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  • Gold: There's No Money Like Smart Money
    The following is a guest post from a member of the FMX | Connect Community.

    Gold Investment Rationale


    “The US faces rapidly rising inflation or deflationary recession: credit cycles (and this one is extreme) always end in a deflationary bust – this is the lesson of the Kondratieff Cycle. The Fed will most likely try to defy economic gravity using increasingly inflationary means. Gold is the only asset to outperform in periods of either uncontrollable inflation or deflation: the US economy is on a knife-edge between the two.” – Redburn Partners, November, 2007.

    Investment Summary:

    We think that regardless of the situation in the future, gold is a better investment vehicle than most other assets. As an inflationary hedge, it will increase in value as a proxy for the US Dollar. In a deflationary environment, gold may not appreciate, but it will outperform relative to financial investment vehicles and most other currencies.

    U.S. Economic Outlook

    Where we are:

    It's been well documented where we are and how we got here. Here is our own two cents worth: Easy money and credit, poor regulatory decisions, irresponsible buyers and sellers, and other enabling factors have all contributed to the situation. As a culture, we have been cashing in on the hard work of generations before us. The American dream has morphed into a feeling of American entitlement. But we do not pass judgment. This is how the emotional component of economic cycles works.

    It is our analysis however that the structural issues precipitating the 2008 crisis and its aftermath have remained unresolved. Simultaneously, the growing cultural austerity of our populace will be a great impediment to reflating a consumerist economy in the United States and other western economies.

    Why the situation will persist:

    Many Cassandra-ish reasons can be made why we are all doomed. To be clear, we do not feel that way. The U.S. just has to retool how it generates income to remain competitive. That said, here are three major reasons we feel the U.S. economy will go nowhere significant in its current state. We are still a credit driven economy, consumers will not spend like they did in years past even if they could, and China is not ready to pick up the U.S. spending slack.

    Still a Credit Driven Economy

    There will be no real recovery until the economy retools itself from a consumer driven one to a capital expenditure one. This means an end to credit as a means to buy things, which won't happen until the fed stops reanimating the easy-money cadaver.

    David Roche, former Head of Morgan Stanley Research and Global Strategy, and currently president of Independent Strategy:

    “….none of the core problems that caused the credit crisis have been addressed. Credit crises end when the economy starts to grow without credit. This can happen because, in a credit contraction, the price of assets and goods and services can fall dramatically. Households lose about 20% of their wealth. But if the price of things (either stuff in the shops or investments) falls by more than the combined contraction of wealth and income, they have become cheaper in terms of the ability of most households to buy them. Those with money do so. They don't borrow to buy or invest but they have the cash. Those that don't are still busy paying down their debts. But the ‘haves' can have enough purchasing power to move the economy off the bottom. This sort of recovery is self-sustaining.”

    Governments react to grass roots changes, they are not proactive. Thus, they are totally behind the curve. While this administration is busy giving easy credit to banks in the hopes it will trickle down to the public, the public has put itself on an easy-money diet. The banks aren't helping either; they are offering to lend only to those who do not need it. The fed is just getting gamed, and monetary policy will not alter the changing habits of Americans. The credit driven method of growing this economy is dead.

    Consumer Sea-Change

    Consumers will resist returning to looser spending habits and will not be the engine of growth for the U.S. economy moving forward. High debt, wage pressures from a globalizing work force, and a moral rethinking of consumerist attitudes all contribute to this. It is our analysis that those who want credit cannot get it, while those with ample credit loathe to use it. No one is spending.

    Roche again:

    “The savings deficit countries (the US, the UK) must see a return to thrift (which will cap consumer spending). One driver of higher household thrift in deficit-ridden countries is that households and corporations realise that the wrecked balance sheets and budgets of the government sector can only be paid for in one way, down the road — with their money.”

    If we are wrong and these changes do not take hold in the consumer psyche we will have a consumer-lead recovery. This is merely a can kicked down the road to the next deflationary debacle. It only affects the timing of our investments, not the choices. Deficit spending cannot be sustainable forever.

    Chinese Spending will not save us

    We believe the view held by some that the Chinese consumer will be a driver in this recovery is not happening anytime soon. The reasons are numerous.

    •China's recent stimulus package was intended to gear up for more export growth, not domestic consumption.

    • It is a political issue for their government to let standards of living grow too much, as it will invite progressive reforms and social unrest. People will know what they've been missing once they see the potential.

    • China, like most Asian economies after their own currency crises, is an inflation hawk. They will seek to cool down their economy more aggressively than most hope.

    •Fear of a rollback to a Maoist regime still weighs on many people. These citizens keep their wealth portable, and live within their means.

