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Gold's Upside Is Tremendous, But It's Probably Not Quite Time Yet

by: Robert Kientz

I don't think the current level of financial fear is enough for gold to break the $1400 resistance level, yet.

I liken the current situation to the cocking of the hammer of a pistol, without the lethal shot having being fired.

The USD is not dead just yet, despite the world actively negotiating trade with other instruments.

The final gold bull catalyst will likely be the beginning of war.

Digital ledgers tied to gold/silver are the next obvious currency platform to solve legacy problems from the old fiat regimes.

Excellent Contributor Andrew Hecht just wrote an article entitled Gold Breaks Higher on Fear. I agree with the premise of the article, as I usually do with this author. However, I think it worthy to gauge how much fear there is and whether this is the catalyst for the next big run up in gold.

Gold has made a solid push up in the last week among a backdrop of rising interest rates, deterioration in bond market, and the Dow Jones falling 7% through last week.

Dow Weekly CrushSource: Trading Economics

As I write this, the Dow is rolling over from an attempted recovery to the 26k level which it could not hold in 2018. Action the rest of this week will tell whether the trend is in and we can expect a second 10% correction this year.

Here is the 6 month chart depicting the failure to sustain new highs in 2018.

Dow Monthly CrushSource: Trading Economics

Long term if the stock market falls through 24k, then it gets ugly and gold may be in for another long bullish leg in a multi-decade bull move. But is the fear level strong enough now to pop the gold market above the critical $1400 level, or are there greater catalysts lurking in the wings that will drive it up into the $2000 range?

Decades long gold bullSource: Trading Economics

Though I warned previously that the US yield curve may be inverting, it has not happened yet. The spread between 2 and 10 year has recently widened.

Source: Bloomberg

Per Bloomberg:

Strategists at most of the Federal Reserve Bank of New York’s primary dealers expect the spread to narrow through the first half of 2019, according to yield forecasts compiled by Bloomberg.

So the bond markets have not fully yielded to the short term fear reflect just yet and it appears there is some hope that the economy could stabilize through the end of the year, with more uncertainty to take hold in early 2019.

While the VIX, colloquially referred to as the 'fear index', recently spiked in October, it has not reached levels seen earlier in 2018. So the market sentiment doesn't seem to be quite as fearful as when we experienced the sharp correction earlier this year.

VIX fear index chartSource: Yahoo Finance

Cocking the Hammer

I think it fair to say that the markets have been warning of structural weakness in the global economy, as per my recent article highlighting issues in emerging market currencies and stock markets. Future analysts will most likely see 2018 as a year of turbulence where signs of traditional business cycle correction were added to rising global trade wars and shifting geopolitical alliances in forecasting a deep global recession likely peaking in 2020-2021.

Let's take a quick look one big driver of US economic health, the labor market. The BLS reports that we have lost about 3% points of engaged, eligible labor since the Great Recession.

BLS labor force participation rateSource: Bureau of Labor Statistics

Much more meaningful than the unemployment rate quoted most often in financial media, the labor force participation rate indicates the top end of economic production from labor by highlighting how many works are not engaged in the economy. When this number falls, as it has over the last decade, it is not reasonable to expect overall production to continue to rise in a straight line, technology advancements notwithstanding.

Technology will only take companies so far, and then they have to make cost cutting measures to keep up the profits. Breaking news on CNBC , as I write this article, has drug giant Pfizer (PFE) offering early retirement to employees ahead of expected workforce reductions. This after telecom giant Verizon (VZ) did the same thing in late September in an attempt to shave $10 billion in costs from the ledgers. These two companies alone represent almost 250 thousand employees in the labor force.

It is likely that we will see more early retirement offerings from US companies in 2018 and may see forced reductions as early as Spring of 2019. There are other signs of structural weakness than bond and labor weakness, such as the tech sector carrying the market in 2018, inflated P/E values leading to a dearth of value stocks, auto markets rolling over, and weakness is the US and global housing markets.

Hot War?

Rhetoric between the US, Russia, and China indicate that geopolitical tensions are rising. In an article US-China Tensions Soar as 'New Cold War' Heats Up, the Guardian notes:

Within the past few weeks, as a trade war loomed between the two countries, US and Chinese warships came within yards of colliding in the South China Sea. And the FBI set a trap in Belgium for a senior Chinese intelligence official and had him extradited to the US, provoking fury in Beijing.

Washington has meanwhile significantly ramped up its bellicose rhetoric portraying China as a dangerous adversary. In a UN security council meeting last month Donald Trump accused Beijing – without citing evidence – of seeking to oust him through interference in US elections.

This story comes after the NY Times wrote an article warning the Chinese accusing the US of starting a new cold war after scathing remarks by VP Mike Pence.

“This will look like the declaration of a new Cold War, and what China may do is more important than what it will say about Pence’s speech,” said Zhang Baohui, professor of international relations at Lingnan University in Hong Kong.

Currency wars between the US and China, followed by trade wars, and now cold political rhetoric may be leading the two nations into a future hot war. The aging US empire is being challenged by the upstart Chinese, who are themselves awakening from a deep slumber.

It is not out of the realm of historical precedent to expect a large change in geopolitical alignment to lead to hot wars. Heck, the US has been engaged in oil/territory wars in the Middle East for nearly 20 years where Russia has recently gotten more engaged in Syria by deploying advanced missile systems, considered a 'significant escalation' by US national security advisor John Bolton.

Digital Revolution Changes the Fiat Game

The conventional wisdom is the US Fed can print its way out of any deflationary recession. This is true as long as global demand for dollars continues to be strong. When demand fails for fiat currency, history shows the end is nigh. That is when gold will really pop, in USD terms.

However, the USD is no longer the defacto reserve currency. Per an article at The Week, author Barry Eichengreen, an economics professor at the University of California, Berkeley, notes:

Digital technology allows everyone to comparison shop between different assets and currencies at the click of the button.

Eichengreen thinks this comes with two consequences.

First, we may not live in a monopoly reserve currency world after all. If China and the Eurozone can get their acts together and America slips, the world could wind up with two or three global reserve currencies all tussling together.

Second, if the change does come, it could come fast. When America created the Federal Reserve system in 1913, for example, the U.S. dollar had virtually no international role. But the Fed and World War I changed things, and within a decade, the dollar had become one of the dominant reserve currencies. Depending on what China, the Eurozone, the United States, and other players do, such a change could happen again. And with modern technology, it might be even swifter than last time.

Ah, now we may see the role of Bitcoin and digital ledgers in changing the dominance of single paper fiat currencies in international trade. Add in the advent of smart contracts, and it appears the world is ready to move on completely from Bretton Woods era monetary and trade models.

2018 has seen lots of change, from deteriorating global economic fundamentals, rise in geopolitical tensions, and introduction of financially disruptive technology. This time may be different, but to what extent? How much will the patterns shift?

Where Gold Will Shine Once Again

I suggest that the march towards substantive political and military conflict has begun which will prevent the continuation of the current Western bull markets. It will mark the end of US hegemony and emergence of a multi-polar world with palpable tensions between East and West. Gold is very likely to shine in such a scenario as the ultimate backstop of central banks and the currency markets. The current action is a blip on the radar, but expect that gold's final hurrah in the current bull run is around the corner, waiting for a world awash in conflict to emerge from the final stages of this aging financial era and into a much different, new one.

Look for more from me soon on emerging digital currencies tied to gold and silver that help solve most current liquidity, exchange, and quality problems with the old fiat paper ones.

Disclosure: I/we 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.

Additional disclosure: I own gold and silver.