Sunday, 11 May 2008

Fundamentals don't point to gold at $600 re: 1974-76

Sunday 11 May 2008: 11:24 pm: Fundamentals don't point to gold at $600 re: 1974 decline!

Is this 1974? Well, er, nope. OK, even if gold does go to $600, to me it looks like it might not be the end of the bull market, just the return of the price to the original slower moving curve in the price graph in existence from 1999 to mid-2005, before the rapid increase after the breakout above about $480 going to $730 by May 2006 - and before the second, even faster increase going to $1000+ between mid-2007 and March 2008.

In 1974, real interest rates were going positive and their was a decrease in the inflation rate. At present, in 2008, we have grossly understated inflation rates and they are increasing despite the data manipulation. Oil and prices are skyrocketing worldwide. We don't seem to be at the peak of the general commodities markets in 2008, whereasthe peak had already occurred in 1973-1974, when gold started its 48% decline.

The Fed had some ammunition in the 1970s to increase interest rates (and to decrease them), whereas in 2008 they have practially no ammunition to do either. They can drop the short term rate from 2% to 0% and we have already discovered the upper limit at just over 5% recently before real estate market started to go bust. The Fed is stuck between 0 and 5%. They havenot had the fortitude to take it even to 6%. The potential for going to 15-20% interest rates to end the present gold and commodities bull market is practially nil, unless we already have impending hyperinflation with inflation already at 15-20%. What really matters is whether the real interest rate (interest rate minus inflation rate) is negative, zero or positive. Rates went positive in 1974 (and also highly positive in 1980) and that, arrested the commodities bull markets, along with decreasing monetary inflation.

Fast forward to 2008: real interest rates are negative at 2% nominal while the understated USA 'CPI' inflation figure is about 4%; that's a real interest rate of -2% already. Account for the skewed propaganda inflation figures of the Consumer Price Index with all its dubious statistical fiddles and you are perhaps looking at 8% inflation using 1995 statistical methodology or even 11+% using 1980 methodology, which surely is the valid one to use because that was the methodolgy used at the time of the last major inflationary economic situation in 1971-1980. That would make real interest rates on short term bills of 2-11 = -9% and on long term debt of 4-11 = -7%, highly negative, which should be exceedingly bullish to the gold price and also highly geared towards more inflation finding its way into prices of real goods on the shelves. It also looks very negative for the relative value of the US dollar compared to other currencies, again potentially highly 'price inflationary' in terms of import and commodity costs.

The first head and shoulders pattern that I mentioned has already broken down and has a target of $800, so that is possible. There was indeed a similar major potential for a larger H&S pattern after the 2005-2006 bull run, but it didn't materialise. Instead, gold had a long consolidation in a converging triangle pattern, from which it broke out 18 months later, explosively, into the bull run that went to $1000 in early 2008. The current correction down from $1000 to the mid-$800s is also less severe in nominal and even less in percentage terms than the post May 2006 correction, although it is significant.

The debt, housing and derivative situations in the USA and by extension the whole world are so way above the risks that existed in the 1970s that we are almost beyond comparison with that time and therefore my fully personal opinion is that gold won't (cannot) go down as far as $600 before bargain hunting by the big US$ holders (oil exporters and China for example) would buy up all the available gold at higher prices than $600 due to the high risk and already existing oversubscription to the US$ by these countries.

Whatever happens, this will be a highly significant test of Technical versus Fundamental analysis of this market and of markets in general (notwithstanding the assertions by GATA that the gold market is heavily manipulated downwards by governments, central banks and their agents and therefore that technical analysis is effectively not much use in the gold market).

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