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Gold and Commodiies Being Hit by Second Wave of Deflation Fear

Commodities / CRB Index Jul 12, 2010 - 02:47 AM GMT

By: Howard_Katz


Best Financial Markets Analysis ArticleBelow is the CRB index, monthly basis, for the past 15 years showing the beginning of the (second) upswing of the commodity pendulum.  (This is the real CRB index, the one which was started in 1955 and weighs the different commodities equally, not one of the modern variants which overweigh the energy group.)

To an experienced chartist, it is a thing of beauty.  Note, for example, the double bottom which formed between 1998 and 2002.  That formation has predicted the entire commodity rise we have seen so far this century.  And if I had carried the chart back to 1980, then you could see that the late 2008 decline carried almost precisely to the 1980 top at 337, indicating a normal pull back to support (with bullish implications) and not an important top.  Think of how much money it was possible to make on the knowledge of this one formation alone.

But today I wish to continue my theme that the theory of “deflation” propounded by the media in late 2008 is the main enemy of speculator profits at this time.  I have argued that the theory is false a) because there is not the slightest evidence of declining prices and b) because there is enormous evidence of a massive rise in prices to come (perhaps the greatest rise since the depreciation of the American continental from 1776 to 1780).  Note, with regard to the first point, I disregard evidence which commits the self-confirming fallacy.  This is where people believe a thesis and then act in a way which makes it appear to be true.  That is, in the latter half of 2008 the price of commodities went down due to speculators who read in the media that prices were going to go down and sold their commodities.  Prices did not go down because of supply and demand.  The media can cause any move in any market, usually small, by appealing to the greed and fear of these speculators.  However, these moves will be followed by opposite moves, and the speculators who believed in them will lose their shirts.

Now when any new theory hits the financial markets, true or false, the markets discount it.  Thus, when the “deflation” theory was announced in mid-September 2008, the commodity markets were hit hard (see chart above).  But because there was no supply-demand reality behind this theory, the speculators who sold when they heard it took terrible losses, and many of them sold near the bottom.

What we have had for the first half of 2010 is a secondary “deflation” scare (see chart).  The CRB is up by 40% from its Dec. ’08 bottom.  Gold is up by 70% from its Oct. ’08 bottom.  Yet the gold community has allowed itself to be shaken by fear.  Mark Hulbert had an excellent article a week or so ago in which he pointed out that his gold newsletter sentiment index had dropped to 23.5% bullish (on July 1) from a high of 68% bullish last December.  If even the gold bugs, who are the toughest speculators and most skeptical of the media hype, are getting scared, then indeed we are in a period of great fear.

And yet, despite this fear look at how little the CRB index has declined since January.  Obviously, the media’s ability to scare the speculative community is waning.  First, the gullible ones have already sold.  (At the double bottom in gold in September-October 2008, there were two massive short squeezes on the bears in gold, as evidenced by the Commitment of Trader report for large speculators.  On each squeeze, gold rallied close to $200 in a month’s time.  They won’t try that again for a while.)  And second, the economic facts are not supporting the theory.

It would be perfectly normal for a decline in commodity prices to cause a decline in consumer prices.  This is what happened to some extent in the 1980s.  The decline in commodity prices resulting from the second downswing of the commodity pendulum was translated into a decline (or a moderation of the rise) in consumer prices.  For example, in 1986 crude oil fell to $10 per bbl (from $40 in 1981), and this led to a decline in the price of gas-at-the-pump below 80¢ per gallon.  In the larger scope, the commodity decline of 1980-1999 moderated the increase in the Consumer Price Index and allowed the Republicans of that era (Reagan, Bush, Sr.) to get away with massive printing of money.

Now (since 2001), however, we are on the upswing of the commodity pendulum.  The “deflation” scare of 2008 can delay but cannot prevent the massive increase in consumer prices which is coming.  The combination of the money which was printed in the ‘80s and ‘90s together with the rise in commodity prices over the past 9 years (and yet to come) will be too much.  And since Bush, Jr. and Obama have continued the printing of money for the past 2 years, this only makes the situation worse.

In economics, there is often a fairly long time period between cause and effect.  For example, what is incorrectly called the Great Depression was caused by the Federal Reserve and by the expansion of money during WWI.  Both of these events were the policies of Woodrow Wilson (who passed the Federal Reserve Act in 1913 and led the U.S. into WWI in 1917).  But because Wilson was long gone from the scene by 1929 the stupid people who discuss politics in this country have never thought to “blame” him for it.  Instead, they follow the policy of “blaming’ a President (in this case Hoover) for what happens on his watch (meaning while he is in office).  Similarly, Jimmy Carter was blamed for the sharp price increases of the late 1970s, but these resulted from JFK’s decision to adopt Keynesian economics (i.e., to print money) in 1963 and Richard Nixon’s decision to abandon the gold standard in 1971.  That, of course, is nonsense and is not followed in any other area of our culture.  One should blame a person for what he does (or doesn’t do) not merely for what happens when he is on the scene.  This is directly relevant to forecasting today’s events because Ronald Reagan escaped blame for (almost) doubling the U.S. money supply during his two terms in office.  The price increase which will follow from this has been delayed by the commodity pendulum.  When it comes, it will be a monster, and the idiots will blame it on some future President.  Right now virtually no one in the field of economics has a clue about this, and they will all be in total shock and surprise when it happens (as they were in the early 1930s).  Of course, it is the normal state of establishment economists to be in shock and surprise.

