The Unavoidable Consequence of the Currency War
This Gold Slam Is a Massive Wealth Transfer from People's Pocket to the Banks
We are entering a new chapter in the unfolding of our economic emergency, one in which the risks to capital are greater than ever. And the rules are increasingly being re-written to the disadvantage of us individuals.
Bernanke is blowing new bubbles, and as we have seen in the past, it is in the early inflation phases of new bubbles that gold struggles. Equity investors are getting sucked in again, and the gold bugs may have to wait until they get spat out again and the Fed’s cavalry again rides to their rescue, that gold comes back.
In any case I remain certain of one thing:
This will end badly.
Obviously, early this Monday a 'lot more short term downside' was indeed in store. It is of course impossible to tell at the moment how much lower gold might go before it finds a durable low, but there are a few target areas one can consider at this point. For instance, the $1,300 level roughly coincides with the 50% retracement of the 2008-2011 rally, as well as the 38% retracement of the entire bull market from 2000-2011. So this is an area that could provide support.
A more painful possibility is of course that gold could replicate its 1975-1976 mid cycle correction, in which case the lateral support at $1,040 might come into play at some point down the road. We simply don't know at this point, we only mention these levels as something one needs to keep in mind.
What is Really the Problem?
In recent days a number of reasons have been forwarded as to what triggered the rout in gold, some of which sound quite reasonable, while others are just obviously hokum. We are referring to fundamentals here, not technical conditions – obviously, breaking important support levels always triggers technical selling, as stops are taken out. Recall that over the past two years many analysts have made a big deal about central bank buying of gold. This never made any sense to us. How can 400 or 500 tons of net central bank buying in a whole year have any appreciable influence on a market the total supply of which is approximately 170,000 to 175,000 tons and that trades between 2,000 and 3,000 tons every day worldwide?
All one can really say about central bank buying is that it is very likely a contrary indicator, as central bankers as a rule are the worst traders in the world. After all, they were all selling hand over fist while gold declined from $400 to its low at $250 in the late 1990s and then kept selling hand over fist while it rallied from $250 to $1,000. Their decision to start buying at prices ranging from $1,500 and higher must therefore be regarded as suspicious and QED, it certainly wasn't a bullish omen at all.
However, considering the timing of the recent crash and the news backdrop surrounding it, it seems actually quite likely that concerns about central bank holdings were what provided the psychological trigger for the sell-off. As a number of observers have argued, the news that Cyprus will probably have to sell its measly 10 tons of gold reserves sparked visions of Italy, Portugal or Spain having to do the same eventually. Not that it makes a lot of sense worrying about that either: in reality, the gold would likely be used as collateral for loans, or be transferred to other official holders (probably Asian ones) without ever hitting the market as such.
Moreover, try to imagine a situation where e.g. Italy's economic situation becomes so dire that is is forced to think about selling its gold. We believe that if it were to come to that point, the euro project would finally be rendered asunder. European nation states would then return to issuing their own fiat currencies again and would likely begin to inflate all out in the misguided belief that this flight forward might actually help them. It is either that, or the ECB will give up all pretense of being responsible and begin to inflate all out rather than risk the euro project's doom. However, all of this is probably in a still fairly distant future anyway, so it cannot really be the main reason behind the rout in gold – the Cyprus story and the deliberations flowing from it merely provided a trigger.
Also, as far-out as that may sound, Jim Rogers may actually have a point when he says that the crash in Bitcoins could have had a psychological effect on the gold market as well. After all, if one state-less alternative currency is crashing, then it seems only logical that the other state-less alternative currency should do the same. And Bitcoin has certainly crashed, although we would regard that simply as part of its growing pains. Unless government manage to crack down on it somehow, Bitcoin isn't going to go away and its finite supply almost guarantees that it will continue to gain in value over the long term.Let us not forget, Bitcoin already crashed once in 2011, falling from more than $47 to slightly above $2. Its imminent demise was darkly prophesied at the time by the same people who are at it again today – all or most of whom are committed statists, we might add, this is to say, the usual suspects. They moaned and griped when it went up, alleging that its apparent soundness made it a 'bad currency' and now they moan and gripe even more loudly as it is going down. However, it isn't going to go away and we are willing to bet that in ten years time, its exchange value will be far higher than today's. We will explain this stance in some more detail in an upcoming post.
