Gold News

Gold Makes "That" Move

Been waiting for gold prices to drop? Here you go...
 
WELL there you go, writes Greg Canavan in The Daily Reckoning Australia. Gold made the move we've been waiting for.
 
Gold went down, falling about US$30 an ounce Tuesday from the previous session. The reason given for the fall was stronger than expected US data – durable goods orders and consumer confidence readings improved – and an easing of tensions in Ukraine.
 
This was just the excuse the market needed to break lower. It had been trading in an increasingly tighter range these past few weeks and the pressure was building. It only required a few marginal data releases to push it either way.
 
That they all seemed to arrive on the same day was just what the bears were after. The bulls capitulated. When the selling took prices down to $1275 (previous support) it triggered a whole bunch of stop-loss selling, which pushed prices down further. It was also options expiration day for the June contract, which added to the volatility.
 
Now that prices have broken to the downside of the recent trading range, we would expect to see the gold price continue to fall in the short term. This is really just a prolongation of the 'bullish on central banks, bearish on gold' trend.
 
Another 'reason' given for the advance in equities overnight was the expectation of monetary easing from the European Central Bank. After all, boss Mario Draghi all but promised it at his last press conference.
 
For now, then, the general mood on equities is pervasively bullish. While there are all sorts of reasons to be bearish in the longer term (like, um, you can't print your way to prosperity) in the short term this just doesn't matter. They don't call it a bull market for nothing. Read Hemingway's Death in the Afternoon and you'll get a sense of just how aggressive, determined and powerful bulls are. When they see a target, nothing will stop them...apart from a sword between the shoulder blades.
 
So in the absence of a sword, stand aside...
 
While the bulls may have turned to the ECB for their monetary red rag, the market still has to deal with tightening from theUS Federal Reserve. The Fed has halved their taper program from $85 billion per month in December to $45 billion per month today. Given the recent data showing the US economy keeping its head firmly above water, the taper program is set to continue.
 
The Fed next meets in mid-June, then again at the end of July. They are likely to cut QE by $10 billion per month each time, bringing monthly purchases down to $25 billion by August.
 
If the taper program continues on schedule, the cumulative amount of liquidity injected into the system this year will be $460 billion. In 2013 it was over $1 trillion. This halving in liquidity creation is monetary tightening, but because it's yet to have a meaningful effect nobody sees it as such.
 
Based on the analysis we did in our most recent report for subscribers, we think this 'taper tipping point' is approaching. It will most likely arrive between July and early August, when monthly QE will effectively halve, from $45 to $25 billion. 
 
Using capital flow data from both the US Federal Reserve and the US Treasury, we showed how foreign capital inflow into the US has dropped precipitously in recent years. Foreign capital is crucial to fund US deficits. This is why the Fed ratcheted up its QE program in late 2012. It was designed to compensate for a lack of foreign capital...to fund the US standard of living.
 
However, there is one problem with this. The Fed is creating liquidity, not capital. Real capital has far more permanence than central bank created liquidity, which relies on confidence to survive. You cannot sustainably fund a deficit with the creation of liquidity. The crucial difference between liquidity and capital may not matter now, but it will matter when everyone decides to care about it.
 
That may sound flippant. But it's how investment markets work when mass psychology is at play. It's why rational people, focusing on fundamentals, end up tearing their hair out as the market continues to advance in the face of monetary craziness.
 
As the market grinds higher, more and more people stop believing in fundamentals. Or they think their interpretation of the fundamentals is wrong. Slowly, more and more people come to believe that the market is not dangerous...it's just the way it is in a 'new era' of central banking omnipresence.
 
'New eras' are often referred to justify why stocks are overvalued or won't correct substantially. New eras are all as beguiling as each other. In the 1920s, the 'new era' was tech stocks (radio was a new invention) as well as activist central banking.
 
In the 2000s, the 'new era' was again technology driven, accompanied (again) by easy money and faith in the Alan Greenspan-led Fed. In 2007 we didn't need a new era excuse to justify high prices. We just had an outright credit bubble that made everyone 'rich'.
 
Now, five years after the last debacle, we're in a weird new era. Technology is back in the game (social media, app land, etc) but this time it's all about central bankers...the perpetrators of the last few booms and busts. Such a view became entrenched in late 2012 when the Fed, the ECB and the Bank of Japan all went nuts on the monetary easing front. Stock markets started moving higher and gold started falling. The dominant theme of the markets is that the central bankers are in control.
 
Don't worry that history has proved time and time again that they are not in control. All that matters is that everyone believes they are for now. More importantly, everyone believes that everyone else believes it. This is a powerful dynamic, not easily altered.
 
Just about the only way that booms turn to bust is via monetary tightening. We're in that phase now. Will the taper be enough to cause a bust, or just a correction as excess liquidity flows out of the market?
 
We'll soon find out. But keep in mind that raising interest rates isn't the only way to tighten monetary policy. It can happen via deflation, which is the market's way of trying to regain balance. Deflation is a general lowering of the price level. In a sane world this would be a good thing, as it increases purchasing power.
 
In a world where debt growth drives economic growth however, deflation is nasty. Because it increases the real burden of the outstanding debt. If the general price level deflates, it increases REAL interest rates, and rising real rates = monetary tightening.
 
But it's all good. The modern central bankers' tool kit is well equipped to deal with such problems. Everyone knows that everyone knows it to be true.

Greg Canavan is editor and publisher of Sound Money, Sound Investments, a weekly financial report devoted to unearthing great value investments amid today's "money illusion" of fiat currency. Formerly editor of Australia's market-leading finance newsletter, Greg has been a regular guest on CNBC, ABC and BoardRoomRadio, as well as a contributor to publications as diverse as LewRockwell.com and the Sydney Morning Herald.

See the full archive of Greg Canavan.

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