Gauging the Mess


By John Cassimatis

Oct 27 2008 12:19PM


I continue to find it interesting just how many people seem to know exactly what is going to happen to the macro economy and then, for the purposes of this web sight, the corresponding reactions of gold and silver. Back in April, I was highly skeptical of the commodity space precisely because I feared the market had too much faith that the then-unfolding housing/bank crisis would be contained to America’s borders. Prognostications about a USD collapse subsequently followed, and a theoretical explosion of gold, all amidst a nervous, but still complacent equity market. While I had urged caution to my readers, and specifically recommended severely paring back positions, inclusive of metal’s positions, I had not quite understood the exact fullness to which those general reservations would grow.  I hadn’t understood the extent of the credit default swaps, and the extent of bank leverage, and the counterparty inter-connectedness that would, before long, sink the ship and now spread to all corners of the globe. One of the things I keep considering in all this is just how many people “knew” then in late spring that “gold would go to the moon” and on CNBC, that stocks were to be “bought today, bought tomorrow, bought next week, and bought next month.” It is in that light that I will share my thoughts, which will, at this dramatic time in financial history, be just that: thoughts. While there are times we can rightfully know, and fully trust in that sense, this is not one of them. But we can have ideas…

As for equities, and the associated deleveraging, which has obviously affected gold negatively, I think we are nearing an intermediate bottom from which we should bounce, maybe as soon as this last week of October. I’m not really sure what the catalyst might be besides the commencement of government responses actually hitting the market coupled with a general easing of the “necessity to sell.”  There are several things that I noticed this Friday, October 24th that lead me to believe this may be true. I will list them.

  1.  Gold staged a 70 point rally off a level of suspected support, $680.
  2. The Japanese Yen has gotten parabolic, indicative of periodic tops that accompany an abatement of “carry trade unwind”, or risk averse pressure.
  3. The dollar is nearing resistance at US trade weighted average of 90
  4. 10-year bond finished down on day, failing around resistance at 116-117
  5. US equities didn’t capitulate while given every reason

It seems to make sense that we are preparing to hold around here, or around S & P 775, and, come the end of the mutual fund’s fiscal year on Oct. 31, possibly begin to find some buyers, which has been the problem. Please do not believe the people that say, for both gold and equities, that these price declines are simply marginal calls, or the product of non-fear based selling--selling that doesn’t have to do with the deteriorating fundamentals, but rather just forced. What those people do not understand is that if the fundamentals looked better, there would be buyers to offset those sales.  Unfortunately, finding those buyers has been the market’s problem. 

Short term, gold looks set to trade between 680-705 on the low side with a push up to 775, and definitely facing pretty good resistance there, as in I’d take my sale on the first approach and re-evaluate.  Silver should find buyers, I will finally be one of them, near $8.30 should it hit that price.  I will be holding out for it with impressive discipline. Short term, the metals are pricing in deflation. The deflationary case is clear. Governments can’t make banks lend.  Banks are hoarding cash. How naïve do you have to be to think banks are going to simply reopen the coffers here?  Private wealth is evaporating at a clip that exceeds the rate of money creation—money creation that has not fully come from the printing press as Treasuries have had a robust bid due to the turmoil? Yes, add in a contracting global economy and these forces are disinflationary at best. By next summer, it wouldn’t surprise me to see the XAU at 45-50. Yes, after a rally here, which very well might not even happen, though I think it will, we are going down more in equities.  We have to.  I’d be shocked if we didn’t.  So far, not out-thinking the relationships that have been, that means more money will likely be pouring into bonds and the USD will have a bid and gold will go lower.  Maybe, as the next wave down will be more of a trickle in my opinion, with far less fear, there will not be a surge in bond demand, and the Dollar will not advance at the same clip.  This is certainly possible.  But at the very least, we need to be concerned that there really doesn’t seem to be a catalyst that will drive gold substantially higher through mid-next year short of the possibility of widespread currency collapses.

But what happens then?  Does the globe enter a Japanese-style prolonged period of deflation or was that a product of BOJ inaction, dissimilar to what we are seeing by world central banks here?  My very smart friend keeps telling me it’s inflate or DIE. It certainly seems as though that is a consequence the US policy makers will not only accept, but given our debt levels, potentially strive for.  So will it be so?  These are the questions. And the answers depend on so many variables. For instance, if the demand for US treasuries stays as strong as it has been, then we will have to inflate less.  If it dries up, we will print the money.  We will have to.  The first scenario drives bond prices up (insatiable demand), and the other, bond prices lower (printing press).  I continue to believe that gold cannot go on the “run to the moon” in an environment of well-bid bonds.  Of this I am sure. If we have to print the money, or if all the money banks are saving up right now keeps building and building before finally being “released on the public”, or, if after the panic subsides, the great transfer of private to public debt that is occurring gets examined with more international disdain, then perhaps, yes, there will be an inflationary period, possibly even a hyper-inflationary period that follows as our currency re-adjusts downwards.  This certainly needs to be a contingency that requires planning. Look at Iceland. And there are mumblings of more debt defaults in Korea and Hungary and, Russia perhaps. That would be big. It almost seems irresponsible to have a great deal of dollar wealth and not protect it somewhat should this outcome occur.  In theory, you could end up with nothing if you don’t. And what of this crisis so far hasn’t been far worse than anything even the biggest bears thought possible?

Sadly, a credit crisis leads to overwhelming deflation fears which collapses everything including the metals and increases the demand for cash which drives up the dollar which decreases the price of the metals further. This is what just happened. No, unfortunately for loyal metals investors, it is only a currency crisis that will drive the metals materially higher.  Whether or not a USD currency “crisis” will ever develop remains to be seen. Every time I think bonds are ready to collapse, they rally. But the bull market in them has been 20 plus years long. What goes up, must…

Read Chris Laird’s latest piece as I think he spells out the situation very clearly.  He refers to a possible currency crisis and I agree with that assessment. All I can say is that if that were to materialize, it wouldn’t matter if you bought your gold at $600 or $700 or $1000. But before we get to that potential nightmare, we must access the probable course for gold in its absence.  Then we can adequately gauge risk. I see it this way--after a brief counter move here in equities and hopefully metals, gold will start the trickle down from higher levels.  It will only end when the aforementioned inflationary scenarios take place, or the markets begin to price it in. Other than that, the trickle down into next summer can only be avoided by a series of non-US currency collapses that heighten risk as to this potential eventuality, and gold will rise some as it prices that fear into the realities of the US balance sheet.

John Cassimatis


John Cassimatis has been managing his own capital for 14 years in various markets.