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Hindenberg Omen For Gold, Death Bell For Overpriced Assets

Stock-Markets / Financial Crash Apr 16, 2013 - 03:31 PM GMT

By: Andrew_McKillop


The Omen, largely based on Norman G. Fosback's High Low Logic Index is rarely applied by analysts to commodities, but applying the Omen's method to equities, bonds and other assets can identify probable future violent downward price movement affecting all markets. Basically, the method sets out to identify if markets are undergoing a period of extreme divergence — many assets at new highs and many at new lows. When this happens, pricing is evidently haywire or "stochastic-oriented", and this divergence is very rarely conducive to future rising prices. Conversely, a healthy market needs a semblance of internal coherence and uniformity whether the uniformity is down tilted, toward declining prices, or the opposite.

Certainly since 2008, in response to an economic, fiscal and financial crisis that itself "slayed" markets and their internal logic, economists and policy makers have favored very unusual policy combinations, especially QE and Keynesian-type stimulation plus outright austerity policies. Sometimes the authors of these policies, themselves, call them "heterodox".  At one and the same time, they apply their own interpretations of Keynesianism, monetarism, liberalism and neoliberalism, corporatism and statism, and "technocracy" - the proverbial dog's dinner!

This pot pourri of ideas, all half-baked by the time they have passed through the mixer of illusions we can call "the political and media process", has been slammed by "Austrian" economists, in particular, who have warned of hyperinflation and gold going to $10 000 per ounce. Since 2008, and with each further dose of QE, each further bank bail-out (and now country "bail-ins" on the Cypriot model), the "Austrians" have been ever more strident in forecasting hyperinflation. Real world facts of a deflating economy - the reason for Japan's supposed Great Monetary Experiment - are "contrarian" to this theory of the economy, and are simply brushed aside, by "Austrians" like almost everybody else.

The collapse of gold prices is finally not about gold, but has been brought about through what we can call the "usual mixture" of the willed and fortuitous, the accidental and the planned. Overall, the "stochastic" wins out. Running a randomized roll-the-dice casino economy will inevitably and surely produce extremely unusual results - like winning! - from time to time. The 'Black Swan' of Nassim Taleb will brief us on the mathematical reasoning, if we need it. Much more basic to the current and coming context, gold's collapse is one "self fulfilling hypothesis" and the vindication of concepts and theories drawn from a large corpus of economic theory and research, which all point to Trouble Ahead. The basic reason is that our elites do not know what they are talking about, but have the tools at their disposal to intensify existing crises while creating new ones - that can be catastrophic.

We can start with the "Austrian theory of hyperinflation", because its absence is already a chilling signal of how wrong the economy has gotten. The collapse of any bubble - whether it concerns a currency, real estate, gold and oil prices, equities, bonds or whatever - signals that the mix of fear and greed, confidence and distrust, which propelled the bubble has suddenly declined or switched away, from that particular tradable asset. Never, or almost never will the analysis and forecast extend to a retreat from all assets fundamentally due to their ovepricing.

The first argument for why gold prices collapsed is that hyperinflation fears have not panned out, quickly followed by the comforting illusion that "if gold is down, equities have to be up". Investors will realize that equities are cheap, and buy them with whatever they get liquidating their gold holdings.

Exactly like equities, gold's claimed "intrinsic value" is will-o'the-wisp. As a simple metal, to be sure, it has some residual value, as a paperweight for example, but this is exactly like saying equity certificates can when needed be used to  make lampshades. Discussion soon veers into the domain of myth, with another quickly marshalled gold myth that its price has nothing to do with global macroeconomic trends and issues. The rest of the economy can keep sailing, without the dead weight of gold - at a certain moment during the cruise trip, it can be thrown overboard. In fact, gold surfs with other traded assets as shown by a large number of coherent indicators - for example that the euro trades up when gold is up, and the inverse. Why the euro should exchange at a premium to the dollar is a related myth.

These are only a few elements of the "collective belief system" of market operators, traders and players which at any time can change. But changing to a belief that all assets, of all classes are overvalued and enjoy an unwarranted premium above their "intrinsic value" is a rare event - resulting in spectacular asset price crashes, such as the collapse of gold.

Underlining the "contrariness" of the present and distorted real world-real economy, bullion market operators, traders and analysts have for some time noted that physical demand for gold is in no way weak and hesitant, but "paper gold" has suffered a massive loss of attractiveness. In turn this highlights that the paper market in gold is not a real market. Paper gold owners and holders can wake up and realize they are holding worthless pieces of paper - exactly like equity and bond holders

Paper gold sales, like purchases, can be for lurid nominal quantities of physical gold. On the single day of Friday 12th April, only in New York, sales probably exceeded 400 tonnes (about 13.5 million ounces). Exactly the same can occur with other commodities, equities, bonds or other assets. Believing this had any relation to the (forced) sale of 10 tons of gold by Cyprus, Japan's Great Monetary experiment, rumors about QE being reprieved or not in the US or accelerated in Europe, the nuclear threat from North Korea, weakening US economic data, or whatever, is at best only a very partial explanation. Gold was, and at around $1385 per ounce as of Apr 16 still is, an overpriced asset.

