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Gold XAU Index and Financial Markets Analysis - Strong Nerves Required

Commodities / Gold & Silver Stocks Jun 27, 2007 - 02:11 AM GMT

By: Brian_Bloom

Commodities

It can be seen from the chart that the most recent price weakness in XAU brought it to rest on the lower trendline that has been in place since 2002.

Can this trendline be penetrated on the downside? Of course it can. It happened for a few months in mid 2005 – before pulling back up to move within the rising channel once again.


The chart above (courtesy Bigcharts.com) is a weekly chart of the $XAU up to June 27 th 2007.

It is drawn on semi log scale which reflects percentage price movements on the Y axis.

Will it break down now?

In my view, this is the wrong question. It reflects a trader mindset. The “right” question is: “Will the primary uptrend of gold shares (and gold) – which has been in place since 2001, be aborted?

In a previous article, entitled “Gold – Major Breakout Imminent” I expressed my view as clearly as I could. The Primary Trend of the Gold Price is “Up”. I remain invested in gold and related investments, and will remain invested until the evidence suggests a need to change my view on the Primary Trend.

One of the problems in modern day markets is the overwhelming presence of traders trying to second guess price movements on a day-to-day basis using computer algorithms and other tools of trading. With this in mind, it's probably appropriate to relate an anecdote to illustrate the process of biofeedback.

Many years ago I landed up in hospital with Tuberculosis (Fortunately I caught it early and it cleared up completely). But I was hospitalised for some weeks. By some perverse twist of fate, I was admitted to hospital on my twenty first birthday. That was a long time ago.

One day an unusually pretty nurse came to my bedside to take my blood pressure and monitor my heart pulse rate. She expressed concern that all the readings were too high and she wanted to call the doctor there and then. I prevailed on her to take the readings a second time.

Using a de-stressing technique I had learned a few months earlier, I ‘centred' my thought processes and focused on relaxing. Taking the readings again, she discovered to her amazement that they were normal. (I told you she was pretty. What do you think happens when a pretty girl approaches a young guy up close and personal?)

This process of slowing down my heart rate and lowering my blood pressure is known as a ‘bio-feedback' process. Armed with information that was endogenous to the system, I applied an exogenous variable which had the effect of modifying the behaviour of the entire system.

Biofeedback is real. The above is one of many examples that I have personally witnessed and/or experienced during my lifetime. It's not just some esoteric concept.  For this simple reason, you can throw all the computer trading programs out of the window. They will work until they are trusted to work and, as soon as they are trusted to work by a sufficient number of people, this very trust causes them not to work. How does one program “sporadic” variables into a computer – those that manifest occasionally and only under certain circumstances? The answer is that one can't, as some Nobel Prize Winners discovered to their shame and multi billion dollar cost. For this simple reason, daily charts are interesting, but not particularly relevant.

I tend to think of daily, weekly and monthly charts in terms of tactics, strategy and philosophy. Primary Trends are a function of philosophy. They are driven by culturally accepted thought paradigms. These paradigms change slowly.

Secondary trends are driven by fashionable thought paradigms (A bit over simplistic, but there's a point to make here).

Short term trends are driven by knee jerk opportunism – which ebb and flow for reasons that may have nothing to do with financial variables. For example, there may be a cold snap; or there may be trouble brewing in Iran. These are little eruptions which have the capacity to change the larger trends if they happen to manifest at critical points in time.

So, if we are going to talk about the Primary Trend of the price of Gold, we need to talk philosophically.

The arguments here are well known and have been discussed ad nauseam. Currency of last resort, inflation hedge, store of value, medium of exchange, external discipline on Central Bank behaviour, etc etc.

I happen to think that these reasons, whilst interesting, miss the “core” point. It is my view that Human Society is reaching the culmination of the Neanderthal Era in its evolution, and we will eventually (sooner rather than later) emerge into a new, post Neanderthal era where the Thought Paradigms of society are fundamentally different than today. All three Abrahamic religions talk of a Messianic Age. On a more prosaic level, it seems we may be on the threshold of a breakthrough in humanity's knowledge and understanding.

Because I am alert to this potential breakthrough, I am also on the lookout for evidence, and this evidence is manifesting in a tidal wave. It's all around us.

By way of example, I have just watched a RealPlayer video which shows seawater “burning” at 1500 degrees Centigrade. By exposing it to radio waves, hydrogen and oxygen are released – both of which are flammable. Humanity's knowledge base is literally exploding, hampered only by the barriers and blinkers being set up by our testosteronal and/or egomaniacal  political leaders.

Depending on the level of wisdom, humility and maturity manifested by these political leaders, this process of evolutionary change could be violent and painful – forced on us by catastrophic collapse of the old system; or it could be slow and sure – orchestrated by a deliberate strategy that is different from what we have been witnessing to date. I am hopeful, but I'm not holding my breath. My personal interest in gold is that I believe gold will have a pivotal role to play in the coming era. Unfortunately, the problem with this philosophical mumbo jumbo is that it doesn't put food on the table, so we need to take a view that is more relevant to our immediate needs.

