Perhaps you may have heard mentions recently of the Austrian School of Economics versus the Keynesian branch. Maybe you saw televised interviews with Congressman Ron Paul (R-Texas.) He is the Congressman who has been trying for decades to pass a bill that would give Congress the power to audit the Federal Reserve Bank. What was once a ridiculed, marginal proposal recently passed the House and will soon be considered by the Senate.

Congressman Paul blames the country's economic woes on a long-dead economist by the name of John Maynard Keynes, whose present-day adherents, he says, are the ones bringing the country's economy to the cliff's edge.

Keynesian economics gained dominance after World War II and it was President Richard Nixon who proclaimed in 1971: We are all Keynesians now. It was about the same time that Nixon "temporarily" severed the link between the dollar and gold, thus laying the framework for the currency's debasement. Congressman Paul is an adherent of the Austrian school of Economics.

Peter Schiff, president of Euro Pacific Capital, is another follower of the Austrian School of Economics.

But there is something else that Paul and Schiff have in common, other than their economic philosophy. Both foretold the housing bubble and the near collapse of our financial system several years before they happened.

Here is what Paul told the House Financial Services Committee in September, 2003, almost five years to the day before the collapse of Lehman Brothers:

The special privileges granted to Fannie and Freddie have distorted the housing market by allowing them to attract capital that they could not attract under pure market conditions. Like all artificial bubbles, the boom in housing prices cannot last forever. When housing prices fall, homeowners will experience difficulties as their equity is wiped out. Furthermore, the holders of mortgage debt will also have a loss. These losses will be greater than they would have otherwise been had government policy not actively encouraged over investment in housing.

Almost no one on the committee, or anywhere for that matter, listened to Paul's warnings. Instead, Paul was mocked and accused of insensitivity towards the poor.

Here is what Peter Schiff had to say in an August 2006 television interview: "The United States economy is like the Titanic and I am here with the lifeboat trying to get people to leave the ship... I see a real financial crisis coming for the United States."

Six months later in a televised debate, Schiff forecast that "what's going to happen in 2007" is that "real estate prices are going to come crashing back down to Earth". As Schiff was sounding the alarm, mainstream pundits were laughing in his face on national TV.

A famous YouTube video with almost 1.5 million views titled, Peter Schiff Was Right, catapulted him into the spotlight and finally vindicated him after years of marginalization and ridicule.

So what is this Austrian School of Economics and why is it being mentioned now? How is it different from the Keynesian school of economics?

The Austrian School is an outgrowth of classical liberalism. Its main proponents were Ludwig von Mises, Nobel Prize winner Friedrich von Hayek and Murray N. Rothbard.

Austrian free-market economists use common sense principles like the idea that you can't spend your way out of a recession. They view entrepreneurship as the driving force in economic development and see private property as essential to the efficient use of resources. They see government interference as counter-productive - you can't regulate the economy and expect it to grow. If you tax people and businesses to death don't expect them to keep producing. You cannot create an abundance of paper money out of thin air without making it worthless. The government cannot cure unemployment by just hiring people or keeping them on the dole forever. The bottom line is that you cannot indefinitely live beyond your means—the economy must actually produce something others are willing to buy.

The Keynesians, on the other hand, advocate a mixed economy predominantly private sector, but with a large government role. According to them, private sector decisions can lead to inefficient outcomes and therefore they advocate active government involvement, including monetary policy actions by the central bank.

Governments should solve problems in the short run rather than wait for market forces to do it in the long run, because "in the long run, we are all dead."

The global financial crisis made Keynesian economics even more popular and provided the theoretical framework for the rescue plans of President Obama, British Prime Minister Gordon Brown and other global leaders.

The Austrian school advocates the opposite. The bust - as painful as it is, should be left to run its course. Society must swallow the medicine, bitter as it is. Any attempt on the part of government to forestall, will only make the inevitable day of reckoning all the more painful. |Here is what Paul wrote a few months ago in a Forbes Magazine column:

Anytime the central bank intervenes to pump trillions of dollars into the financial system, a bubble is created that must eventually deflate… Rather than allow the market to correct itself and clear away the worst excesses of the boom period, the Federal Reserve and the U.S. Treasury colluded to put taxpayers on the hook for trillions of dollars. Those banks and financial institutions that took on the largest risks and performed worst were rewarded with billions in taxpayer dollars.

