|Date posted as sample
the 26th February 2014 Interim Update:
Confusing Cause and Effect
As we explained in multiple TSI commentaries last year, the large 2013
decline in the Comex gold inventory was an effect of the large decline
in the gold price, not a cause of it. Furthermore, based on the
historical record it was a predictable effect, in that over the past 35
years major trends in Comex gold inventories have followed major trends
in the gold price. In other words, there was nothing untoward,
suspicious or even the slightest bit strange about last year's Comex
It's a similar story with the physical gold inventory of bullion ETFs
such as GLD. There's a nuance here in that changes in the quantity of
gold held by GLD are not directly driven by changes in the gold price,
they are driven by arbitrage. More specifically, if the price of a GLD
share rises relative to the gold price then arbitrage activity will
cause physical gold to be added to GLD's inventory, and if the price of
a GLD share falls relative to the gold price then arbitrage activity
will cause physical gold to be removed from GLD's inventory. (It's this
arbitrage activity that prevents the GLD price from ever wandering far
from its net asset value.) This means that a rising gold price won't
necessarily result in gold flowing into GLD's inventory and a falling
gold price won't necessarily result in gold flowing out of GLD's
inventory. However, because trend-followers and other short-term traders
exert a greater influence on the price of GLD shares than on the price
of gold bullion, GLD's price will tend to rise faster than the gold
price during a strong upward trend and fall faster than the gold price
during a strong downward trend. This creates a tendency for the
arbitrage activity mentioned above to add gold to GLD's inventory during
strong gold markets and remove gold from GLD's inventory during weak
The main point we want to make is that a likely EFFECT of an upward
trend in the gold price over the months/years ahead will be the addition
of gold to the Comex and GLD inventories, but going by past performance
many analysts will confuse cause and effect and wrongly interpret the
inventory change as the cause and the price change as the effect. There
is a self-reinforcing element in that as physical gold is added to the
GLD inventory there will be marginally less gold to satisfy demand
elsewhere, but the process begins with a change in the price trend.
the 19th February 2014 Interim Update:
In the latest Weekly Update, we said: "Silver is likely to trade at
least as high as $23 and could trade as high as $24-$25 within the next
three months." Here's where these numbers came from:
The following weekly silver chart shows a 10WMA/15% moving-average
envelope, meaning that it shows a 15% envelope around the 10-week moving
average. Except for times when the silver market is crashing (e.g.
H1-2013 and H2-2008) and times when a silver mania is in progress (e.g.
H1-2011 and H1-2006), short-term trends never extend significantly
beyond this envelope or remain outside this envelope for long. This year
there is very little chance of a crash, because a crash occurred last
year, and very little chance of a mania, because manias only ever occur
during the late stages of multi-year advances, so it is reasonable to
expect that the 2014 rallies and downturns in the silver market will be
limited by the 10/15 envelope.
Additionally, after clear-cut price-related evidence of a short-term
upward trend has been received, as is the case right now, the rally
usually continues until the top of the 10/15 MA envelope has been
reached, with short-lived spikes above the top of the envelope being
common. The top of the envelope, which is just above $23 and rising,
therefore defines the current rally's MINIMUM upside target. Hence our
comment that silver is likely to trade at least as high as $23 in the
The following daily silver chart shows that the $24.50-$25.00 range
coincides with the top of a long-term channel and intermediate-term
lateral resistance. This confluence of important resistance could act as
both a magnet and an obstacle over the next few months. It is an obvious
target for short-term speculators to shoot for, but there is little
chance of it being breached on the first attempt. Hence our comment that
silver could trade as high as $24-$25 in the short term.
the 17th February 2014 Weekly Update:
The evidence of a major trend reversal
continues to pile up. For example, last week the US$ gold price broke
decisively above its 150-day MA (the red line on the first of the
following charts) and the US$ silver price blasted through resistance at
$20.50 (refer to the second of the following charts).
The next significant resistance for gold lies at $1350. We expect that
this resistance will be overcome within the first half of this year, but
not within the next few weeks. Furthermore, if gold moves up to test
this resistance in the near future the short-term downside risk will
then be as high as the remaining short-term upside potential. Our
short-term gold outlook will therefore shift from "bullish" to "neutral"
if gold moves up to the $1340s within the next two weeks.
Silver is likely to trade at least as high as $23 and could trade as
high as $24-$25 within the next three months. Silver also has the
potential to trade as high as $30 (but not significantly higher than
that) before year-end.
