We live in an era of unparalleled confusion on monetary and economic issues. It's almost like a shoot-out among the economists in the Old West, except that here you can't tell the good guys from the bad guys. You read so many conflicting reports, editorials, and newsletters that it's easy to get befuddled.
There are those who say inflation, those who shout deflation. Some say print more money, others say halt the printing presses. There are those who say bail them out, and the others who say let them fail. There are those who say gold is going up to $2,000 and even to $5,000, and those who say it's a bubble about to burst. We're in a bear market, sell all your stocks. No, we're in a bull market, buy, buy, buy.
At Sunshine Profits we follow the reports, read the newspapers to stay current, but we shut out the noise. Technical analysis is a world of its own and when you learn to listen you can hear its music. There are harmonies, rhythms and patterns, sometimes sharp, sometimes flat.
Nevertheless, we thought it might be useful to look at some of the economic theories and how they are being put into practice in these confusing times. It is very important to understand the difference between the various schools of economic thought employed by governments. After all, economic, monetary and fiscal policies affect us directly right where we feel it-in our pockets and in our standard of living.
There are many schools of thoughts, but today's showdown with guns loaded seems to be centered between the Keynesians and the Austrians. They don't even try to hide their contempt for one another. In 1998, Paul Krugman, a Nobel Prize winning Keynesian economist plainly dismissed the Austrian theory as not "worthy of serious study." The Austrians say the Keynesians are dead wrong about how to deal with the recent subprime crisis and, in fact, are largely responsible for it. One called the Keynesian theory "a con job from day one." Another said Krugman makes "an enticing argument that is nevertheless built on rubbish."
A Brief Explanation
Keynesian economics is a macroeconomic theory based on the ideas of 20th century British economist John Maynard Keynes, without question the most influential economist in the 20th century. The Keynesians argue that private sector decisions sometimes lead to inefficient outcomes and therefore the government should step in with active monetary policy actions by the central bank. The recent economic crisis caused resurgence in Keynesian thought with U.S., British and other world leaders using Keynesian economics to justify injecting billions into the economy with bail out programs and government stimulus programs. Keynesians claim that government policies kept the world economy from collapse and that more stimuli are needed. You might recall that it was President Richard Nixon who was quoted as saying "I am now a Keynesian in economics" when in 1971 he took the United States off the gold standard. (Keynes himself called gold "a barbaric relic.") New York Times Nobel Prize winning columnist Paul Krugman is a champion for Keynesian economics.
The Austrian School takes an opposite tack. The Austrians (They are nowhere near Austria today, but that is where the economic theory began) argue for an extremely limited role for government and the smallest possible amount of government intervention in the economy, especially in the area of money production. According to the Austrian Business Cycle Theory, the central banks attempt to control the economy is ineffective and creates volatile credit cycles and periods of boom and bust. When the central banks artificially "stimulate" the economy with artificially low interest rates it causes bubbles to form, inflation and consequent recessions. Austrians predicted the subprime bust in 2006.
Austrian theorists such as Murray Rothbard, Ludvig Von Mises, and Friedrich Hayek believed in government restraint, the protection of private property and the defense of individual rights. Austrians see entrepreneurship as the lifeblood of economic development. Many Austrian School economists support the abolition of the central banks and advocate a return to the gold standard. The Austrians advocated in 2008 that the FED should do nothing, that Fannie and Freddie should be allowed to go under, and that the stimulus bill should be voted down. Congressman Ron Paul is a firm believer in Austrian school economics, as are investors Peter Schiff and Jim Rogers. Milton Friedman of the Chicago School is closely associated.
So to simplify, the Austrians say the market is a self-correcting mechanism, just leave it alone and it will follow fairly smooth and manageable cycles. The Keynesian say government should intervene with deficit spending and ever-changing fiscal policy to "guide" market cycles.
