We favour the "routine bullish correction" possibility, because it meshes with the idea that the broad stock market is close to an important peak and because it is more consistent with the Dollar Index's recent price action.

When it comes to anticipating currency trends, also worthy of consideration is that the Greece-related problems that have made headlines over the past month are indicative of deeper and more widespread issues that will eventually lead to the unraveling of Europe's monetary experiment and/or a far more inflationary stance by the ECB.

We don't have a strong opinion on exactly how Europe's monetary union will break apart. There's a lot of talk at the moment about Greece and some of the other "PIIGS" choosing to -- or being forced to -- leave the union, but Germany is the only country that could leave and end up with a more stable currency as a result. However, there won't be sufficient incentive for Germany to leave the union until the average German believes that the costs of staying are much greater than the costs of leaving; and this situation probably won't eventuate until it becomes obvious that a major euro-inflation problem is brewing. Therefore, if there is going to be a fracturing or contraction of Europe's monetary union over the next 12 months then it will probably involve the departure of one or more of the "PIIGS".

Just to be clear: the potential for a break-up of Europe's monetary union is not the main reason we are intermediate-term bearish on the euro and bullish on the US$. The primary basis for our currency-market outlook is that a global economic contraction commenced in 2007, was interrupted during 2009, and will resume during 2010. As the private sector de-leverages in response to this contraction there will probably be an increase in US$ demand relative to the demand for currencies that were elevated by the boom of 2003-2007 and the 'echo-boom' of 2009.

Idiocy or Dishonesty?

At an event at the London School of Economics early this week, world-renowned economist Joseph Stiglitz said "[both the U.K. and the U.S.] deserve to keep the Aaa rating" and "the likelihood of a default is...small, particularly in the U.S. because all we do is print money to pay it back." He went on to assert: "The notion of a default is so absurd, it's another reflection of the absurdities in the financial markets."

But, Mr. Stiglitz, isn't printing money a form of default? That is, isn't it the case that when the government creates new money out of nothing in order to pay its debts it is effectively defaulting on its obligations, except that rather than the cost of the default being borne directly by those who loaned money to the government it is spread across all savers within the economy? And why is it OK for a government to print new money to pay its debt and not OK for a private entity to do the same thing? To put it another way, why is it called "economic stimulus" or something else with a positive connotation when the government does it, and counterfeiting when someone outside the government does it?

While we are at it, here are some more questions for the 'great' economist: Are you aware, Mr. Stiglitz, that the government doesn't actually "print" new money in the strict meaning of the word, but, instead, borrows new money into existence? That is, are you aware that for every new dollar the government brings into existence, the government's debt must rise by at least one dollar? Continuing on, doesn't this mean that the government only pays off its old debt by creating new debt, such that the total quantity of debt always expands and we are, in effect, dealing with a Ponzi scheme of unprecedented proportions? Lastly, if a Ponzi scheme doesn't ultimately end in default, then how does it end?

As if the quips about money printing and default weren't enough, Stiglitz went on to state: "What we need now is a second round of stimulus, [because] if we don't the heavy level of indebtedness is going to press down on the economy."

So let us get this straight -- to prevent the heavy load of indebtedness from pressing down on the economy, what we need is...more debt.

Is Joseph Stiglitz really that stupid, or is he being very economical with the truth in order to support an anti-free-market/pro-intervention agenda?

Gold Stocks

Gold bullion lost about $17 over the course of last week while the HUI gained 16 points. This has created a bullish divergence between the HUI and the HUI/gold ratio as indicated on the following chart. This divergence has the form of a lower low for the HUI in parallel with a higher low for the HUI/gold ratio, followed by a rise to a new multi-week high by the HUI/gold ratio. It is the opposite of what happened between mid September and early December of last year, although on a much smaller time scale. Refer to the following chart for details.

Gold Stocks

The following chart shows that the HUI spiked below its 200-day moving average on Wednesday and then ended the day right at this moving average.

Gold Stocks

We downgraded our short-term gold sector outlook to "bearish" via the email alert sent to subscribers after the close of trading on Monday 11th January. The risk is that the HUI completed a counter-trend rebound at Monday's intra-day high (475) and that the next move of consequence will be a decline to test, and probably breach, the December low (416). As noted in the email alert, this bearish view will be 'stopped out' if the HUI closes above 475.

The HUI's current situation is shown below. Our guess is that it will spend the next week or so 'horsing around' between Wednesday's low of 440 and Monday's high of 475.

We view the on-going strength in the industrial metals in both dollar and gold terms as the triumph of hope over logic. It is indicative of a general perception that the world is entering a period characterised by robust growth and minimal inflation risk. This, in our opinion, is not only unlikely, it is one of the lowest-probability outcomes we can imagine.

