Markets trade off of a strange mix of rumor, hard facts, and innuendo. But the one thing we can count on today is that whatever narrative is being spun by governments and central bankers is what will push the markets in the direction they want them to go. I've been an observer of this long enough now to look past what is being said, and try to make sense of what is actually happening. It seems as if every 60 days there is another crisis of market-shattering proportions. If this crisis is not resolved the way those with power want, then the consequences will be unspeakably horrible.
Markets dominated by massive hedge fund high-frequency volatility -- whose computer algorithms are trading off of headlines and key phrases in central bank pronouncements, as opposed to market fundamentals -- sow confusion and create fear when they should be discovering prices. In gold and silver, this fear is created through massive stop-loss raids.
This brings me to my first question. Do you honestly think Congress will not raise the debt ceiling when the time comes?
Given the statements by President Obama and outgoing Treasury Secretary Tim Geithner recently, it is pretty clear that if the House Republicans attempt to shut down the government, the hedge funds will crash the markets in retaliation. Read Geithner's letter (see link) and tell me that Goldman Sachs et al. would hesitate to play out the same drama it did during the original TARP vote four-and-a-half years ago when the Dow dropped 770 points in a day. They wheeled in a Big Board for that one. The only thing missing was George C. Scott and a few nuclear bombs.
Politically, the debt ceiling fight is a non-starter for Boehner and the Republicans, lest anyone forget Newt Gingrich (believe me, I try to every day). Therefore, it is a foregone conclusion -- in my mind -- that the debt ceiling will be raised. So this is nothing to fear.
Once the debt ceiling is raised, the last bit of uncertainty regarding where U.S. monetary and fiscal policies are headed will be removed. This will allow the markets to fully price in the effects of QE 2 and QE 4. Like the theater last summer over Spain and Italy, which brought the euro to its breaking point, these past five months have been staged to promulgate the fear of default and/or contraction in the U.S. That would be highly credit-deflationary and bad for gold in the short run. The endgame in Europe was the consolidation of power by Germany over the PIIGS, with the ECB as their leg-breaker. But neither catastrophe was ever a credible threat. It was a brilliant power play by the Germans to advance the euro project and a convenient time-buying mechanism for the Fed.
First, we were supposed to fear Romney's threat to Bernanke's job if he won the election. Then, on election night when he lost, it was the fiscal cliff we needed to worry about. Before the ink was dry on that deal we were moved right to being scared of the debt ceiling.
There wasn't even an intermission between acts to take a deep breath. It doesn't matter. It worked. The important strategic commodities (gold, silver, oil, and copper) stayed range-bound, even if they kept making higher lows on each correction.
But at what price? The amount of intervention into the gold (GLD) and silver (SLV) markets to keep prices under control was staggering. More than 200 of tons of gold were moved to China alone through Hong Kong. And that's just what they reported publicly. There have been rumblings coming out of Germany for months now, and on Monday evening a report I found on Zerohedge indicated that the Bundesbank will repatriate some of its gold. This isn't Hugo Chavez, folks. This is Germany and Germany has been playing for keeps during this entire eurozone crisis.
The immediate speculation from the gold bulls' side is: What happens when the Fed or the French cannot produce the Germans' gold because it has been loaned out almost a hundred times? That would be bad, certainly, but I don't think that's even necessary to speculate on. The Bundesbank will get its gold. The bigger question is: What happens when the next country asks?
And here's my second question: Has the current price management scheme in gold and silver gone on so long that the central banks are breaking ranks and moving to protect themselves from each other? China has already made its intentions clear by refusing to buy U.S. Treasuries and recycling its current account surplus into gold and other commodities.
The Swiss have let go of their peg against the euro (FXE). This will allow it to buy back all of those Francs it printed and get a little extra gold in the process. Buy low, sell high. Since the ECB's announcement last week not to raise rates, the EURCHF has risen sharply. I wouldn't doubt if January's TIC Report shows the Swiss selling some U.S. Treasuries.
The $1,800 Glass Ceiling
Any novice chart reader can look at $1,800 per ounce and see how important that price is to the gold market -- a quadruple top on the monthly chart. But the seeds for another assault on $1,800 have already been sown. All that remains is for the last small threat of deflation to be erased, and then there will be no credible means by which to talk the gold price down from where it wants to go.
Between now and that day, however, we can expect a barrage of bearishness and speculation that will create the idea of a gold bull market that is over. When, in reality, this is simply a long pause before the next leg up in the cycle. The House Republicans may even make a grand finale to their little stage play and shut down the government for a few days, playing to their portion of the crowd, while the punditocracy shouts epithets from each end of the gallery -- cue Rachel Maddow and Sean Hannity.
In that case, I would expect to see gold get flushed to re-test the December low of $1626 and possibly lower. Only on a weekly close first below $1,600 and then $1,520 would I be worried about the validity of the gold bull market.
However, if we see a break of December's high at $1,718 this month -- not a high probability right now, just 46.3% as of the close Jan. 14 -- then that would likely set up a very strong February, just in time for the final act in this drama. Or is that tragedy? Either way, it doesn't matter.
Gold's role in this drama hasn't even begun yet. Gold is like Orson Welles in "The Third Man," off-screen and only seen in glimpses until the final act -- a specter weighing on everyone's conscience and presumed dead. But unlike Harry Lime, who was a fake and an immoral slimeball to boot, when gold shows up onscreen it will be all the other currencies that wind up shot dead in a sewer.
Which brings me to my last question: Are you prepared for what happens then?