    •China is deepening relationships with LATAM countries to export goods, seeding the next big consumerist economy potentials

    Maybe next generation folks. That said, if we are wrong and China does become a buyer of finished goods and services, U.S. inflation will explode.

    What the Gov't has done thus far

    Up to now the U.S. government has embarked on a reflation attempt which will either fail and end in a deflationary crisis on par with 2008, or it will succeed and slip into an inflationary environment. The stimulus is a temporary measure at best and will only serve to delay deflationary pressures without fundamental changes in our behavior. It's a circle of hardship. We don't judge current actions as right or wrong. We just seek to anticipate what comes next and hopefully profit from them. And we think the choices available to the government from here are quite limited.

    Government Choices Moving Forward

    Not much of a choice:

    What must be done to combat our current paralysis and its effect on the U.S. government's ability to repay its own debt?

    Choices are limited with regards to the debt: Restructure it or devalue it. Restructuring is essentially defaulting and letting the deflationary forces run their course, and devaluing the debt consists of monetization.


    U.S. Monetary and fiscal policy will continue to be geared towards devaluing its debt. Even with these attempts, more deflationary events are likely. The Greek crisis is an example. The alternative is a deflationary depression that will wipe out tax revenues entirely.

    The U.S. monetary recipe

    In short order we think the following will be their policies for the next several years.

    •Monetary policy will remain much easier than the conventional wisdom due to a backlash against government stimulus spending. Low rates will be all they have
    left to make it work.

    •Fiscal policy in the form of another Quantitative Easing (QE2) will be put on the table, but will have a tough chance of passing due to a trickle up of austerity from the public to its elected representatives (witness the Mass. election and the populist rhetoric to cut spending).

    •Taxes will go up. No surprise here. It has already started. Wealthy families will be taxed directly, and the rest of the country will be via the companies in their portfolios getting taxed at higher rates.

    The global situation does not help matters, and will only force the U.S. hand.

    Economic nationalism

    As a consequence of globalization, our economies are more tied together than ever. One of the factors that brought about the great depression was a nationalistic backlash against trade. The result of which was countries pulling in the reigns, drying up liquidity, and consequently deflating asset prices even more. Governments are resisting this urge today, and have learned the lessons of the past. But, banks may not care so much.

    As global credit risk causes lending institutions to decrease international loan exposure, banks begin to repatriate their money and lend more locally. This is an economic nationalism, and can have the same effect as the political ones did in the 1930's. Governments have little choice but to engage in competitive devaluations in an attempt to stave off the effects of these (localized) lending practices.

    Race to the bottom

    In order to attract trade away from competing countries, it behooves most governments to opt for a weaker currency. If every country knows this, then we have a prisoner's dilemma situation. We believe there may be less honor among governments than among thieves, and a race to the bottom will be the result. Such a situation may be good for the winning individual country, but it is bad for the group and citizens everywhere. In this case, global inflation is the outcome. The countries with the most to lose are those with the most debt, and the least flexibility to deleverage. They must devalue fastest.


    • Governments almost always choose devaluation- it is better politically, and is consistent with the kick-the-can down the road mentality of short term outlooks, limited to reelection time horizons. Some end up defaulting regardless.

    •Fiscally taxes will go up, there may be a QE 2 but most of the work will remain monetary policy.

    •We will either get deflation resulting in inflation or inflation resulting in deflation, but we will get both.

    •1970 Chevy Malibu carburetor analogy- the U.S. economy is an old car with a sticky carburetor. The fed's foot has been on the gas and will continue to be until the spring loosens and the intake opens (inflation) or the spring breaks (deflation) and the intake snaps shut. Either way, the fuel system has to be fixed, because that spring is going to break soon regardless.

    The only thing that remains is what to invest in, and to either time the market or just diversify risk.

    Investment Choices

    Moving forward we think inflation and deflation are both a risk to the markets and that the golden age of capitalistic monetary management is over. We like real estate in countries with little or no leverage on their balance sheets (personal or government), especially LATAM and Caribbean countries that may benefit not just from growing credit cycles but from an influx of wealthy U.S. and European retirees. We like seats on agricultural commodity exchanges, and we are buyers of gold in spread, physical and option form.

    Before we go further, we'd like to lay out our definitions of inflation and deflation.


    Inflation is a function of monetary policy. All monetary systems can experience inflation, but paper money is most inherently prone to it. The two most popular and conflicting definitions of inflation are Keynesian and Austrian.

    To oversimplify it: Keynesians believe inflation is largely demand-based and occurs when prices increase. Austrians see inflation as strictly a function of money supply, and increasing prices are merely a symptom of the problem. Either school of thought works here.