As the financial crisis unfolded the governments reacted according to the Keynesian textbook. They began pumping the printing presses, lowering interest rates and injecting billions to bail out and jump start the economy. Now, it's beginning to look like policy makers are making a startling about-face and are embracing austerity and deficit reductions, a more Austrian approach.
Congress recently failed to extend unemployment benefits and abandoned plans for another round of stimulus to combat what is the worst economic recession in over a generation. Are we really at the dawn of a new age of austerity? Has Austrian economic thinking replaced the Keynesian addiction to government spending? How does this affect the case for gold?
Stimulators Vs Austerians
Krugman, a Keynesian, is horrified by governments wanting to tighten the belt and what he calls "balanced-budget orthodoxy" instead of more stimulus spending. "We are now, I fear, in the early stages of a third depression," he wrote in a recent New York Times column. "And this third depression will be primarily a failure of policy." The policy to which Krugman is referring is the recent G-20 meeting where governments, spooked by the debt troubles in Greece, agreed about the need for belt-tightening when the real problem, according to Krugman, is not enough spending. He wrote:
It's almost as if the financial markets understand what policy makers seemingly don't: that while long-term fiscal responsibility is important, slashing spending in the midst of a depression, which deepens that depression and paves the way for deflation, is actually self-defeating.
Krugman calls the G-20 move "the victory of an orthodoxy that has little to do with rational analysis, whose main tenet is that imposing suffering on other people is how you show leadership in tough times." He is, of course, referring to the Austrian school.
The Austrian Response
Peter Schiff had an interesting view on the growing ideological divide between the economic thinking between Europe (Austrian) and the US (Keynesian) and some answers for Krugman. Here is what he wrote in an article for Marketwatch:
Despite the apparent deficit-cutting solidarity that emerged from the G-20 meeting in Toronto, it is clear that the great powers of the industrialized world have not been this philosophically estranged since the end of the Cold War...We now are witnessing a struggle between two camps that I playfully call the ‘Stimulators' and the ‘Austereians' (from Austerity).
Both warn that a worldwide depression will ensue if governments now make the wrong choices: the Stimulators say the danger lies in spending too little and the Austereians from spending too much. Each side also has their own economic champion: the Stimulators follow the banner of Nobel Prize-winning economist Paul Krugman, while the Austereians are forming up behind the recently reformed former Fed Chairman Alan Greenspan. In a recent Wall Street Journal editorial, Greenspan argued that the best economic stimulus would be for the world's leading debtors (the United States, UK, Japan, Italy, et al) to rein in their budget deficits, a strategy dubbed ‘austerity' by the press...
Meanwhile, in several articles for his New York Times column...Krugman has argued that those who push for austerity in the face of recession are either doing so for political expediency or out of a ‘crazy' fealty to archaic economic views. Krugman has apparently judged inadequate the trillions of dollars worth of deficit spending unleashed by the United States and European governments in the last 24 months. He believes our only remedy is to spend more - no matter how much debt results
.
What Krugman proposes is nevertheless built on rubbish. Economies do not grow because consumers spend; consumers spend because economies grow.
The Stimulators...believe money grows on trees and that a printing press is a legitimate creator of wealth. However, printing money merely encourages people to spend their savings now rather than wait for it to lose value through inflation. This is okay to Stimulators, because stimulating "demand" by any means necessary is the only goal they can see.
The Austereian argument is that reductions in government spending will allow the private sector to generate the additional supply of goods and services. Europe seems to understand this; unfortunately, the U.S. does not. If Greenspan and the Austereians are correct, the stimulus will fail and leave us in a much deeper hole. As long as governments create bigger deficits, we will never have a sustainable recovery.
So there you have it, the Keynesians versus the Austrians. Who is right? We continue to believe in the small government, but the history will prove to be the ultimate judge. Meanwhile, we will continue to do what we do best, study the charts.
To see how the price of gold will do in the upcoming weeks let's begin this week's technical part with the analysis of the currency indices. We will start with the Euro Index chart (charts courtesy by http://stockcharts.com.)
