The analysts were confident about valuations going forward, especially long term. Company execs swore their deals didn’t need any money, while brokers and bankers alike had a gleam in their eye about the financing opportunities amid the debris — even a sense of urgency. One broker — my former business partner, actually — wondered whether the fundamentals for gold have ever been as bullish in our lives.

The answer was unambiguous. The market has answered too.

Newmont and Freeport this week filed documents in conjunction with potential underwritings by J.P. Morgan (NYSE:JPM) and Citigroup (NYSE:C), in the amounts of $1.2 billion and $750 million, respectively, totaling just under $2 billion. Kinross sold UBS about $400 million worth of stock last week. Lundin’s Red Back also negotiated a bought deal worth about $150 million with a group of underwriters led by Cormark Securities and BMO last week. Earlier this month, Yamana (NYSE:AUY) closed a $135 million share offer and borrowed $200 million, while in December, Agnico-Eagle (NYSE:AEM) raised some $300 million from stock issuances after borrowing $300 million a few months earlier (in September). Where’s the deflation?!

The money is coming into the gold sector. The Canadian National Post reported last week that gold miners are “raising cash with ease… many generalist funds have jumped onto the precious metals bandwagon.”

Many juniors have also reported financings where needed. Some are turning them away. Share issues are just too dilutive down here, and any company that doesn’t need money to survive 2009 is prudent to refuse.

Asked about the ability of miners to raise cash in this environment, the analysts at the podium at the Cambridge House investment conference in Vancouver all agreed there is always funding for assets that have sound economic fundamentals. They finance themselves. In fact, in my experience, it is often better to buy the shares of companies with good assets that need cash than companies with cash and no assets, even if the latter are trading at a discount to cash breakup, and even if funding is relatively scarce. Companies with a lot of cash can sometimes get lazy and put up their feet, or insiders waste it — or even steal it, if they lack integrity. Cash itself yields nothing. It’s a depreciating good, as you know. It’s one thing to buy a company at below cash breakup and then break it up and keep the extra cash. It is another thing to invest in a company at cash breakup or less. We invest to earn profits.

If you want to buy cash at a discount, buy a T-bill or term deposit. Or else, you’re just sharing in potential losses due to debasement, negligence, debauchery or theft. That doesn’t mean you should avoid the deals that have a lot of cash — just that’s not what you’re investing in. You are investing either in the underlying asset, which yields profit (i.e., more cash in the future) or management’s abilities.

Ultimately, sound “assets” will hold their value better than idle cash in an inflationary environment.

It is obvious that through this crisis, despite some turbulence, gold prices have held up better than just about any other asset, commodity or currency (other than dollars and yen) we may imagine. From the point of view of a gold miner, this is a very good thing. Even better is that the price of oil, a significant cost input for miners, has fallen a lot relative to gold. This is bullish for margins. Also bullish for gold miners is that the slump may have freed up capital and labor for the development of gold assets, where previous scarcity drove up capex estimates so much that some projects had to be abandoned.

The combination of strong investment demand for gold and lower input costs makes gold stocks one of the only sectors poised for any growth in operating results (i.e., earnings and cash flows) in 2009.

On the other hand, the ratio of gold prices to many of the commodities, and the averages, is at more than a 10-year extreme, and it is not sustainable. As a matter of fact, I think it could be a drag on gold prices. Gold is the only commodity challenging the resistance point in its post-March 2008 downtrend.

It looks poised to break out, and the other commodities appear to be bottoming.

However, while the extremity lasts, it could cap gold prices.

My feeling is that the gold ratios (i.e., gold prices relative to other assets, commodities and currencies) are going to ebb in the short term while commodity prices catch up a little. I continue to think that this catch-up phase will include a rally in stock prices, and a general recovery in risk appetite, even if short-lived. While it lasts, it is likely to shave a few safe-haven points off gold. It hasn’t started yet.

I’m not looking for new lows in gold on this… just some backfilling and consolidation while the other commodities and assets catch up some. This could happen over the next few months. Then look out.

Regardless, however, I expect gold shares to benefit from the general return of risk appetite too.

That is, but for some ebb and flow, I expect gold shares to do well whether gold goes up or not — so long as it doesn’t go down too much. As long as it holds the $800-850 level, gold shares are a buy.

It is still a buyer’s market. Many gold shares are still factoring in a gold price of less than $800. But don’t be hasty.

Rather, be deliberate, which means don’t waver from the plan or your conviction on dips. Buy them. Try not to buy on days when everyone else is, like today, but make sure you have a shopping list and just pick away at it when you get the dip.

Investors should always wade in (and out) of their positions, rather than jumping in and out — as ole Jesse Livermore used to do. They called him the “Boy Plunger.” He made big on the way up and lost big on the way down. There are lots of folks like that on Wall Street. They’re big gamblers. You could say the Fed made them. They don’t care about the black swan, because they believe that should they lose, they will just win again tomorrow.