Gold's recent performance relative to the US$ is interesting, but its
recent performance relative to some other commodities is even more
interesting. Of particular note:
a) The gold/GYX ratio (gold relative to industrial metals) has just
broken above the top of a downward-sloping channel that began to form in
October of 2012. This is a bearish omen for the broad stock market.
b) The platinum/gold ratio has broken out to the downside, suggesting
that platinum peaked relative to gold early this year. We won't be
surprised if the early-2014 peak in the platinum/gold ratio is tested
later this year in similar fashion to this ratio's August-2012 test of
its late-2011 bottom, but our guess at this early stage is that an
important trend reversal is in the works.
The recent breakouts in the gold/GYX and platinum/gold ratios reflect a
decline in economic confidence.
the 5th February 2014 Interim Update:
In terms of indicating the recent, current and likely immediate future
performance of the US economy, the monthly ISM Manufacturing report
provides the most useful numbers we know of. And of the numbers included
within each ISM report, the New Orders Index has the best record as an
economic indicator. The shocking decline in the New Orders Index
revealed by the latest ISM report should therefore not be taken lightly.
The ISM manufacturing numbers for January-2014 that were published on
Monday 3rd February included one of the largest-ever single-month
declines in the New Orders Index. As illustrated by the following chart,
"New Orders" plunged from near a 4-year high to near a 4-year low. It is
still above the demarcation line between expansion and contraction, but
It's distinctly possible that January's ISM data painted an inaccurately
dismal picture, perhaps due to unusually cold weather across much of the
US during the month. We won't know until early March when we get to see
the February data. However, we certainly can't rule out the possibility
that the data are accurate and that the US economy is now tanking.
When rapid monetary inflation creates the appearance of economic
strength by propping-up prices and artificially boosting demand, the
economy will usually deteriorate with 'surprising' speed following a
significant reduction in the rate of money-supply growth. A classic
historical example occurred during 1936-1938. In 1936 the Fed began to
increase reserve requirements due to concern that an inflation problem
was building. The higher reserve requirements caused the money supply to
level-off during 1937-1938 and precipitated a quick-fire 30% decline in
manufacturing output. In 1938, the US economy was almost as weak as it
had been at the depths of the Great Depression in 1932-1933.
It isn't correct to say that the Fed's modest tightening in 1936-1937
caused the 1937-1938 collapse in the economy. The fact that the economy
fell apart so quickly following the cessation of money-pumping is
evidence that the preceding growth was largely an artifact of monetary
inflation and was therefore destined to evaporate with breathtaking
speed. The Fed could certainly have postponed the collapse by continuing
to inflate, but in doing so it would only have set the stage for an even
more devastating future collapse.
the 29th January 2014 Interim Update:
The Emerging Markets
In the latest Weekly Update we said: "...with the downward trend in
the EEM/SPX ratio (emerging-market equities relative to US equities) now
into its fourth year it is too late to be getting bearish on the
emerging markets. At the same time it is too early to be getting bullish
on the emerging markets, as a final capitulation could still lie ahead."
We are now going to present an alternative view that can be summarised
as: Although the trend in emerging-market relative weakness is 'long in
the tooth', it might not be too late to take a bearish position because
the final phase of this trend could be dramatic.
The thinking behind this alternative view is that the long-term trends
in EEM (the iShares MSCI Emerging Markets ETF) and the major commodity
currencies (the C$ and the A$) are similar, but unlike the currencies,
which have broken down and become very 'oversold' on an
intermediate-term basis, EEM has held up quite well to date in nominal
dollar terms. A possibility worth considering is that EEM will do what
the commodity currencies have already done.
Here are charts that illustrate what we are talking about. The first
chart compares EEM with the C$ and the second chart compares EEM with
One way to trade the potential breakdown in EEM would be via the
purchase of EEM put options. Another way would be via the purchase of
EEV, the ProShares UltraShort MSCI Emerging Markets ETF. EEV is designed
to have daily percentage changes that are approximately twice the
opposite of the daily percentage changes in EEM. For example, on
Wednesday 29th January EEM fell 1.43% and EEV rose 2.96%.
Note, though, that even if EEM is destined to break downward in similar
fashion to the major commodity currencies, it could chop around for a
few months before commencing the sort of downward trend that generates
substantial returns for bearish speculators.
the 27th January 2014 Weekly Update:
If we use a magnifying glass we see that gold broke out to the upside
last Friday, but if you have to use a magnifying glass to see a breakout
then a breakout hasn't really happened. The US$ gold price is clearly
very close to providing us with preliminary evidence of an upward trend
reversal by breaking above its channel top and its December-2013 rebound
peak, but some additional strength is required.