Euro and USD Indices
This week's long-term Euro Index chart shows an upward trend confirming last week's observation that the bottom was indeed in. It is likely that we will see a pause to the current uptrend, but this is in fact healthy for a rally.
As we have noted in previous updates, several short periods of sideways movement are frequently seen within many long, sustained rallies. It appears that investors may simply take a breather from buying at times and when an immediate downturn is not seen, the money again begins to flow into the market. This further contributes to the strength of the following rally.
The multi-year resistance level will soon be tested. On two occasions in 2009, this particular resistance line stopped rather sharp declines. If the euro does indeed break through this level of resistance and move above the 130 level, this will be quite bullish and provide a very positive outlook for the euro in the weeks ahead.
Analysis of historical data and other current signs indicate a probability that the rally will not be strong enough to be sustained unless we seen some kind of consolidation. An additional factor is the Fibonacci retracement level (based on the massive 2000-8 rally), which is quite close to today's Euro Index level. This will likely provide resistance to the uptrend. Let's take a look at the short-term chart for more details.
Our short-term Euro Index chart shows a possible breakout above the declining resistance trend line. Remember that several consecutive days of closing above such a level is needed before it is confirmed (in most cases it is appropriate to use the 3 consecutive closing prices). Since this is not presently the case, we cannot at this time state that consolidation is not likely.
The possibility of a 1-2 week consolidation period is still very much a possibility. The market moves in the next few days will likely provide the clues we are presently lacking.
Another possibility is for the Euro Index to first move up to the Fibonacci retracement level and then to consolidate. This would result in a local top which is consistent with the present RSI level. On Thursday, the 70 level was surpassed, indicating an overbought situation. This further supports a short-term bearish sentiment for the euro, which is likely to come to effect in several days.
This week's long-term USD Index chart shows movement in the opposite direction of the Euro Index as expected. There has been a breakdown below the rising trend channel and this is likely the beginning of a serious decline. The breakdown has been confirmed by several closings below the previous trading channel.
It is quite likely that the USD Index will move lower although perhaps not right away. Actually it may take several weeks or even months before reaching a bottom. On the other hand, a short-term correction may be seen very soon. Note that the RSI is very close to the 30 level. This indicates an oversold situation and in the past has coincided with local bottoms after periods of strong decline. For this reason, we must note that a slight rally may be seen before downturn resumes.
Gold, silver and mining stocks have shown some slight, positive reaction to the weakness seen in the USD Index recently. This has not been of any great significance, however, and we do not feel any bearish sentiment at this time. Even a slight decline will not be seen as directly related to movement in the USD Index, as precious metals moved both up and down during current dollar's slide.
Last week the short-term USD Index chart was thought to be indicating an imminent turning point in the following days/weeks. This week we can see that the bottom might be already in, or at least very close to being in, as the next cyclical turning point is due in just a few days. This is supported by the RSI level, currently slightly below 30. Yet another cyclical turning point looms in the days ahead. A temporary rise perhaps to the 84-85 target level may be seen before closest resistance will be met and a local top probably formed.
Several resistance lines are in play here. The rising support line formed by the January and April bottoms provides one resistance level and the upper border of the declining trading channel is also in play. Finally, the previous local high in the 84-85 range is yet another factor into our expectation that the next local top may be formed in that particular area (marked on the above chart with the blue ellipse.)
Summing up, in the near-term it is likely that the Euro Index will decline slightly and the USD Index move upwards a bit. A rally to the 84-85 level is possible before the underlying weakness in the USD results in further declines. This may take more than just a few days and the corresponding reaction in the precious metals sectors will be very interesting indeed. Our focus will remain on the gold, silver, and mining stocks as the currency markets waver and eventually move consistently.
General Stock Market
This week's long-term chart for the general stock market is even more bullish than we have seen in recent weeks. The rally, which began last week, has continued and the bearish head-and-shoulders formation turned out to be a fake and did not further materialize. Although we cannot put it completely behind us yet, its failure has been a positive factor on the outlook for stocks.
