Spreading the Risk

By Scott Silva

Editor,  The Gold Speculator

12-12-11

The sovereign debt crisis in Europe has caused leaders there to adopt a new collective policy that would link members under a strict fiscal structure which may be called the European Fiscal Union. Like the European Monetary Union, which established the Euro as the common currency, the EFU would establish common liability for member state fiscal conditions. Under the terms of a new EU treaty, each member state would be required to meet debt/GDP ratio limits and other financial stress tests in order to access bailout funds provided by a larger European Financial Stability Fund. Using leverage, the EFSF could grow to 1 Trillion Euro. The IMF and the ECB are additional sources of bailout capital, although the ECB has been hesitant to lend to failing countries without other collateral or backing.

As of Friday, 27 nations pledged to join the new treaty arrangement. The United Kingdom has declined to participate in the wider fiscal union.

Initially, the developments across the pond were good news for the markets. The Dow rallied nearly 200 points Friday, and the Euro gained against the Dollar. Gold and silver benefited as well Friday, but are giving up gains as the markets slump in early trading today.

But the devil is in the details. All 17 nations that use the Euro agreed to sign a treaty that allows a central European authority closer oversight of their budgets. Nine other EU nations are considering it. A new treaty could take three months to negotiate and may require referendums in countries such as Ireland. While the nine non-euro-zone countries said they would join the new fiscal union, there were quickly notes of caution from some corners, including the Czech Republic and Hungary.

Meanwhile the debt bombs in Italy and Spain are ticking. Active ECB support will be vital in the coming days with markets doubting the strength of Europe's financial firewalls to protect vulnerable economies such as Italy and Spain, which have to roll over hundreds of billions of Euros in debt next year. European leaders did agree to loan the International Monetary Fund €200 billion ($267.7 billion) to help struggling euro-zone countries and launch a €500 billion European Stability Mechanism by July 2012. The ECB has yet to commit more than 20 billion Euros to failing clients at any one time, and is reluctant to risk the much larger transactions required to stabilize debt-heavy governments.  One reason is that ECB funding may be a disincentive for countries to follow through with austerity measures. Free money is easy to spend, and given the chance, governments usually do.

Without access to new funding under tight fiscal controls, Europe may slip once again into a deep recession, which would hurt US economic growth as well. The stakes are high for Europe to get it right quickly.

 So we can expect the markets to remain highly volatile as events unfold in Europe. Today’s market action, for example shows gold and the Euro are under pressure.  The price of gold is telling us the grand EU fiscal cannon is too small to succeed.  Investors are choosing to sell their risk holdings in favor of cash. Some investors are turning to gold as a source of capital, in some cases to meet margin calls. Gold has been the only asset class that has performed with double digit gains this year while stocks and other commodities have barely kept above water. 

And it’s not just investors that are skeptical. Standard & Poor's reiterated its warning that downgrades of Eurozone nations are a possibility while Moody's Investors Service said the new fiscal agreement offered "few new measures" and it still expects to reassess its credit ratings of the European sovereigns.

Europe is not the only economy facing a debt crisis and possibly another recession. We need only to observe our own policymakers to see what lies ahead.

Federal Reserve Policy

The Federal Reserve meets Tuesday for its regular two-day Federal Open Market Committee (FOMC) meeting. That means Wednesday we will hear from Chairman Ben on the latest status and outlook of the US economy. There has been some talk that the Fed is considering reviving the practice of publicizing its internal projections of interest rate and inflation forecasts in an effort to better “communicate” to the public. The Fed dropped this practice in 2007 because it was considered largely ineffective. And besides, it proved once again that, as Yogi observed, “Predictions are hard, especially about the future.”

Expectations are that the Fed will continue to keep interest rates at 0.0 -.25%, and despite some calls for additional stimulus, no new massive bond buying will be initiated—just yet. Chicago Fed president Charlie Evans is calling for more stimulus now. “There is simply too much at stake for us to be excessively complacent while the economy is in such dire shape,” Evans said in his December 5th speech in Muncie, Indiana. “It is imperative to undertake action now.”

Chairman Ben has come to realize that the US remains in a liquidity trap, that helpless condition wherein injecting additional cash into the money supply has no positive effect on GDP growth. Even Paul Krugman knows that interest rates simply cannot get lower than zero.

Notwithstanding, QE3 would go a long way to boost Wall Street. And we have heard some preparatory statements from some Fed governors on the merits of additional quantitative easing, as long as inflation remains “in check”.

Would that the Chairman realize that economic prosperity does not stem from monetary intervention.

We know now that Federal Reserve policy has failed. Massive intervention has resulted in higher prices, growing inflation and persistent unemployment near Great Depression levels. The Dollar buys less and less. Real wages are declining. Government data show over the past decade, real private-sector wage growth has bottomed at 4%, just below the 5% increase from 1929 to 1939.

Economic recovery requires real wage growth. More disposable income helps create demand for goods and services. Increased demand causes businesses to expand, which means more production and usually more employment.

But that simple calculus is lost on the central planners. Instead, Washington believes that government spending creates demand. But government spends the tax dollars it first takes out of the economy in order to distribute funds to “better uses”. Robbing Peter to pay Paul.

What we need is fundamental change. This will only come when the majority of citizens realize that Keynesian economics is not the path to prosperity and that the principles of free markets, private property and sound money should and by right, ought to be embraced.

Until then, one must rely on individual choice to guard against oppressive monetary policy. Sound money is the answer.

Investors from around the world benefit from timely market analysis on gold and silver and portfolio recommendations contained in The Gold Speculator investment newsletter, which is based on the principles of free markets, private property, sound money and Austrian School economics.

The question for you to consider is how are you going to protect yourself from the vagaries of the fiat money and economic uncertainty?  We publish The Gold Speculator to help people make better decisions about their money. Our Model Conservative Portfolio gained 66.7% in 2010, and 55% for 1Q2011. Subscribe at our web site www.thegoldspeculatorllc.com  with credit card or PayPal ($300/yr) or by sending your check for $290 ($10 cash discount) The Gold Speculator, 614 Nashua St. #142 Milford, NH 03055

What's Driving Gold

By Scott Silva

Editor,  The Gold Speculator

11-14-11

Eurozone Driving the Markets

There is no doubt that the European sovereign debt crisis is a major factor driving the global markets lately. The imminent Greek default and the loss of confidence that Italy can avoid contagion and its own severe debt crisis has toppled both governments and set the stronger Eurozone nations on a path to socialized bailouts and eventual monetization (printing trillions more Euros). These actions may forestall immediate catastrophe but also create other serious economic problems, such as inflation, recession or both (stagflation) across the Continent.