Keep in mind, though, you’re not buying blue chips here. Small-cap miners (and options) are extremely volatile and risky.

Remember this is for 10-20% of your financial assets — whatever you can sleep at night with. Some people can sleep with more — some can’t sleep anyway. I guess the analogy doesn’t apply to insomniacs, but you get the gist.

Good trading,

Ed Bugos
for The Daily Reckoning

Source: Gold Ratios: Bearish for Gold Prices, Bullish for Gold Shares

This from The Daily Reckoning:

The markets got off to a bad start Wednesday following the news that some members of the Federal Open Market Committee slipped the word “deflation” into the minutes of its last meeting, in December.

Thus, the media jumped all over the deflation theme. Although there was only one mention of “deflation” in the entire 6,000-plus word release, it prompted headlines like this one from MarketWatch: “FOMC Members Discussed Mounting Risks of Deflation, Depression at Mid-December Meeting.”

The stock markets crumbled. Most commodities fell. And even though the dollar fell, gold prices fell $24 on the Comex in response to all this noise Wednesday, while the gold stocks were among the worst performing sectors on the board. Recovery sentiment halted in its tracks as the deflation trade came back with a vengeance. Of course, I’ve been more cautiously bullish with gold prices approaching the resistance points controlling their intermediate downtrend. But my reasoning is that the reflation trade will win out and drive up both stocks and commodities broadly, at gold’s expense, but only short term.

The bulk of the evidence supports this trade, but it has ebbed a little this week because of the news flow – none of which says anything new about the prospects of “deflation” in the Fisherine sense of a liquidation of debts and contraction in deposits. It was just more of the same drivel about falling prices and the shrinking economy, profits and employment, with commentators dragging in long-discredited concepts like velocity of money, the multiplier or even Japan’s alleged deflation during the ’90s.

Of course, as with any other “bubble” – if I am right to call it that – it implies an extent of irrational exuberance or popular delusion, and then there is the sustainability feature… bubbles simply don’t last.

In the reader comment section in response to the MarketWatch report on the minutes of the FOMC, there were example after example illustrating that people believe deflation is caused by a slowing in the economy; rising unemployment; or falling wages and prices, including asset prices… or that deflation is bad; or saving is bad; or deflation existed throughout the ’30s, despite the Fed’s efforts.

I have already dealt with most of these misunderstandings in past issues. My influence must be waning, because they’re not fading away!

Now let me take this opportunity to emphasize something. I do not mean to seem stubbornly fixed to the inflation paradigm. I’m not, in fact. I worry about the deflation possibility. I am always considering new facts and old premises as part of an analytical check to my evolving outlook. My recent tirade is not against the “possibility” of deflation – which cannot be denied. It is a reaction to the nonsense that underlies the great many bad arguments for deflation, which are either littered with factual errors about history or rely on theoretical concepts that are outdated, obsolete and have been long discredited.

The best argument for deflation, given the current monetary system, is if central banks decide that they want to take liquidity out of the system one day (i.e., run a deliberate deflation policy) or be serious enough about fighting inflation, they might overshoot. But no one is making this case.

Unlike the period 1929-33, central banks today can print “reserves” up. You can see this yourself.

There is nothing much to check this process but the will of the populace or the prudence exercised by politicians. The original deflationist, Irving Fisher, made sure of that. He scared America off the gold standard much like the deflation calls of the day have scared the Fed into ballooning its balance sheet!

Speaking of Fisher, I want to deal with one of the most ancient nonsensical theories about money that underpins the deflation scare today: the “velocity of money,” a concept that Fisher himself resurrected.

According to proponents, an increase in money supply doesn’t necessarily mean that money will lose its purchasing power if the velocity of circulation slows down, which happens if people don’t spend.

David Rosenberg, Merrill Lynch’s chief economist, recently put it this way:

“Money supply will increase, but money velocity will not. We are getting asked repeatedly these days how it is that the government debt creation we are about to see is not going to be inflationary. After all, aren’t we going to see a boom in the money supply? Well, we’re sure that the money supply is going to increase, but at the same time, we are going to see the turnover rate of that money, or what is called money velocity, decline.”

And in a segment on CNBC Wednesday discussing the grave threat of deflation, Art Cashin said:

“Even if you walked over and gave somebody a trillion dollars and they either put it in the mattress or just in their pocket, it doesn’t help the economy. You need the velocity of money to move. You gonna give people money, they gotta go out and begin to use it. And we’re seeing some of that worry coming home to roost here in the market today. We saw Intel…”

With people like this, big credentials and all, promoting such ideas, it’s no wonder the deflation scare has teeth, even though it can’t bite through the flesh. Contrast their words with those of former Wall Street Journal reporter and economist Henry Hazlitt, who brought the Austrian School to America:

“Monetary theory would gain immensely if the concept of an independent or causal velocity of circulation were completely abandoned. The valuation approach, and the cash holdings approach, are sufficient to explain the problems involved.”

