to the USGovt Mortgage Bailout Plan, smelling more money flooding the system. The benefits of higher gold prices to miners must exceed the pain of their energy costs. Personally, a smile comes to my face when gold is seen closing near 810 today while crude oil is back toward 90.

CENTRAL BANKS SHIFT EMPHASIS

The Euro Central Bank held rates steady today at 4.0%, still 50 basis points above the stodgy desperate US Federal Reserve. The ECB continues to sound concern over the price inflation threat, while economic growth remains steady. ECB Chief Trichet warned that some policy makers supported a move to hike the official rate. The Bank of England cut their official interest rate by 25 basis points to 5.5%, citing deteriorating conditions in financial markets and downside risks to their economy and consumer prices. The credit squeeze has intensified in England, a surefire consequence of adopting the insane US economic model of asset inflation dependence from an unsustainable housing bubble. The Bank of Canada surprised markets with a 25 basis point cut to 4.25% on Tuesday. They cited silly lower projected price inflation as political cloud cover, but very real threats to exports. So England and Canada cut, while Europe kept a pause when it clearly prefers to hike. By the way, the Reserve Bank of Australia held firm at 6.75% after having hiked the official cash rate in November. These maneuvers assist the hamstrung USFed, which operates in an ugly Catch-22, one which my preference is to describe as Sophie's Choice. She was demanded by Nazis to choose her son or daughter to be executed in the death camps.

The dithering USFed Chairman Bernanke, dripping with fear and oozing lack of confidence, has been aided for these foreign central banks. The dreaded choices left with the USFed are to defend the USDollar with an interruption in rate cuts, or to defend the stalled USEconomy and declining housing market and cratering mortgage finance market and seized up banking sector with continued rate cuts. ALL CENTRAL BANKS WILL SOON BE LOWERING INTEREST RATES, TO AID THE SYSTEM, WHICH WILL ENCOURAGE MORE SPECULATION, OR ELSE IMPLOSION IS ASSURED. The USFed will lead almost all central bankers to the golden valley. Gold will next rise from monetary inflation, price inflation, and perceptions of broad rescues of a fractured system, much more than due to any continued USDollar breakdown.

Forget the Bank of Japan, which will do what its American masters instruct them to do. They will do their best to find justification for insane chronic low official interest rates so as to continue funding the gargantuan Yen Carry Trade. To be sure, the YCT is unwinding to some degree, from a rising Japanese yen currency. The engineered rally in USTreasurys removes some incentive for YCT traders to liquidate their carry trades as USTBond principal values have produced a powerful rally. The USTreasurys serve as object investments in the YCT speculation.

Then there is China, whose yuan currency realized a substantial gain since yesterday overnight. The yuan moved from 7.3880 to 7.4095 per US$, a move of almost 3/10 of 1%. That is equivalent to only a 42 basis point upmove for the euro. However, one should beware that the Chinese yuan makes extremely slow small moves. Forward contracts in the yuan currency indicate an expected 8.7% appreciation in the yun to 6.8150 in the next twelve months. Premier Wen Jiabao maintains the stubborn position of Gradualism in currency changes, ignoring pressure by the USGovt criticism that the yuan gains are not fast enough.

THE CONCLUSION IS THAT CENTRAL BANKS HAVE BEGUN TO FIRST ASSIST THE USFED WITH NO MORE RATE HIKES, NOW SOME ACTUALLY CUTTING RATES. BY THIS TIME NEXT YEAR, ALL THREE CONTINENTS PLUS MAYBE THE MIDDLE EAST WILL BE DESPERATELY ATTEMPTING TO INFLATE ENTIRE ECONOMIES. THEY MUST BEGIN WITH PROPPING UP ENTIRE BANKING SYSTEMS, AS THEY ASSIST TROUBLED HOMEOWNERS. THEY WILL NEXT FLOOD THE SYSTEM AS THEY REDEEM DAMAGED MORTGAGES. IN TIME RIDICULOUSLY LOW INTEREST RATES WILL BE BACK, JUST LIKE 2002.