    Deflation is closely tied to fractional reserve banking. At its worst, it ends with runs on banks. People and institutions would rather have currency jingling in their pockets due to its scarcity than a debt from someone to give us money at a later date. During a panic, that is exactly what happens. Depositors see their money as a loan to their respective bank and call in the loan.

    Both of these have horrendous implications for citizens. In a deflationary situation; cash is king, and everything else deflates as the word says. In an inflationary devaluation; cash is trash because purchasing power is destroyed and assets must keep pace with inflation just to justify ownership.

    It is also important to note that to the degree that one approach is chosen, the other will surely follow as a reactionary result unless our economic engine replaces consumption with creation as its primary fuel.


    We like gold in a domestic inflationary environment for obvious reasons. But we also feel it will hold its own against other currencies. Gold is money, that is all. And as a store of value, it will compete with paper currencies more and more. We also believe as do others, it will increase in an almost Giffen Good manner moving forward.

    Gold is also subject to fractional reserve banking. We have seen firsthand what happened in 1997 when Warren Buffet decided to take delivery of silver. The result was a backwardated spread market equal to a $40% yield annually. Unallocated gold accounts where investors have claim to a pool of vaulted gold can be subject to the same risk.

    We like gold in a deflationary environment as well. Everything drops in a deleveraging, deflationary period to be sure, except currency. Gold will also most likely drop. But it will suffer the least of other assets for a couple reasons. It is money and can be easily quantified as such. It's portable. Finally, gold is internationally recognized and understood.

    We believe this all ends in a deflationary collapse and healthy economic retooling. Gold may end up being the tallest pygmy in a deflationary environment. To date we have implemented our spread strategy. We expect to accumulate a physical position over the next 60 days.


    For the complete document, with additional pictures & charts, please click here.

    The information, opinions, scientific data, quantitative and qualitative statements contained in these reviews have been obtained from research, trade and statistical services as well as other sources believed to be reliable. The information, opinions, rankings or recommendations contained in these reviews are submitted solely for advisory and informational purposes. Echobay Partners Ltd. opinions and estimates reflect current judgment; they are neither all-inclusive nor can they be guaranteed to be complete or accurate. The opinions expressed are our current opinions as of the date appearing on the review only. Our analysis is subject to possible change without notice.

    Disclosure: FMX | Connect is a commodity data and analytics portal, not a trading firm. No positions.
    Tags: GLD, IAU, DGL, ABX
    Mar 01 5:50 PM | Link | Comment!
  • A New Era for Gold Bulls

    Gold bears; watch out.  The dollar’s showing signs of weakness, China’s lumbering in the distance, and speculative shorts are running for cover.


    After bottoming out at $1050 just slightly over a week ago gold is back on the climb, and appears ready to go farther.  Truth be told, it is hard to picture a scenario that is bearish for gold in the short term.  Gold has been strengthening against the euro through the last couple of weeks and shows signs of decoupling from the dollar.  Let’s take a look at a couple of scenarios and their impact on gold:


    Workers took to the streets in protest over budget cuts last Wednesday and public sentiment has been growing more poisonous by the day, punctuated by a bombing outside JPMorgan in Athens.  Logistical details of the bailout remain murky, but continuing details about currency swaps and Greece’s accounting adventures should give the market a better idea of what to expect.  If for some reason Europe decides to let Greece default (unlikely) its economy will crash and drag down the euro as the reverberations ripple through the surrounding countries. EU leaders have pledged their support for Greece but it is unclear what this support will consist of and to what extent the IMF is going to get involved.  EU member states remain divided on the terms of the bailout and whether there should even be a bailout, not to mention the bureaucratic nightmare of organizing an aid package from such a wide coalition of interested parties.  Sweden, for example, does not use the euro but is willing to contribute. However the crisis gets resolved the question remaining is not whether the euro will drop, but by how much.  The strength of the bailout will be measured less on its ability to recoup losses from Greece than its success in staving off additional aid requests from the rest of the PIGS.


    Gold vs. the Dollar
    Gold vs. Dollar

    Speaking of currency, seasoned traders may have noticed the decoupling of gold and the dollar’s inverse relationship.  Looking at the above graph one can observe the close correlation between gold and the dollar, albeit in opposite directions.  Gold and the dollar have a long-standing relationship, and while they normally trend in opposite directions they both tend to rise together during crises.  When Long Term Capital Management imploded in 1998 the gold and dollar moved upward in tandem as investors fled to safe assets.  As fears subsided gold and the dollar went back down in value but gold fell farther. This pattern was repeated during the 1st Iraqi War, the 2nd Iraqi War & the Asian defaults. This phenomenon appears to be losing its reliability, however.   Since the start of February gold has become less and less responsive to the dollar’s appreciation.  The inverse relationship of recent years has weakened to the extent that both the dollar and the gold can finish the day up without the expectation that the other is down. Gold and the dollar have become competing flight-to-safety type assets.