Hazlitt wrote that in 1968 in an essay in which he demolished the velocity of money notion.

Simply put, the idea “refers to the rate at which money circulates, changes hands or turns over.” It is a very old idea, harking back to the days when the “mechanistic quantity theory” of money predominated. That is, before we understood how individual judgments determined value, this concept of velocity explained variations in the value of money that were out of proportion with the variations in its supply. Under the mechanistic quantity theory, such changes were to be proportional.

Fisher adopted the idea of velocity in his dubious formulation MV=PT (where M is the supply of money, V is its velocity of circulation, P is the general price level and T is the volume of trade).

Both the mechanistic quantity theory and Fisher’s equation have long since been refuted. No credible economist takes either of them seriously. But the idea of the velocity of money has survived, nevertheless, and today it’s a pain in the neck. Hazlitt’s insights were as follows.

First, as far as Fisher’s equation goes, velocity (V) is not an independent variable. It is always exactly equal to the volume of trade T, and is driven by trade, not vice versa – it does not drive trade:

“What we have to deal with, in the so-called circulation of money, is the exchange of money against goods. Therefore, V and T cannot be separated. Insofar as there is a causal relation, it is the volume of trade which determines the velocity of circulation of money, rather than the other way around… the velocity of circulation of money is, so to speak, merely the velocity of circulation of goods and services looked at from the other side. If the volume of trade increases, the velocity of circulation of money, other things being equal, must increase, and vice versa.”

Changes in the velocity of circulation are thus the effect, and not the cause, of changes in the demand for money and/or goods. The concept is a makeshift explanation for the factors affecting the demand for money. For example, if the price level did not change in direct proportion to the money supply, the “Fisherine quantity theorists” would explain it with reference to changes in the velocity of circulation.

Yet the statistic has no more bearing on the value of money (its purchasing power) than the concept of “inventory turnover” has on the price of the individual units of inventory. It cannot cause anything.

Second, as Ludwig von Mises explained, money doesn’t really circulate at all. Nor is it idle. It is always in someone’s possession, but ready to be exchanged (or used). It only spends a fraction of the time changing hands – i.e., without an owner. And when it is exchanged, someone else wants it for the same reason: to keep on hand for future use. It does not simply circulate on its own, as if by some unexplained force, and especially not independent of human judgments of value or expressions of the demand for money, as von Mises pointed out in his famous treatise Human Action:

“The service that money renders does not consist in its turnover. It consists in its being ready in cash holdings for any future use. The main deficiency of the velocity of circulation concept is that it does not start from the actions of individuals, but looks at the problem from the angle of the whole economic system. This concept in itself is a vicious mode of approaching the problem of prices and purchasing power. It is assumed that, other things being equal, prices must change in proportion to the changes occurring in the total supply of money available.”

Third, neither does velocity measure the willingness of people to hold or get rid of their cash, because for everyone who is rendering their cash, someone is taking it, so that at all times, Hazlitt tells us:

“Average individual cash holding must always be the total supply of money outstanding divided by the population… People who are more eager to buy goods, or more eager to get rid of money, will buy faster or sooner. But this will mean that V increases, when it does increase, because the relative value of money is falling or is expected to fall. It will not mean that the value of money is falling, or prices of goods rising, because V has increased… It is the changed valuation by individuals of either goods or money or both that causes the increased velocity of circulation as well as the price rise. The increased velocity of circulation, in other words, is largely a passive factor in the situation.”

He did find, however, that increases in money velocity corresponded with periods of intensifying speculation, whether that speculation was a bullish or bearish extreme. That is, this velocity has no directional significance even as a byproduct – it was just as likely to rise with too much speculation on the bearish side as on the bullish side. Consequently, since it is tied to the volume of speculation and trade, “velocity of circulation cannot fluctuate for long beyond a comparatively narrow range.”

In summary, I am not saying deflation is impossible – only that if the Fed is inflating, we’ll have inflation.

This truth is so simple that it is bewildering to see so many people take the other side of that bet. It is a testament to the effectiveness of the Fed’s propaganda campaign that the deflation argument tends to recruit some of its otherwise potentially most ardent critics.

Keep your eye on the ball, and in the end, you will see that the deflation bogeyman is just that – a myth – used by politicians and central bankers to fear monger the masses into allowing them to inflate.

It has never been anything more.