There is a slight possibility that another shoulder may be developing - at times we get to see a head-and-shoulders formation with more than one shoulder on one or both sides. The volume levels however, do not support this premise as they have been not been low and one of the signs of the bearish head-and-shoulders pattern is low volume during an upswing. It is therefore more likely that this is indeed a true rally and is likely to continue.
On this week's short-term SPY ETF chart, we have seen some sideways movement in the past few days. This is not cause for concern at this time; we remain bullish for the short-term.
To support our previous statement, there is what could be called a triple resistance level. The declining resistance line, the 200-day moving average, and the 50-day moving average are all likely to provide resistance and/or support in the near-term, meaning that it will not surprise us to see some bullishness. Moreover, there has been a slightly bullish confirmation from volume levels recently. Upward movement has had higher volume than recent declines. This is itself a bullish sign. However, the strength of this signal is limited given the size of these daily moves.
Additional confirmation comes from another proxy for the general stock market - the DIA ETF (also known as Diamonds)
No matter which declining resistance line you take into account (based on daily highs or on the daily closing prices), it has been broken.
Summing up, indications are that stocks may move higher in the weeks ahead once consolidation has been completed. This will be a continuation of recent short-term trend.
With regards to precious metals, their lack of reaction to the general stock market has been disappointing. Gold, silver and mining stocks have moved up and down during the past month but overall have generally followed stocks. Recently they declined when stocks declined; however, the reverse trend did not take shape as in the general stock market. Perhaps further declines will be seen before the next big rally can begin for precious metals.
New developments constantly occur, which affect numerous markets. We will continue to watch the precious metals sector for the impact of currency and stock markets worldwide and always keep our Subscribers informed on all important events.
Correlations
In this week's correlation matrix we see little of importance in the 30-day column. This is consistent with recent surprises in market relationships. It seems that whereas, in the past, some markets moved together and some in opposite directions, recently we have seen this fail to materialize. As mentioned above, gold, silver, and mining stocks were positively correlated with the general stock market, but this phenomenon has weakened in the recent days. The lack of a rally in the precious metals sector is far from bullish given that the general stock market has been trending upwards of late.
Before moving on to the gold section, we would like to provide you with additional information about the correlation matrix. Namely, we would like to emphasize that the relationship that it describes is not a mathematical equation that allows us to calculate one price based on a different price. These numbers tell you, which markets were moving on average in the same direction and therefore provide a slight indication that this tendency may hold be true also in the following days/weeks. Generally, the longer time frame you take to make calculations on (different columns above), the more long-term relationship will you catch.
Consequently, the short-term (30 trading days) column that we usually analyze does not provide one with the ability to calculate the exact price levels. There are statistical tools that do and they have been included in our Leverage Calculators (basing the value of a particular gold/silver stock on the price of the underlying metal). The correlation coefficient on the other hand let's you know, which markets could influence the value of gold, silver, and mining stocks in the next few days/weeks/months (depending on the column that you take into account) and how likely that is.
Gold
This week we have much to tell about gold. Our coverage will be somewhat expanded as there are multiple targets possible and a number of consistent factors which we will discuss. Also, Subscribers have requested that we discuss some downside targets to assist them in their decisions to hold or sell. We are able to do this by utilizing current tools in a slightly different manner.
Last week we discussed silver possible moving to the $30 level by the end of 2011. It is possible that gold too will reach a new high near the end of next year (marked with the red ellipse on the above chart.) Our focus today is, of course, where is gold likely to go this year and this month.
Getting to the very long-term chart above, there is a clear pattern each summer with exception of the 2008-09 period which saw a huge decline. The consolidation bottom point each previous summer was right at the 50-week moving average. This was a nearly foolproof way of determining how low gold would go. This year we are not even close to that level as summer begins.
