Runaway Spending Fueling Gold

By Mike Swanson                        September 19, 2005   wallstreetwindow.com

When gold broke 450 last week it made a key breakout. For the past nine months, 450 has been resistance on gold. The move up in gold is being helped by fears of inflation due to several things - the flooding in New Orleans, high oil prices, signs that the Fed is near the end of its cycle of raising interest rates, and an increasingly vulnerable dollar.

The spending approved by Congress and the President for New Orleans is busting the budget deficit. According to Republican Congressman Ron Paul:

"Congress reacted to Katrina in the expected irresponsible manner. It immediately appropriated over $60 billion with little planning or debate. Taxes won’t be raised to pay the bill – fortunately. There will be no offsets or spending reductions to pay the bill. Welfare and entitlement spending is sacrosanct. Spending for the war in Iraq and the military-industrial complex is sacrosanct. There is no guarantee that gracious foreign lenders will step forward, especially without raising interest rates. This means the Federal Reserve and Treasury will print the money needed to pay the bills. The sad truth is that monetary debasement hurts poor people the most – the very people we saw on TV after Katrina. Inflating our currency hurts the poor and destroys the middle class, while transferring wealth to the ruling class. This occurs in spite of good intentions and misplaced compassion."

"We face a coming financial crisis. Our current account deficit is more than $600 billion annually. Our foreign debt is more than $3 trillion. Foreigners now own over $1.4 trillion of our Treasury and mortgage debt. We must borrow $3 billion from foreigners every business day to maintain our extravagant spending. Our national debt now is increasing $600 billion per year, and guess what, we print over $600 billion per year to keep the charade going. But there is a limit and I’m fearful we’re fast approaching it."

"Runaway inflation is a well-known phenomenon. It leads to political and economic chaos of the kind we witnessed in New Orleans. Hopefully we’ll come to our senses and not allow that to happen. But we’re vulnerable and we have only ourselves to blame. The flawed paper money system in existence since 1971 has allowed for the irresponsible spending of the past 30 years. Without a linkage to gold, Washington politicians and the Federal Reserve have no restraints placed on their power to devalue our money by merely printing more to pay the bills run up by the welfare-warfare state."

"This system of money is a big contributing factor in the exporting of American jobs, especially in the manufacturing industries."

"Since the last link to gold was severed in 1971, the dollar has lost 92% of its value relative to gold, with gold going from $35 to $450 per ounce."

"Major adjustment of the dollar and the current account deficit can come any time, and the longer the delay the greater the distortions will be in terms of a correction."

On Friday, the University of Michigan sentiment survey was released and showed a sharp plunge in consumer confidence from 89.1 in August to 76.9 this month. Even more troubling, the survey's expectations component fell to 63.6 from 76.9.

High oil prices and maxed out credit cards may finally be taking their toll on consumers. They certainly have them worried, but consumers have not yet taken action based on these worries, they have yet to slow down their spending. It is only a matter of time before they'll have no choice in the matter. The economy has been slowing all year. Over the past four quarters, GDP growth has slowed down. Manufacturing orders have been falling every month.

These facts have economists looking forward to the end of the Fed's cycle of raising interest rates. The Fed meets Tuesday to decide whether or not it will raise rates again this September. Some weekend news stories are looking for the Fed to raise rates, but to cushion the impact by dropping its familiar verbiage of doing so at a "measured pace" to prepare the ground for the end of the cycle. I don't know if they are going to do that or not, but I'm sure such speculation has helped fuel gold over the past few days. I wouldn't be surprised if gold pulls back down after the Fed meeting. Markets have a tendency to buy the rumor and sell the news and, in this case for gold, the rumor is the Fed meeting.

This would make sense technically also. Often when a stock or a market breaks out of resistance it pulls back into its base, pauses, and then breaks out again to begin its real run. I expect this to happen again. What is more, gold stocks are now overbought:

Just like the metal, the XAU gold stock index flashed a major long-term buy signal last week when the XAU/gold ratio broke out of a downtrend resistance line that goes back for almost two years. Every time in the past three decades when this type of resistance line has been broken, gold stocks have rallied for at least six months. This time is unlikely to be any different.

However, I would expect some sort of pause before we rally much higher. The XAU has gone straight from 100 to 110 in the past two weeks. And 110 is resistance that goes back to the Fall of 2003.

The XAU is also overbought. It is above its bollinger bands and is also now above the resistance line in its upward trend channel that has been in place since May. I can see it pulling back to the 102-105 area, then basing for a few weeks before breaking out again.

I am not selling my gold stocks. I am holding on and I plan on selling when I get a long-term sell signal - when the price of gold outperforms the XAU for at least a week. I am not getting a sell signal now, only a signal telling me that the XAU is overbought.

But an overbought signal is not a reason to sell. The big gains aren't even here yet. We've only seen a preview of what is to come. When the Fed stops raising interest rates in one or two FOMC meetings after this next one, the price of gold is going to explode. If gold is going up now on mere 'speculation' that the Fed may change some of the language in its statement, what do you think will happen when they actually stop raising rates?

The dollar hasn't even started to drop yet and gold is going nuts! I think we're going to see the XAU and gold pause over the next few weeks to digest its gains and then breakout again as the US dollar tops out and starts a move towards its 80 resistance level into the end of 2005.

The move then in gold stocks will be incredible. You have no idea how good it can be. Gold stocks are going to end up trading like Internet stocks did in 1999.

What you should do now is go over your portfolio of mining and exploration stocks. Don't sell all of them. Go over them and sell those that are lagging or are questionable companies with the intention of placing the cash you raise into better companies over the next couple of weeks.

You want to be positioned before the next breakout in the best gold stocks so you can fully benefit from this gain. I plan on picking a few more out once we see gold make a pullback. It could happen right now or in a few days, but it will eventually happen. If it does pull back, don't let it scare you! You should be ready to buy more and build your position up.

To find out what gold stocks Mike Swanson holds and plans on buying subscribe to his free Weekly Gold Report at http://wallstreetwindow.com/weeklygold.htm