The Eurozone crisis pushed global equity markets up and down in triple digit waves,

as drama played out first in Greece with the resignation of Prime Minister George Papandreou, and then the ouster of Italy’s Silvio Berlusconi, who resigned over the weekend.

The bond market had forecast the Italian capitulation, as we identified in the last issue of The Gold Speculator. The bond vigilantes attacked the Italian 10-year note, driving its yield to over 7%, the signal used by many that the end had arrived. Portugal required bailout funds when its bond yield hit 7%, a full 4 points above the German Bund.

The new governments in Greece and Italy are expected to pass and implement severe austerity measures in return for debt relief from the new European Financial Stability Facility, the co-investment fund that is soliciting investors to establish a 1 Trillion Euro firewall to stem contagion in the Eurozone, the ECB and the IMF.

And there’s the rub. Greeks have already begun to riot to protest deep cuts to entitlement benefits. Italian citizens may also turn to the streets and shut down essential services in a general strike. Italy is now forced to cut programs that support much of the population at the same time that economic growth is stalling. It’s a classic death spiral. It is unclear that any amount of debt restructuring can fix the fundamental problem for the dying social welfare state.

US markets seem fixated on the travails of the Eurozone debt crisis. The fact is, US banks have relatively little direct exposure to Italian debt, with $47 billion in exposure, compared, for example, to France's $416.4 billion.  But larger U.S. banks may be carrying vastly more indirect risk from struggling European economies as a result of the credit default swaps, or CDS. U.S. banks are holding almost three times as much as their $181 billion in direct lending to the five countries at the end of June, according to the most recent data available from BIS. Adding CDS raises the total US bank risk to $767 billion, an amount reminiscent of the mortgage backed securities meltdown.

One outcome resulting from continued uncertainty in Eurozone is the flight to safety.

We can see this in the price of gold, which has moved up to challenge the $1800/oz level.

US Debt Policy and the Markets

Fear of Eurozone debt contagion is not the only factor driving the markets. There is also a major event looming for the US economy, namely the showdown of the Super Committee. With the deadline to craft the $1.5 Trillion debt reduction deal now nine days away, there seems to be little progress by the select lawmakers. In fact, the talks broke down when Democrats walked out this last week after ignoring the latest Republican proposal. The US budget battle is likely to reach center stage once again over the next ten days. An impasse will roil the markets once more.

The credit agencies may act before the Super Committee does. Many analysts believe a further downgrade of US sovereign debt is probable. Rather than taking the lead at this critical juncture, the president is taking a trip to Hawaii and Asia. It is becoming more apparent that the Administration would rather there is no deal; another example of the “do nothing opposition”.  There was a time in this country when our leaders put needs of the country before politics. Those were the days…

So fasten your seat belt. We’re in for a bumpy ride. The stock market will remain highly volatile with daily triple digit swings. The bond market offers no escape. Treasury prices are bid up as funds flow out of Europe and equities into “safe” US notes, despite negative real interest rates for the instruments, and bid down when investors flood back into higher yielding stocks. Each trade represents a loss of capital (as well as a tax event).

It’s no wonder that prudent investors are once again turning to gold as the true safe-haven trade.

Fed to the Rescue?

It is inevitable that the Federal Reserve will implement more Quantitative Easing in a last ditch attempt to jump start the ailing US economy. Chairman Ben as much as said so in remarks this week before a military audience in Texas when he pointed out the economy could “tolerate a little more inflation.”  He was referring to the ancient belief held by Keynesians that there is a trade-off between inflation and employment, as embodied in the Phillips Curve. The theory, which dates back to 1958, states higher employment comes at the expense of higher inflation. No one would argue that 9% unemployment today is trivial.  The true measure (U-6) is 16.2% as of October. To the contrary, the Fed chief called the US unemployment a “national crisis.”  Likewise, the Chairman characterized 2% inflation as “tame.” So, given the Fed’s mandate to support full employment, it could easily justify creating a bit more inflation by printing more money, as it did under QE1 and QE2. Using the calculus of the Phillips Curve, implementing QE3 at about $1 Trillion would bring unemployment down to 6% or so.

The problem with that logic is that QE1 and QE2 failed to create net new jobs over that last three years. The other problem is the Phillips Curve theory fails in general to account for the coincidence of high inflation and high unemployment, as occurred in the 1970s’ stagflation under Carter.

But facts have never dissuaded the Chairman from pursuing his preferred political policy. Besides, QE3 would be good for Wall Street.

Inflation and the Money Supply

We know from Nobel Laureate Milton Freidman that inflation always and everywhere a monetary phenomenon. We also know that commodity prices are a good proxy for inflation. That is higher commodity prices reflect higher inflation. So we can examine the Commodity Price Index in comparison to the money supply for correlation.

We see that after the meltdown of 2008, commodity prices have climbed higher propelled by QE1 beginning in 2009 and later in 2010 by QE2.  Commodity prices started to decline when the end of QE2 was announced earlier this year.

We also see that the Fed increased the Monetary Base dramatically, adding nearly $2 Trillion to the Fed balance sheet by purchasing bonds under QE1 and QE2. QE3 (and QE4 and QE5) will push inflation to record levels.

So how will the debt crises in Europe and the US affect the price of gold?  Gold will continue to climb in price as investors seek relative safety from volatile markets and a hedge against devaluation of fiat currencies such as the Euro and the Dollar through continued central bank intervention.

Investors from around the world benefit from timely market analysis on gold and silver and portfolio recommendations contained in The Gold Speculator investment newsletter, which is based on the principles of free markets, private property, sound money and Austrian School economics.

