Ira Epstein's Weekly Metal Report

Since it became apparent that there was not going to be a compromise forthcoming soon between the President and the House of Representatives, I’ve been trying to figure out the impact that has on gold. I think I understand it, which is the reason for this reports “Austerity” headline.

First, let’s first do a short review of what’s going on in Europe and China in the most simplistic terms.

Europe for the time being has successfully collared its Greek and Spanish issues. This doesn’t mean that the issues are solved. Rather it means that Europe has kicked the can far enough down the road that Europe can now turn its attention on how to embarking on economic growth. Europe has entered a period of economic healing that will take a long time to make things better, easily over a year.

The positive for the time being is that Europe as a whole has succeeded in stopping itself from sinking into an abyss. In the process those who had bet against the EU staying together this year have lost that bet. John Paulson’s hedge fund is one of those.

What continues bothersome is that each time the ECB is provided with an opportunity to get ahead of the curve, it fails to do so. Today the ECB met. It was a chance to lower interest rate, which would probably have had a more than normal impact. What did they do? Nothing!

So, Europe stays as is going into the New Year, but won’t be much of headline maker for a while.

China on the other hand has turned on the spigot in terms of offering financing for inward for growth. The Chinese call it “urbanization”, which I define as growing their cities infrastructures and the business located in those cities that serve their population. The idea here is to create demand from within for products made in China so that in the longer term the heavy economic reliance on exports is won’t be as great as it is today. As Chinese economics mature, labor costs are going up. As the costs move up, other countries labor forces are “suddenly” low enough to compete head on with China, hurting Chinese exports. Even General Electric is moving plants back to the US as their accounting has shown that the savings in labor alone doesn’t make up for ease of deployment of products from US warehouses, located near their plants. Therefore, this is probably a good move by China since in the long term as it makes them more self-reliant.

Here’s a schedule I found in an article in the Wall Street Journal this week that does a great job of summarizing how fiscal cliff events might unfold.

Austerity, like it or not, is being forced on us. The end result is probably higher taxes, which produces more income and spending cuts, that force savings.

On Wednesday morning the President spoke to business leaders in a televised conference. He made it very clear that neither he nor the US were going to be held hostage to any House of Representative posturing on the debt ceiling. Any deal the White House agrees to has to be all encompassing, as the President does not want to fight a battle in March about the debt ceiling. Secretary Geithner backed this up on CNBC in an interview, stating that without a real increase in taxes on the wealthy, there will be no compromise. Harry Reid came out today calling for taxes on the wealthy of 39.6%.

What’s going on is a chess game. The President has way more players left on the board than his opponent, has move valuable pieces and has a better chess strategy. The Republicans still have their “king” left, but their pawns are gone as are their knights and most bishops. When the President shifted gears today and made the debt ceiling part of any compromise, he took the Republican’s “queen” away, basically leaving the king with his rook. He’s basically defenseless.

What I’ve come to realize in trying to figure out what’s behind the recent fall in gold prices is that the forcing of austerity on the US, is gold prices’ enemy. Austerity measures are meant to control budgets. Fear of course comes with forced measures as some think too much austerity pushes down economic growth. Other than fear, I don’t see anything bullish gold. Middle East issue, European woes and a slowdown in China’s economy have driven gold up to the mid 1700’s. These issues will not be as bad soon. Therefore, surprises to gold might be bearish, not bullish.

That’s not to say that if a compromise were reached that if it were to include another round of financial stimulus I wouldn’t change my opinion. I would as that would deflate currency values. However, without another round of stimulus I see interest rates ultimately going higher as economies rebound. That rebound would likely hurt gold unless it unleashed a strong round of inflation, which I doubt it would in its initial stage.

So, what to do on any given remains an open question, as short covering could happen in the current time window due to compromise on the US budget.

Regardless of what occurs, I think gold will have great problems getting up to $1800 an ounce this year.

If the US goes over the cliff, while you might get spurts upward in gold prices due to fear, the odds favor that if stock prices fell, gold would fall with it. I continue to see a strong correlation between stock and gold prices.

The 15 year and 5 year historical pattern is shown on the seaonal chart above. In addition, I’ve plotted on the bottom of the chart both Bull and Bear year patterns.

