"The fundamentals for gold are unassailable, the long technical picture is excellent and gold remains very inexpensive when compared to almost every other alternative (most particularly, bonds, treasury bills and bank deposits). With currency debasement assured and some form of hyperinflation probable, gold should trade at several multiples of the current price before this bull market reaches its end." John Embry.
Will debt problems, decreasing use of the dollar as the global reserve currency lead to a Black Swan event with the dollar plummeting and US power collapsing? Dr. Paul Craig Roberts, Former Assistant Secretary of the Treasury and Wall Street Journal columnist, laid out just such a scenario in a recent KWN phone interview.
Roberts did not think much of the recent settlement about the debt ceiling. He said, "They haven't solved anything. They've just pushed it off until January or February." Roberts argued that another crisis may further erode confidence in the US dollar. "So if it happens again, you might finally get the black swan event that brings the whole house of cards down."
The general consensus seems to think that interest rates should be going down as the Federal Reserve continues to buy their own government paper to keep short-term interest artificially low. But in fact, since May 2013, interest rates started climbing. This confirms that there are more willing sellers instead of what the Federal Reserve is creating on the buy side, as reflected by the increase in interest rates. In other words, foreign investors are beginning to sense that what the Feds are doing is ultimately destroying the purchasing power of the US dollar and are willing sellers of any type of US government paper or security.
The Feds are losing credibility and their balance sheets are making them look insolvent. It is interesting to note that the Feds got rid of most short-term paper to retain only long-term obligations, and as long-term interest rates increase, it further reduces the market value of its principal. The numbers seem to indicate that the expected effect has already taken place as the Feds are leveraged 55 times their net worth. You only need a small move against you to wipe out your principal. As we look at the rise in interest rates since May 2013 (prices coming down), there is a strong case that the value of those Treasury securities has declined by more than the Feds' net worth.
Will the Fed need a bailout?
The Fed may not only need a bailout but may throw in the towel. There is a school of thought that the government could potentially forgive the debt owned by the Federal Reserve. From an accounting point of view, you can do that in the asset side. But what do you do in the liability side? If you forgive $3TN (trillion) of debt it also has $3TN in liability. Debt is in basically 2 forms; first, it is the flat currency we carry around in our pockets and second the bank deposits in the Federal Reserve. It would be a huge loss on the banking system if they lost three trillion dollars on deposit on the Federal Reserve balance sheet and would cause the US dollar to collapse.
The real problem, Roberts said, is the move away from "the use of the dollar. Others are just going to stop using it." He mentioned that China and the Bank of England and the EU have signed currency swap agreements, which no longer require the use of the US dollar. Even what he called "lackey puppet states," such as Australia, are now settling their trade balances with China in their own currencies. All of this means that there is less demand for the US dollar, which pushes the price down. The key is that the US can print more and more dollars to buy bonds to shore up the dollar, but it "can't print foreign currencies to buy dollars."
"The real black swan," Roberts said, "that's waiting to happen: When does the dollar plummet? When can the Fed not get enough loans or foreign currencies to buy back the dollar, and when that happens, it's all over. They lose control, interest rates skyrocket, bonds collapses, stocks collapses, real estate collapses, and the deficit becomes huge, I mean really huge….There's no thought about it….The whole situation is, to use an old expression, headed to hell in a hand basket."
Even though the Fed can print unlimited amounts of paper, will they still need a bailout?
The point in all this is that you can only print money so far before you start to lose investor confidence on the creditworthiness of the issuer. This is the current situation with the Federal Reserve's balance sheet - it is highly leveraged, buying only long-term paper, and the value of those assets have been going down as interest rates have risen recently. The solvency of the Federal Reserve is what should be called into question.
Furthermore, the more the Treasury pursues Quantitative Easing, the worse the pressure on the dollar. But they can't stop without pressure on the Fed's ability to cover the deficit.
How does the record gold physical demand and the paper market price manipulation affect the price of gold?
Turning to gold, Roberts argued that "The intervention in the gold market is part of the plan to prolong the life of the dollar." The policy is to sell naked shorts to prevent the strong demand for physical gold from driving up the price. If gold is rising so rapidly against the dollar, he said, "it raises the question of how can the dollar be worth the same against other currencies?"
"We're rolling toward the collapse of the dollar," Roberts predicted, "and with it the collapse of American power." He argues that the United States will have massive bills, which the US will be unable to pay.
Is gold the answer?
Roberts said, "Most people can't accumulate gold….Real family income in 2012 was 9% below where it had been 12 years before…The number of people who can buy gold is limited in number." Such a small subset of the population can't save economy, they don't have enough buying power.
Although gold can't save the United States, he urged that "If you have gold, hold it, buy more. Buy silver." He argued that when there is the Black Swan event and the dollar plummets, "that's when the price of precious metals is going to rise so fast that no one is going to be able to buy them."
Physical gold currently is offering long-term tremendous value when paired with the other side of the paper market currently with all its liabilities. Owning physical gold at these levels can give you a way to offset the risks offered by government securities and the U.S. Dollar.
Let's take a look at the gold market technical picture and see what trading opportunities we can identify over the near term.
The December gold futures contract closed at 1289. The market closing below the 9 day moving average (1316) is confirmation that the trend momentum is bearish. A close above the 9 day moving average would negate the weekly bearish short-term trend to neutral.
With the market closing below the VC Weekly Price Momentum Indicator of 1300, it confirms that the price momentum is bearish. Cover short on corrections at the 1271 to 1254 levels and go long on a weekly reversal stop. If long, use the 1254 level as a Stop Close Only and Good Till Cancelled order. Look to take some profits on longs, as we reach the 1316 to 1344 levels during the week.
The information in the Market Commentaries was obtained from sources believed to be reliable, but we do not guarantee its accuracy. Neither the information nor any opinion expressed therein constitutes a solicitation of the purchase or sale of any futures or options contracts.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.