There appears to be strong indications towards a possible $1,100 level for spot gold. This target is confirmed by the Fibonacci retracement level, which would create a target bottom based on the 2009 high. We therefore have double confirmation on this chart and wish to keep this in mind as we analyze additional charts.
The long-term chart shows declining volume during an upswing which indicates that this move is a correction and not the beginning of a strong move upward. Frequently, when gold is declining after a substantial rally, it often formed a mid-decline contra-trend rally. The question is how high will the rally go?
Using the Fibonacci retracement level, gold corrected approximately between 50% to 61.8% of the previous declines. Extrapolating to today, it seems likely that gold will move higher before the next decline begins. The likely target for the GLD SPDR is between $119 and $121.
Additionally, please note that the 150-day moving average (red slope on the above chart) used to provide support several times in the past months. This is particularly visible on the following short-term chart.
The declining volume is also more evident on this week's short-term GLD chart. The 150-day moving average has previously predicted local bottoms. This held true for the February and March bottoms this year, and it could easily be the case that it will provide strong support also this time (note the upper red ellipse on the above chart.) The target here is about $113 for the GLD ETF.
Please keep in mind that the very first gold chart featured in this update included the 50-week moving average - representing approximately 250 trading days. On the above chart it's marked with the dashed black slope slowly moving upward to the $110 level (marked with the lower red ellipse on the above chart), which is another target for the decline.
Note: This is not the spot gold price but can be used to
forecast where gold's actual price will go.
A number of additional tools can be utilized here as well. One is the 50% and 61.8% retracement levels from the February-June rally. Since the rally was substantial these retracement levels are important. The 1.618 (Phi) factor applied to the previous downswing and analyses of the declining trading channel are also of value in this exercise. Moreover, while it is not visible on the above chart because it would make it rather unreadable, if we doubled the amount of what gold already declined in late June / early July, we would get the lower target area of about $110.
Note: Trading channels are developed for current trends by applying
the same angle to the angle of decline seen from a previous important (Dec 2009) top.
The abovementioned trading channel (marked with declining blue dashed lines) provides us with both top and bottom confirmation.
As far as the former is concerned, double resistance level is indicated just below the $120 level and this may in fact correspond to the next local top. Once the top is formed, a relatively big decline is likely to materialize. This decline may drop to the level of $113 or possibly $110 as indicated in the chart. In summary, this will cause the price of gold to drop about $100. At this point these targets are not precise (more data needed such as the price, at which gold tops), but they do provide you with the most likely size of the next move in the yellow metal.
It's a tough call at this time to predict the ultimate bottom and consequently whether a sell-off is warranted. We will advise our Subscribers immediately when we feel the top is in to allow bets on lower prices, perhaps by buying put options with a small amount of one's capital.
From a non-USD perspective, we also see gold in the middle of a decline. A likely target for the gold:UDN ratio appears to be between 42 and 44. This target is determined by a rising support line and the previous important top.
Historically, there has been a clear tendency for gold priced in currencies other than the USD to go back to previous highs and test it for some time before the next rally materialized. A decline to 42-44 and then a move higher would be consistent with this trend.
We realize that the value for the ratio itself may be difficult to apply, so the more Reader-friendly form of this analysis is that from the non-USD perspective, gold appears to be right in the middle of the decline.
On a general note, the non-USD gold price (for instance gold priced in euros) will move even higher than gold in USD if the trends for gold and the USD Index are bullish. Conversely, if the trends are bearish, the decline in non-USD will be even greater than gold in USD. Finally, if gold and the USD Index have opposite trends, that is one is bullish and one is bearish, the move in the price of gold from a non-USD perspective will likely be smaller than that visible on the "regular" USD gold charts.
Summing up, gold may continue to trade sideways for the next few days; however, a substantial decline is likely to follow. The final call is always up to you, but at this time we do not suggest selling long-term investment for this decline. In the previous Premium Updates we have mentioned that we need to watch out for a severe decline, but this was associated with the risk of a severe plunge on the general stock market. As mentioned above that risk is much lower now. Still, it is likely a good idea to prepare for using speculative capital to bet on lower precious metals prices in the next weeks. This is not a sell signal yet.
