Inflation: Silver Leads, Gold Follows
Stewart Thomson | Oct 06, 2015 11:04AM ET
When combined with rate cuts, QE becomes a deadly deflationary cocktail. Banks have no incentive to make loans, and T-bonds become the asset of choice. The T-bond money is squandered by governments, and money velocity implodes.
The bottom line is that bank and government wealth is inflated by QE, and the wealth of the average person is massively deflated. “QE to infinity” is better described as “deflation to infinity”.
In the mid-1990s, US money velocity peaked, and entered a multi-decade bear market. It was caused by the Fed forcing savers out of banks and into risk markets.
As government became an ever-bigger part of the global economy, productivity also entered a gigantic bear market.
The situation is dire. Modest rate hikes are desperately needed, because rate hikes pressure global governments to shrink themselves.
The hikes also incentivize savers to put money back into banks, where it can be professionally loaned to consumers and entrepreneurs.
That’s the quarterly bars XAU:gold chart. The Fed’s obsession with rate cuts helped grow government, destroy savers, and it also created an enormous multi-decade bear market in gold stocks.
I’ve predicted that the bear market will be ended by Janet Yellen. Her decision to get rid of QE, and her coming decision to raise rates, is the right one; government size and power is out of control, and I think Janet will do what is necessary to end what is essentially an insane “bull market in government”.
I realize that many investors in the Western gold community were terrified of the taper to zero, and they are now almost as equally terrified of rate hikes. It’s important to understand that what matters to gold price discovery is demand versus supply, inflation, and the real level of interest rates.
If rates rise, but inflation rises faster because of a reversal in money velocity, money managers will buy a lot of gold.
The four main drivers of higher gold prices in the coming years are Asian central bank buying, Indian economic growth, a rise in US inflation linked to a reversal in money velocity, and geopolitical events in the Mid-East.
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Markets tend to move in anticipation of these key fundamental events. That’s the daily Market Vectors Gold Miners (NYSE:GDX) chart. Note the huge volume bars in play during the last two trading sessions!
GDX has now penetrated a significant downtrend line, and done so on high volume. Forward-thinking money managers are likely buying in anticipation of higher nominal rates, and lower real rates.
That’s the daily silver chart. Silver just staged a very interesting breakout, from a multi-shouldered inverse head and shoulders bottom pattern.
In the short term, a quick pullback to the $15 area is possible, but the target of the pattern is the $17.25 - $17.50 area, and I think that’s very realistic.
The bottom line is that when system risk dominates the radar screen, top money managers buy T-bonds and gold bullion. When inflation dominates, they are inclined to focus on gold stocks and silver bullion.
That’s the daily gold chart. I predicted that gold and related items would decline into Friday’s US jobs report, and then blast higher as the report was released.
That’s exactly what happened, and I think the potential is there for the rally to extend until the next FOMC meeting in late October.
Gold is trading in a magnificent symmetrical triangle. If the breakout is to the upside, and odds are growing that it will be, the technical target is about $1250!
That’s the daily Market Vectors Junior Gold Miners (NYSE:GDXJ) chart.
Note the big green wedge pattern. It’s very bullish, and suggests that GDXJ is poised to surge to my $28 target area.
Professional money managers could move serious liquidity into the GDX and GDXJ ETFs very quickly now, in anticipation of a rate hike that is a game changer for money velocity.
All gold community eyes should be on the GDXJ $30 area. I’m looking for a three week close over $30, to signal an end to the multi-decade bear market in US velocity.
If that happens as Western bank economists begin to take notice of the Chinese central bank’s new gold-buying program, and as India’s “titans of ton” continue to ramp up their demand for gold, I think the Western gold community is going to be very happy, for a very long time!
Thanks!
Cheers
Stewart Thomson is a retired Merrill Lynch broker. Stewart writes the Graceland Updates daily between 4am-7am. They are sent out around 8am-9am. The newsletter is attractively priced and the format is a unique numbered point form. Giving clarity of each point and saving valuable reading time.
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