A weekly close above $1300 would be conclusive evidence of an upward
In A$ terms, gold bottomed last April and has since made a sequence of
higher lows. This price action should lead to relatively good results
for gold producers with operations in Australia.
In the 6th January Weekly Update, we wrote:
"Gold's fundamentals turned more bullish in mid-2013 and in our
opinion will become increasingly so over the next 6 months, but right
now the fundamental backdrop for gold can best be described as mixed.
The reason, in a nutshell, is that there is still a lot of economic
optimism and confidence in both the Fed and the ECB. That's why credit
spreads have been relentlessly narrowing since June of 2012 and are now
almost as narrow as they ever get.
The narrowing of credit spreads is indicated on the first of the
following charts by the upward trend in the HYG/TLT ratio (high-yield
bonds relative to Treasury bonds), because HYG outperforms TLT when
investors become less risk averse and bid-up high-yield (junk) bonds
relative to US government bonds. The HYG/TLT ratio probably can't go
much higher, but it needs to start trending lower to become 'gold
bullish'. A break below 0.85 would confirm a downward trend reversal."
The HYG/TLT ratio hasn't yet become 'gold bullish' by confirming a
downward trend reversal, but the following chart shows that it is now
heading in the right direction.
the 20th January 2014 Weekly Update:
Probably the most important fundamental
[gold] driver right now
Given that gold is widely viewed as a hedge against problems in the
financial system it makes sense that the relative strength of the
banking sector tends to have a significant effect on the gold market.
Over the past few years this effect has been much stronger than usual.
In fact, we noted in a recent commentary that the banking sector's
relative strength, as indicated by the BKX/SPX ratio, currently appears
to be the most influential of gold's fundamental price drivers.
The strong inverse relationship between the US$ gold price and the BKX/SPX
ratio is illustrated below. Notice that the major 2011 high for the gold
price roughly coincided with a major low for the BKX/SPX ratio and that
the late-June bottom for the gold price roughly coincided with a peak
for BKX/SPX. The jury is still out as to whether the June-July 2013
extremes for the gold price and the BKX/SPX ratio were the major
By the way, gold has tended to lead the BKX/SPX ratio by 1-3 months at
significant turning points over the past three years. We are referring
to the fact that gold turned lower about 3 months before BKX/SPX turned
higher in late-2011, that gold turned higher about 1 month before BKX/SPX
turned lower in mid-2013, and that gold turned lower about 2 months
before BKX/SPX turned higher in Aug-Oct of 2013. At this time we have a
late-December upward reversal in the gold price that should, if it is
genuine, be confirmed by a downward reversal in BKX/SPX by the end of
Always one of the least important fundamental [gold] drivers
As explained in many TSI commentaries over the years, changes in annual
gold production are so unimportant that they can safely be ignored when
considering bullish and bearish influences on the gold price.
The gold market can be likened to a company that increases its share
count by about 1.7% every year. In this analogy, the amount of new
supply added by the mining industry to the aboveground gold inventory
each year is equivalent to our hypothetical company's small annual
addition to its share count. Some years the increase in the share count
could be as high as 1.9% and some years it could be as low as 1.5%, but
in terms of effect on the share price these variations in the number of
new shares will be dwarfed by changes in sentiment, the performance of
the broad stock market, company-specific fundamentals such as earnings,
and economy-wide fundamentals such as monetary policy.
In the gold market, the small annual change in the total aboveground
supply will always be trivial compared to influences such as central
bank monetary machinations and changes in economic confidence. So,
anyone who is currently basing a bullish gold view on the possibility
that gold production will decline is probably going to be right for the
the 8th January 2014 Interim Update:
The Stock Market
The potential for a change in leadership
The Baltic Dry Index (BDI), an index of international ocean-going
shipping rates, peaked at around 12000 during the second quarter of
2008. It then collapsed in spectacular fashion to less than 1000 by the
final quarter of 2008 in response to the global financial crisis and
recession. The crisis abated and the BDI rebounded to around 4000, but
by 2012 it had dropped back to the vicinity of its 2008 low. After
chopping around near its 2008 low during 2012 and the first half of
2013, it has since moved up to around 2000. What do we make of this?
Up until a few years ago we used the BDI as an indicator of global trade
and US$ turning points, but by early 2011 it had become apparent to us
that the BDI's trends were being determined to a far greater extent by
changes in the supply of ships than changes in the volume of trade. What
happened was that a lot of new ships were built in reaction to the high
shipping rates of 2007-2008. When this new supply came on line during
2009-2011 it cut short the rebound in shipping rates that was underway
and caused the BDI to drop back to its 10-year low despite a recovery in
global demand. The low rates rendered all but the newest and most
efficient freight carriers unprofitable, leading to many old ships being
scrapped and addressing the over-supply problem.