As long as the broad stock market holds together there probably won't be large price declines in most industrial metals, but at their current prices the downside risk certainly appears to be high relative to the upside potential. This is particularly the case for copper, a metal that has now recouped the bulk of its 2008 losses despite burgeoning inventory levels.

We were long-term bullish on the industrial metals complex throughout the past decade, but even with the strong likelihood of a lot more monetary inflation over the next several years the risk/reward no longer justifies such a view.

Anyone who thinks they know the path that the stock market -- or any market -- will take over the coming 12 months is kidding themselves, but the map provided by the green line on the above chart does not look unreasonable to us. For one, it is roughly in line with the "1937-1942 Model". For another, it suggests that by the second quarter of this year market participants will start becoming suspicious of the economic recovery's sustainability. This meshes with our expectations.

Gold Stocks

The HUI's correction low to date occurred on Tuesday 8th December. It has since drifted sideways.

Gold

Gold Sentiment

As we noted a week ago, the recent touting in the mainstream press of ambitious upside price targets for gold created the right sentiment backdrop for a correction. That the gold market was very extended to the upside (the gold price was a long way above its moving averages) and that large speculators had built up a record-high net-long position in COMEX gold futures also set the scene for at least a short-term correction. However, the people who believe that gold sentiment recently hit the sort of extreme that would be consistent with a major peak are, we think, completely misreading the situation.

The best measure of sentiment is what the public is doing with its money, and right now the average member of the investing public has ZERO exposure to gold. Also, for the small percentage of the population that currently has some exposure, in most cases the exposure is relatively minor. Very few people have more than 10% of their net worth in gold-related investments. This tells us that what some analysts refer to as the bull market's "speculative third phase" has not even begun at this time. To put it another way: "You ain't seen nothing yet."

Current Market Situation

On a short-term basis the gold market appears to be in a similar situation to the HUI in that it probably has just completed, or will complete early this week, the first stage of a multi-stage correction. December gold moved to within 2% of its 50-day moving average on Friday (see chart below), so it's likely that almost all of the correction's price decline is now behind us. However, the correction is only 6 trading days old, which probably means that more time will have to be used up before the next rally to new highs gets underway.

In our opinion, support at around $1000 continues to define the MAXIMUM downside risk in the gold market on both a short- and intermediate-term basis.

Gold Stocks

...The short-term prospects of the gold-stock indices are unclear to us, but the long-term outlook is clear. We'll describe our long-term outlook with the aid of the following weekly chart of Newmont Mining (NEM), the world's largest unhedged gold producer. Here's how we interpret the chart:

1. A long-term bull market began in November of 2000

2. The first major leg of this long-term bull market ended during the first half of 2006 and was followed by the bull market's first primary correction. Note that the HUI moved well above its H1-2006 high during the first quarter of 2008, but when the HUI reached its peak the majority of gold stocks (including NEM) had already been in correction mode for 1-2 years. This means that for NEM and most other gold stocks, the plunge that began in March of 2008 and ended in October-November of 2008 was the final phase of a multi-year downturn.

3. The rally that began in Q4-2008 is the first intermediate-term advance of the long-term bull market's second major upward leg. If the second major upward leg lasts as long as the first, it will end during H1-2014.

4. It is possible that the first intermediate-term advance of the long-term bull market's second major upward leg has just ended. However, we point out that none of the intermediate-term advances during the first major upward leg ended until after the weekly RSI shown at the bottom of the chart had moved above 70. In other words, despite the power of the past year's advance NEM is not yet sufficiently 'overbought' on a weekly basis to indicate more than a short-term top.

Gold

Current Market Situation

Either gold has entered blow-off mode (not likely, but possible) or it will soon begin to 'correct'. A normal short-term correction would take the gold price down to $1050-$1070.

We are presenting the following weekly charts to counter the increasingly popular idea that gold has entered 'bubble territory'. At the bottom of each chart is a 60-week rate-of-change (ROC) indicator.

The first chart shows that when platinum was peaking in early 2008 its 60-week ROC was 100%, meaning that it had doubled over the preceding 60 weeks.

The second chart shows that when oil was peaking in mid-2008 its 60-week ROC was around 120%, meaning that it had more than doubled over the preceding 60 weeks.

The third and final chart shows that gold's 60-week ROC is presently around 30%, and that gold broke out to the upside from a lengthy basing pattern only 7 weeks ago. It looks 'overbought' on a short-term basis, but does not appear to be remotely close to 'bubble territory'. By way of comparison, when gold was peaking in 1974 its 60-week ROC was above 150%, and when it reached its ultimate peak in January of 1980 its 60-week ROC was in excess of 200%.

Weimar-style hyperinflation: Is it possible today?

