Wednesday, January 20, 2010

Why Does Gold Appear To Be Temporarily On Pause?

Someone has failed to read the Gold script and the yellow metal is acting a bit unexpectedly weaker than expected at this juncture.  Some pundit, who regularly provides his "Take", has been anticipating a virtually immediate launch higher. That very same pundit is starting to wonder whether Gold has some more backing and filling to do.

Now "Let Me Make Things Perfectly Clear", as President Nixon used to say.  I have NOT changed my longer term view of Gold and Silver one iota.  I still anticipate a huge parabolic rise into at least early 2011, taking Gold up to something like $5,000 and Silver to about $300 per ounce!  The question is the path.

I believe the recent stall in Gold is partly the result of a sudden strengthening in the dollar.  Here's where things get complicated.  The dollar is possibly being used as part of a "carry trade".  What the hell is a "carry trade" you ask?  Ok, I'll 'splain.

Since interest rates continue to be so low, it pays to be a borrower and not a saver.  Unfortunately, the reverse ought to be true in order to turn the economy around, but as I've pointed out before, for every 1% increase in interest rates across-the-board, the U.S. budget deficit RISES by $120 billion!

Now, if we view the dollar and the low interest rates it "carries",  lending or "selling short" dollar denominated Treasuries can be employed to buy higher yielding assets in other currencies. That's a "carry trade".  Use a country's low rates against them and use another country's higher rates to create a "spread".  If the bonds used are both short term, one can create a virtually "risk-free" position, acting like a bank.  Borrowing low and lending high!  Carry trades are commonly employed by hedge funds.

The risk to any "carry trade" is that it can be suddenly unwound without notice!  Once speculators have piled on too many "sold short" dollars, they must eventually "cover" or re-purchase those shorts, which can be wicked if the short position is large enough! 

The dollar appears to be in some sort of short term bottoming process, possibly the result of some unwinding of the "carry trade".  If this is indeed the reason for the dollar's sudden strength, it is also acting as a temporary headwind against Gold. There is also speculation that last night's election in Massachussettes is contributing to a stronger dollar by foreshadowing a change in Congress. Whatever the reason, the dollar strength is making the precious metals sector appear more sluggish than it would otherwise be.

I DO NOT expect Gold to break $1,100 for any sustained period of time and with any materiality.  A break below $1,100 by say 3-5% for a half a day or so would constitute a warning that something of a more serious correction is in the works. 

In fact, the backing and filling process is now nearly 7 weeks old after the last interim top at the end of November.  As pointed out many times before, the market is re-energizing and the upward launch may still be a few weeks away. 

Whatever the "cause" of the pause in Gold really doesn't matter.  The fact is that it will ultimately do its thing when it's good and ready.  As long as rates stay so far below inflation and money printing continues unabated, the seeds for a serious move higher remain in place. 

So stay patient.  And, use this opportunity to accumulate whatever your own risk tolerances allow you to handle.  A good rule of thumb:  if you can't sleep at night, then you have too much at risk! 

Marko's Take

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