    Deflation vs. Inflation

    There are two camps for holding gold, one that it is a hedge against inflation, and second that it is a hedge against deflation.  In an inflationary environment the purchasing power of a currency diminishes against an index of goods. Gold has a history of outperforming other assets in inflationary environments.  There is only a limited supply of gold while governments have the power to print unlimited amounts of paper currency (effectively reducing the value of every denomination). Therefore, in periods of high inflation or hyperinflation gold is likely to be a strong performer.  One scenario where inflation (or stagflation) is likely to occur would be the Federal Reserve refusing to raise the federal funds rate for fear of damaging the economic recovery and increasing unemployment.

    If inflation is the byproduct of too many dollars chasing too few goods deflation is the byproduct of too many goods and not enough interested money.  Increasing the money supply will not prevent deflation if no one is spending or no banks are lending.  Expanding the money supply loses its effectiveness when interest rates are at zero.  In a deflationary environment currency is almost the last thing anyone wants to own as its intrinsic value can drop all the way to zero and be permanently lost in the case of default. Gold is an excellent store of value for deflationary situations. If the world is headed for a double dip recession the combination of excess capacity/inventory and feeble demand is likely to cause deflation.

    Recent Events & Short Term Outlook

    April Gold Futures

    The above graph tracks the April gold contract.  After trending downward since December the technicals are looking very bullish.  Earlier this week gold broke out of its descending triangle formation, moving almost $30 in a single day.  Technicals remain bullish despite the market’s knee-jerk reaction to news that the Federal Reserve was raising the discount rate .25 basis points and the IMF trying to unload 191 tons of bullion.  Raising the discount rate will have more of an impact psychologically than it will fundamentally.  It is foolish to think that traders are not pricing the eventual rise of interest rates into the asset.  Furthermore, gold looks like it may be forming a pennant, which has historically indicated the price will continue to move upward.

    There are plenty of reasons to be bullish on Gold even if you don’t trust the voodoo science of technical modeling.  Money around the globe is flowing to safety in the face of intercontinental default risk.  Anyone who’s been listening to Marc Faber or watching what George Soros is really up to should see that Gold and the dollar will continue to benefit from the trend.  Even if gold doesn’t it has demonstrated a growing resilience to the dollar’s upswings and if nothing else, is likely to trade on a more fundamental basis.  International demand for gold continues to remain strong as indicated by the large bulk purchases from Asia. Gold’s status as an international currency can only stand to rise as so many other currencies appear ready to crash and burn.  Whether it be from a love for all things shiny, or simply a sound understanding of macroeconomics, this looks like a great time to be long gold.


    Trading Recommendations: Buy now (currently at 1125) with a stop at 1070 (below major support) and target the 1200-1240 range.

    Disclaimer:This is not a solicitation to buy or sell any security.  A purchase or sale of a security may result in a loss of principle.  Please consult with an expert advisor who can explain the risks of any investment you consider.


    Author: Gregory Ceponis

    Julian Vignaud
    Vince Lanci


    Disclosure: None
    Tags: GLD
    Feb 19 1:28 PM | Link | Comment!
  • Gold Technicals: Inverted Cup & Handle is Very Bearish

    Gold is poised to break significant support, and if it does, you should see a major unwinding of the long-term bullish trend. Below, the daily gold chart shows an inverse cup and handle formation, reinforced by a triple bottom. Inverse cup and handles are very bearish, which corroborates with our triple bottom axiom – that triple bottoms are meant to be broken. Gold’s last major support level is the 100-day MA which was tested yesterday and last Friday. After breaking its 20 and 50 day MA’s , gold is now at the mercy of its 100-day MA. 


    The dollar index chart shows a cup and handle formation, reinforced by a triple top. This is very bullish for the dollar. The index is also above it’s 20, 50, and 100-day MA’s. The dollar and gold are inversely related.


    Recent global events have been bullish for the dollar, and bearish for gold. Specifically, China tightening its monetary policy, which will slow global growth. Furthermore, the E.U’s Greece problems are hammering the Euro. Finally, Obama is taking advice from Paul Volker – a well known fiscal conservative. These macro trends affirm the technical charts.

    Daily Gold Chart:

    Daily Dollar Index Chart:

    Disclosure: None
    Tags: GLD
    Jan 26 6:42 PM | Link | Comment!
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