The party is over, said Schiff about U.S. consumption in a recent television interview. Schiff says the U.S. must transition from borrowing and spending, to saving and producing. The government's efforts to "ease the pain" with economic stimulus packages and bailouts will only make things worse in the long run and could result in hyperinflation if the government continues to "replace legitimate savings with a printing press."

Generally, we agree that the free market is the most efficient mechanism, when applied to the vast majority of economic issues, but let's not forget that there are several mechanisms, where it does not work perfectly - for instance in the case of the tragedy of commons phenomenon. The above does not change the big picture and our libertarian views, but we simply don't like providing you with just one side of a coin.

Going back to the previous analysis - what does Schiff say about gold?

He is among those who believe it will go up to $5,000 even before Barak Obama leaves the White House. If he's been right about so many things during the past few years as far as the fundamental picture is concerned, maybe he's also right about the yellow metal.

Moving on to the technical part of this week's Premium Update, we would like to use yesterday's Market Alert, as a starting point and make additional comments for each of the points that it included.

Precious Metals have been moving lower and many of the previously mentioned signals were flashed / target areas have been reached. Therefore, given the recent volatility, it seems that you will find this Market Alert valuable, even though it is not a "clear buy signal."

I've decided to send out this alert because silver, HUI Index, GDX ETF are currently either in the target area for this downswing or trade very close to it. Please note the following facts:

Precious Metals Stocks

(the HUI Index has just touched its 200-day moving average)

Much of what we wrote in the previous Premium Update regarding the long-term HUI chart (charts courtesy of http://stockcharts.com) is still relevant. We wrote the following:

Please take a look at the thin blue lines coming from the same price/time combination. Each of them was pierced, before the final bottom was put in, and this is what I expect to take place this time.

(...) taking the historical performance of the gold stock sector into account, it seems that PMs will need to move a little lower before putting in a bottom.

The long-term support line has just been broken, which suggests two things:

• The next bottom will be reached relatively soon (days/weeks),
• The rally following the decline will take precious metals stocks much higher.

The bottom is likely to be accompanied by the RSI Indicator just above the 30 level.

This is exactly what we have seen today - the RSI is very close to the 30 level (blue horizontal line on the above chart), and HUI has broken below the rising support line just like it was the case in the past before the bottom was formed.

Consequently, the HUI Index appears oversold, and it is likely that the bottom will be formed soon. Still, it does not mean that the bottom is in, as prices may go from oversold to even more oversold in the short run.

Two of the following points that we made yesterday were that the GDX ETF has just touched its 200-day moving average and that the GDX ETF has move VERY close to the lower border of the declining trend channel and the price that stopped the decline in early October 2009. Let's take a look at the short-term chart for details.

The short-term chart confirms that the GDX ETF is currently very close to the bottoming area (that we've drawn 2 weeks ago), which means that one should get ready to buy as far as the speculative capital is concerned.

Volume does not provide us with a clear "the bottom is in" signal. During the last two days the volume has been lower than in the previous three days, but it is not extremely low to suggest that there is hardly any selling pressure on the market.

Silver

(the SLV ETF is currently in the $15.5 - $16.5 target area, and it is in the "bottoming territory" according to the cyclical tendencies present on this market)

Silver moved below the rising support level, to the $15.5 - $16.5 area, and the Stochastic indicator moved below the 20 level. The latter often meant that a bottom is in or is about to emerge.

The short-term chart reveals that silver is very close to a strong support level - we've marked it on the above chart with a blue horizontal line. Please note that the RSI indicator is also right at the blue horizontal line, which in the past meant that we are at a particularly favorable buying opportunity.

One of the messages that I've received yesterday (I regret that I'm not able to reply directly, but I'm thankful for each of them) included a question about the volume in the SLV ETF.

In the last 5 trading days there have been 4 down days accompanied with very heavy volume. The only up day show approximately half the volume of the down days. During that 5-day period the price dropped about 2.00. Could you address this activity and what I perceive as weakness, in the upcoming weekly update?

Please take a look at the above chart - we've marked the situation in volume with blue and red arrows. The volume clearly confirms the direction, in which the price is going - down. This is one of the things that makes us say that this is not yet a "crystal clear buying point". Naturally, there is no such thing as a perfect entry point, but based on the risk/reward ratio it seems that speculators may want to wait for additional signals - we will describe them in the following part of the update. For now, the most probable target for this decline for the SLV ETF is around the $15.8 level.

Gold

The similarity between this and previous declines suggests that gold may need to move a little lower before turning up again. Please note that in the past the second part of the downswing took gold below the previous low - and this was not the case this time, at least so far.