At this time we suspect that the BDI's rebound over the past 6 months
has more to do with the scrapping of old ships and the consequent
reduction in shipping supply than a significant increase in global
trade, but it's certainly possible that there will be a demand-driven
surge in the BDI if the inflation-fueled boom of the past two years
lasts another 12 months. That's a big 'if' that relies on a) the US
stock market experiencing nothing more negative than a 10% correction,
b) the euro-zone banking system remaining crisis-free, and c) China's
economy maintaining the outward appearance of strong growth. However, it
is an intermediate-term possibility worth considering.
If the inflation-fueled boom and the associated stock market rally last
another 12 months or so then there could be a change in stock market
leadership, with basic materials and commodity-related stocks taking
over the leading role. Whether this leadership change happens in the
stock market (under the continuing boom scenario) will largely be
determined by the currency market. Specifically, a continuing stock
market up-trend in parallel with US$ strength would probably be
accompanied by additional upward acceleration in the types of stocks
that led the way last year, whereas a continuing stock market up-trend
in parallel with US$ weakness would probably be accompanied by a shift
in leadership that favoured commodity-related equities (including
gold-mining stocks). The former possibility would be akin to 1999-2000
and the latter possibility would be akin to the 12-month period prior to
the 1987 stock market crash.
Note that neither of the aforementioned possibilities have high
probabilities. In our opinion, the US stock market is either topping on
an intermediate-term basis right now or will do so during April-May in
synch with the Presidential Cycle Model. However, a 12-month
continuation of the inflation-fueled boom cannot be ruled out,
especially with monetary conditions remaining 'easy' in the major
the 6th January 2014 Weekly Update:
The Stock Market
The US Presidential Cycle
The following chart was taken from
Mike Burk's free weekly
report. The red line on the chart shows the average performance of
the S&P500 Index (SPX) during all years since 1928 and the blue line on
the chart shows the average performance of the SPX during the second
year of the US Presidential Cycle (2014 will be the second year of the
current cycle) over the same period.
The Presidential Cycle (PC) Model predicts that the US stock market will
maintain its upward trend into April and then embark on a 5-6 month
During any given year the market can deviate in a big way from its
average historical performance, and there are good reasons to be
concerned about short-term downside risk right now. We should therefore
not assume that the market will track the PC Model and maintain its
upward trend for a few more months. However, IF the market maintains its
upward trend into April it will probably mean that the PC Model is
overriding other influences and that a bearish speculation will be
appropriate at that time.
Current Market Situation
The December close for the S&P500 Index (SPX) was bullish, or, at least,
not bearish, in that December turned out to be an 'up' month. Based on
the historical record, an 'up' December doesn't mean much, but a 'down'
December is a bearish omen for the year ahead.
The US stock market is clearly overbought and over-valued with sentiment
at an optimistic extreme, but at this stage the upward price trend is
The SPX and the Dow Industrials Index broke above their respective 2007
highs during the first half of 2013, but the NYSE Composite Index (NYA)
has not yet done the same. As illustrated by the following weekly chart,
a test of the 2007 peak is currently underway.
It will be interesting to see if the NYA is able to confirm the new
highs achieved by the SPX and the Dow.
Our final stock-market chart shows the TSX Venture Exchange Composite
Index (CDNX). The CDNX is a proxy for small-cap Canadian stocks (mostly
resource stocks) and has just risen to the point where any significant
additional strength will signal an intermediate-term upward trend
Notice that every CDNX rally since mid-2011 has ended at or below the
200-day MA (the red line on the chart) and that the CDNX ended last week
right at this MA. Additional strength from here would therefore be
different from anything that has happened over the past 2.5 years.
the 11th December 2013 Interim Update:
The Bitcoin Speculation
Unless you've just regained consciousness after being in a coma for at
least two months, you are probably aware of the extraordinary
performance of the Bitcoin price. Since the beginning of last month the
price of a Bitcoin has gone from $200 up to $1200 down to $650 and back
up to $900+ (see chart below). What's the story?
As far as we can tell, the latest round of speculation in this "digital
currency" had two main drivers.
First, the US financial establishment gave Bitcoin an implicit stamp of
approval, thus contradicting the idea that holding Bitcoins is an
effective way to keep purchasing power away from the prying eyes and
hands of central banks and governments. That the financial establishment
would utter soothing words about Bitcoin should not be a big surprise,
though. This is because a long-term goal of the government-bank
partnership is for all regularly-used currencies to be electronic,
leading to a digital record of all payments and thus theoretically
making it possible for every financial transaction to be either
monitored in real time or traced after the event.
