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There is often a
moment in a major market move where public perceptions of the item suddenly
change and the feeling is something like: "Yup, this REALLY is a bull
market!" or "Yup, this REALLY is a bear market!" This is
sometime called the "Point of Recognition".
Gold and the US
Dollar seem to be experiencing something of this nature right now, except
that gold is being recognised as being in a bull market and the US Dollar as
being in a bear market. The Point of Recognition generally occurs about
midway through a major move, and is a useful guide as to the remaining length
of the move underway. Very often the Point of Recognition is seen as a large
gap on the chart of the item.
 
Data updated to
26 Oct 2007.
In this chart of
the COMEX Gold price, a gap occurred Friday 26 October 2007 and with gold
trading in Asia at around $790 in morning trade on Monday 29 Oct 2007,
another gap may be formed in USA
trading today (29 Oct 2007). There is little doubt that the perception of
gold has changed in the past week and one can sense the new sentiment of
"Yup, this is REALLY a bull market" has emerged in the market
place.
If we
saw the midway gap on Friday 26 Oct 2007 at $777 on the Gold COMEX Futures,
we can estimate that the current up move should take the gold price to around
$900 without any significant corrections on the way. This is
calculated by deducting the starting point of the move at $647 from $777,
giving a figure of $130. When $130 is added to the midway point of $777, we
get a target of $907.
There are still
sceptics around, people pointing to sentiment indicators that suggest that
gold is over-bought. Numbers such as 92% bulls are suggested as a reason why
the gold market should turn around and correct. The fact is that in a real
bull market, sentiment numbers can (and often do) remain extremely extended
for considerable periods of time. People who rely on these
over-bought/over-sold indicators may find that they miss a major opportunity
or, worse still, suffer burnt fingers.
The Point of
Recognition appears to have come about due to an increasing awareness of the
economic crisis that has developed and the safe haven properties of precious
metals. The world is facing a truly unprecedented series of global events,
the consequences of which will represent the single most important factor
impacting investment decisions from now onwards.
We cannot
understand the present or make practical, useful, forecasts without knowing
where we have come from. Some historical detail is imperative. The following
few paragraphs are extracted from an article by Richard Duncan in the
September issue of FinanceAsia and they explain the
historical perspective succinctly and extremely well:
Flaws in The
Dollar Standard
The Dollar
Standard is the most appropriate name for the international monetary system
that evolved following the collapse of the Bretton
Woods System in the early 1970s. The principal flaw in The Dollar Standard is
that it has no mechanism to prevent large and persistent trade imbalances
between countries. Consequently, the deterioration in the United States' current account deficit has
gone unchecked, recently reaching nearly 7% of US GDP. The countries with a
trade surplus with the United
States have been blown into economic
bubbles. Japan in the 1980s, the Asia Crisis countries in the 1990s, and China today
are examples. Moreover, as the central banks of the United States' trading partners have
reinvested their dollar surpluses back into US dollar assets, the United States
itself has also been blown into a bubble. In short, the US current
account deficit has destabilized the global economy. That was the theme of my
book, The Dollar Crisis: Causes, Consequences, Cures (John Wiley & Sons,
2003, updated 2005).
Before the
breakdown of the Bretton Woods International
Monetary System, international trade balanced. Subsequently, however, the gap
between what the United States
bought from the rest of the world and what the rest of the world bought from
the United States
began to steadily expand.
Under a Gold
Standard, or the quasi gold standard Bretton Woods system, such large trade deficits would not have
been sustainable since the US
would have had to pay for its deficits out of its limited supply of gold
reserves. However, the willingness of the United
States' trading partners to accept payment in dollars
instead of gold meant there were effectively no limits as to how large the US trade
deficits could become. This vendor financing arrangement allowed much more
rapid economic growth around the world than would have been possible
otherwise. The larger the US
current account deficit became, the more the United States' trading partners
benefited.