Irving Fisher was one of its earliest authors, and it was he who lobbied for creation of the Fed, and advised the subsequent abandonment of the gold standard. Certainly, there is no precedent for what the Fed is doing today, but that by itself is no reason to summon the deflation bogeyman.

As for why the reserves the Fed is creating have not been multiplied, the answer is simple: Interest rates are too low! If you fixed the price of oil at 50 cents per barrel, supply would run out quick too.

Source: Deflation Bubble Update: Debunking the Velocity of Money

This from The Daily Reckoning:

The Long-term Outlook, Three-Five Years

My outlook for this period is very bullish. Having spent both the peace and productivity dividends of the last few decades, the current direction of government policy – increasingly interventionist – threatens to set in motion the forces of capital flight… into gold. The effect of this on the dollar will be historic. There is no more honest a measurement for this forecast.

However, it is a three-five year outlook. It may start to unwind tomorrow, or perhaps not for two or three years.

Technically, the long-term chart contains no great knowledge. I don’t put much stock in the charts of any price trend spanning more than 10 years. My calls would lag major turning points by about five years. But as far as the long-term chart goes, the gold price is still in a long-term bull market.

The last highest low in the eight-year bull trend lies at around $540, which is just above the final resistance point of the previous bear – the break out point after which the gold price accelerated in 2005…the year that Bernanke was chosen to head up the Fed. Go figure – turns out gold was right about him.

However, the more normal “primary” trend support lies at around $700.

The “primary” trend is the sequence that shows up most prominently in the five-10 year (weekly or monthly) chart.

In the case of gold, it is the trend that began back seven or eight years ago.

In a normal trend, the correction lows stop at previous highs, or resistance levels, which are at the $700 mark here. Note that the bulls bumped up against that level a few times during 2006 and 2007, before ultimately breaking out. That just makes support that much more significant at this level.

However, during a correction to the primary sequence, the normal support points might fail, and it becomes difficult to figure out whether it is still a bull market at all. In other words, it is possible to see gold prices fall to $600, or even $540, even if the general bull market is still on.

Percentagewise, a correction of just such magnitude occurred in 1975. Gold prices fell from around $200 per ounce at the 1974 peak to just above $100 a year later, before soaring to new highs, and to over $600 by 1980. So the long-term technicals tell us almost nothing, except that there is room on the downside whether or not the bull market is still on.

There are two facts, however, that argue against a correction of the same magnitude today.

One is technical, sort of, and the other is fundamental.

From a technical standpoint, it should be noted that the advance in gold prices leading up to 1975 was larger (percentagewise) than the advance from the $260 low in 2001, and occurred over a shorter time frame. I don’t know how much that may be worth, but it’s something to consider.

Fundamentally speaking, moreover, simply comparing the Federal Reserve’s policies today with those of 1973-74, when it was similarly trying to rescue the world economy from a crisis that saw a 40% decline in the Dow, it cannot be denied that the current policy is far more inflationary… more bold… more off the charts, if you will. If the Fed underestimated its contribution to the inflationary events of the ’70s, as Bernanke argued in a speech about inflation last year, what is the 2008 Fed doing?

The Medium-term Outlook, One-Two Years

My outlook for this period is also quite bullish for gold, as the positive short-term effects of the government’s current policies begin to wear off and the negative effects start to set in sometime in this time frame. I know this is counterintuitive to anyone who believes what the government is doing today is beneficial, but that is really the only way it can work. In this period, you will see asset prices recover, along with commodity prices, and maybe even a fleeting boom (bubble) somewhere, like in biotech, or public works – wherever. However, the rising tide won’t come in fast or high enough to keep all the boats rising like in other bull markets, or even in significant bear market advances.

Let me distinguish here between a recovery in the economy and reflation.

I expect significant deterioration in the economic fundamentals in the medium term. However, much of it is priced in, and the effects of monetary debasement will underpin the dollar value of the soundest assets. Indeed, only the soundest equity or real estate assets will provide real protection against the confiscatory policies of governments over this period. These include gold-related assets, and some of the other important commodities, though it isn’t certain whether gold will outperform in this time frame.

It could take a full year for inflation expectations to recover from their current trough.

Moreover, although the Fed has been a leader in the reinflation program in 2008, it had not inflated nearly as much as the other central banks between 2003-2007. This fact created the illusion of a global boom that would sustain even as the U.S. economy recessed. Now it is being liquidated.

That is one of the reasons the commodity liquidation was so excessive, and also why the dollar rallied this summer. I don’t know exactly what to expect from the dollar in the next year or two, but at best, trade should continue to be choppy.

Currency markets won’t offer much opportunity for most people until the dollar’s bear market resumes – sometime after 2009, in my judgment. However, this should not hinder gold’s performance. Moreover, my feeling is that the Fed will pursue a low interest rate policy for longer than other central banks, which will eventually be the catalyst that undermines the dollar and sets it up for the final chapter in its bear market – the one that leads to a brush with hyperinflation.