The question for you to consider is how are you going to protect yourself from the vagaries of the fiat money and economic uncertainty?  We publish The Gold Speculator to help people make better decisions about their money. Our Model Conservative Portfolio gained 66.7% in 2010, and 55% for 1Q2011. Subscribe at our web site www.thegoldspeculatorllc.com  with credit card or PayPal ($300/yr) or by sending your check for $290 ($10 cash discount) The Gold Speculator, 614 Nashua St. #142 Milford, NH 03055

Gold Stimulus

By Scott Silva

Editor,  The Gold Speculator

9-6-11

Gold is trading above $1900/oz once again, pushed up by continuing financial turmoil in the Eurozone, weak US economic data and strong words from a voting member of the FOMC who reiterated his conviction that the Fed should continue its large scale monetary stimulus policies. Chicago Federal Reserve Bank president Charles Evans told a CNBC interviewer that “We need to do much more to increase the level of accommodation.”  But Fed Chairman Bernanke did not announce a new policy at the annual Fed conference at Jackson Hole, Wyoming.  In fact, the Chairman’s speech was underwhelming. The Fed is out of bullets, and Chairman Ben knows it.

Certainly, the Fed has very powerful monetary tools at its disposal. The Fed can set interest rates that banks charge each other for short term transactions, which influences the shape of the yield curve. Lower interest costs usually spur investment. The Fed can also provide liquidity to the general economy by buying US Treasury bonds and other long term fixed assets (Quantitative Easing). The Fed and most Keynesian economists believe Quantitative Easing can stimulate the economy in the same way Federal spending adds to aggregate demand.  These monetarists believe that by adding Fed credit to member banks, more money becomes available to lend, demand deposits expand, along with economic activity. Since the financial meltdown of 2008, the Fed has maintained near-zero interest rates and added $2.3 Trillion in monetary stimulus credit. Despite these massive stimulus measures, 2^nd quarter US GDP growth has slowed to 1.0% (and 1^st quarter GDP has been revised down to 0.4%) while the unemployment remains above 9%.  Zero net new jobs were added in August.

John Maynard Keynes attributed the deterioration of economic conditions despite muscular monetary stimulus measures to the “liquidity trap.” According to Keynes, this is the condition in which real interest rates cannot be reduced by any action of the central bank. The real interest rate cannot be reduced beyond the point at which the nominal interest rate falls to zero, however much the money supply is increased. The trap occurs when central planners are unable to promote investment by cutting real interest rates, even when rates are near-zero. Paul Krugman, the Princeton economist, believes that 70% of the world’s economies are in a liquidity trap.

We have seen this play out in recent history; the Fed should study what occurred in Japan. In 1991, the Bank of Japan hiked rates suddenly, bursting the speculative real estate and stock market bubble created by nearly twenty years of easy money.  After asset values dropped by more than 60%, the Bank of Japan slashed rates to near-zero and implemented massive quantitative easing, setting up a classic liquidity trap. From 2001 to 2006 the Bank of Japan increased the monetary base by over 70 per cent. Japan’s economy ground to a halt and unemployment spiked. Stagflation took hold. The effects of the bubble's collapse lasted for more than a decade with stock prices bottoming in 2003. Japan’s “Lost Decade” is the direct result of central bank intervention and misguided monetary policy.

We know that increasing the money supply, in any interest rate environment, devalues currency in circulation. More money chasing the same assets drives prices up. Increased economic activity combined with declining real output can produce hyperinflation, as we have seen in extreme cases such as Weimar Germany, Argentina and Zimbabwe. Conversely, contractions in the money stock push prices (and wages) down. In the 1930’s the Fed reduced the money supply by 30% which deepened and extended the Great Depression.  

To combat the current recession, the Fed has adopted a near-zero interest rate stance and injected trillions into the economy by purchasing US Treasury bonds and other fixed income securities, while extended unprecedented levels of Fed credit to member banks. Rather than turn the economy around, these measures have weakened the US Dollar and pushed prices up at the producer and the consumer levels. The CRB index, a broad measure of commodity prices climbed over 45% since the Fed made its first trillion dollar credit injection, then jumped another 35% after the Fed added $600 Billion to the money supply through it second round of Quantitative Easing (QE2). Since QE2 took effect, the US Dollar has dropped nearly 16% in value.

 Low interest rates usually help stocks. But equities have become quite volatile as nervous traders quickly sell on any hint of bad economic news, and rush in to buy on any whiff of positive data, hoping to have finally found the bottom. As of today, the Dow is down 4.59% year-to-date and the S&P 500 is down 8.33% year-to-date. Treasury yields are at record lows, which are pushing fixed income investors out to the long end of the yield curve. After inflation and taxes, this asset class is underwater, too.

Increasingly, investors have turned to gold in the safe-haven trade. Gold has gained 38% year-to-date and 52% over the last 12 months. While the US Dollar has declined, some analysts believe gold could become a shadow currency against which all other currencies are evaluated as the world monetary base expands. Central banks around the world have become net buyers of gold bullion. J P Morgan Chase is now accepting gold as collateral for client accounts. And retail investors are pouring into gold as the means to diversify their holdings and hedge against economic uncertainty. It wasn’t long ago that $1000/oz gold was considered unthinkable. Today $2000/oz gold is within reach.

It is not likely that Washington will pivot abruptly away from its current economic azimuth. Wall Street is hoping for QE3, and it may get its wish. Gold and silver prices are telling us that the Fed will continue its near-zero interest regimen and will likely expand its bloated balance sheet in some novel and debilitating way, yet.

The simple truth is new government spending and more monetary expansion, even in the name of job creation, will not add permanent private sector jobs. More government spending only comes from higher taxes, more federal borrowing and the printing more paper money out of thin air. Every dollar of government spending comes out of the pockets of its citizens, which reduces economic activity. As we know from Proudhon, “Property is theft.” If higher taxes don’t ruin us all, inflation will.

So prudent investors must continue to act to defend their private property and protect their wealth. Investing in gold, the true sound money, is the way.

Investors from around the world benefit from timely market analysis on gold and silver and portfolio recommendations contained in The Gold Speculator investment newsletter, which is based on the principles of free markets, private property, sound money and Austrian School economics.

The question for you to consider is how are you going to protect yourself from the vagaries of the fiat money and economic uncertainty?  We publish The Gold Speculator to help people make better decisions about their money. Our Model Conservative Portfolio gained 66.7% in 2010, and 55% for 1Q2011. Subscribe at our web site www.thegoldspeculatorllc.com  with credit card or PayPal ($300/yr) or by sending your check for $290 ($10 cash discount) The Gold Speculator, 614 Nashua St. #142 Milford, NH 03055

Breakout in Precious Metals

By Scott Silva

Editor,  The Gold Speculator

8-22-11

Silver is breaking out for another run to new highs. The metal is moving higher along with gold in the safe-haven trade. The precious metals are likely to get another push up from US economic policy-makers.

