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Moderating the Gold Rush Euphoria

Commodities / Gold and Silver 2010 Sep 20, 2010 - 12:47 PM GMT

By: Seth_Barani


Best Financial Markets Analysis ArticleThe herd is rushing into gold and silver. These commodities have staged a multiyear rally by a scale that is not fully justifiable on physical demand, but mostly from futures speculators. What is ahead for these?

Gold is in a heavily overbought territory. The RSI is way above 70 in monthly, weekly and daily charts (see images). There is also a strong negative divergence. Technicals demand that there must be a downward correction or else stochastics would become irrelevant in trading. The correction may begin anytime in a matter of days to weeks and could last many weeks to months.

The forecast that there will be a downward correction may not be well received by some gold-bulls. According to them dollar will get trashed soon which will propel gold to dizzy heights.

Forecasts mean nothing unless they are substantiated with a time range within which they are valid. In our anticipated correction, we expect the correction to last up to at least a year before reversal. Why do we think so? The debt deleveraging will result in reduced money supply at M2, even if Fed pumps cash at M1 level, since, the law of diminishing returns tells us that regardless of how much excess money is stashed at M1, M2 is what determines how much of M1 will be economically relevant.

The reduced money supply will lead to deflation and possibly another credit crunch for the banks and dollar will suddenly get very strong similar to what happened a couple of years ago. The falling bond yields is a clear indication that the market expects a deflationary scenario than an inflationary one. The data at Federal Reserve also shows that the credit lending has been decreasing for the past few years. Commercial bank lending has been falling quarter after quarter (both by tightening of credit requirements and an organic fall in the loan demand), which portends another credit crunch.

The debt deleveraging must be fully done (whether borrowers pay back debt or banks write-off the loans, either way M2 falls). Until then there will be no inflation to drive the gold price up. The present gold and silver prices are unsustainable in the deflationary scenario. Comparison to any historic inflation is like between apples and grapes. The present gold price levels are mainly from speculative trading, and some fear factor but not from any anticipation of hyperinflation. The following are the indicators for a potential infation/hyperinflation:

-Treasury Yields must go up
-USDJPY must rally towards 100+ without BOJ intervention factor
-M2 must expand
-Housing prices must stabilize
-Unemployment must fall towards 6.0%

Until then it is premature to talk about hyperinflation. But when that date arrives, gold will return with a vengeance and head to $10,000 within months.

Regarding Silver, ("the poor man's gold"), it cannot sustain the run up. The poor cannot drive these commodity prices. The poor do not have the means to invest in silver as they are already burdened with other serious problems. The rich buy gold. That is why gold/silver ratio is increasing. The expanding gap between gold and silver (1:60) is the measure of how badly the wealth is skewed more in favor of the rich than poor. It is not quickly reversible.

Author Seth Barani is a PhD in physics and is a freelance capital market researcher and trader. He can be reached at

© 2010 Copyright Seth Barani - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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