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Gold Disconnect

Commodities / Gold and Silver 2010 Oct 06, 2010 - 07:58 AM GMT

By: Neil_Charnock

Commodities

Best Financial Markets Analysis ArticleGold now has an RSI reading of over 84 as I write this article; it is sitting just under US$1350 an ounce and it is very overbought.  This is not to say it cannot get more overbought short term however it can indicate gold needs to take a breather very soon now.  When fundamentals push additional cash flows along a trend the technicals will give way and reach extreme levels every time.  We are more likely to see a price consolidation as that RSI cools off before it launches ahead again.  Silver is agreeing with this scenario and so are the gold stocks.  The AUD price of gold is currently $1377 which is well under the record highs reached in 2008 and the middle of this year. 


The Australian gold index is in power mode with the ASX – XGD nudging 8,000 today on a new break out.  I have been saying that the Australian gold sector would play catch up one day and this is now coming to pass.  I have screamed this from the WWW roof tops for 4 years now so I am extremely pleased to see it.   I hope you have joined in and are prospering too as this was my intention.  Before you think that these stocks are all overbought I want to show you a chart available at GoldOz via our friend Nick Laird at Sharelynx:

As you see above these emerging producers are still way under some of the former highs which were all printed when AUD gold was well under current levels.  What you cannot see above is the new breakout today after that short consolidation period just under 120.  If gold consolidates for a breather soon we may get a new buy opportunity so it is important to get educated about this fantastic opportunity as soon as possible – or miss out.

I have also been in agreement with my colleagues that the time for gold to really shine would come at a sad time for society and we are seeing that in Europe, the USA and many parts of the developed world in the form of social pain.  This is the greatest global debt bubble in history which was only fully understood by gold bugs and this industry over recent years.  So much for ridiculous accusations that we are a bunch of - whatever  - it has all been thrown at us.  I have been writing about the bond markets (debt) in our newsletter to show details about the mess emerging now.  This gave our subscribers a heads-up so at least they understand how and why we are where we are.  I provide an overview of the big picture, at least certain aspects, in this article.  This makes for more informed investment decisions. 

Many equity investors are either unaware or misunderstand the monetary system yet this dictates cash flows which drive asset classes up and down.  It is an essential part of your financial education and once you get the hang of it you will be in a far better position than most.

The lack of growth, QE and lack of viable investments in the current climate is causing massive currency fluctuations as nations rush to devalue.  This is causing horrendous pain in developing economies.  This current AUD strength is mainly due to USD weakness and fears that the USD is in a collapse.   I am also reading these terrific claims that the total collapse of the USD is upon us now.  The fall in the USD is also part of the cause of the rise in gold at present so we better take a close look at this scenario. 

The AUD has not moved against the Euro since May – same level and we have not moved against the JPY in the past 12 months either!  We are just reaching the March / April highs against the NZ Dollar and the Loonie (Canadian Dollar) has been falling against the USD this month.  Go figure – C$ falling while the A$ (AUD) has risen sharply sending the AUD nearly up to par against the Loonie and USD.  Normally the resource currencies move in the same direction and I smell a rat here.  Which currency is telling the truth, the Loonie or the AUD?

The USD denominates roughly 70% of the world’s assets – across all asset classes – so if it really did go then so does the whole global economy.   I do believe there is an exit strategy to get away from the USD over time however this cannot be accomplished so soon.  Believe me the USD is not dead yet because Japan, China, SE Asia, UK, Europe and the Arab states all need to protect their own interests (assets).  The emerging economics hold massive USD reserves they cannot afford to lose and they need the export market to the USA. 

This is an interesting point; everybody wants to export so they can get back to the old normal – so we are seeing competitive currency devaluation.  The Western governments think they can export their way out of trouble like the old days before they exported their manufacturing bases.  It is just that the USA is winning at the moment, on their devaluation effort and the AUD / Euro / JPY etc. are losing.  There are other important factors too.