Silver
The long-term chart for silver indicates that a decline is likely coming rather soon. The target level for this decline is about $16 in the SLV ETF. This target is based upon the declining trend channel, the rising multi-month support line, and the level of previous bottoms which are often a psychological influence.
Generally, we expect silver to trade in tune with gold, so points made in the gold section above are largely important for silver as well.
Silver's short-term chart reveals an upside potential likely to be near $18.50 for the SLV ETF. This is based upon the previous two local tops and the corresponding declining resistance line. The downswing projected in the previous section would then take silver down to the lower target level previously discussed - around the $16 level. For spot silver, the above targets are: $18.80 and $16.30
Summing up, it seems likely that silver will see lower prices soon. It must be noted that technical analysis for silver is notoriously less precise than it is for gold and mining stocks. For those who wish to trade in the precious metals markets today, gold and mining stocks would likely provide trading signals more clearly than would silver. So, if you're willing to take positions in the white metal, please keep gold and mining stocks targets in mind as well.
Precious Metals Stocks
The HUI Gold Bugs Index chart above gives us some insight to assist Subscribers, who are inclined to trade in precious metals stocks presently. The trend still appears to be up, but please note that after a similar trend broke in the past a sizable decline followed. In this case it may mean that we can expect a sizable decline to materialize soon. Let's take a look at the short term GDX ETF chart for details.
The previously featured gold chart shows that the December top was followed by a big decline, though the second part of the decline was in fact smaller. The opposite appears true for mining stocks (as visible on the above GDX chart.)
Today's situation seems quite similar to December's. Both timeframes saw major tops and strong support levels tested several times. The December support level was broken on the second attempt. This could happen again as the 50-day moving average is close to today's price level. Perhaps it has already happened (given Friday's intra-day action), but it's too early to make such conclusions.
If this is to repeat, the RSI and GDX ETF behavior have been quite similar of late. Also, Fibonacci retracement levels can be used twice to analyze the same move. The 61.8% retracement would bring us to around $52.5, close to the upper border of the trading channel. This could form if the slope of the declining trend line repeats itself here as in December.
The downside target is in the $45 - $46 area, as marked with the red ellipse on the above chart.
Summing up, even if the precious metals companies are to report huge gains, charts suggest that this information may already be "in the price" meaning that very positive earnings won't move the price while only the slightly positive one's could decrease it. It's just a matter of market's expectations. This is something that the charts could help us estimate and at this point charts suggest a move lower relatively soon, but not very likely right away.
Summary
The trend for the USD is bearish although a short-term correction is likely. The Euro Index will likely see a pause to its recent upswing, a rally, which we expect to then continue. The general stock market appears to have a bullish period ahead. A short consolidation phase may be seen in the next few days before any additional upward movement. This does not change our bullish sentiment for the short-term.
Precious metals have been trading independently of the currency exchange markets and the signs suggest a slight correction upwards to be followed by a period of decline (especially given gold's, silver's and mining stocks' weak reaction toward strength on the general stock market.) It does not appear at this time that the downswing will be a major plunge that could take gold to $700 or so. Likely approximate downside targets are:
- Spot Gold - $1,100 - $1,120 and $1,150
- GLD ETF - $110 - $111 and $113
- Spot Silver - $16.30
- SLV ETF - $16
- GDX ETF - $45 - $46
It may be a good idea for Subscribers to prepare for lower prices but to wait for additional information to become available. As is always the case, Market Alerts will be issued to our Subscribers when warranted.
In other words, we will let you know, if we believe that it is profitable to bet on lower prices of precious metals / mining stocks, or if the situation changes significantly in any other way before the next Premium Update is posted.
This completes this week's report.
Thank you for using the Premium Service. Have a great weekend and profitable week!
Sincerely,
Przemyslaw Radomski