Whenever any comfortable 'can't lose" asset takes a beating, and especially gold, the airwaves are thick with claims this was due to US Federal Reserve undercover action to bolster the dollar. Supposedly, the competition of the overvalued euro incited enough alarm in Ben Bernanke's head to do the same thing - seek an overvalued dollar, possibly because of "race memory fear" of inflation. The covert Fed action was operated by "agents of the Fed" hitting the gold market, the afternoon of Apr 12, with 500 tons of naked shorts in a desperate but determined attempt to bolster the dollar.

The rationalization continues by claiming the orchestrated effort "to suppress gold and silver" was a sign that not only American, but global authorities are now frightened by major but undisclosed "major threats" to the world economy that will be impossible to control unless there is renewed and strong confidence in the dollar. The US dollar must be shored and strengthened, before the shock, so gold had to be done away with. This particular conspiracy theory is claimed by some to have been started, by the Fed, on April 1st profiting from the cover that April Fool's Day conferred on their conspiracy - market players would tend not to believe it was real, and not take avoiding action.

The international version of the theory is that other central banks, with the US Fed and the IMF, have for some while been trying to shut down private buying of gold, and to do this first need to smash the gold price, then intensify their own buying "on the dip". Why private buyers would not also rush to "buy on the dip" needs to be explained, creating highly interesting potentials for further market disinformation through artificial, short-term upward blips in the gold price from today's $1385.

So far, however, the most dangerous theory - of global and all-asset deflation - has been kept far away from all major business and finance sites and news outlets. Why equity markets have "tanked" since week ending 12 April has been given a highly traditional set of rationalizations, for example "temporary stalling of the US recovery" and of course the "Eurozone crisis". One of the most laughable ex post facto rationalizations for gold's price crash predictably came from Goldman Sachs, on Apr 16, saying the whole event was "sparked by investor concern that European governments may have to follow Cyprus in selling part of their (gold) holdings".

Metals and oil sank, food commodities sank, Emerging market technology stocks sank, European stocks and the euro sank. Commodity index gauges shrank along with equity indexes.

Bellwether gauges for overpriced oil as big as the Russian economy also tell the same story. Russia’s $2 trillion economy is growing at the weakest pace since the 2008-2009 contraction it suffered as collateral damage from the "first instalment" of the Eurozone debt crisis, which curbed oil, gas and metals exports to Europe and prompted Russian companies to cut investment as the Kremlin scaled back State spending, after Putin and Medvedev had been comfortably re-elected. Analyst forecasts for Russian growth in 2013 extend down to far below 2%, and even Economy Ministry forecasts have been sharply cut from earlier, unrealistic official claims that the Russian economy could achieve 3.6% growth.

Very closely tracking the decline of Brent and WTI prices, the Russian ruble has lost about 2.7% in the past 4 weeks against the US dollar, its second month of decline, and the worst performance among more than 20 Emerging-market currencies. Reinforcing the "petro-economy" linkage and dependence on overpriced oil, Russia had already tried to rein-in State spending on infrastructures and transport with its so-called "budget rule" which caps public spending - when or if oil prices decline.

Oil is easliy able to be called an even more ovepriced asset than gold. The all-in cost of gold extraction by major miners such as Barrick Gold, including new and controversial accounting items included under "deferred stripping" or the balance sheet treatment of mine wastes, is forecast by Barrick as about $1050 per ounce in 2013. Many oil producers have production costs on an all-in basis far below $50 per barrel and even high-cost enhanced recovery, deep offshore, tarsand oil and shale oil output is mostly set in an upper range of about $60 - $70 per barrel. Prices for Brent have however only now, on the back of the gold price crash, slid to the "$100 threshold". Oil prices could decline another 25%.

Many other commodity assets, such as natural gas anywhere outside the US and electric power in many countries and regions, especially in Europe still profit from an unrealistic and unjustified "market premium". Put another way, the potential for a major price break on the downside is strong, but upside price growth or price appreciation is unlikely. The assets have "topped out".

As the 2008-2009 sequence for all world stock exchanges and commodity markets showed, the break pattern can trigger and spread very fast from almost "trivial causes", such as the now-mythologized role of the Lehman Bros. bank and brokerage collapse. Following the gold price collapse, and the sure and certain attempts that will be made to "mystify the process" through symbolic partial price recoveries, the coming all-asset deflation or devaluation to more realistic, more sustainable price levels will signal an overdue mega-change of the economy.

By Andrew McKillop


Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights

Co-author 'The Doomsday Machine', Palgrave Macmillan USA, 2012

Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.

© 2013 Copyright Andrew McKillop - 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 advisor.

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