Technically, the intermediate trend (i.e., the nine-month trend) is still down. The bulls have bounced off normal primary support at $700 nicely, and October tends to herald correction lows, seasonally speaking. Most of my leading indicators, including gold shares, moreover, suggest the low is in.

The technical objective of the seven-month top formed January-July 2008 was also already achieved at $695, plus or minus, suggesting the bear leg is complete. However, until the last lowest high ($940) in the downtrend is cleared, we have to tame our enthusiasm. What’s more, the current rally has stalled at the downtrend line, which intersects the current time horizon at about $890.

If the bulls can’t make it back up to at least the $940 high of September/October before the market falls back through $830, then I would worry the market MIGHT either retest its $690 low, or go lower.

The Short-term Outlook, One-Three Months

My outlook for this period is neutral to bullish, with the possibility of one more test of support in the mid-high $700s if bullish sentiment returns to Wall Street prematurely. Although the policies governments are pursuing are fundamentally and relatively bullish for gold, it is more than possible that they engender a recovery confidence in the short term that may hinder the performance of gold.

The last highest low in the short-term sequence is around $830. If the market falls through this level before extending the current rally to the $940 area, as mentioned above, there is the slight risk that there is something wrong with my bullish medium-term (or intermediate) outlook above.

But this risk is not that great considering all the bullish permutations that could still take shape. Still, the most likely scenario in my mind is for a pullback to somewhere between $750-800, whether or not the current two-month sequence extends to $940 in the next few weeks.

But until we get over $900, the $830 handle should be watched, as a break through it before a higher high could trigger the liquidation of the two-month advance and start a correction to at least $775.

Source: Gold Price Outlook – The Long and Short of It

Humor me. Let’s crunch those numbers.

Those gold certificates have a book value of about US$14 billion, if you include special drawing rights and coin holdings ($1.7 billion). Even if you revalued this inventory, it would still total less than $300 billion, or 12% ofthe Fed’s total assets. So far, that’s a weak defense against our allegations. And it only goes downhill from there. Assuming it still got the goods at all, a lot has changed in just three months. In August, this gold had a market value that represented over 30% of the Fed’s assets.

Back then, additionally, U.S. Treasury securities still made up half the Federal Reserve’s asset base.

Today, however, in a very short space of time, the market value of both of these assets together comprises just 30% of the central bank’s total assets. It is fruitless to discuss what makes up the rest of its “portfolio,” because whatever it is, it is of lesser quality — aka higher risk.

His proposal was interesting, however, for other reasons. In case you missed its inference, the idea of a revaluation in gold reserves on the Fed’s balance sheet is to boost confidence. It is but a keyboard stroke away, a technical matter. Most analysts already take gold’s market value into account anyway.

Still, two outcomes of such a revaluation occurred to me over and above the obvious, I think.

The first: It would align the Fed’s interests with gold prices — by increasing gold prices, it would boost the value of its balance sheet, for instance.

Second, it would inflate gold’s perceived importance — an endorsement of sorts, in the eyes of the Fed. The public and the market would have to reassess their fundamental outlook about the importance of gold, too.

On the surface, Gramley’s proposal aims at making the Fed look like some kind of gold standard bank. But in fact, this kind of thing, especially if it were spun out in reaction to a crisis of confidence, might be so bullish for gold that it sinks the Fed.

If Bernanke were smart, he would want that gold to disappear off the balance sheet without notice.

But let’s forget about what would be bullish for gold and point out what in fact is the fear of deflation.

The Great Reinflation Update

In December, the Fed shoveled another couple hundred billion new Washingtons into the banking system, out of its many open windows. B-r-r-r!

Its balance sheet expanded to over $2.3 trillion as of last week’s report, which came out the day after it decided to cut rates to nothing. My guess is that we’ve seen nothing yet. You thought “cheap money” was bad. This is the era of FREE money. This stuff grows on trees. You don’t even need choppers. Already, despite the intensity of the deflation rhetoric, the money supply numbers continue to point the other way — toward the Great Reinflation. Or should we say “because” of the intensity of the deflation rhetoric!

This week’s money supply numbers suggest the alleged credit freeze continues to thaw.

After stagnating with little or no growth, stuck at under $1.4 trillion over the past four years (since the Fed began hiking rates in 2004), even as the Federal Reserve started cutting rates in 2007 again, U.S. M1 has grown by over $130 billion, or 10%, since August alone. That’s when it stopped sterilizing its “liquidity” injections. But this kind of growth in three months is a record. Percentage-wise, too.

Most of that growth, moreover, is occurring in checkable (demand) deposits. U.S. M2 is growing at almost $100 billion per month, and it is approaching a 9% year-over-year growth rate — its strongest growth since early 2002, midway through the Fed’s last reinflation effort (2001-03).