When the foreign
companies selling product in the United States took their dollar
earnings home and converted them into their own currencies, it put upward
pressure on those currencies. The central banks of those countries intervened
to prevent their currencies from appreciating so as to preserve their trade
advantage. They intervened by creating money and buying the dollars entering
their countries. In this way, the exporters were able to keep their export
earnings in their domestic currency and the central banks accumulated large
foreign exchange reserves.
As the US
current account deficit grew larger, central banks created more and more
money and intervened on a greater and greater scale each year. In fact, total
foreign exchange reserves have doubled over the past four years. In other
words, during the course of the last four years, foreign exchange reserves
have increased by as much (US$ 2.8 trillion) as in all prior centuries
combined. The reinvestment of those dollar reserves into US dollar assets
fuelled the credit excesses in the United States that culminated in
an unsustainable property bubble there.
It is this
sequence of events that has created the vast distortions in the world
economy, the vast growth in Debt, Deficits, Derivatives and other acronym
challenged pieces of paper. The real estate crisis in the USA, combined with illegal and
fraudulent practises in the sub-prime market, has resulted in a situation
where global credit markets are caught up in a systemic crisis, possibly the
worst ever.
The US
is caught between a rock and a hard place. If the Fed does not reduce
interest rates, the economy will unravel and massive de-leveraging will occur
with devastating consequences. If the Fed does reduce interest rates, the US
Dollar will continue to tank, probably at an increasing rate. We already know
that the Fed has made its choice. It will abandon the US Dollar and try and
save the economy.
Let's
be blunt about it: THE US DOLLAR IS IN A DEATH SPIRAL. This is already
(and will become increasingly more so) the single most important factor to
consider in investment decisions.
Those countries
that continue to intervene in currency markets to prevent their currencies
from appreciating against the US Dollar will cause their currencies to follow
the US Dollar into the Death Spiral.
We are facing
the end of the US Dollar Standard in world trade. It is the end of an era
that has spanned 36 years and there is no ready-made replacement for the US
Dollar as a unit of measurement. The world is facing a period of monetary
chaos.
How this will
all work out is extremely uncertain. It is possible that the world is facing
a debt implosion and a deflationary crash. The background factors for that to
happen are all in place. Governments, such as the USA
and Britain,
have indicated that they are not prepared to accept the pain of a
deflationary depression and will do whatever they have to do in order to
prevent this from happening. They are prepared to sacrifice their currencies
and endure a wild ride on inflation - if that is what is required. There
appears to be no middle or "muddle-through" path. An ugly, damaging
landing of some description seems to be inevitable.
These opposing
forces, Deflationary vs Government Intervention, in
an era where the US Dollar Standard is rapidly coming unhinged, leads to an
expectation of Hyper-Stagflation as the possible economic outcome.
How does one
handle the situation from an investment standpoint? If the deflationary
forces do produce a massive collapse despite the Government's and Fed's best
efforts, the safest and possibly best place to be is in Government Bonds. If
it is the Hyper-Stagflation scenario, one would want to be in tangible
assets, "store of value" items, of which precious metals will no
doubt prove to be the best and safest haven.
As nobody can be
absolutely certain as to the how this major crisis will play out, the prudent
and conservative policy is to have something in both camps, adjusting the
percentages as time goes by when it becomes clearer which of the two outcomes
will prevail.
Money is
flooding into US Treasury bonds and into gold, silver and oil. It seems that
money managers have passed the "Point of Recognition" and are
adopting the prudent and conservative policy suggested above.
Alf Field
Disclosure and Disclaimer
Statement: The author is not a disinterested party in that he has personal investments
gold and silver bullion, gold and silver mining shares as well as in base
metal and uranium mining companies. The author’s objective in writing
this article is to interest potential investors in this subject to the point
where they are encouraged to conduct their own further diligent research.
Neither the information nor the opinions expressed should be construed as a
solicitation to buy or sell any stock, currency or commodity. Investors are
recommended to obtain the advice of a qualified investment advisor before
entering into any transactions. The author has neither been paid nor received
any other inducement to write this article
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