Second, gamblers in China discovered Bitcoin. Members of the same group
that completely ignored valuation while bidding the Shanghai Stock
Exchange Composite Index up from 1000 to 6000 within the space of two
years (Q3-2005 to Q3-2007) and completely ignored valuation while
bidding permanently-vacant apartments up to absurd prices, have recently
turned their attention to Bitcoin.
Some gold bulls are against Bitcoin because they believe that, like a US
dollar and unlike an ounce of gold, a Bitcoin has no intrinsic value.
This line of thinking is wrong, because value is always subjective. A
US$, a Bitcoin and an ounce of gold have exactly the same intrinsic
value: zero. By way of further explanation, gold will have a different
value to different people and could have a different value to any single
person depending on that person's circumstances. For example, in our
present situation we think gold is very valuable, but if we were
stranded alone on an island with no hope of being rescued we would value
a fresh coconut or a fish more highly than an ounce of gold. Under such
circumstances gold would most likely have no value to us, but something
with "intrinsic" value would, by definition, have value under all
From our perspective, one important difference between gold and Bitcoins
is that gold is a physical quantity that has been highly valued by
humans for its physical properties for thousands of years and will
probably be highly valued for the same physical properties for a very
long time to come. A Bitcoin, in contrast, doesn't exist outside the
memory of a computer. It's not about intrinsic value, it's about
physical presence. Related to this difference is that gold has
subjective value outside of its role as a currency or an investment or a
speculative plaything, whereas Bitcoin's current subjective value is
almost totally based on its role as a speculative plaything.
A second important difference is that whereas there are strict
limitations on the supplies of both gold and Bitcoins, there is an
infinite supply of things that are identical to Bitcoins in every way
except name. The Bitcoin network can be duplicated ad infinitum, which
means that maintaining a high value for a Bitcoin involves maintaining
the belief that there is a significant difference between a Bitcoin and
the other digital currencies that are created using the same coding,
when in reality no such difference exists.
Due to the points outlined in the above two paragraphs, we are confident
that gold will be worth a lot more in real terms five years from now
whereas we have no idea if a Bitcoin will be worth a lot more or a lot
less. Moreover, gold will still have substantial value under any future
scenario we can imagine, but we perceive a high probability that
Bitcoin's value will eventually drop to zero.
We haven't speculated in Bitcoins yet and probably won't, because, due
to its extreme volatility and our belief that its ultimate price will be
zero, we know we wouldn't be able to hold through the corrections. To
hold through the corrections you need to be a true believer.
the 9th December 2013 Weekly Update:
A classic bubble economy
In the 27th November Interim Update we
discussed our personal experience with Malaysia's property investment
bubble. As is always the case when real estate prices rocket upward
throughout a country, the root cause of what's happening to property
prices in Malaysia is the combination of rapid monetary inflation and
low real interest rates spawned by the central bank with the
enthusiastic support of the government. In more general terms, a rapid
broad-based rise in asset prices is always due to the manipulation of
money and credit by the bank-government partnership. In present-day
Malaysia and many other countries, surging real-estate valuations are
the most obvious sign of this manipulation. However, they aren't the
As discussed in the very good article posted
HERE, present-day Malaysia is a classic credit-bubble story. First,
there has been a large increase in household debt, from 39% of GDP in
1997 to 70% of GDP in 2009 to 83% of GDP today, with double-digit gains
every year since 2008. Second, overall private-sector indebtedness has
jumped by more than 80% over the past 5 years, and there has also been a
large increase in the government's indebtedness. Third, due to the way
today's monetary system works, a rapid increase in debt generally goes
hand-in-hand with a rapid increase in the money supply. In this regard
Malaysia has not been an exception, with the following chart revealing
that Malaysia's M1 and M2 money supplies have grown at an average of
around 12% per year since 2006. Fourth, the nominal bank lending rate
has oscillated around the low level of 5% for the past few years,
leading to a substantially negative real interest rate for anyone
borrowing money to invest/speculate in the property market. Fifth,
Malaysian consumers have ramped up their spending as if the good times
were going to last forever. Sixth, the inflation-fueled boom has
attracted a flood of foreign investment, which has, in turn, added more
fuel to the boom. Seventh, flushed with the optimism that an economic
boom always generates, property developers in Malaysia are now planning
to construct the tallest
building in South-East Asia.