Most of that growth is occurring in money market fund holdings.

The definitions of money supply that I put stock in suggest that the banking system is inflating deposits at roughly5% year over year, but of special significance is that this growth rate is picking up now.

It certainly is not as robust as the narrow measures of money or the Fed’s balance sheet.

But it is not deflation.

I promise to keep looking for it, nevertheless.

Source: The Great Reinflation

Facts: The open interest in futures contracts on the Comex has fallen to its lowest level since summer 2005, breaking a general uptrend in place since 2001. From a contrarian standpoint, the short-term bottoms in these data tend to favor the buyers over the sellers. However, the statistic went into orbit during the last half of 2007 — it broke away from the upper channel on the charts, creating a bubble in appearance. The current extremity could simply be a symmetrical reaction to that extreme.

Nevertheless, this is a bearish fact, technically speaking, if it represents a lasting new trend.

It is tempting to suggest that the threat of a raid in futures contracts is causing a short squeeze.

It is true that the commercials are liquidating their short positions promptly. But the funds are increasing their short bets, and the liquidation of longs is such that the net short ratio has hardly budged off its mid-September low — which, incidentally, is a level that has coincided with strategic buying points at seven other junctures since the bull cycle began in 2001.

However, the record of this statistic in gold is unique in that during bear markets, the commercials tend to be net long (wrong) most of the time.

So the fact that they are covering their short interests on net does not necessarily presage a rally if a bear market has set in. A bear market would mean that gold prices could fall as far back as US$500.

Fundamentally, the conditions just don’t look ripe for a bear.

I don’t believe the COTs (Commitment of Traders report published by CFTC) have any real predictive value. They tell us only whether the market is too much extended one way or another; they don’t tell us how long those conditions will last. Right now, the structure of the market is healthy. The commercials are covering their shorts, the funds are getting short and the numbers basically favor the bulls. The contraction in open interest worries me a little, but it could be explained in terms of a collapse in spread trades linked to various index products.

In its most recent report on gold demand, the World Gold Council said as much in trying to explain the drop in the gold price in the context of soaring physical demand. In its third-quarter report on gold demand, the WGC noted growth in both jewelry and investment demand across the spectrum relative to both the last quarter and the year-ago quarter. I don’t want to go into a critique of the method here, except to point out that it chronically understates investment demand and overstates jewelry demand.

The inclusion of ETFs all but proves the point.

In just one year, investment demand has grown in importance from under 15% to over 30% of total gold demand, causing the deficit (supply shortfall) to grow nearly tenfold. The WGC interprets this deficit as supply coming from speculative sources, like futures trading or changes in inventories at the various exchanges — like at Comex. Thus, it calls it “inferred investment.” Formerly, it called this the “balance.” But as it grew, the WGC decided it meant something. What is causing it to grow, aside from growing demand in general, is that while the WGC is “identifying” new kinds of demand, it has not kept up with the various sources of supply. Gold bugs have argued for years that the supply of gold is not limited to mine production, officialdom or scrap… that it is not like other consumable commodities.

It is more useful to assume that most of the gold ever produced is held as a reserve, or store, aboveground. And if this is true, then investment demand must be much larger than the WGC calculates, or the price would, frankly, never go up. If the WGC is smart enough to include producer hedging (or dehedging) in the equation, it should also include a measure of demand that expresses itself through all the exchanges and bring itself up to speed on all the sources that supply the market. It assumes that jewelry demand dominates the market, which is incorrect, but even if it were, it still has the wrong idea.

Jewelry demand may be price sensitive in the short term, yet it has grown every year, at successively higher prices, since the bull market began. Despite my objections, however, I am in total agreement with the council’s explanation why gold prices have fallen despite the evidence of soaring gold demand:

“Notably, the selling captured by the [inferred] investment category was mainly by investors with a short-term focus. It largely reflects the fact that gold was caught in the downdraft of other commodities and other assets — it does not reflect a questioning of gold’s value or role as a safe haven. The strong buying in the ETF and bar and coin markets during the quarter, which reflects investors with largely a longer-term focus, suggests that investor belief in gold’s role as a safe haven and store of value is stronger than ever.”

Morgan & Citigroup Gold Analysts Bullish on Gold Regardless of Dollar

No wonder the commercials are covering. The establishment is getting hot for gold.

PMorgan’s gold analysts “urged” investors to stock up on gold this month, citing counterparty risk and tight supplies. See the article here.

Citigroup’s foreign exchange group also put out a bullish tout.

Well, that’s an understatement, actually. “[Gold] continues to look like a bull market to us. We continue to believe that a move of similar percentage to that seen in the 1976-1980 bull market can be seen, which would suggest a price north of $2,000,” Citigroup’s FX group said last week.