GOLD WILL SKYROCKET AS THE DUAL FORCES ARE RECOGNIZED:

1. SPILLOVER OF MONEY FLOODING THE SYSTEM IN RESCUES & REMEDIES, AND EXPANSIVE GRAND INITIATIVES, WHETHER SUCCESSFUL OR NOT
2. BROAD PRICE INFLATION WHICH CAN NO LONGER BE DISGUISED BY POINTY HEADED BUREAUCRATS, SHOWING UP EVERYWHERE, EVEN WELCOMED BY LEADERS

FIRE TRUCKS

In past articles, my position has been clearly stated that eventually a $2 trillion bailout package, complete with grandiose resolution trust platform, augmented by numerous policy agendas, will be executed in order to address the housing crisis and mortgage debacle. The President's pathetic Federal Housing Authority plan announced several weeks ago now seems a drop in the bucket. The attempt to create a Structured Investment Vehicle superfund fell on its face. The plan to increase Freddie Mac loan limits might see more resistance after a giant $2 billion loss was announced, when credit derivatives were finally marked to market. Talk continues to use both Fannie Mae and Freddie Mac as the new & improved secondary mortgage market centrifuge, but they must raise capital since they are both insolvent. Ironically, raising Freddie Mac capital might result in a Fitch debt downgrade! Forget the moral hazards. How about financial system health hazards revived by taking a twin cesspool and directing it to be the centerpiece in a national platform to resuscitate the secondary mortgage market??? The phrase "A dog returns to its vomit" seems appropriate!

All mortgage delinquency figures are worsening, from 2Q2007 to 3Q2007, the aggregate DQ rate, the prime mortgage DQ rate, the subprime DQ rate at 16.3% incredibly. A national plan is in the works to freeze mortgage rate resets, to call a moratorium on home foreclosures, and to wave prepayment penalties and tax consequences. We have seen the usage of the courts to interrupt people from being forcibly removed from homes. Social unrest must be averted. Expect the free 800# telephone banks cited for USGovt deployment to be inadequately staffed, by people who have inadequate information. Meanwhile, Wall Street banks attempt to defend themselves against the growing suspicion that they are insolvent, meaning assets do not cover liabilities. Citigroup is bankrupt, Abu Dhabi welfare donations or not!

So far, to date almost all USFed injections have been pathetically minimal. Lower interest rates are really just a measly 75 basis point reduction, not enough to matter. Banks continue to distrust each other to a monumental degree, since the majority of commercial paper is traded with mortgage bonds offered as collateral. Federal Deposit Insurance Corp reports point to a rather large demand, implied from LIBOR sources in England. A defiant mismatch inconsistency has been flashing for two months, ever since the USFed began its woefully inadequate monetary ease, with flimsy rate cuts which should include sizeable interim rate cuts. The big banks are desperately trying to deal with insolvency, as they are forced to place cratered mortgage bonds and their credit derivative CDO bond disasters. They should be facing felony charges, but instead just fight for survival. A grand failure is in progress. Former USFed Chairman Greenspan boasted that the USEconomic dependence upon housing asset inflation was legitimate, since it was true wealth. NO MORE! The USEconomy is at risk from severe stall, both from housing decline approaching historically unseen proportions, and from a banking system crippled by mortgage bonds.

THE PRESSURE BUILDS FOR A GRAND DIVERSE DEEP RESCUE PLATFORM TO DEAL WITH THE HOUSING & MORTGAGE CATASTROPHE. AS IT TAKES SHAPE, AS IT IS FUNDED, AS ITS INADEQUACY IS DEALT WITH GREATER REINFORCEMENT, THE GOLD PRICE WILL ADVANCE TO $1000 PER OUNCE EASILY. So far, USGovt and Dept of Treasury officials actually boast of no federal money to be used in the current Mortgage Rescue Plan. This is an admission of inadequacy and future rampups in the rescue, but it is a start. As the stimulus package, rescue platform, and diverse desperation devices are put into motion, the mining stocks will finally gain traction. So far, rising costs and uncertain funding have combined to forestall the expected rise in mining stocks. That will change as the government initiatives are empowered, funded, and enabled.

FUEL FOR US TREASURY RALLY

Plenty of evidence is available to accuse the USTreasury Bond rally as being engineered. A 'Flight to Quality' is phony when foreigners shun USTBonds, when FOMC auctions are duds. The USDollar decline would grow into a rout if both the US$ fell and the USTBond principal fell. So a USTreasury rally was ordered. Look to JPMorgan and their credit derivative book for hints of the engineered rally, larger than the entire market! In fairness, three other factors contribute to USTreasury rallies.

1. evidence of a USEconomic recession is glaring, which motivates migration from S&P500 stocks into USTreasury Bonds, despite high pricing inflation (read: STAGFLATION)
2. unwinding the typical mortgage bond spread means to sell the mortgage bond and to buy back to cover the USTBond, which results in rising credit spreads; ditto on other spread trades like with junk bonds and emerging market bonds, anchored by the USTBond
3. as troubled beleaguered institutions like Freddie Mac reduce their credit derivative hedge book, they sell many leveraged contracts anchored by USTreasurys, which means more short covers for the USTBond.