There's no doubt that the word "bubble" is being used too often these
days, but the hard reality is that this word can legitimately be applied
to more markets and economies today than ever before. In other words,
the increasing use of the word "bubble" is not solely a function of
incorrect usage. It also reflects the fact that the escalating attempts
by policy-makers to manipulate money and credit are causing larger and
more frequent price distortions. As the swings from boom to bust and
back again become greater in a perverse -- albeit predictable --
response to the increasingly aggressive attempts by central banks and
governments to maintain stability, bubbles are becoming more
the 9th December 2013 Weekly Update:
Never pay high premiums
When the Sprott Physical Silver Trust (PSLV) traded at a premium of more
than 20% to its net asset value (NAV) during the first half of 2011, we
said that this was due to the sort of irrational enthusiasm and
uninformed buying that generally only occurs near an important price
peak. However, PSLV advocates assured us at the time that there were
good reasons for the hefty premium.
If the explanations as to why PSLV should trade at a hefty premium were
valid in 2011 than they would be valid now, but with the large decline
in the silver price and the associated change in sentiment the premium
disappeared. PSLV actually traded at a small discount to its NAV earlier
this year and currently trades within 0.5% of its NAV. The following
chart shows the path taken by PSLV's premium to NAV since the fund was
introduced in October-2010.
Recall PSLV's performance during 2011-2013 the next time you hear/read
arguments for why something deserves to trade at a large premium. There
will always be a next time, because it will always be possible to
justify any price, no matter how high or how low, by imagining a future
scenario in which today's unreasonable price becomes reasonable.
However, when you have to imagine an extraordinary future scenario in
order to justify today's price it probably means that the market in
question is nearing a major trend reversal.
By the way, at the end of last week the Central Gold Trust (GTU) and the
Central Fund of Canada (CEF) were trading at DISCOUNTS of 7.2% and 6.6%
to their respective net asset values.
the 2nd December 2013 Weekly Update:
Although the gold price did very little last week, the price action
helped to define the two price channels indicated on the following daily
chart. Notice, in particular, that last week's intra-day low coincided
with the bottom of a channel dating back to the late-August rebound high
and the bottom of a narrower and more steeply-sloped channel dating back
to the October rebound high.
Friday's close coincided with the top of the steeply-sloped channel
dating back to the October high, so any additional price gain from here
would create a minor upside breakout. However, more important resistance
lies in the $1270s. A counter-trend rebound shouldn't do more than test
this resistance, which is why we would interpret consecutive daily
closes above $1280 as confirmation that an important bottom was in
Over the past 5 years, one of the most important gold-market
'fundamentals' has been the relative performance of the US banking
sector as indicated by the BKX/SPX ratio. Gold tends to do well when the
banking sector is weakening relative to the broad stock market and gold
tends to do poorly when the banking sector is strengthening relative to
the broad stock market. The following chart shows the performance of the
There is preliminary evidence in the market action that the BKX/SPX
ratio made a trend reversal of at least intermediate-term significance
at the end of June-2013. Taking out the early-November low would provide
conclusive evidence of such a development and would substantiate the
view that the gold market commenced a major bottoming process in June.
the 13th November 2013 Interim Update:
Inflation and nothing but
Last week's surprise interest rate cut by the ECB changed nothing at a
fundamental level. It was purely symbolic. The ECB was, in our opinion,
making the point that there are no limits to how far it will go along
the inflation path, a point that had already been made by the US Federal
Anyone who has been bearish on gold over the past two years due to a
belief that deflation was about to happen has been on the right side of
the gold market while being as wrong as they could be in their
reasoning. They got lucky, because the gold price has fallen in parallel
with considerable inflation. In essence, they got lucky because the Fed
The Fed got lucky over the past two years due to the fact that its
money-pumping boosted the 'right' prices, where the right prices are
equities, bonds and real-estate investments. It was primarily luck,
because the Fed doesn't have much control over the paths taken by the
new money it creates. We note, for example, that similar bouts of money
pumping from late-2008 through to mid-2011 gave the biggest boosts to
the 'wrong' prices, most notably gold and commodities.
Now, when we say that the Fed got lucky we aren't saying that gold
bulls, including ourselves, got unlucky. We missed some signs that the
markets had entered a multi-year period during which the pendulum would
swing in favour of the central planners and the inflation policy would
appear to work. Of equal importance, the simple fact that the 'wrong'
prices had risen so far so fast during 2009-2011 created the potential
for a substantial swing in a different direction.
In any case, that the "QE" programs and the other extraordinary measures
implemented by the senior central banks have appeared to work over the
past two years will encourage more of the same and therefore greatly
reduce the probability of monetary policy becoming prudent anytime soon.
In order to get a positive change in policy, the problems caused by
previous actions will have to become blatantly obvious. Also, from the
collective view of policy-makers, influential economists and the
financial press, deflation will have to be eliminated from contention.