Bitcoin crashes as well
So what is actually the problem, what important fundamental development may have upset the gold market?
We believe it actually does have to do with Cyprus, in an indirect way. When analyzing gold, one must never lose sight of the fact that it is a monetary metal, and investment demand for it can therefore be described as monetary demand. A such it competes with other currencies, most of which can be created in unlimited quantities by central banks with the push of a button.
However, what happened in Cyprus was a timely reminder that the fiduciary media created by fractionally reserved banks are ephemeral indeed and can be sent to money heaven at any time if the authorities so decide.
Deflationary potential ?
At the same time, it has come to our attention that bank credit expansion is slowing down lately, respectively even going into reverse in many regions of the world, in spite of heavy monetary pumping by various central banks.
In short, what the gold market may really be worried about is the deflationary potential of all these events. It is quite conceivable to us that another major deflation scare is just around the corner; after all, Europe's wobbly banks haven't magically become solvent overnight – they are merely temporarily reliquefied by the ECB's LTROs. Consider for instance the weakest of Germany's big banks, Commerzbank. Its CEO Martin Blessing is quite adamant that dispensing haircuts to depositors is the way forward. He is also, as Der Spiegel points out, an incorrigible optimist and bad market timer:
“SPIEGEL: Mr. Blessing, you have recently again used a good portion of your annual salary to purchase Commerzbank shares. What are you — a gambler or an incorrigible optimist?
Blessing: Neither. I'm a long-term investor and a staunch supporter of Commerzbank. In this combination, I feel very good about my investment.
SPIEGEL: Despite the fact that you once purchased shares at a price of €30 ($39) and the shares are now worth €1.17 ($1.53)?
Blessing: I have purchased Commerzbank shares on a regular basis and have never sold any — and I won't do so, either, as long as I'm active. Of course Commerzbank shares have been hit hard by the financial and sovereign debt crisis over the last few years. But that is true of all shares, particularly shares in banks.
SPIEGEL: Not many have fallen from 30 to just one euro in value. How far would the price have to rise for you to recoup your losses?
Blessing: The current price would have to roughly triple.
SPIEGEL: Taxpayers — who will still have nearly a 20 percent stake in the Commerzbank even after the planned capital increase — aren't doing any better. How do you intend to triple the price?”
“Blessing: In late 2012, these business activities — public-sector financing, shipping financing and commercial real estate financing — still made up €151 billion. By 2016, we intend to reduce this to slightly more than €90 billion. Currently, these reductions are going faster than planned.”
The important point is of course the last sentence – where Blessing explains how he plans to triple the share price to recoup his losses. Namely, by shrinking the bank's credit exposure.
Commerzbank share price with time line, via Der Spiegel.
Commerzbank may be an extreme case, but roughly similar deliberations are informing the banking business across Europe – definitely no-one is seriously considering growing their loan book. Besides, there is very little credit demand anyway. This is inherently deflationary.
However, letting the deposits of depositors in insolvent banks go up in smoke is even more so, even if it is the right thing to do (it is definitely more just than simply stealing money from tax payers to prop these failed banks up). As an aside, a budding plan to simply cancel all € 500 banknotes under the pretext of 'hitting organized crime' may produce a big profit for the ECB, but it would be intensely deflationary as well.
Naturally, there is every reason to doubt that the authorities will allow a system-wide deflation to happen if push really came to shove and the entire € 3.5 trillion in fiduciary media issued by commercial banks in the euro area were in serious danger of evaporating. This is even more true in the case of the US banking system and the roughly $7.8 trillion in fiduciary media outstanding there. However, we do think that a deflation scare has a high probability of occurring within the next year or two and that the decision to allow depositor haircuts to happen is imparting a certain impetus to this.
