-- Posted Monday, 30 June 2008 | Digg This Article
| Source: GoldSeek.com
by Howard S. Katz
A Good Start to Summer
The explosion in gold and gold stocks Thursday and Friday, June 26 and 27, heralds an important new move both in gold and in commodities in general.
Gold had me worried in the spring as a large and powerful head and shoulders top formed in the weekly basis chart. Had this formation broken its neckline, I would be looking for a pullback in gold to the apex of the giant triangle it formed in 2006-07, which is $670. But on Thursday and Friday, it moved aggressively in the opposite direction and broke its downtrend line.
A head and shoulders deserves respect, even when it does not complete. How does one choose between these two signals, one bearish, one bullish. The answer is that there is a larger picture. Just as most individual stocks move with the general market, so gold reflects these larger forces, which manifest themselves in the commodity pendulum.
The Commodity Pendulum
The commodity pendulum is a series of large swings in commodity prices, up and down. These movements can be traced back to (the Kennedy tax cut of) 1963. Prior to 1963, prices in the U.S. were mostly stable. The few periods of rising prices were associated with wars and usually lasted just a few years.
The commodity pendulum became noticeable in the 1970s when the CRB index rose from 96 to 337. We all know the result of this. The rise in commodities fed through into consumer prices. Soon the nation was faced with “double-digit inflation,” and the Federal Reserve was forced to tighten credit. In the end, long term interest rates rose to 15%, and the DJI was knocked down to 780. (Note: A few years back the Commodity Research Bureau tried to rename the CRB index, calling it the Continuous Commodity Index. I guess they felt that they named it originally; therefore they had the right to change. However, this created a problem because by that time the CRB index had acquired a character, well know to economists and commodity traders. To suddenly change the name was confusing and incredibly complicating. If a young couple names its child “Bill,” then they may have the right to do this initially. But 40 years later they do not have the right to change his name to “Sam.” If this were done, it would be incredibly complicated to everyone who knew Bill. By age 40, Bill had acquired a character, and the name stood for that character. In the same way, over its half century of existence the CRB index acquired a character, and to associate this character with a new name is incredibly difficult. For this reason, I simply ignore the modern Commodity Research Bureau’s pseudo-mathematics and continue to use the old CRB index and to call it by its real name.)
In the 1980s and ‘90s, the exact opposite happened. Commodities fell from 337 to 183. This was a very extreme move because consumer prices had quadrupled from 1971 to 1999, and therefore the 183 reading on the CRB was 46 in real (1971) terms. Two things: 1) The decline in commodities from 1980 to 1999 fed through into low increases in the Consumer Price Index (“disinflation”). This allowed the Fed of that day to print money at a horrific rate without suffering the normal consequences of higher consumer prices. 2) But the very low CRB index of 1999-2001 drove commodity producers out of business. The higher prices from the printing of money in the ‘80s-‘90s were not avoided. They were merely postponed. This is why commodities put on such a dynamic performance in the early years of this century. They had built up a head of steam.
In its years of trading, gold has proved to be a very good stand-in for the average commodity. Many of us are uncomfortable with the commodities markets. Each commodity has its own character, and one must study it carefully to master it. If one is simply aware that the Government is depreciating our money and wants to adopt his personal financial situation to that fact, it is difficult to make a special study of each commodity (which can only be gained in the school of hard knocks). Gold is sort of an average commodity which reflects the general economic trends and policies. It is well-behaved technically, and it very rarely contains surprises. It is proving a very good way to play the commodity pendulum.
Where Are We Now?
Very well, what does the theory of the commodity pendulum tell us about our current situation? What is the outlook circa Independence Day 2008? First, let us note that (in establishment eyes) whereas Greenspan could do no wrong, Bernanke can do no right. Greenspan put the Fed funds rate down to 1% (in 2003). The establishment cheered. Bernanke put the Fed funds rate down to 2% (in 2008). The dollar collapsed. Gas-at-the-pump hit $4.00. And people started screaming for Bernanke’s head. The reason is that Bernanke took office just as the second upswing in the commodity pendulum was picking up a head of steam. Since commodity prices are moving up rapidly, then consumer prices are following them. Thus the current Fed has the worst of both worlds. And we can expect this to continue for some time.
Second, just where are we in the pendulum? The first upswing in the pendulum (1971-1980) caused the (nominal) CRB to triple. But the CRB in 1999 had been driven down to extremely low levels. Since 2001, the CRB has multiplied by 3.3 times. This puts it up from a real (1971) value of 46 to a value of 152. When did the 1970s CRB first hit 152? Sometime in early 1973. (Note that at this time the DJI had just topped. Perhaps the Oct. ’07 top in the DJI is the corresponding point here in the second upswing.) We are definitely in the (2nd upswing of the) commodity pendulum, but we are nowhere near its end.
Third, it looks very much as though the period March through June was an intermediate decline in commodities. Many commodities had sell-offs digesting their gains of the Aug. ’07 to March ’08 period. I have a number of intermediate indicators based on various Commitment of Trader reports, and they all moved from overbought in March to oversold in June. (Those who elect to subscribe to my newsletter, The One-handed Economist, will learn about these indicators in more detail.) Even though crude oil kept rising over this period (a fact which I put down to its extreme bullishness) most commodities had reactions, and there were several spike tops.
Conclusion: If we are in a raging bull market which has run for seven years but has a lot further to go and if we have just completed an intermediate decline in that major bull move, then what we have to expect is a powerful advance as the new bullish intermediate trend combines with the bullish major trend in both gold and other commodities. The establishment will be dumbfounded. As gasoline moves from $4.00 to $4.50, there will be a howl of public outrage. But as long as the majority of people are so stupid as to vote for the very politicians who are robbing them, then the present crisis cannot be solved.
The specifics of how to put the coming crisis to your own advantage (including individual gold stocks to buy) are discussed in my fortnightly newsletter, The One-handed Economist. The subscription rate is $300 per year. You are also invited to visit my website, www.thegoldbug.net, which comments on social and political issues from an economic perspective. The current blog is “The Right of Property.” The blog/website is free, and the website will give you instructions for subscribing to The One-handed Economist. Thank you for your interest.
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-- Posted Monday, 30 June 2008 | Digg This Article | Source: GoldSeek.com