Gold and silver are benefitting from the flight to safety trade driven in part by the continuing European debt crisis and high volatility in the equity markets. Higher inflation, the US credit downgrade and slowing economic growth are also impacting equities; money is flowing out of equities and into hard assets.

We can see this dynamic playing out in the price of gold, which is testing new highs at the $1900/oz level. Gold’s rise this month has accelerated on a parabolic trajectory, while the S&P 500 has sold-off steeply.

Money is also moving from stocks into US Treasurys, despite the US credit downgrade. Yields on the 10-year Treasury are at historic lows, dipping below 2% for the first time since the 2008

financial meltdown. But real rates for Treasurys have been negative at the published inflation rate. And the tax man takes his pound of flesh not matter what. So many investors choose gold and silver.

While gold has been move steadily compared to stocks this year, silver has been more volatile than gold. Silver declined a bit more than gold back in May, and has been trading in a range since. That is until it broke to the upside in the last two trading days. We cans see price action for COMEX silver has produced a bullish ascending triangle pattern over the last several weeks. Ascending triangle patterns are reliable bullish indicators. We saw an ascending triangle pattern in silver back in September 2010 when we called a buy at $20.78/oz and a target of $60/oz. 

We can see that the pattern formed on declining volume, and that volume ticked up on the Friday’s breakout. This volume behavior confirms the chart pattern. The point count for the ascending triangle pattern above creates a near-term price objective of 47 for COMEX silver. We would consider the breakout indicator to have failed if silver closes below 42 on any near-term pullback.

The longer term outlook for gold and silver is bullish as well. For gold, we can see rising money stocks as the major catalyst for further price gains. Another bullish factor is extended economic turmoil in the Eurozone. The gold/silver ratio dynamic will help pull silver up along with gold. Any move by the Fed to implement additional quantitative easing will accelerate the rise of gold and silver prices from here.

The quantity of money in the economy is increasing. As we know from Milton Freidman and Henry Hazlitt, “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.” Fearing deflation would set in as a result of the financial meltdown in 2008, the Fed and central bankers around the world have flooded the place with liquidity. But, the Fed was wrong in 2008. Deflation was not the problem. The housing bubble burst, but prices in general were not falling into the abyss. The credit freeze was not a general phenomenon. Only a few Wall Street investment banks were locked out of the repo market on no confidence votes from counterparties. The Fed action to add $1.6 Trillion to the money supply was a gross over reaction to the tempest in the Wall Street teapot. The Fed’s additional $600 Billion QE2 stimulus measure also contributed to growing inflation for all.

And on the inflation front, it will get darker before the dawn. The reason is “excess reserves.” That is, Fed member banks have been sitting on $1.6 Trillion in cash and have been reluctant to lend. But some of those reserves are now leaking out to the general economy. We can see that from M2, the Fed statistic that measures money in circulation plus demand deposits, savings account balances and small time deposits, has increased by $500 billion in the last two months. So there is more cash available to chase the goods and services, the surefire path to higher prices.

Excess liquidity is causing inflation, which is showing up in producer and consumer prices. The US Producer Price Index has jumped to 7% year-over-year, which is squeezing corporate margins and flowing into higher consumer prices. The US is also importing inflation from China. Inflation in China ticked up despite several efforts by its central bank to raise reserve requirements and tighten rates. 

Gold is the premiere hedge against inflation, so we are seeing the price of gold move steadily higher. We can expect gold to reach $2000/oz and beyond in the next few months.  The gold/silver ratio is telling us that silver could outperform gold this year on a percentage basis.

The question for you is, “How can I protect myself and my assets from inflation and market volatility?”

Investors from around the world benefit from timely market analysis on gold and silver and portfolio recommendations contained in The Gold Speculator investment newsletter, which is based on the principles of free markets, private property, sound money and Austrian School economics.

The question for you to consider is how are you going to protect yourself from the vagaries of the fiat money and economic uncertainty?  We publish The Gold Speculator to help people make better decisions about their money. Our Model Conservative Portfolio gained 66.7% in 2010, and 55% for 1Q2011. Subscribe at our web site www.thegoldspeculatorllc.com  with credit card or PayPal ($300/yr) or by sending your check for $290 ($10 cash discount) The Gold Speculator, 614 Nashua St. #142 Milford, NH 03055

Steady as She Goes

By Scott Silva

Editor,  The Gold Speculator

8-15-11

High volatility in the markets seems to have become the norm lately. Equity markets around the world have whipsawed investors, as the indices swing wildly up and down in roller-coaster fashion. And the unruly changes from one day to the other are not small. When the Dow shed 520 points in a day last week, it represented a loss of $1.6 Trillion in capital for equity holders. Likewise, stock market rallies last week were sharp and short-lived, only to reverse in further massive selling. It’s no wonder that many investors have decided to head for safe haven assets.

There are many reasons for the recent high volatility in the markets. A major cause was the US debt ceiling deal. The markets sold off sharply when the deal was announced, which surprised some that thought that that raising the US debt ceiling would have a stabilizing effect and save the nation’s AAA credit rating. The markets reacted negatively on news of the deal, and by selling off on Thursday, August 4th, correctly anticipated Standard and Poor’s decision of Friday, August 5^th to downgrade, for the first time ever, the credit rating of US sovereign debt. In its press release, S&P said that “political brinkmanship” in the debate over the debt had made the U.S. government’s ability to manage its finances “less stable, less effective and less predictable.” It said the bipartisan agreement to find at least $2.1 trillion in budget savings “fell short” of what was necessary to control the debt over time and predicted that leaders would not likely achieve more savings in the future. The debt deal ducked the central issue, namely reducing runaway government spending.

Failure of the US government to solve its debt crisis was not the only factor that roiled the markets last week. A slew on new unfavorable economic data also pressured stocks. Consumer Sentiment, a key indicator of consumer demand, plunged in August to the lowest level since May 1980, adding to concern that weak employment gains and volatility in the stock market will cause households to retrench. The Thomson Reuters/University of Michigan preliminary index of consumer sentiment slumped to 54.9 from 63.7 the prior month. The measure was expected to decline to 62, according to the median forecast in a Bloomberg News survey. Unemployment remains high at 9.1% with no signs of improving. Food and energy costs continue to rise; buying power of the Dollar is shrinking, and wages are not keeping up with rising household costs. Housing values continue to fall, while rents are rising.