What I found particularly intriguing, besides the timing of these calls, was that they both discounted the dollar. That is, they noted, as I have in the past, that the foreign exchange value of the dollar may not be important at this stage. Morgan said, “It is not an absolute given that a rally in gold means a falling U.S. dollar,” while Citigroup (NYSE:C) pointed out, as I also have, examples of just such a situation during the 1970s.

Anyway, it’s not a sure thing yet, and it all makes great fodder for the bull market in gold.

Source: Bulls Rev up for Comex Raid, Commercials Exit Stage Left

The rally was a no-brainer. There is a strong line of support at $700, which was resistance during 2006 and the first half of 2007. Moreover, the market was, and is, oversold.

The catalyst was news that the U.S. government had to bail out Citigroup (NYSE:C), the world’s largest bank by revenues. The event has given way to new concerns about the economy, which weighed on stocks and gold this week, or at least provided an excuse to take some profits in the latter.

The big question now is whether it was just a retracement rally that ultimately gives way to new lows or whether we have seen the bottom in gold, with this rally being only the first of many to come.

I don’t think the chart can answer that question alone. Technically, the structure of the market is healthy now, and as far as the fundamentals go, gold should not remain under $1,000 for very long.

Indeed, I sense the market is building up for a very bullish move.

Allow me to touch on some of the bullish factors coming into play.

Deflation Scare Past Its Apex

“Notwithstanding the many developments on the bailout front during the past six weeks, The New York Times, like other media outlets, continues to quote Wall Street insiders who report” [that] “‘You have a market that is frozen.’ What planet do these guys live on? It certainly is not the same one to which the Federal Reserve’s data apply. I’ve been singing this song for many weeks, but I’m going to keep singing it until somebody in the news media wakes up and realizes that these ‘frozen credit market’ tales are pure hooey. Look at the data, for crissake.”

– Robert Higgs, author of Crisis and Leviathan, in a recent essay on the bailout programs

The fundamentals are significantly bullish for gold. I’d like to say they are bearish for the dollar, but in truth, they are increasingly bearish for all paper currencies. Outside of the Bank of Japan, everyone is inflating madly. In the G-7, narrow money (M1) is growing at 7-10% on a year-over-year basis in the U.S., Canada, the U.K. and Australia — more in developing countries like China. And this rate is picking up now.

October’s data are not in yet for the ECB. Its balance sheet increased by some 400 billion euros during the month, which is the first big change since the second quarter, and will probably reflect in M1. The Bank of Japan started inflating M1 again in September too, after holding it steady for most of the year.

The broader monetary aggregates (i.e., those determined by the banking system at large) are growing briskly everywhere but in the U.S. and Japan, though even the latter are still growing.

Broad money in the U.S. is growing between 5-10%, depending on whether you rely on TMS or MZM or higher, if you like M3 (I don’t).

The U.S. data are good through October. Up till the end of September, as far as we are updated, the year-over-year growth rate in broad money approached 20% in Australia, its highest rate in almost 20 years. In the U.K., the broader monetary aggregates are growing at close to 14% on a year-over-year basis, which is its highest growth in almost a decade.

These growth rates are almost as bad as China’s, which is approaching 20% year over year too, again. Given these numbers, it is no surprise to me whatsoever that the yen is the strongest currency, followed by the U.S. dollar, or that the Aussie and the pound are taking the greatest beatings, along with all the other riskier currencies.

The actions governments are taking now are bearish for stocks and bullish for inflation. But they are not just bullish for inflation — they are remarkably bullish.

I don’t mean to sound happy about it. It’s just an observation that the market has yet to come to terms with. Since September, the Fed has expanded its balance sheet a total of $1.3 trillion. Of that total, it has created about $600 billion in reserves out of thin air.

Most of that is not counted in money supply, because it excludes deposits held by depository institutions. Total money supply is about $6 trillion, if you rely on the Austrian School definition (I do). It has, nevertheless, translated into growth of about $100-200 billion in new money created by the banking system since September already. Deflation is a no-show so far, and I don’t think it will arrive at all. I think history will see this as just another scare.

The Federal Reserve just announced two new programs that commit it to another $800 billion, and that is even before President-elect Obama puts his stimulus package together.

Reuters cited (NYSE:WB) Wachovia’s chief economist:

“Some, however, are worried the mounting costs of the measures, which have the potential to reach several trillion dollars, could eventually fuel a troubling inflation.

“‘It may mean (a) longer-run issue with inflation and inflation concerns,’ said John Silvia, chief economist at Wachovia Securities in Charlotte, N.C. ‘It may be too much of a good thing is a bad thing.’”

Ya think?