At the moment idiot (sorry this is harsh yet well earned) governments also think they can grow out of the mess they are in by printing more money than is needed, to create inflation, a lower currency and hence higher GDP.  They hope and indeed rely on the fact that for this to work the households have to start buying more and saving less which is hard when you are already tapped out, in negative equity or out of work.   They have not thought through the fact that the buyers of their debt are the same groups and they are taking losses, currency losses if a currency is devaluing.  They will want a higher interest rate to but that debt if the currency is falling wont they. 

Let me pose this question: how can households throughout the western world go deeper into debt to hype consumption back up to old normal levels when they are already buried under a debt mountain?   Their assets (houses mainly) are now falling in value as the cost of capital goes back up towards historic averages.  Remember rising asset prices allowed people to refinance to free up capital for consumption which turbo boosted GDP growth.  The debt mountain is going to be tough to shift because the servicing cost is going up making it harder to repay the loan principle.

The bond markets are already realizing that 5% GDP is not coming back because we are facing a massive deleveraging and a stagflation period like Japan has faced for the past 20 years.  Without at least 3% growth the “grow your way out of trouble” theory starts to break down in reality so there is little point even ramping up production in the hope of exporting to each other.  Where is the growth that will present new market opportunities to soak up new manufacturing capacity?

The bond markets are pricing in 2.5% growth at best and likely to fall according to Pimco.  Other governments are trying another experiment because they have to – forced austerity measures and this is not good for growth either as seen in Ireland and Greece where GDP is contracting sharply.  GDP contracted at an annualized rate of 5%, that is -5% growth in the last quarter. 

Indeed growth in “Chindia”, Asia and Brazil is growing more dependent on internal consumption yet this synchronized global contraction (Europe, UK, Japan and USA) has come several years too early on their growth path for them to avoid pain too.  Their internal economies (domestic consumption) are not yet developed enough to support themselves when exports are falling, debt is high, inflation is high and they have massive excess capacity.  Their export models have been described as being dependent on the Anglo – PIIGS (Euro zone) being willing to bankrupt themselves and this is sadly true.  

I predict the law suits will start soon on Ireland over the “restructure” of Anglo Irish bank and this will essentially be seen as the default point when the smoke finally clears.  This is not a fast process however it is stressful, especially if you were a bond buyer who had a government guarantee which has now evaporated. 

Getting back to the previous paragraph (sorry I digressed), this is essentially the same growth model the developed world has been dependent on too .  Only in this case it was the domestic market that had to endlessly gobble up debt as asset prices rose and they all felt rich!  Eg. debt growth in USA against rising house values to fuel new SUV’s, boats and more condo’s.  How can we all be millionaires and hold 12 houses each and keep borrowing against the rising value of assets into infinity?  This model was flawed and doomed for failure creating massive reverberations for banks and consumers.

This social / debt myth and the “disequilibrium” in the global economy, between the deficit nations and the surplus nations are unsustainable.  The world is currently starting to wake up to this horrible fact yet they fail to see that when you find yourself in a hole you should stop digging.  Currency extremes are also unsustainable for all nations just as I have described the situation of parity and beyond for Australia.  Overvaluation created massive pressures and hence the current battle among nations to devalue for the sake of competitiveness.

Where does gold fit into this?  Gold is essentially an anti-currency whereby it sort of acts like a currency; is used in the Central Banking system as ballast and acts as a last resort as a store of wealth for the rich and fortunate.  It cannot be used to buy groceries at present so it cannot be classified as a functioning currency at this point in history.  This does not mean it is not a form of money though.  The great news is that it does not suffer from the same limitations as national currencies do because it cannot be debased (physical) and it is not tied to any one nation.  Therefore it has no theoretical upside limit.  Therefore the gold producers will also have no theoretical upside limit when this goes ballistic.

