Gold – a Primer for 2017

by Alasdair Macleod, GoldMoney:

You know when to buy gold: it’s when nearly every trader and commentator tells you that gold is going lower and you should sell it.

This is Harry Dent on 10th January: “I still see gold landing somewhere between $650 and $750 in the next year or so” i. Dent invokes Elliott Wave Theory. EWT states that a bull market is comprised of impulse waves of three separated by two corrective ones, totalling five all together. Bear markets are made up of three waves, two impulse in the direction of the bear trend, separated by one consolidating countertrend.

I am simplifying the theory considerably to make a point, but I do know my onions, having in the past taught, examined and lectured on EWT on behalf of the UK’s Society of Technical Analysts. Ralph Elliott only applied his theory to equity markets. Reflecting the greater value over time placed on stakes in human progress, it makes sense. It is modern chartists who have extended its use to other markets.

But money and currencies? The first decision you must make is which of the two variables in a price is in a bull market. It is commonly thought gold is the variable, but the chart below illustrates the problem is more likely fiat currencies priced in gold.

The four currencies shown, including the dollar, have been firmly in bear markets since the year before Bretton Woods was abandoned. Note also that the price scale in the chart is logarithmic, so these are enormous losses for fiat currencies. So, Dent and his fellow-travellers are effectively using a theory that was never intended to be used outside equity markets to recommend their clients and subscribers play a counter-trend rally that’s already over five years old.

Elliott theorists are also oblivious to a mathematical impossibility. If a currency is deemed to be in a bull market, it moves up in fives. If the other currency being measured against it, or commodity if you must, is in a bear market, it moves down in threes. How can one be moving in fives, while the other moves in threes? It cannot, it is a story of square pegs and round holes, and wholly disqualifies EWT applied to gold.

You cannot rule out the possibility that gold will go to Mr Dent’s $650 to $750, but for that to transpire I suggest two things would have to happen. Interest rates would have to be raised beyond the point where bad debts and falling bond prices break the banks, and the Fed would have to convincingly signal to markets that it is prepared to stand aside and let the banks fail. I believe these two conditions to be extremely unlikely. In the event of an interest-rate induced crisis, it is far more likely the Fed will repeat the successful formula (from the Fed’s point of view) of providing unlimited credit, as it did post-Lehman. A pathological fear of deflation ensures the outcome. And unlike the time of the Lehman crisis, investors will know the solution in advance, and their response will differ accordingly.

It was the post-election move in gold that wrong-footed everyone. A Trump victory was quickly turned from an event that brought with it heightened uncertainty, to one that promised higher interest rates, higher bond yields, and a strong dollar. The winners in this about-face, in the gold contract on Comex at least, were the bullion banks, which were very short. It suited them to drive gold and silver lower to close their short positions, and/or show favourable year-end book values. Amateurs in the game, who are nearly always caught out by the bullion banks’ periodic bear-raids, take the aggressive fall in prices as evidence that they should panic at what often ends up being the bottom of the market.

These banks are still short, having not managed to buy back all their positions, which is probably one reason why the current rally is so strong. And things are not looking good for the bullion banks, with prices running away from them with only a partial increase in open interest. As can be seen in the graph above, measured in gold the dollar has lost 97% of its value since 1969. If the dollar was a stock, informed opinion would be that it is bust and should not be bought. The same would be true of sterling, which has lost 98.5%, and the euro (including its components before 2001), down 98%. The legendary trader of yore, WD Gann, reckoned that any stock that fell to less than ten per cent of its high was probably bust, and should be avoided. It’s a good rule of thumb, and on that measure, not even the yen has a future.

The confusion for investors seeking guidance from so-called experts is they are always presented with charts showing gold priced in dollars. The immediate and unwritten assumption is that it’s the gold price that moves, and the currency is constant, overlooking the fact that the dollar persistently loses its purchasing power, confirmed by the almost continuous increase in the consumer price index. Showing gold priced in dollars, or any other currency for that matter, also encourages the myth that gold is an investment which either outperforms or underperforms cash. Technically, gold is not an investment. It is either a commodity, money or both, depending on your point of view and how you define things. Almost all financial commentators, including most gold bugs, make this very basic mistake.

Another myth that must be addressed is that gold is no longer money. For most of the world’s population, it most certainly is money, mainly because of its superior qualities as a store of value. Our second chart shows what has happened to selected Asian currencies over the same time-frame as the first chart, and includes the US dollar for comparison.

A Turkish national, holding on to his lira, has lost 99.99999% of his purchasing power measured in gold. An Indonesian has done somewhat better having lost 99.92565% on his rupiahs, but we are splitting hairs. The point is, does anyone seriously think the nearly two billion people behind this sample regard their governments’ fiat currencies as having any use beyond a means of rapid exchange?

Obviously not. Gold will always be regarded by all Asians as the preferred money, to be bought and held by selling the fiat. The only people who argue that gold is no longer money are Western-educated economists and their followers, having influence over an audience which mostly doesn’t care one way or another. These economists and their epigones probably number no more than a million or so, being a percentage of the global population that is not too remote from the percentage losses an Asian has suffered by holding on to his national currency.

The economists’ motivation is not so much a search for the truth, but more of a consequence of the sponsorship of their education by governments, and subsequent employment by both government agencies and a compliant financial establishment. Economists are like the three wise monkeys in their support for government currencies. The United States government does not want to see any challenge to its primacy over issuing the world’s reserve currency, and does everything to protect it, with a special dislike (or is it fear?) reserved for gold. Therefore, establishment economists dance to this tune, and are paid to do so.

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