It’s hard toargue that gold hasn’t followed gold’s historical “Bull Year” pattern. As such,I don’t expect the remainder of 2012 to have much of a downside bias..

The above Monthly Chart pattern remains in a bullish mode, having a chart pattern of higher highs and higher lows. Support, according to where the 18-Month Moving Average of Closes comes in is at 1680.8. , the low of November’s at 1672.5 is the most recent low.

It’s only December 6^th, so it remains to be seen if 1672.5 will be broken this month or not, but let’s assume it isn’t broken. If December passes without taking out 1672.5, or the current high of 1794.8 is not taken out, the breaking of 1672.5 in January should it occur creates a very bearish chart pattern with a lower high and a lower January low. Longer-term that would be very bearish and signal the possibility of much lower prices.

Currently, The Swingline Study is displaying a pattern of higher lows and higher highs. This is bullish. I’ve shown the lows in “red” the highs in “blue”. In addition, prices continue to trade over the 18-Month Moving Average of Closing Prices, which technically speaking helps to confirm this charts bullish chart formation.

Momentum as measured by the Slow Stochastic Study continues to point sideways to higher and is not in overbought territory.

The chart picture on the Weekly Chart is very different than that of the Monthly Chart. It is clearly bearish.

The momentum as displayed by the Swingline Study, which labels previous highs and lows, is one of a lower highs and lower lows. This is the opposite of that seen on the Monthly Chart.

Another negative on the Weekly Chart is that prices are trading well under the 18-Week Moving Average of Closes, 1716.5.

Prices are not oversold according to the Slow Stochastic Study which needs to see a reading under 20 before I declare it oversold.

Last, the 1672.5 number. If this is broken, it would confirm not only the Monthly Chart Swingline Study turning bearish, but would add another level of bearishness on this chart since that would further the run of lower highs and lower lows.

The Slow Stochastic Study is oversold which takes place when either the K or D lines, the red or brown lines have a reading under 20. Since both are not under 20, this condition is called oversold. If both were to get under 20, the situation would change and become a condition I call “embedded”. If this occurs I get very bearish.

Current price resistance is against the 18-Day Moving Average of Closes, 1722.4. It would take a move over 1731.2, the most recent Swingline High on this chart to negate the current chart pattern of lower highs and lower lows.

If the Slow Stochastic reading were to embed, sharply lower prices might be seen as this condition would probably happen with prices breaking under 1672.5, which triggers even more bearish action on the Monthly and Weekly Charts.

It’s not easy to trade rumors on whether or not Congress and the President reach a compromise or let the US go over the so-called financial cliff. You can be a hero one minute and villain the next.

I see 1672.5 as a key number. If it were broken, I would switch camps. I have been in the bull camp this year, but breaking that number would immediately switch me over to the bear camp.

Therefore, where price are at now is very important and explains why prices in gold are simply hanging around the $1700 level, not going up or down very much.

Since I use the Daily Chart of the shorter term trading and since prices haven’t confirmed the downtrend on the Monthly Chart, I have no bias either to the upside or downside right now.

I simply think you hit and run where you can until the chart picture gets clearer. I see near term resistance in the February Contract in Gold near 1724.5 I expect to see short sellers try to hold prices from rising if that price were to be hit and for the short sellers to back away from their bearish stance if 1733.8 were hit. Until this occurs, I remain short term bearish.

Disclaimer: This publication is strictly the opinion of its writer and is intended solely for informative purposes and is not to be construed, under any circumstances, by implication or otherwise, as an offer to sell or a solicitation to buy or trade in any commodities or securities herein named. Information is taken from sources believed to be reliable, but is in no way guaranteed. Chart data is courtesy of LGP-IraCharts. No guarantee of any kind is implied or possible where projections of future conditions are attempted. Futures and Options on Futures trading involve risk. In no event should the content of this market letter be construed as an express or implied promise, guarantee or implication by or from The Ira Epstein Division of The Linn Group, Inc. or The Linn Group, Inc. that you will profit or that losses can or will be limited in any manner whatsoever. No such promises, guarantees or implications are given. Past results are not indicative of future performance.


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