The surplus nations are buying gold providing support during these consolidation periods seen all along the weekly or monthly chart pattern.  There have been five major consolidation phases in this gold bull to date and each one was characterized by claims that it was all over for gold.  Most of the Asian Central Banks have relatively low gold to reserve ratios anyway so it makes excellent sense for them to stock up.  The rest of the Central Banks have mostly stopped selling and the IMF sales are being snapped up by these Central Banks.  The Indians and Chinese both have a deep affinity for the king of metals so the populations are buying it with their rising wages. Investors in countries that are devaluing their currencies now have to wake up as they see gold flying in local currency terms.

These rising wages in the developing will go a long way to restoring some of the balance needed to get surplus nations and deficit nations on a more even footing.   Surplus nations like Brazil, India and China are soaking up the excess liquidity printed in the West overheating their economies adding to wage pressures.  This process will gradually equalize wages in the world economy but not without pain first due to the overheating factor.  You will see rising wages in the surplus economies (read - growth pains) and falling living standards in the West (read - austerity pains).

The periods when growth pains are at their worst in the developing world will be when the resource economies like Canada and Australia catch pneumonia.   I am afraid they are unavoidable.  When we (Australia) hit the hospital bed what do you think will happen to asset prices and the AUD here?????

Where do global investors put their money?  Do they invest in the Eurozone where the ECB is frantically buying bonds to prevent a sovereign default?  The German participation in the ECB / IMF rescue package is to be tested in a court case in Europe soon, a dark cloud hanging over the EMU.  Do investors buy Japanese Yen with their government intervening to debase the Yen at this time?  Japanese problems include a declining savings profile and debt at 2x GDP.  Do they buy Sterling with the UK in its current shape and a declining property bubble?  In the UK there is also the counterparty risk on Europe? 

Remember bonds and cash make up the major proportion of the global investment liquidity pool and could not possibly all head into gold and gold stocks as much as we would like them to.  So they tend to flood from one currency to another to take advantage of the volatility and this will continue.  I have been saying all along we will see massive currency volatility and I have been right so far. 

When, not if but when Europe staggers next time, risk will be avoided, and exited rapidly, once again and the exotic currencies will get hit hard as they always do.  And the USD will go back up and the AUD will come crashing back to reality, it may even overshoot to the downside.  Thank you I rest my case now we wait and watch and see when it unfoldsJ.  Longer term I think the AUD will see another carry trade and recover strongly against an ailing USD which is ultimately doomed.  It is all about the timing.

Longer term this gold stock bull has at least half a decade to run and will end in a mania.  The question is what will you be doing when we get to that point?  I hope it end well for you.  Much of this article was taken from a section of the GoldOz Gold Members newsletter.  We welcome all new clients if you are interested we have a secure site as we use EWay, a secure payment gateway.  The gold stock sector disconnected from the rest of the stocks here back in April – the activity is still hot and strong.  We are also covering the white hot Rare Earth sector in our newsletters as a special situation.

Good trading / investing.
Regards,

Neil Charnock

www.goldoz.com.au

GoldOz has now introduced a major point of difference to many services.  We offer a Newsletter, data base and gold stock comparison tools plus special interest files on gold companies and investment topics.  We have expertise in debt markets and gold equities which gives us a strong edge as independent analysts and market commentators.  GoldOz also has free access area on the history of gold, links to Australian gold stocks and miners plus many other resources.

Neil Charnock is not a registered investment advisor. He is an experienced private investor who, in addition to his essay publication offerings, has now assembled a highly experienced panel to assist in the presentation of various research information services. The opinions and statements made in the above publication are the result of extensive research and are believed to be accurate and from reliable sources. The contents are his current opinion only, further more conditions may cause these opinions to change without notice. The insights herein published are made solely for international and educational purposes. The contents in this publication are not to be construed as solicitation or recommendation to be used for formulation of investment decisions in any type of market whatsoever. WARNING share market investment or speculation is a high risk activity. Investors enter such activity at their own risk and must conduct their own due diligence to research and verify all aspects of any investment decision, if necessary seeking competent professional assistance.

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