Looking at it another way, there will be no limit to what central banks
will do to devalue their currencies as long as the problems caused by
earlier attempts to devalue are not blatantly obvious and as long as
deflation is generally perceived to be a realistic possibility, so
afraid are most central bankers, economists and journalists of your
money being able to buy more in the future than it does today.
Consequently, the more correct the deflation forecasters appear to be in
the short-term, the more incorrect they will end up being.
the 11th November 2013 Weekly Update:
Currency Market Update
The 'big' fundamental change last week was Thursday's surprising
decision by the ECB to cut the Refinancing Rate (the interest rate that
banks pay to borrow money from the ECB) from 0.50% to 0.25%. It seems
that 0.50% was deemed to be too high a price for banks to pay for
This rate change is only symbolic, because taking a near-zero interest
rate a little closer to zero obviously won't remove any constraints. In
effect, the ECB's message to the world is: "We can be just as profligate
as the Fed!"
The currency market's reaction to the ECB news was interesting. The euro
initially plunged and the Dollar Index moved well above short-term
resistance at 81, but the US$ then gave up most of its gains and failed
to end Thursday's session above 81.
Thursday's market action was US$-bearish, but a stronger-than-expected
US employment report on Friday reignited fears of Fed "tapering" and
caused a new wave of US$ buying.
As noted on the following daily chart, the Dollar Index successfully
tested intermediate-term support at 79 late last month and broke above
short-term resistance at 81 last Friday. It is now clear that a
short-term bottom is in place, meaning that the Dollar Index is unlikely
to trade below its October low over the remainder of this year. However,
it is not clear that the Dollar Index has much additional short-term
The following long-term weekly chart puts the swings of the past two
years into perspective. On the long-term chart, the swings of the past
two years look more like ripples than waves.
Our view is that the Dollar Index is immersed in a major multi-year
basing pattern, not unlike the pattern that formed during 1988-1995.
What we don't have a strong opinion about is whether or not there will
be one more decline to the low-70s to complete the basing pattern. A
weekly close below 79 will signal that one more decline to the low-70s
is, indeed, on the cards.
the 4th November 2013 Weekly Update:
Eric Sprott's Flawed Analysis
Great success in business or investing does not imply great
understanding of macroeconomics or how the gold price is formed. This
has been proved many times in the past by Warren Buffett. Recently, it
has also been proved by Eric Sprott in an
open letter to the World Gold Council (WGC). Sprott criticises the
hopelessly-flawed supply-demand analysis of both the WGC and Gold Fields
Mineral Services (GFMS), but not for the right reasons. He actually uses
the same hopelessly-flawed methodology, the only differences being in
some of the figures that are plugged into the analysis.
Sprott, the WGC and GFMS tally the amounts of gold bought by some parts
of the gold market and call this quantity "demand", and tally the
amounts of gold sold by other parts of the gold market and call this
quantity "supply". They then compare the two tallies to determine
whether the gold price should be rising or falling.
In this method of analysis, the gold-mining industry is by far the
biggest seller. In fact, in this method of analysis the supply side of
the equation is always represented by the 2400-2800 tonnes per year of
gold produced by the mining industry plus the amounts of gold sold by a
few relatively minor players. Over the past year the gold ETFs have
collectively been one of these minor players on the supply side
(physical gold has left the ETFs).
In the real world, however, the supply side of the equation is the total
aboveground gold inventory, which is about 150,000 tonnes. Since all the
gold is always held by someone, demand is also equal to the total
aboveground inventory of (very roughly) 150,000 tonnes. In other words,
at any given time supply equals demand equals 150,000 tonnes.
In the real world, the gold sold by the mining industry is no different
to the gold sold by any of the current holders of gold. For example, if
the gold price reaches a level at which Trader A wants to buy 1,000
ounces of gold, then Trader A's demand can be satisfied by a sale of
gold on the part of any of the current holders of gold, including the
Price is the quantity that changes to keep supply and demand in balance.
If demand increases relative to supply at a certain price, the price
will immediately adjust upward by as much as it takes to re-establish
the balance. By the same token, if demand falls relative to supply at a
certain price then the price will immediately adjust downward by as much
as it takes to re-establish the balance. Price, therefore, is the only
measure of whether the urgency to sell is rising or falling relative to
the urgency to buy.
