Gold: $1525 Support Seems Likely to be Broken

Conclusion

It seems likely that, within the next week or two, the market will come to understand that a “hyperinflationary” solution to the European financial crisis is very unlikely given that the European Central Bank has a monopoly on printing Euros. The reason is that it is very unlikely that the ECB will bypass the double entry bookkeeping convention and just “print” money with no matching debits showing Euro denominated loans owing. i.e. Inflation of the European money supply will be matched by growth of debt levels within Europe.

Author comment:

I am not a  financial adviser, but if I were a betting man, I would bet that the gold price will soon resume it secondary southward move within its Primary Bull Trend. My reasoning is very simplistic: If any European country were to unilaterally withdraw from the EU, then whatever debt it has in Euros would have to be treated as a potential bad debt in terms of Generally Accepted Accounting Practice (GAAP). Applying a “reasonable man’s” argument , if Greece were to unilaterally withdraw (or be kicked out), it is quite reasonable to expect that the Greek Government  would no longer have the support of the ECB and would need to print drachmas to pay its bills. The flip side of this would be that the drachma would collapse relative to the Euro – implying that Greece’s sovereign debt that is denominated in Euros would almost certainly be rendered unpayable. In turn, writing off Greece’s sovereign debt would have a “knock-on” effect because the five large banks in the US who hold most of the world’s derivatives, would need to crystallise a provision for losses on payout of its debt derivative contracts, thereby decimating their already unacceptably low capital adequacy ratios in terms of BIS guidelines; which will probably render them bankrupt.  In turn, banking institutions that thought they had insurance, and that now discover that they don’t, will also have to provide for bad debts, and their capital adequacy ratios would fall to unacceptably low levels; and many of those banks would be bankrupted. The logical end result will be a total – and overnight – collapse of the world’s financial system. The probability of this happening voluntarily is zero, and if some cockamamie rationale were to be put forward that an “agreement” had been reached that Greece’s withdrawal from the EU would not require a provision for bad debts equivalent to 100% of its sovereign debt, then this would be such an affront to common sense (and in such flagrant disregard of GAAP) that confidence in the financial system would be shattered . Therefore, Greece cannot be allowed to withdraw until after “firewalls” have been put in place. Therefore, those who have bought gold for “speculative” reasons, in anticipation of a European break-up, are unlikely to see their anticipated “rocket ship to the stars” profits in the short term.

Interestingly, whilst the US equity market undoubtedly gave a Dow Theory, Primary Bear sell signal a couple of weeks ago, the 3% X 3 box reversal Point & Figure Chart  below has not yet given a sell signal. Further, if it does, the measured move target will be around the 10,000 level (9,815 – 10,182) – which would not be catastrophic.

So what is the market seeing? How can we work our way out of the apparently insoluble mess? Stay tuned. The opportunity to be discussed in my second article of the trilogy on US Deflation vs EU Inflation may sound like a long-odds bet, but it does seem to have legs; and whilst “time” will be the enemy of this particular opportunity, capitalising on the opportunity itself will take the world economy a step in the right direction.

Brian Bloom
Author, Beyond Neanderthal and The Last Finesse
www.beyondneanderthal.com