Therefore, we can't rule out a decline to the long-term support at $100 in the GLD ETF. However, we currently don't see it move much below this level, and we certainly don't see gold moving 40% lower or so.

I've received a several requests to comment on Mr. Robert Prechter's recent appearance on CNBC, so here we are. One of the things that Mr. Prechter says is that the general stock market is likely to plunge from here - which is in tune with what we've written previously.

The next thing that Mr. Prechter says is that once the general stock market moves lower there will be a flight to safety in the form of the U.S. Dollar, as it was the case in 2008. We respect views and work of all our colleagues, but we currently don't agree with the above point.

Our view is that at some point investors will stop perceiving USD as a safe haven, because of the massive creation of paper money. After all, why would anyone choose to hold an asset that is slowly going down and it happens according to the current economic policy - instead of owning gold, which not only was used to preserve wealth throughout history, but has been in a strong uptrend for years? We realize that gold doesn't pay any interest, but why would anyone bother with interest if interest rates don't keep up with inflation?

Mr. Prechter also provides his thoughts on the inflation/deflation debate, but we don't want to go into this issue here (we have covered it briefly in the past), as it is simply too big to cover in this update, given many other (urgent) things that we would like to write about.

For instance, Mr. Prechter says that in 2008 PMs plunged along with the general stock market, so it is likely to happen again. This might be the case, but we strongly believe that a one-time event is not sufficient to make any conclusive future calls.

If you take a coin (without examining it) and toss it (betting on tails) two times and get heads each time, you may think it's a bad luck. But, if that happens 20 times in a row, then you start expecting that there's something wrong with the coin. After examining it, you see that it has heads on both sides. Now, the point is - we're you able to prove (or even make a rational accusation) that the bet is not honest based on just a few tosses? No, it could have been an accident. How about just one of them? Definitely no.

In the January 8th Premium Update we wrote the following, and it perfectly fits into this week's issue as well:

Yes, the precious metals stocks (and underlying metals) plunged along with main stock indices in 2008, but there were also many times when PM stocks moved higher along with lower values of the main stock indices, for instance February and September 2001. So, the question arises - how do we know what the outcome will be this time.

Naturally, there are no sure bets in the markets, but if the objective/unemotional analysis is the key to estimating what is probable and what is not, then it seems that using mathematical/statistical calculations is one of the best approaches - after all, very few things are less emotional than a math equation.

Therefore, we view the fact that PMs moved lower with the general stock market in 2008 as insufficient to state that this will happen also this time, because it is not a tendency - it's a single event. Please note that the reverse is not certainty either.

Let's turn to the short-term gold chart for more short-term details.

Speaking of signals that appear relevant, but after taking a closer look they are not that important, gold (the GLD ETF) has just moved higher on a low volume, which normally suggests that the move up was a fake one and lower prices are to be expected. However, taking the very recent history into account suggests that the strength of this signal is rather low. Please note that the December bottom was accompanied by a day when price of gold rose on a tiny volume. The same can be said about the bottom in early July, and in late September.

Consequently, the bottom may be in, but that is not very likely, especially since the USD Index has not reached the 80 level yet.

USD Index

(USD Index touched its 200-day moving average)

There are no changes in the long-term picture, except that the U.S. Dollar touched its 200-day moving average, which is one of the classic support/resistance levels. It does not have a recent history of stopping a decline or rally, so it does not need to mark a turning point this time.

The short-term chart shows that while the 200-day moving average has been hit, we are still ahead of the next turning point according to the cyclical tendencies (red vertical lines.) Consequently, the short-term trend remains up.

The next thing that we mentioned in the last Market Alert was the GDX:SPY ratio.

Precious Metals Stocks Outperformance Relative to Other Stocks

(The GDX:SPY ratio (used to measure outperformance of PM stocks relative to other stocks) has reached a strong support level)

Tops and bottoms in the above ratio tend to correspond to tops and bottoms in the PM sector, so analyzing it often confirms (or invalidates) points made while analyzing other charts. This time the ratio has just hit a long-term support level, which suggests that the bottom in PMs is very close, or that we have just seen it. Please note that not only did the ratio itself reach a support level, but the RSI indicator is also flashing a "buy" signal.