That's why the weekly charts are important. They bring the trends down to the here and now, but still manage to avoid the day-to-day opportunism which sometimes serves as nothing more than static to obscure what is really happening.

In my view, one of the most important charts that decisionpoint.com publishes is the chart of the goldollar index. This is derived by multiplying the gold price by the US Dollar Index. The weekly chart is reflected below, and I would like to draw the readers attention to several ‘clues' contained in this chart.

The points of interest flowing from the charts above are:

  1. the upper trendlines of the channels join two spikes in the gold price and the goldollar index
  2. These upper trendlines represent an “angle of incline” – which is the “rate” of increase in price on both charts, and which is mirrored by the angle of incline of the lower rising channel line on  each chart.
  3. The direction of travel of the US Dollar Index chart has been pointing down since 2002 – which is the opposite direction from that in which the gold price has been travelling. This is what has led most “investors” to argue that the gold price moves inversely to the US Dollar – ‘Therefore' they have concluded, ‘Gold is the currency of last resort'
  4. The US Dollar is approaching the apex of a triangle which may lead to a breakup. The concern of many investors is that if the Dollar breaks up, that's the end of the gold bull market

Let's look at percentages:

The Dollar Index fell from 120 to 80 or 33%.  By the inverse argument, the gold price should have risen by 50%. In fact it rose from $300 to its current level of $650, or by 116%. The inverse relationship is simply not true. We don't have to argue about it. The conclusion is based on fact. Let's move on.

Facts notwithstanding, which way is the Dollar likely to break?

The argument for the past few years has been something like this:

The Fed has been profligate in the way it has printed US Dollars. The US National Debt is approaching $9 trillion. Interest on that debt alone is $450 billion a year and rising. The US deficit is chronic. It's a matter of time before the world's Central Banks start to shy away from the US Dollar. A US Dollar collapse is therefore inevitable.

The problem with this argument is that it ignores the fact that 70% (seventy percent) of all the reserves of all the world Central banks added together is comprised of US Dollars. As a matter of pragmatic fact, there is no alternative currency – no matter what “public announcements” may or may not appear from time to time about the intentions of China, Saudi Arabia or whoever else happens to want to get their face in the news. Oh, so you don't like the US Dollar? Okay, so what's the alternative? Euros, Yen, Renminbi, Gold? All these added together represent the other 30%. It's a matter of simple and unarguable fact that the tail cannot wag the dog.

So, given that this is also a fact, let's move on.

For the world's Central Bankers (acting in concert and in their own self interests) to avoid implosion of the value of their reserves, and contrary to popular argument, the most logical behaviour on their part would be to support the US Dollar, not dump it. Under no circumstances can the US Dollar be allowed to collapse – at least not now.

But how can they justify their supportive behaviour to their own constituencies? 

Well, how about this?:

“Capital needs to be put to work. It needs to earn a return. Investing in the US Dollar now would be smart, because the yields in the US are at the beginning of a long term rise. (Chart below courtesy of decisionpoint.com)

This has sinister implications to the mega-dollar capital value of US Treasury Bonds. If yields enter a primary rising market, hundreds of billions of dollars will be lost in the Treasury markets (which can be hedged by the smarter operators by forward dollar contracts). How can we avoid a catastrophe of 1929 proportions – which led to an implosion of debt?

Are we talking tactically, strategically or philosophically? Philosophically, we can't. It's impossible. The US economy is “toast”.

But maybe, from a strategic perspective, we can ameliorate investor fear for the time being by allowing the equity markets to rise in monetary terms.

Okay, let's look at the S&P 500 (the 500 large cap stocks)

Technically, it could be argued that the SPX is hitting a Double Top, from which it may reverse. If it pulls back significantly, there is a high likelihood that the Gold Shares ($XAU) will get caught in the down draught – and that the $XAU's rising trendline will be penetrated on the downside.

Ah! But the Central Banks are not going to sit on their hands just waiting for the technical analysts to panic. Therefore, this is what they might be arguing over their post dinner Cognacs. “The Dow Jones Industrial Index only contains 30 stocks. Using derivatives maybe we can arrange for some obfuscation which will get us through this period of uncertainty.”

Okay, so let's look at the Dow Jones Industrials:

Oh my! Will you look at that? It's broken up through its double top. Oh yes, it could pull back, but the technical evidence suggests a period of strong rises ahead. Yup! If that could be orchestrated then the losses on the Treasury Markets might be offset by the profits in the equity markets.

So the (admittedly circumstantial) evidence suggests that the Central Bankers believe they can arrange for the tail to wag the dog. (Of course they can't, but they will die trying – and they may postpone the day of reckoning for a year or two or three)

Thus, if a situation could be orchestrated whereby the S&P breaks up, this will evidence “inflation”, and money will flow back into the property markets because everyone knows that property (and gold) is the ultimate hedge against inflation.