So a picture begins to emerge in which everything makes sense.  For some time, I have been talking about the giant ascending triangle in gold which formed from March 2008 to September 2009 and broke out upside in October 2009.  The price objective line is now at $2,500, and it will be $3,200-$3,300 by spring 2011.  What more natural way for the massive bull move needed to fulfill this triangle to start than with a period of great pessimism in gold, such as we are now going through?  And what is more natural to produce this pessimism than a rehash of the original “deflation” argument of 2008?

The theory of contrary opinion says to buy when sentiment is very bearish and sell when sentiment is very bullish.  Extreme swings in sentiment do not occur frequently, and they are not the only factor which moves markets.  But it is wise to take advantage of them when they come along.

To sum up, the media (preaching “deflation”) are false.  The chart (warning of “inflation”) is true.  By only showing a minor decline during this period of bearish sentiment, the CRB chart is revealing amazing strength, strength which will manifest itself in the future.

As I have noted, the strategy for making big money in the financial markets is to put yourself in harmony with the long term trend.  The trend is your friend.  Wait for evidence that a new trend has started (such as the double bottom in the CRB above or the corresponding saucer bottom in gold at the same time).  Then take your position.  MAINTAIN THE LONG VIEW.  Be aware that the media will try to shake you out of your position first by bringing you up too close to events and second by telling a number of lies along the way, all designed to get you to sell.  (With regard to the New York Times and the media which follow it, we know that these are not deliberate lies because the Times lost an enormous amount of money following its own advice.  To identify the guilty party vis a vis the “Great Recession” of 2008, we must step up a notch to Secretary of the Treasury Henry Paulson, who came up with the idea of a financial crisis and sold it to President Bush.  It was Paulson’s firm, Goldman Sachs, which was the chief beneficiary of the “crisis” in the form of a $750 billion taxpayer bailout to companies which owed it money and could not otherwise have paid.  Even more incredible, the Times had spent the previous 8 years telling the country how stupid President Bush was, and yet they believed every word he said when he endorsed the Paulson line on the country’s financial situation.)

Of course, even though trends go on for much longer than most everyone expects and by far the most common mistake is to sell too soon, every trend must end some day.  So the second job before you is to identify the final end of the bull trend when it does come.

In the gold bull market of 1970-80, it was not terribly hard to see the top when it came.  First, all of those people who had made fun of us for being bullish in the early 1970s now wanted to come on board.  Second, the speculative end of the group (silver and the exploration companies) exploded on the charts.  Third, the media were screaming “double digit inflation,” and this was as close as they had ever come to being bullish on gold.  Fourth, the advance in gold in 1979 was 100% while the advance in consumer prices was 13%.  And fifth, the day of the top in gold, Jan. 21, 1980, saw a classic one-day reversal on the chart: sharp move up in the morning, heavy volume, decline in the afternoon to close near unchanged.  (Americans did not know about candlestick charting at that time, but to the Japanese it was a very tall upper shadow and possibly a gravestone doji.)

Remember that the first downswing in the commodity pendulum lasted 8 years, and the first upswing lasted 9 years.  The second downswing (1980-1999) lasted 19 years, and therefore the second upswing will probably last a bit more than 20 years.  Two other criteria will probably be a spike top and a real gold price equal to the 1980 peak (adjusted for the value of the currency at that date).

So far none of these things have happened, and we can assume that the second upswing in the commodity pendulum has a long way to go.  And we are making a lot more money with our sitting than we ever could have with our selling.

The paper money system is an evil which punishes those who believe in it.  Just like any other confidence game, what you need to do is to say in your own head, “One cannot get something for nothing,” and then you are free.  Immediately you know what you have to do.  You know exactly how the present system started.  In 1933, the Democratic Party said, “We’re going to rob from the rich and give to you.”  Rob they did.  Take from the rich?  Not a chance.  Once you voted for rob, you became a victim.  It is just like those people who play the state lottery.  They lose and lose and lose, but their heads are full of big winnings around the corner.

For those who will say, “One cannot get something for nothing,” I write a fortnightly newsletter predicting the markets, with special emphasis at the present time on gold.  It is possible for you to avoid being robbed.  The system has no power over you.  This newsletter is the One-handed Economist.  It costs $300 per year, and over the past decade it has been outperforming the average U.S. mutual fund by about 2:1.  You may subscribe either by visiting my web site: and hitting the Pay Pal button.  Or you may subscribe by sending a check for $290 ($10 cash discount) to; The One-handed Economist, 614 Nashua St. #122, Milford, N.H. 03055.  The One-handed Economist is published every other Friday (most recent issue July 9) with special bulletins when necessary.  Thank you for your interest.

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