The Federal Reserve signaled its pessimism on the prospects of the US recovery by announcing it would maintain near-zero interest rates to 2013. The markets rallied briefly on the uncommon certainty of the Fed statement, only to sell-off again on the realization that the economy is grinding to a halt. US economic growth for the first quarter was revised down to 0.4%, down from 1.9%.  Most economists, including those at the World Bank, see US growth slowing, not accelerating over the next months and years. According to the World Bank, the US is leading the global economy into a “Danger Zone” of likely recession. The odds of a US double-dip recession are now 1in 3 according to economist survey data.

Fears of insolvency in Italy, Spain and maybe France and the uncertain response by the ECB also weighed on investors. European markets sold off, and the US markets followed with more selling. The question remains whether the EMU will survive chronic bailout measures, or the weaker members are allowed to fail and then cut away from the stronger Eurozone members.

One reliable measure of market volatility is the VIX Index. VIX is the ticker symbol for the Chicago Board Options Exchange Market Volatility Index; it measures the implied volatility of S&P 500 index options. We can see at once that the VIX reflects market sentiment. When the VIX is high, markets tend to swoon. When the VIX is down, the markets tend to gain. We see this dynamic in the chart below. Just before the market sell-off of 2008, the VIX reached 80. The VIX also climbed to 48 in May 2010 and reached 48 again last week, each time corresponding to big sell-offs in the S&P 500.

The Sturm und Drang that plays out in wild swings in the markets that ruin portfolio values and destroys wealth does not affect those that have prepared themselves against the onslaught. The key to the preservation of wealth is diversification. In today’s volatile economic environment, investors are finding once again, that owning gold provides stability as well as a store of value.

We can see how a portfolio that is diversified with gold performs well when the markets are volatile. Gold tends to be much less volatile than the general markets. Because gold has intrinsic value, gold is considered the premiere safe-haven asset. In uncertain economic times, investors cash out of stocks and low-yielding bonds and purchase gold. Significantly, today we are seeing the central banks are buying bullion. The World Gold Council's most recent figures show central banks are net buyers of bullion. In the first half of this year central banks net purchases totaled 208 tonnes of gold. In 1981, ten years after the end of Bretton Woods, the largest annual net gold purchase by central banks was 276 tonnes of gold bullion. Gold is proving once more it is the universal reserve currency. By the way, it was 40 years ago today that President Nixon took the US off the gold standard.

So how does gold hold up for the individual investor in volatile times? The answer is straightforward: Gold outperforms the markets in turbulent times. We can see the evidence in the chart below. It compares price action of the Dow vs spot gold over the last few months.

What is significant here is highlighted in the oval. It shows the 13% decline in the Dow in last week’s big sell-off, and gold climbing to over $1800/oz.  Investors that have owned gold in a diversified portfolio protected their wealth, while those that relied on stocks were savaged by the sell-off.  The DJIA has lost 1.18% year-to-date. The S&P 500 has lost 4.54% year-to-date. The Model Conservative Portfolio available to subscribers of The Gold Speculator has returned 43% year-to-date.  So for us, in these turbulent and volatile economic times, the order of the day is “Steady as She Goes.”

Investors from around the world benefit from timely market analysis on gold and silver and portfolio recommendations contained in The Gold Speculator investment newsletter, which is based on the principles of free markets, private property, sound money and Austrian School economics.

The question for you to consider is how are you going to protect yourself from the vagaries of the fiat money and economic uncertainty?  We publish The Gold Speculator to help people make better decisions about their money. Our Model Conservative Portfolio gained 66.7% in 2010, and 55% for 1Q2011. Subscribe at our web site www.thegoldspeculatorllc.com  with credit card or PayPal ($300/yr) or by sending your check for $290 ($10 cash discount) The Gold Speculator, 614 Nashua St. #142 Milford, NH 03055

Where the Smart Money Is

By Scott Silva

Editor,  The Gold Speculator

8-3-11

Many who hope to succeed in the markets seem to forget one of the primary laws of market speculation: Sutton’s Law. This axiom has proved correct time after time and is now used in several disciplines, ranging from law enforcement, physics, medicine, economics and market speculation. Sutton’s Law is described precisely by its namesake, William “Willie” Sutton, the prolific 1920’s bank robber who, when asked why he robbed banks answered, “That’s where the money is.” In the teaching of medicine, Sutton's law states that when diagnosing, one should first consider the obvious. Likewise, the FBI investigator puts a premium on physical evidence when building a case. Even the garage mechanic will check for fuel in the tank of the car that refuses to start before proceeding further. Sutton’s Law also applies to successful market speculation, where and important key is following the flow of smart money-- “where the smart money is”

So how can one determine where the smart money is going?  Well, one way is to follow the tape.

That is, the ticker will show price movement, up or down, for a given traded good. And the volume of trades pushing prices up (more buyers than sellers) or down (more sellers than buyers) is a primary indicator of market sentiment (bullish or bearish) and future market direction.  But, markets reverse, and there is the rub. Price action can reverse in minutes or over months.  So how can the speculator profit given the fickle nature of the markets?  One way that has proved itself over time is to apply Sutton’s Law: go to where the smart money is. In the commodities market, we can see where a big chunk of smart money is flowing by using indicators based on the CFTC Commitment of Traders (COT) data. So let’s examine the case for trading gold with the aid of COT data.

The Commodity Futures Trade Commission publishes trade data by the major players in the commodities market. These are 1) Large Speculators, professional fund managers and institutional traders, 2) Commercials, the industrial producers of the commodity, and 3) Small Speculators, private investors that speculate in commodities. Large Speculators tend to follow the market trends. Commercials tend to hedge, or bet against the trend in order to reduce price volatility risk. Small Speculators tend to follow trends as well. The Commitment of Traders data is collected weekly after the close on Tuesday and the Commitment of Traders Report is published after the close on Friday. COT data consists of the number of long and short contact positions placed by each of the player segments. Outstanding contract positions display current market sentiment of the holder. For example, if more Large Speculators hold long contracts than those with short contracts, then Large Speculator sentiment is bullish. Commercials are typically on the other side of Large Speculator trades, so Commercials tend to be short when Large Speculators are long. 