So let's look at the Real Estate indices: (Again, courtesy decisionpoint.com)

Fascinating! Again, the rising trend is still intact – notwithstanding the recent strong price falls.

So, when we put all the pieces of the jigsaw puzzle together, we see a picture emerging:

Prices generally have been rising within identifiable channels. Prices have been pulling back within these channel. Investor confidence is being severely tested, because a breakdown below the long term rising channel lines could lead to catastrophe.

This situation needs to be managed. How can the Central Banks do this?

By protect the US Dollar, and by “ramping” the Down Jones Industrials in the hope that it will spill over into the other equity markets.

Will they succeed? Philosophically? Not a snowball's hope in hell! Strategically?  Yes, I think they might pull it off for a year or two – in the hope that the centre of gravity of the world's economy can be shifted to Asia. When that has been achieved, the US consumers will have served their purpose and they can be sacrificed.  Oh well. For a few years there they had it good. Now its someone else's turn.

Personally, morality aside, I have a problem with this strategy because it relies on Neanderthal Fire as the primary energy input across the planet.  There is no way that Nuclear Fission is ever going to replace Neanderthal Fire. My problem is that if you treat the symptoms and ignore the cause, the patient will inevitably drop down dead.  His systems will become overloaded and collapse.

But let's look at what is likely to happen in the medium term.

If the US Dollar breaks up , then this will cause significant (short term) consternation in the gold camp because “everyone knows” that Gold moves inversely to the US Dollar.

But investors are pretty smart nowadays. It won't take them long to work out that the rules of the game have changed. If the rising dollar and rising interest rates do not give rise to a collapse in equity prices then it will become obvious to Blind Freddy that we are facing an era of inflation.

Inflation hedge assets will boom.

At the point that recognition dawns generally that we are facing an era of inflation, the gold price will sever its historical linkage with the US Dollar and will break up. The break up will be “major”.

And what if the Central Banks fail? What if the double top on the SPX is a true double top? What if the DJIA tail can't in fact wag the economic dog – even in the short term?

Well then, we have to go back to fundamentals.

Fundamentally, the cause of the world's economic problems is not debt or fiat currency. It is that we are stuck in a Neanderthal Energy Paradigm. For many reasons Fossil Fuels need to be replaced with more appropriate and far more powerful energy paradigms. Why we are stuck here is a function of Neanderthal attitudes towards the very concept of “control”. Think of the cartoon picture of Neanderthal Man – carrying a club in one hand and dragging his woman by her heir behind him. Neanderthal man was the ultimate control freak. Our solutions lie in the era which, in turn,  lies Beyond Neanderthal. (see www.beyondneanderthal.com )

After twenty years, I have concluded that there are at least three energy technologies which, together, could facilitate a new Energy Paradigm. They all appear practical from the perspective that they can be perfected and commercialised within a decade. One of these will be ‘fuelled' by gold.

Gold is therefore a three way bet for me.

1. If the Central Banks are successful in their game playing, inflation will be upon us and the gold price will soar

2. If they are unsuccessful, the dollar will collapse and the gold price will hold its value and maybe even soar upwards – because it is an insurance policy against systemic failure

3. In time, if the system does fail, gold will form a foundational cornerstone in a new era. If we still have an affinity to the concept of amassing riches, then the gold price will soar.

Short term, the gold price may weaken further. Long term, the Primary Trend is UP. Nowadays, the short term is very short indeed.

Brian Bloom

www.beyondneanderthal.com

Since 1987, when Brian Bloom became involved in the Venture Capital Industry, he has been constantly on the lookout for alternative energy technologies to replace fossil fuels. He has recently completed the manuscript of a novel entitled Beyond Neanderthal which he is targeting to publish within six to nine months.

The novel has been drafted on three levels: As a vehicle for communication it tells the light hearted, romantic story of four heroes in search of alternative energy technologies which can fully replace Neanderthal Fire. On that level, its storyline and language have been crafted to be understood and enjoyed by everyone with a high school education.  The second level of the novel explores the intricacies of the processes involved and stimulates thinking about their development. None of the three new energy technologies which it introduces is yet on commercial radar. Gold, the element , (Au) will power one of them. On the third level, it examines why these technologies have not yet been commercialised. The answer: We've got our priorities wrong.

Beyond Neanderthal also provides a roughly quantified strategic plan to commercialise at least two of these technologies within a decade – across the planet.  In context of our incorrect priorities, this cannot be achieved by Private Enterprise. Tragically, Governments will not act unless there is pressure from voters. It is therefore necessary to generate a juggernaut tidal wave of that pressure. The cost will be ‘peppercorn' relative to what is being currently considered by some Governments. Together, these three technologies have the power to lift humanity to a new level of evolution. Within a decade, Carbon emissions will plummet but, as you will discover, they are an irrelevancy. Please register your interest to acquire a copy of this novel at www.beyondneanderthal.com . Please also inform all your friends and associates. The more people who read the novel, the greater will be the pressure for Governments to act.

Brian Bloom Archive

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