Wednesday, 9 April 2008

Chart hints at Financial Disintegration: 2007-12-23

Sunday 23rd December 2007: 10.52pm

Two comments are in my head - one concerning the Dow-Gold ratio and the second concerning the fact that we have new all-time high in gold in Pounds Sterling.

Starting with the latter, we have seen a recent 1/4 point interest rate cut by the Bank of England and also a gigantic 500 billion Euro 'liquidity' injection (that means your money folks) by the European Central Bank (ECB) into the European banking system, presumably to try to 'unfreeze' the credit markets, especially interbank lending, to try to make the interbank lending rates some down to the intended rate set by the Central Banks and to cover the mounting and huge writedowns of financial asset values, especially those concerned with subprime mortgage backed securities and the many derivatives that are likely to be affected by the devaluation of these underlying assets. Injecting 500 billion Euros in a single day may become standard practice for the ECB as this mega-crisis unfolds. Your money and mine remember! This kind of monetary inflation will likely contribute currency devaluation risk and therefore high price inflation that might destroy savings such as the assets in pension funds, even if those assets are not already destroyed by being connected to those written down in value by the credit collapse that is unfolding.

Perhaps this latest BoE rate cut is the reason that the Pound has declined against the US Dollar and now stands at $1.98 ratherthan the $2.06 it was before the cut. With gold oscillating at around $800 and staying below its recent $840+ highs,one might have thought that there was perhaps a bit of weakness in the metal, with some pundits pontificating on a possible significant move down to the 720+ range or the $760+ range.

The symmetrical triangle pattern that you can see on the Kitco gold charts for 2007 or the jsmineset charts posted by Dan Norcini (with commentary) look like a typical consolidation pattern that gold has exhibited on a larger scale before in 2003, 2004 and 2006 for instance (see December 7th blog entry). Anyway, while pondering if just under $800 might be a nice point for a purchase of a few ounces of gold bullion, based on historical evidence of upside breakouts from this trading pattern, I did a mental arithmetic whilst lying in bed last night after seeing that Sterling is now under $2 and that a UK gold dealer was asking £424.00 per Krugerrand for a set of three coins! My initial thought was 'That is a big premium, innit?' even considering that typical premiums can be 7% in the UK. I took 800/1.98 and suddenly realised that gold was over £400 per ounce - that is a new all-time high in Sterling that came by stealth whilst I had been concentrating on the slight relative weakness in quoted dollar gold prices. WOW! Remembering that gold popped up to $810 this Friday, I factored in 810/1.98, well that's about 405+1%, i.e. £409. Hmmm, 424-409=15, that's less than a 4% premium on the spot price. That means my other gold dealer who charges 7% premium would want 409+7% = 409+28 or thereabouts = £437! 'I'm not paying that much! I bought some Proof Krugers for under £420 only about 3 months ago!' was my reaction. Now they want more than that for plain bog standard ones! Yikes!

This shows the error of my ways in thinking only of the US Dollar gold price when I as a UK 'citizen' or British subject would have to buy in Sterling. That is the lesson of today: NEVER LOSE SIGHT OF THE PRICE MEASURED IN YOUR HOME CURRENCY. Of course, if I complain that Sterling gold is getting expensive, the good news is that my glass is half full as well as half empty - all my existing gold is worth more and is at an all-time high in my home currency - if I decided to sell it, I would be in profit. Maybe it's time to flog it all and buy that sports car after all. My current car is a complete dog. As for the Dow-Gold ratio, that will have to wait for longer commentary. My basic thought is that the Dow-Gold ratio chart might not in some kind of oscillating gentle uptrend channel (see here but has been in a positive feedback loop since forming the Fed and leaving the Gold Standard in 1913-1914 and that it might therefore go below a ratio of 1:1 this time around, contrary to what many pundits suggest. See the ratio from Steve Saville's Kitco article here and an excellent pdf file that I have just found on here. However, probably the best two charts are on the excellent Sharelynx at these links: Dow-Gold since 1900 and Dow-Gold since 1800. The chart looks to me like a resonant oscillation of a driven system exhibiting positive feedback, such as the Takoma Narrows bridge collapse shown here on YouTube or the kind of positive feedback that you might get when putting a microphone too near to the speaker at a rock concert. If so, the result might be the complete collapse of the monetary system. Could it happen this time around? Here is my adaptation of the Dow-Gold since 1800 sharelynx chart, with thanks to Nick at sharelynx for permission:

If the red trendlines are correct and are followed, the possibility of the Dow:Gold ratio bottoming at less than 1 is implied.

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