We can see the disposition of each player in the gold market as of last Tuesday in the chart below. The bars above the zero line represent net long positions; bars below the line are net short positions. We can see that Large Speculators have been increasing long positions in gold over the last month. At the same time, Commercials have purchased more short contracts. We can also see that Large Speculator bullish sentiment has moved up 4 points from last week to 87%.

This is useful information to keep in mind, but as my friend Jim Cramer would say, “Fine, but can you trade with it?”

Well, it turns out that COT data can provide very good trading information. The predictive property comes from movements of the COT Index. The COT Index is the net position of each of the major players (Large Speculators, Commercials and Small Speculators) over a 26-week period. As such, it is similar to a moving average. Changes in the COT Index tend to predict future price action. This is because Large Speculators tend to be trend followers and good market timers, and Commercials tend to be good at hedging against future market movements. We can see this dynamic playing out in gold in the chart below, which shows movement in the COT Index at the bottom.

We can see the COT Index for the Large Speculators (called Large Traders here) by the green line, and Commercials, the blue line. The COT Index represents net position change, so its scale is 0 to 100 percent. As expected, the COT Index for each displays the inverse relationship to one another. What’s important is the when major changes take place. For example, back in February, the Large Traders began to go long. We can see the price gold climbed in February to March. The Commercials, anticipating higher gold prices, loaded up on short contracts over the same period. In April, Large Traders added new long contracts, while the Commercials shorted some more. Gold surged to over $1550/oz by May.  In late June, Large Traders dumped their long contracts, and Commercials went long. Gold dropped $50. In early July, the Large Traders went long in a big way; the Commercials shorted in turn. Since then gold has jumped to over $1660/oz.

We can see that Large Speculators have earned their right to be considered “smart money” when it comes to gold. And that’s part of the reason subscribers to The Gold Speculator benefit from going to where the smart money is.

Investors from around the world benefit from timely market analysis on gold and silver and portfolio recommendations contained in The Gold Speculator investment newsletter, which is based on the principles of free markets, private property, sound money and Austrian School economics.

The question for you to consider is how are you going to protect yourself from the vagaries of the fiat money and economic uncertainty?  We publish The Gold Speculator to help people make better decisions about their money. Our Model Conservative Portfolio gained 66.7% in 2010, and 55% for 1Q2011. Subscribe at our web site www.thegoldspeculatorllc.com  with credit card or PayPal ($300/yr) or by sending your check for $290 ($10 cash discount) The Gold Speculator, 614 Nashua St. #142 Milford, NH 03055

Anatomy of a Technical Trade

By Scott Silva

Editor,  The Gold Speculator

7-27-11

One of the laws of market espoused by those that embrace the efficient-market hypothesis states

“Stock market prices are unpredictable.”  Technical analysis, however, has proved effective at predicting future price direction through the study of past market information, primarily price and volume. To be sure, predicting future prices of a stock or commodity can be challenging, and not always successful, but the speculator can profit from correct technical analysis of a traded good. The price movement of silver over the last eleven months provides a good example. So let’s examine the anatomy of a technical trade in silver.

One of the most liquid markets for silver is the market for silver futures, traded on the COMEX.

Other markets for silver include exchange traded funds, or ETFs, which trade similar to stocks. Price and volume history for each type security are readily available, which allows the technician to work.

The technical analyst searches for chart patterns that develop with price action over time. Volume associated with price action is an important factor in evaluating the validity of a particular chart pattern. Independent indicators can also help confirm the validity of the primary pattern. Back in September 2010, we identified a breakout pattern in COMEX silver that predicted a bullish move up. We saw this play out in higher silver prices since that prediction. 

Here is what we observed on September 3, 2010:

BREAKOUT

                As we survey the various elements of the precious metals group in the run-up to Labor Day, it becomes very clear that something big is brewing.  As we see, the chart of silver has formed an ascending triangle going back to Dec. ’09.  This triangle has broken out today, and it presages breakouts throughout the precious metals group. Using the semi-log continuation chart (www.timingcharts.com) we can predict the price objective for silver at about $60 using the present data.

Technical analysts know the ascending triangle pattern is a bullish formation that usually forms during an uptrend as a continuation pattern. Although there are instances when ascending triangles form as reversal patterns at the end of a downtrend, they are typically continuation patterns. Regardless of where they form, ascending triangles are bullish patterns that indicate accumulation. The length of the pattern can range from a few weeks to many months with the average pattern lasting from 1-3 months. As the pattern develops, volume usually contracts. When the upside breakout occurs, there should be an expansion of volume to confirm the breakout.

We use the ascending triangle pattern to calculate the price target by projecting a line parallel to the ascending trend line (bottom trend line) starting at beginning of the horizontal resistance line, and extend it to intersect the price scale. This can be seen as a mirror of the ascending triangle with a common horizontal base. Care must be taken to account for semi-logarithmic price scale. For COMEX silver, the September 3, 2010 breakout from the ascending triangle pattern produced a target price of $60/oz.

We recommended subscribers buy COMEX Silver at $20.78 on September 17, 2010.

Price action in November and December produced bullish pennant patterns that confirmed the continued move up for silver. The chart below was explained to subscribers on December 10, 2010.

       The key technical formation of the moment is the pennant which formed in silver over the month of November.  Silver did move into new high ground early in December.  But it fell back and appears to have met support at the $28-$29 level. The November pennant gives a point count to $40.  There was a 61% move in silver from late August to early Nov., and the pennant predicted an equal (percentage) move.  A 61% rise from $25 gives us a target price a touch over $40.  Our objective for silver at $40 is mid February (on the argument that the second leg out of the pennant will be equal to the first leg in time).

We know that commodities, including silver correspond to movements in the Dollar. This makes sense since silver is usually purchased in Dollars. So when the Dollar weakens, the same ounce of silver commands more Dollars in exchange. Likewise, the strong Dollar buys more Troy ounces (31.1034768 grams) of silver. Hence, silver usually has an inverse relation to the Dollar. It is important to recognize that the price movement of one does not cause the price movement of the other. Prices rise when there are more buyers than sellers for a particular good. The value of the Dollar decreases with increases in the money supply.  The technical analyst can use these facts to his advantage in predicting future price movements.

We can see the inverse relationship between the Dollar and silver in the chart below.