Gold

Current Market Situation

The December gold futures contract ended last week at 'round number' resistance ($1100) and at the top of its short-term price channel. As such, there is a good chance that some sort of downward price correction will soon commence. Our short-term outlook remains bullish, however, due to the risk of an upside blow-off.

An upside blow-off is not the most likely short-term outcome, but it's a possibility that should be taken seriously. It should be taken seriously because we are into the final two months of the year and with the exception of interest-bearing securities such as T-Bills, which have almost no remaining upside potential, gold is the only high-profile market that is at, or near, an all-time high. This puts gold in the position where it could conceivably attract substantial additional speculative demand between now and year-end as hedge funds and other large speculators scramble to maximise their 2009 returns.

By way of further explanation, gold's current position could be likened to the position of the NASDAQ100 Index (NDX) exactly 10 years ago. At the end of the first week of November 1999, the NDX had just completed a 3-week surge from 2300 to 2750. Based on most oscillators and other momentum indicators it was very 'overbought' at the time and apparently in need of a pullback; however, it continued to move upward with almost no hesitation and ended the year at 3750. In other words, it ignored most technical indicators and gained 40% over the final 7 weeks of the year.

We are not forecasting something similar for the gold market, primarily because we think gold's bull market has at least a few years to run (upside blow-offs such as that experienced by the NDX during the final quarter of 1999 and the first quarter of 2000 usually only occur at the ENDS of long-term bull markets). What we are saying is that an upside blow-off is a realistic possibility given the gold market's current position.

With regard to downside risk, we suspect that $1000 has become the 'floor' under the gold market.

Gold relative to other currencies and other 'stuff'

Up until about 6 weeks ago gold's short-term rally had a lot more to do with US$ weakness than genuine gold strength, but gold has recently begun to strengthen relative to almost everything. For example, the first of the following charts shows that gold is now clearly in a short-term upward trend in euro terms, while the second chart indicates that gold is probably about to complete its consolidation -- and resume its upward trend -- relative to the CRB Index.

By the way, if gold/CRB can build on its recent gains it will be a bearish omen for the broad stock market as it will confirm that a shift away from riskier investments has commenced.

Gold

Gold's Fair Value

A well known gold-market analyst likes to calculate a "fair value" for gold by assuming that the percentage change in the gold price should approximate the percentage change in the money supply, which amounts to applying the simplistic "Quantity Theory of Money" (QTM) to the gold price. The reality, though, is that QTM creates a misleading picture of how changes in the money supply affect prices. It should not be applied to anything, including (especially) the gold market.

It is vitally important to understand that an X% increase in the money supply will NOT lead to an across-the-board X% increase in prices. The reason is that new money does not get evenly spread throughout the economy; rather, it enters the economy at specific points and benefits the first recipients at the expense of everyone else. Monetary inflation is, in effect, a means for stealing and redistributing wealth as opposed to a means for raising the average price level.

Due to the way it works, monetary inflation will lead to dramatic increases in some prices while other prices barely rise or perhaps even decline. The distortion of relative prices will, in turn, create major economic problems, and once these problems start becoming evident to the masses (including policymakers) the response will tend to be twofold. First, policymakers will try to mitigate the problems caused by monetary inflation by promoting even more monetary inflation. Second, the public will attempt to increase its savings, but due to the blatant efforts of policymakers to inflate their way out of the economic morass created by prior inflation it will begin to dawn on people that it is no longer prudent to save in terms of the official currency. At this point gold could become the focal point of the public's collective desire to save, resulting in a gold price that bears absolutely no relationship to the growth in the money supply.

A "fair value" for gold can't be determined based on changes in money supply, but the more general point is that there is no such thing as a fair value for gold. The whole concept of a fair value for gold is nonsensical, because value is subjective. If we had enough data we could perhaps conclude that over extremely long periods of time the gold price had tended to oscillate around a number determined by the difference between the change in money supply and the change in gold supply, but because the gold price has only been 'untethered' since 1971 we don't have anywhere near enough data to do such an analysis. Furthermore, even if we had enough data to do the aforementioned analysis it wouldn't lead us to a "fair value" for gold and it may not tell us anything about gold's future (since the future is not just an extrapolation of the past).

Although we shouldn't kid ourselves that it is somehow possible to calculate gold's "fair value", history does give us some clues as to what we can expect from gold over the coming decade. For example, the previous two secular bear markets in US equities have taken the Dow/Gold ratio down to 1, versus its current level of around 10. Financial-market history therefore suggests that gold has additional long-term upside potential of around 900% relative to the Dow Industrials Index. For another example, the following chart shows that the gold/TMS ratio (gold relative to the True Money Supply) was about 5-times higher at its January-1980 extreme than it is today.