LATE SIGNALS

The 2-year USTreasuy Bill yield has fallen more since my last article. It is just under 3.0% incredibly, down from 3.2% a couple weeks ago. This short-term yield indicates the USFed is over 1.5% behind the curve. Three 50 basis point rate cuts are dictated, yet the goon squad at the USFed sits on its hands. At this point, a mere 25 basis point rate cut on December 11 would not be met favorably. As the USFed catches up, again kicking and screaming, they will ignite the gold price. The priority for the USFed will continue to shift from concerns over price inflation to concerns of risk for USEconomic deterioration amidst a profoundly crippled bank structure. The dire bank situation is an order of magnitude worse than what was seen in the 1989 Savings & Loan crisis. This crisis is much worse, yet to be recognized. The 1991 Resolution Trust Corp was designed to deal with liquidated failed banks. The 2008 Resolution Trust platform will be an order of magnitude more grandiose in its design and execution. As the USFed makes clear its only priority is to save the USEconomy from a deadly lethal recession, gold will skyrocket. As the monetary medicine is finally given, the precious metal mining stocks will respond and rise in magnificent fashion. Mining stocks do not respond to diagnosis, but rather to administered medicine. To date, that medicine is late to arrive, after diagnosis is slow, too much talk and not enough action.

Herein lies the powerful rub! The 2-year TBill yield has come down quickly, deeply, without interim USFed rate cuts urgently needed. This means the USFed is behind the curve. But the 10-yr Treasury Note yield has also come down, from 4.5% in mid-September at the start of USFed rate cut cycle, to under 4.0% today. The two yields individually deliver the same message, A RECESSION IS NEAR OR HERE. However, another message can be dissected.

LOUDER PRICE INFLATION SIGNAL

Quietly, with little notice except for a few intrepid market mavens, the spread for the USTreasurys between the 2-year and 10-year yield has finally reached 100 basis points. The 2-year TBill yield is just under 3.0% and the 10-year TNote is just under 4.0%. In 2004 and 2005 and 2006, even early 2007, this yield curve was inverted. The message is clear, that PRICE INFLATION IS HERE AND POWERFUL IN ITS ARRIVAL. This is yet another signal for gold. The only crystal clear similarity to the 1970 decade in my analysis is STAGFLATION. Gold loves stagflation, since monetary pumps are applied endlessly.

The total picture is enormously complex. Strong forces of deflation have hit housing, mortgage bonds, bank sector stocks, as well as wages. Strong forces of inflation are evident with a nearly 15% annual rate of increase in the US$ money supply, in energy prices, and material prices, and the ultimate meter in the gold price. Neither deflation nor inflation will win any battle. Both will ravage and destroy almost everything in its path, except the gold price. By this time next year, both deflation will wreck havoc worse and inflation will wreck havoc worse. The storm differential of low pressure and high pressure will produce powerful storms, with gold the beneficiary like a storm shelter. Watch both deflation and inflation prevail, as both continue to gain power. The unspoken objective for policy makers is to turn housing from the deflation side to the inflation side of the ledger again. The Herculean task will take at least two years more!!!

A mildly wet finger put to the wind can detect absolute desperation setting in with the US Federal Reserve, the Dept of Treasury Secy Paulson, Wall Street bankers, Debt Rating Agencies, National Assn of Realtors, Mortgage Bankers Assn, and the President of the Untied States. Like with the unheralded movie 'Backdraft' from 1991 starring Kurt Russell, immediately before a gigantic powerful explosion, a reverse draft develops. The fire needs oxygen, which it sucks from its surroundings. The explosion in economic slide, in bank system seizures, and policy response is soon to come. A monetary gusher is being prepared, which requires political acceptance foremost. The gusher has sucked money from market surroundings in the preliminary phase. The explosion will be historically unprecedented in its size and scope. We are witnessing possibly the end of the US banking and financial system as we know it, since the Greenspan Era killed it. Dependence upon housing, abandonment of manufacturing, unchecked leverage in bonds, and colossal fraud on Wall Street have broken the system. Gold investors should hope that some semblance of solution can be accomplished. Otherwise, martial law will be ushered in faster than you can say GERONIMO.

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Jim Willie CB is a statistical analyst in marketing research and retail forecasting. He holds a PhD in Statistics. His career has stretched over 24 years. He aspires to thrive in the financial editor world, unencumbered by the limitations of economic credentials. Visit his free website to find articles from topflight authors at www.GoldenJackass.com. For personal questions about subscriptions, contact him at [email protected]