We saw the Dollar drop steeply in September-October 2010. This corresponded to the first large leg up for silver over the same period.  In December we recognized a bearish pattern (head-and-shoulders top) on the Dollar index that broke to the downside for the next five months. This corresponded to the second large leg up for silver over the same period.

Here is what we told clients about the Dollar on December 15, 2010:

Here is the weekly basis chart of the US Dollar.  Notice that the chart gives the clear head-and-shoulders top. This formation has to dominate our thinking on the intermediate term.  A breakdown from the neckline predicts a drop to 74 or lower.  We can expect commodities to benefit on the Dollar decline.

We saw silver continue on a parabolic rise on its way to $60/oz. At $50/oz, the CME slammed the door on buyers by raising margin requirements to 50% of position value. Retail buyers who got in late bailed out, or were called out on margin. Since then, silver has made a return to over $40/oz as investors return to silver and gold as the debt crises in the EMU and the US unfold.

Today, silver and gold have reclaimed milestones. Gold is trading over $1600/oz and silver is trading over $40/oz. The Dollar is selling off, just a point away from its May low of 72.86.

Resolution of the US debt issue is likely to reverse the Dollar’s slide, and pressure gold and silver. But the US debt issue has devolved into a day-to-day melee; Congress and the White House may not be able to control the situation before the credit agencies take action. One thing is certain- downgrade of the US sovereign debt would be catastrophic for the markets here and around the globe.

So, how should the prudent investor be positioned today? Technical analysis helps show the way.

Investors from around the world benefit from timely market analysis on gold and silver and portfolio recommendations contained in The Gold Speculator investment newsletter, which is based on the principles of free markets, private property, sound money and Austrian School economics.

The question for you to consider is how are you going to protect yourself from the vagaries of the fiat money and economic uncertainty?  We publish The Gold Speculator to help people make better decisions about their money. Our Model Conservative Portfolio gained 66.7% in 2010, and 55% for 1Q2011. Subscribe at our web site www.thegoldspeculatorllc.com  with credit card or PayPal ($300/yr) or by sending your check for $290 ($10 cash discount) The Gold Speculator, 614 Nashua St. #142 Milford, NH 03055

Safe Haven Trade

By Scott Silva

Editor,  The Gold Speculator

7-18-11

Gold is showing its true colors as the ultimate safe haven asset. Gold has been trading at all-time highs as national economies in the European Monetary Union teeter on bankruptcy, threatening the legitimacy of the Euro as a legitimate currency. Adding to global economic uncertainty is the US debt crisis, which has forced the major credit rating agencies to place US sovereign debt on negative credit watch for potential downgrade.

It seems inconceivable that the US would lose its AAA credit rating. US Treasurys have been considered the riskless asset compared to all others. That is, the probability that the United States would default on its debt has been considered zero, up until now. Moody’s has stated that the chances of US default in the next 90 days are 50-50. That’s a long way down from “riskless”.

The US Dollar and US Treasurys have been traditional safe-haven assets. US Dollar denominated assets surge in price when investors sell risky assets such as stocks and high-yield bonds in the so called “risk-off” trade. We saw the Dollar climb at the height of the global financial crisis, right after Lehman Brother’s bankruptcy in September 2008.  US Treasurys also surged. In January 2011, the Arab Spring followed by the Libyan oil shock in February put pressure on the Dollar as commodity prices, led by oil, spiked. Also in January, fears of a Euro-zone debt crisis began to take hold. Investors piled into gold, in a flight to safety, driving the price above $1400/oz.

Traditionally, the Dollar and gold are negatively correlated, which is to say gold prices tend to rise as the Dollar declines, and vice versa. We have seen gold prices, measured in Dollars, rise steadily since 2009. Over the same period, the US Dollar has seen an overall decline. This is not to say that one caused the other. Contrary to popular belief, correlation is not causation. The US Dollar has declined in value primarily due to Fed increases in the money supply. Gold prices have increased because there are more buyers than sellers. The price of gold is a good measure of economic uncertainty.

Another measure of investor sentiment (fear or uncertainty) is the CBOE Volatility Index, or VIX. It measures market expectations of near-term market volatility conveyed by S&P 500 stock index option prices. Since its introduction in 1993, VIX has been considered by many to be a reliable barometer of investor sentiment and stock market volatility.

We can see in the chart above that the VIX and the S&P 500 are negatively correlated. Stocks tend to fall when the VIX rises. This makes sense. When investors expect the markets to be volatile, fear of losses drives them to sell. Of course, for most investors, selling begets more selling. Many flee to US Treasurys, considered the safe trade.

But that relationship is now breaking down. Today, stocks are selling off; the Dow is down more than 150 points and S&P500 is down 1.3% to below 1300. Price action in the VIX predicted the sell-off by moving up from 16 on July 11 to 21.78 today. The Dollar index, however, is trading slightly lower than the last week’s levels (75.85 vs 76.31) and, the 10-Year Treasury is trading at the same level as nearly a month ago. So proceeds from the stock sell-off are not flooding into US Dollar denominated assets.

Instead, funds are flooding into gold and gold stocks. COMEX gold has broken through $1600/oz, and the gold mining stocks are breaking higher. The NYSE Arca gold BUGS index (HUI) is up 17% over the last 30 days.  The Philadelphia Gold/Silver index is up 11% for the same period.

Clearly the ‘safe-haven’ asset is gold. Right now the flight to safety is away from stocks and away from the Dollar and Treasurys and into gold and gold stocks.

Subscribers to The Gold Speculator have owned gold and silver (metals and mining stocks) since early in 2010. Specific portfolio recommendations produced 66% profit in 2010 and gains of 40.5% year-to-date for 2011. In comparison, the Dow is up 7.10% year-to date, and the S&P 500 is up 4.09% year-to-date.

Investors from around the world benefit from timely market analysis on gold and silver and portfolio recommendations contained in The Gold Speculator investment newsletter, which is based on the principles of free markets, private property, sound money and Austrian School economics.

The question for you to consider is how are you going to protect yourself from the vagaries of the fiat money and economic uncertainty?  We publish The Gold Speculator to help people make better decisions about their money. Our Model Conservative Portfolio gained 66.7% in 2010, and 55% for 1Q2011. Subscribe at our web site www.thegoldspeculatorllc.com  with credit card or PayPal ($300/yr) or by sending your check for $290 ($10 cash discount) The Gold Speculator, 614 Nashua St. #142 Milford, NH 03055

Too Big to Fail

By Scott Silva

Editor,  The Gold Speculator

7-12-11

The United States is too big to fail. The largest economy in the world is too strong and too influential to fail. The United States economy leads all other economies as it has for the last 100 years; it has extensive ties to the global economic community. What’s good for the US is good for the world. And what’s good for the US government is good for its citizens.