In yesterday's Market Alert, we also wrote the following:

The above factors suggest that the bottom is very close or has been reached today. However, on the other hand, the USD Index did not reach its target for this rally (80 level), and one should not ignore the fact that the general stock market appears to be ready to plunge. Although the correlation between the general stock market and the precious metals market is NOT very high (we have numbers in the Correlation Matrix from our Tools section to prove it), we would like to see additional confirmations of the above mentioned tendency before clearly stating that there's nothing to worry about as far as the plunge in the general stock market is concerned.

General Stock Market

The SPY ETF has been moving lower without a bigger correction after touching several resistance levels just above $115, and the volume has been visibly higher during this downswing. This means that the odds of this being the beginning of a serious move lower have increased.

The short-term chart confirms points raised above. The volume has been very high during the decline, and the current small pause is characterized by small volume, which is partly why it seems that what we see right now is just a pause, not a bottom. Another reason is that the current decline is likely to at least correct the whole March 2009 - January 2010 upswing, and two days of lower prices don't seem to be even close to being sufficient in size.

We've mentioned the correlation between the general stock market and the precious metals sector many times in this update, so it should be very useful to provide you with appropriate numbers.

Correlations

In the latest Market Alert we mentioned that the correlation between the general stock market and the precious metals market is NOT very high (we have numbers in the Correlation Matrix from our Tools section to prove it), we would like to see additional confirmations of the abovementioned tendency before clearly stating that there's nothing to worry about as far as the plunge in the general stock market is concerned.

Based on the most recent data, the values of the correlation coefficients have increased for S&P / gold, silver and the HUI Index. This means that the odds of a simultaneous decline in PMs and the general stock market are higher than they were just a few days ago. The value of correlation coefficient between gold and S&P has been moderate in the 30-day period (0.57), so it currently doesn't provide us with any decisive details.

Consequently, we have to wait for additional signals of confirmation for either of the two scenarios (general stock market plunges along with PMs or without them).

In the latest Market Alert we wrote that it currently seems that the next several days will provide us with critical details, and possibly a confirmation of the above comments (or they will be invalidated.) I will comment on the situation more thoroughly (and I'll explain what type of signals will confirm that the bottom is in) in the next Premium Update (scheduled for tomorrow).

The first thing to monitor is the way PMs react to changes in the value of the main stock indices - especially gold, because silver and PM stocks are historically more correlated with the general stock market (silver's industrial uses etc.), so high correlation here is not much of a divergence. If PMs trade very much in tune with the general stock market during both upswings and downswings and we don't have identical moves in the USD Index (as we will see in the main stock indices - but in the opposite direction), then PMs may be in trouble.

If, on the other hand, PMs stop declining or even rise modestly along with falling main stock indices, it will mean that even more declines should not cause serious damage to the PM market.

Additionally, if we see the USD Index move higher and PMs refuse to move lower, it will give us a "probably the bottom is in" signal.

The abovementioned phenomena should be visible for at least several days before we can make decisive calls.

Unfortunately, if the USD Index and the main stock indices trade in tune (but in the opposite directions) - meaning that they will be highly correlated, then the abovementioned technique won't work. Should this be the case, and suddenly this correlation (between USD and the general stock market) disappears, then the market which PMs will follow in the next several days following this "disconnection" is likely to be the market leading the metals in the coming weeks.

Before summarizing, we would like to provide you with the description of one more of the points made in the recent Market Alert. We wrote that our unique indicators (available in the Premium Charts section) have flashed buy/extreme signal.

Sunshine Profits Unique Indicators

The SP Short Term Gold Stock Bottom Indicator has turned while being under the dashed line, which is when it flashes a buy signal. Please note that in the past several months this signal has been very reliable.

Another two signals were flashed by our Top indicators, which signal extremes - historically, most of them were tops, but this changed recently and they are now more likely to signal bottoms as well.

Both indicators moved below the dashed line, meaning that the top/bottom is likely in or very close to be in. Given the fact that PMs have been declining since December 2009 it is likely to mark a bottom. Please note that these signals were also highly accurate in the previous months.

Summary

If it wasn't for the USD Index, and the general stock market, we would recommend going long right away. However, given the current level of globalization in the economy and financial markets, one must keep in mind that no market moves alone - they are connected in this or the other way. From time to time realizing this fact makes us get additional confirmations from markets that one would normally ignore. This time, however, we get a "caution warranted" signal, and we don't think that one should totally ignore it. We'll keep you updated - once we get more clues we will either write about it in the next Premium Update or send out a Market Alert (if it takes place before the next update is posted.)

This completes this week's Premium Update.

Thank you for using the Premium Service. Have a great and profitable week!

Sincerely,
Przemyslaw Radomski