In short, gold's recent crash is probably an expression of growing market fears that a hitherto unexpected deflation scare may be on its way as a result of the decisions that have been taken regarding the status of big depositors following the Cyprus 'rescue'.Addendum: Technical Conditions
As an addendum to our yesterday website update, we want to show the weekly and daily charts of the HUI – the weekly RSI has now declined to an improbable new all time low of just 17.38, and it seems quite possible that the recent gaps in the chart represent so-called 'exhaustion gaps'.
The HUI, weekly – the gap at the end of the decline may be an exhaustion gap, especially as it coincides with an RSI of just 17.38. Hopefully it isn't a 'measuring gap', see the next chart as to why.
On the daily chart of the HUI we can see both potential 'measuring gaps' as well as the two potential exhaustion gaps in the latter stage of the decline. Note that an RSI-price divergence has formed as well on the daily chart (though not on the weekly chart – there is a remote possibility that the gap on the weekly chart is actually of the 'measuring' variety) – click on chart for better resolution.
Not surprisingly, the XAU-gold ratio has hit a new all time low as well (the BGMI-gold ratio, which has a longer history, remains at its lowest level since the Pearl Harbor market crash of 1941-1942).
XAU/gold hits a new all time lowConclusion:
It is not possible to tell where the ultimate low of this move will be. What we know for certain is where various areas of support and resistance are (note in this context that the $1,525-$1,540 area will henceforth be stiff resistance, as it has held almost two years as a support line) and that gold sentiment has morphed from 'intensely bearish' to 'outright panic'.
Above we have speculated as to what the decline in gold may be telegraphing and what the worries underlying its decline may really consist of. Naturally, should authorities allow many more banks to go under and take their deposits with them into oblivion, then the supply of the underlying currencies will begin to shrink.
This would be genuine deflation and it would be normal for these currencies to gain in value against gold (deflation is not possible in gold). However, we also believe that these and other worries in the context of potential central bank gold sales in the euro area are quite overblown. It should be clear that not a single central bank in the Western world will in the last resort allow deflation to truly take hold. They would probably rather 'go Weimar' on us than allowing that to happen. In fact, a budding deflation scare all but ensures that even more money printing will eventually ensue. Note in this context that ECB governor Benoit Coeure recently already remarked that there is allegedly 'not enough inflation' in the euro area:
“The European Central Bank will monitor euro zone inflation carefully over the next 18 months as it threatens to sink further below the ECB's 2 percent target, Executive Board member Benoit Coeure said on Friday.
Euro zone inflation slipped in March for a third straight month to an annual rate of 1.7 percent, compared to the ECB's goal of close to, but not above, 2 percent.
"We have a rate of inflation which looks set to move away from the ECB's 2 percent target over the next 18 months," Coeure told reporters at a breakfast event, adding that a drop in inflation was as worrying as a rise. "It is still fairly close to the 2 percent target but it is moving below that goal and this is something the board of governors is clearly following as we have a goal of 2 percent," Coeure said.”
There you have it. Not even a mild decline in the CPI inflation rate below the 2% 'target' can occur without triggering the urge to increase the pace of monetary pumping. It seems abundantly clear to us that no genuine deflation will ever be allowed to happen – therefore the market's fears over this possibility seem quite misplaced.
There is only one environment in which it makes sense for Gold to go up, and that is negative real interest rates. The Gold bull throughout 70′s was a result of interest rates lagging inflation. As soon as Volcker raised interest rates above inflation, Gold topped out. The Gold bull since 2003 was a result of the Greenspan Fed turning interest rates negative after the tech bust. By 2008, the housing bubble had burst, turning interest rates positive.
The reason for the current Gold bull run is probably because of negative rates in China. The reason Gold prices have started coming down is because the china bubble has burst, turning interest rates positive. Since Gold pays no interest, there is no reason for Gold to appreciate in a positive rate environment.
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