Here's another way to look at the situation: For every purchase there
must be a sale. That is, the amount of gold sold must always be equal to
the amount of gold bought (another reason, by the way, that it makes no
sense to separately tally sales and purchases as if one could ever be
larger than the other). What causes the price to change, therefore,
isn't a greater volume of selling or buying, it's the relative eagerness
of buyers and sellers. For example, if a large number of eager
get-me-out-at-any-price sellers enter the market then the volume of
trading will increase, meaning that the amount of gold sold and the
amount of gold bought will increase by the same amount, and the price
will fall. Some analysts will look at the increase in buying that
accompanied the price decline and will be nonplussed, because they don't
seem to understand that an increase in buying MUST go hand in hand with
an increase in selling, and that the price decline tells you with 100%
certainty that the sellers were more eager than the buyers.
Over the past six months we've probably devoted too much space in TSI
commentaries to debunking the nonsensical gold supply-demand analysis
that gets put out by GFMS, the WGC, and now Eric Sprott. However, it's
an important issue, because gold bulls (including us) can't learn from
past mistakes unless they understand why they were wrong. If you were
bullish over the past year and you still believe that you were right to
be bullish, then you haven't learned anything and you will almost
certainly make the same mistake again.
the 16th October 2013 Interim Update:
The China-Gold Myth
Rather than cast doubt on the wrongheaded idea that China's buying is a
cornerstone of the gold bull market, the fact that a major 2-year
correction in gold's bull market has coincided with a large increase in
the amount of gold flowing into China has only served to fuel conspiracy
theories. After all, how could the gold price trend downward in parallel
with a large increase in Chinese demand unless powerful, unnatural
forces were at work?
The gold price is capable of trending downward in parallel with a large
increase in Chinese demand because the change in China's demand for gold
explains very little about past movements in the gold price and says
very little about likely future movements in the gold price. In more
general terms, the amount of gold flowing from one geographic region to
another or from one set of holders to a different set of holders tells
us nothing useful about gold's major price trend. The reason is that the
flow of gold is an indicator of trading volume, which can increase or
decrease in parallel with a rising or a falling price. The market-wide
urgency to buy relative to the market-wide urgency to sell is what
determines the price, and the only reliable indicator of whether buyers
or sellers have greater urgency is the change in the price itself.
By way of further explanation, consider a model of the global gold
market in which there are only two traders: China and the World
Excluding China. We'll refer to China as Trader A and the World
Excluding China as Trader B. Clearly, in order for Trader A to increase
its gold exposure, Trader B must decrease its gold exposure, and vice
versa. To put it another way, for A to be a net-buyer B must be a net
seller, and for B to be a net-buyer A must be a net seller. Price is the
force that keeps the change in A's demand in balance with the change in
B's demand. This means that if B is not prepared to part with enough
gold to satisfy an increase in A's demand at a gold price of X, then the
price will rise to (X+Y) where Y is whatever it needs to be to bring the
market into balance.
Those making the "China's buying is bound to drive the gold price to new
highs" claim are, in effect, only looking at one side of the equation.
They are looking at A's buying and forgetting about B's selling. They
seem to be making the assumption that A is increasing its buying while B
does nothing, but this assumption is patently wrong because A cannot
possibly increase its buying unless B increases its selling. The change
in price is the only valid indicator of which is the more important, A's
buying or B's selling. Moreover, a net flow of gold from A to B or from
B to A could be accompanied by either a rising or a falling gold price.
In fact, not only is a net flow of gold from B (the World ex-China) to A
(China) not inherently bullish, a net flow in the opposite direction
would not be inherently bearish.
Another relevant point is that Trader B (World ex-China) is the
proverbial gorilla in the gold market. To understand why, consider that
in very rough terms there are probably at least 150,000 tonnes of
aboveground gold in the world and probably no more than 10,000 tonnes of
gold in China. This means that when total gold supply is taken into
account, China is probably no more than 6.7% of the global market. This,
in turn, means that it would take a 30% increase in China's gold demand
to offset a 2% decrease in gold demand across the rest of the world. It
is therefore fair to say that if the overall demand for gold outside
China rises by at least a few percent then the gold price is going to
rise, regardless of what's happening in China, and if the overall demand
for gold outside China falls by at least a few percent then the gold
price is going to fall, regardless of what's happening in China.
To sum up, we aren't saying that an increase or a decrease in China's
gold demand is completely irrelevant. We are saying that a) China can
only increase its gold ownership if the World Excluding China decreases
its gold ownership, b) price is the only reliable indicator of the
importance of China's gold demand relative to the gold demand of the
World Excluding China, and c) China's gold demand is dwarfed -- in terms
of effect on the gold price -- by the overall change in gold demand
As explained in many previous TSI commentaries, the overall change in
gold demand outside China is largely determined by confidence in the
senior central banks and the stock market's valuation trend.