Assessing Gold’s Drop – Sep 23, 2011

Assessing Gold’s Drop – Sep 23, 2011

Here’s the news of the week – and how we see it here at McAlvany Wealth Management:

1. Assessing Gold’s Drop: There is no way to sugar coat it, gold dropped by a whopping 6.82% during the week, with the majority of that drop occurring Friday. Silver was true to form and followed suit, shedding nearly 19%. Silver has erased a little over 75% of its rally for this year – which started in late January.

Deliberate manipulation by short-sellers, covering stock losses, deflationary concerns, reductions in “hedging,” and rumors that even the French were selling gold were all offered up as plausible reasons for the sharp correction. None of these explanations, though somewhat believable, really made sense to us given the stability of the markets on Friday. In reference to covering stock losses, the last time the Dow rested at 10,700 as it is today, gold traded in excess of $1,900, so selling gold for these reasons and with such violent contempt seemed a bit unrealistic.

As for the deflation argument, we still have yet to see the full impact of the last ten years of inflationary exploits carried out in the markets. The Treasury market has yet to discount once ounce of that inflation, and, as we’ve said before, gold still sells at a massive discount to its inflation-adjusted price.

As it turns out, the CME had raised margin requirements on gold by 21.5% and on silver by 15.6%, triggering deleveraging in the futures market for the metals. This had more to do with gold’s record drop than anything else. All of the other reasons were simply icing on the cake.

On the brighter side, Gold did manage to close above its 100-day moving average of 1638, in the recent past this has indicated a turnaround was imminent – though we cannot rule out further consolidative action in the short run.

To be fair, gold was “toppy” and overdue for some kind of correction regardless of the activity in other asset classes. And it certainly doesn’t help matters when so many economists and analysts are throwing out what we believe to be spurious comparisons to 2008 in the process.

The simple fact was that, in the face of a strengthening dollar and Treasury market, gold simply couldn’t hold it’s own. But we feel that this cannot continue indefinitely. Treasuries in particular have reached bubble dynamics as of late, despite the fact that insolvency for the government is intensifying in the face of the economic contraction now underway. And as folks sour on Treasuries due to lack of future profit potential, gold and silver may not be in the doldrums for long as the list of safe havens narrows in their favor.

2. Fed Fails at “Beat the Number”: The FOMC meeting came and went with a yawn. The expected (or dreamed of) $600B to $1T QE party was arrested by a $400B plan whose net effect may actually do more damage than good to the economy. The plan was essentially neutral in terms of monetary creation, since the $400B would be raised from the sale of short-term securities the Fed holds and exchanged for debt with maturities of the 6- to 30-year persuasion. The market of course wanted some escalation in printing activity, but instead received a plan that may impede lending – since flattening the yield curve may impair carry trade operations.

What followed the FOMC announcement was a veritable slaughter in the markets (both here and abroad). Most everything shaved points save for the Treasuries and the dollar. In US markets, stocks fell an average of 6.5%, commodities fell 7.45%, while the dollar rose 2.18%. The yield on the 30-year Treasury, the Fed’s target in this case, fell 22 basis points to 2.90% – not yet the record of 2.52 set in 2008. The lower rates didn’t help real estate indexes, which shed over 10% along with bank stocks this week.

US Housing data came in better than expected for the month of August (probably due to bonds again), while jobs data worsened – we won’t bore with the details. Obama is due to launch his “American Jobs Act” sometime in the next month. Several are calling it the “Save Obama’s job Act” since his rankings in the polls are the worst ever – even among Democrats.

The plan is supposed to spend $447B on jobs while cutting some $3.6T from the budget over 10 years. We think the cuts may be largely fictitious, trimmed mostly from the growth in spending, but it may still qualify him to receive the extra $1.5T from the recent debt ceiling increase – his deadline to qualify ends in February next year.

Overseas, there appears to be no solution to the Greek bankruptcy issue. The Greek parliament is voting on some proposed austerity measures in order to qualify for aid. However, it also appears they are considering a withdrawal from the ECB altogether to face their problems alone. We submit that the Greeks may appreciate a weak(er) currency as a means to shift their economy back into some semblance of normalcy.

Italy’s rating was cut again, one grade to “A” this time, and the G20’s pledge to aid the eurozone went unnoticed by the markets. Along those lines, dollar swap costs across eurozone banks remain virtually unchanged from levels seen prior to the coordinated central bank plan announced last week – indicating a no-confidence vote with regard to additional monetary intervention. Siemens definitely sees something that frightens it. The industrial conglomerate has transferred nearly €6B from various eurozone banks into ECB facilities over recent weeks.

We mentioned a few weeks ago that the Fed may need to be more reverent about inflation, and perhaps its zero-sum QE plan reveals a more gradual development in policy. On the other hand, the Fed may not have seen much reason to print, as stock markets have yet to enter crisis territory – technically speaking.

Whatever the case, we do not rule out additional QE efforts, especially at critical junctures, but there is a growing concern that these injections of money into the system may be producing more harm to the economy than good (more inflation than growth) – limiting the Fed’s ability to be progressive in the future.

You might find interesting the information released by both Reuters and the WSJ pertaining to a letter written by House Republicans instructing the Fed to refrain from further intervention – delivered to the Fed just prior to Wednesday’s decision. We could not provide links in this case, but recommend the articles when/if they are posted on non-restricted access sites.

Best regards,

David McAlvany
President and CEO
MWM LLLP

David Burgess
VP Investment Management
MWM LL

2014-10-06T21:42:53+00:00

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