These are the arguments we hear as the US debt issue approaches a full-blown debt crisis, similar to the near bankruptcy in Greece that continues to plague the EMU.  Today Italy and Spain appear to have caught the Greece contagion.

Could the US actually default on its obligations?  Would default be catastrophic? Is the United States, in fact, too big to fail?

There is no doubt that the United States is coming very close to actual default, just as Greece did earlier this month. The US Treasury must pay interest on outstanding national debt by August 2, 2011. It pays interest from monthly federal income (taxes, fees and interest earned) and from borrowing. The Federal government borrows 40 cents of every dollar it spends. And there’s the rub. Federal borrowing is limited by law, and Congress has already spent up to (and a bit beyond) the legal debt limit of $14.3 Trillion. So if Congress does not raise the debt limit by $2.5 Trillion by August 2^nd, the Treasury will be forced to pay debt interest and not pay out some domestic obligations. If it defaults on its debt payments, the credit rating of its sovereign debt will be downgraded, and the Dollar will decline. Secretary Geithner called the potential result “catastrophic.”

Unlike Greece, the US has no higher collective available with bail-out funds at the ready. Neither the ECB nor the IMF can help the US. Not even the Bank of China could rescue the US today. It already owns over a $1Trillion is US Treasurys.

The current Keynesian solution is to raise taxes by $1Trillion or more over the next ten years, and maintain the current growth rate for federal spending.  Maintaining the growth rate of federal spending implies cuts in federal programs because national demographics portend rapid cost growth in entitlement programs such as Medicare and Social Security. The tax hikes, now called “revenue increases” would come in the form of “closing tax loopholes” on corporations and setting higher tax rates for “millionaires and billionaires.” Taxing the rich, it is thought, will help close future budget deficits and therefore reduce the federal debt. Budget cuts would maintain the current spending growth rate (rather than reverse the slope of the spending curve), and be limited to discretionary programs, including defense, but would not include Medicare and Social Security.

Those opposed to raising taxes cite the nation’s anemic GDP growth rate, which has slowed to just 1.8%, and persistent high unemployment, which ticked up to 9.2% in June. Raising taxes, the opponents claim, might push the economy into a double-dip recession, or worse.

The president agrees that raising taxes in a recession is a bad idea. That’s why he said in his press conference on Sunday that no new taxes will take effect until 2013. The president has stated this position before. In August 2009, on a visit to Elkhart, Indiana to tout his stimulus plan, Obama sat down for an interview with NBC’s Chuck Todd, who passed on a question from Elkhart resident Scott Ferguson: “Explain how raising taxes on anyone during a deep recession is going to help with the economy.” The president responded, “First of all, he’s right. Normally, you don’t raise taxes in a recession, which is why we haven’t and why we’ve instead cut taxes. So I guess what I’d say to Scott is – his economics are right. You don’t raise taxes in a recession. We haven’t raised taxes in a recession.”

But delaying tax hikes to 2013 will not change the need to pay debt obligations on August 2, 2011. And not fixing Medicare and Social Security is no solution to the controlling the largest consumers of the federal budget.

Opponents say it is time to re-prioritize the federal budget, and slash programs that are not essential to operating the federal government, while lowering taxes across the board.  In Greece, the parliament agreed to deep cuts and a wide-ranging austerity program, required by its bail-out creditors.

The bail-out creditors in our case are the US citizens and businesses that pay federal taxes, purchase goods and services with US Dollars. Without substantial budget cuts and entitlement reform, taxpayers will pay more for spiraling federal costs directly by taxes, or indirectly through the inflation that follows the creation of money (and US Treasurys) out of thin air.

So it is the US taxpayer that will bear the brunt of a decision that does not cut federal spending by 3 times or more than the debt ceiling credit raise.

The US debt negotiations are being held in secret, away from the well of the Congress, away from debate, and away from the American people. The people are left with one-way press conference quips and few facts on which to judge, much less to act. And the story keeps changing.  It’s a wonder that the rating agencies have not come down with a verdict already. But the day ain’t over yet.

The markets are reacting. Monday, the Dow dropped 150 points. The NASDAQ shed 2%. The sell-off may have come in part from new fears of debt crisis contagion in Italy and Spain. But there is no good news coming out of the secret US debt crisis negotiations. To the contrary, the US Treasury Secretary took to the Sunday talk shows with a message of impending doom.

Gold is reacting also. Gold continues to move up in price as investors seek the safe-haven trade.

Gold open interest has swelled by 12,000 overnight contracts. Large Speculators have increased their long positions substantially, according to the CFTC.

What is more significant is the fact that since the negotiations began, Gold and the Dollar are moving in positive rather than traditional negative correlation.

It’s time to start thinking about real solutions to our spending problems. As usual, Europe is light years ahead of the United States. The EMU addressed the debt crisis in Greece by enforcing strict austerity by the Greek parliament. We should learn from this example before, by accident or by treachery, the US debt negotiation catapults into a full-fledged debt crisis.

Part of the solution should be a return to sound money-- Bretton Woods II, with some refinements based on experience. One cannot build a sound monetary system based on money backed by thin air. Gold-backed US currency would bring fiscal discipline to the government and help grow the economy.

With a gold standard, commerce would flourish and citizens would prosper.  The Federal government would be smaller and maybe more efficient. The United States economy would grow and become once again, a shining example for the world to see, a tower of financial and economic strength-- too strong to fail.

Investors from around the world benefit from timely market analysis on gold and silver and portfolio recommendations contained in The Gold Speculator investment newsletter, which is based on the principles of free markets, private property, sound money and Austrian School economics.

The question for you to consider is how are you going to protect yourself from the vagaries of the fiat money and growing inflation?  We publish The Gold Speculator to help people make better decisions about their money. Our Model Conservative Portfolio gained 66.7% in 2010, and 55% for 1Q2011. Subscribe at our web site www.thegoldspeculatorllc.com  with credit card or PayPal ($300/yr) or by sending your check for $290 ($10 cash discount) The Gold Speculator, 614 Nashua St. #142 Milford, NH 03055