Even more inflationary, in my opinion, is the fact that the talking heads think the Fed’s latest facilities are simply not enough. They are complaining the programs do not include direct purchases of credit card debt and mortgages in the secondary market and that the Fed isn’t going to buy mortgages with maturities of more than one year. Not long ago, the Fed never bought anything but Treasury notes.

Source: Gold Looks Bullish as Dust Settles

More from The Daily Reckoning:

The late November rally in gold prices wasn’t quite as spectacular as mid-September’s gain, but it was still impressive. There was good follow-through too, though the momentum softened as bulls knocked on resistance near $850.

The rally was a no-brainer. There is a strong line of support at $700, which was resistance during 2006 and the first half of 2007. Moreover, the market was, and is, oversold.

The catalyst was news that the U.S. government had to bail out Citigroup (NYSE:C), the world’s largest bank by revenues. The event has given way to new concerns about the economy, which weighed on stocks and gold this week, or at least provided an excuse to take some profits in the latter.

The big question now is whether it was just a retracement rally that ultimately gives way to new lows or whether we have seen the bottom in gold, with this rally being only the first of many to come.

I don’t think the chart can answer that question alone. Technically, the structure of the market is healthy now, and as far as the fundamentals go, gold should not remain under $1,000 for very long.

Indeed, I sense the market is building up for a very bullish move.

Allow me to touch on some of the bullish factors coming into play.

“Notwithstanding the many developments on the bailout front during the past six weeks, The New York Times, like other media outlets, continues to quote Wall Street insiders who report” [that] “‘You have a market that is frozen.’ What planet do these guys live on? It certainly is not the same one to which the Federal Reserve’s data apply. I’ve been singing this song for many weeks, but I’m going to keep singing it until somebody in the news media wakes up and realizes that these ‘frozen credit market’ tales are pure hooey. Look at the data, for crissake.”

- Robert Higgs, author of Crisis and Leviathan, in a recent essay on the bailout programs

The fundamentals are significantly bullish for gold. I’d like to say they are bearish for the dollar, but in truth, they are increasingly bearish for all paper currencies. Outside of the Bank of Japan, everyone is inflating madly. In the G-7, narrow money (M1) is growing at 7-10% on a year-over-year basis in the U.S., Canada, the U.K. and Australia – more in developing countries like China. And this rate is picking up now.

October’s data are not in yet for the ECB. Its balance sheet increased by some 400 billion euros during the month, which is the first big change since the second quarter, and will probably reflect in M1. The Bank of Japan started inflating M1 again in September too, after holding it steady for most of the year.

The broader monetary aggregates (i.e., those determined by the banking system at large) are growing briskly everywhere but in the U.S. and Japan, though even the latter are still growing.

Broad money in the U.S. is growing between 5-10%, depending on whether you rely on TMS or MZM or higher, if you like M3 (I don’t).

The U.S. data are good through October. Up till the end of September, as far as we are updated, the year-over-year growth rate in broad money approached 20% in Australia, its highest rate in almost 20 years. In the U.K., the broader monetary aggregates are growing at close to 14% on a year-over-year basis, which is its highest growth in almost a decade.

These growth rates are almost as bad as China’s, which is approaching 20% year over year too, again. Given these numbers, it is no surprise to me whatsoever that the yen is the strongest currency, followed by the U.S. dollar, or that the Aussie and the pound are taking the greatest beatings, along with all the other riskier currencies.

The actions governments are taking now are bearish for stocks and bullish for inflation. But they are not just bullish for inflation – they are remarkably bullish.

I don’t mean to sound happy about it. It’s just an observation that the market has yet to come to terms with. Since September, the Fed has expanded its balance sheet a total of $1.3 trillion. Of that total, it has created about $600 billion in reserves out of thin air.

Most of that is not counted in money supply, because it excludes deposits held by depository institutions. Total money supply is about $6 trillion, if you rely on the Austrian School definition (I do). It has, nevertheless, translated into growth of about $100-200 billion in new money created by the banking system since September already. Deflation is a no-show so far, and I don’t think it will arrive at all. I think history will see this as just another scare.

The Federal Reserve just announced two new programs that commit it to another $800 billion, and that is even before President-elect Obama puts his stimulus package together.

Reuters cited  Wachovia’s (NYSE:WB) chief economist:

“Some, however, are worried the mounting costs of the measures, which have the potential to reach several trillion dollars, could eventually fuel a troubling inflation.

“‘It may mean (a) longer-run issue with inflation and inflation concerns,’ said John Silvia, chief economist at Wachovia Securities in Charlotte, N.C. ‘It may be too much of a good thing is a bad thing.’”

Ya think?

Even more inflationary, in my opinion, is the fact that the talking heads think the Fed’s latest facilities are simply not enough. They are complaining the programs do not include direct purchases of credit card debt and mortgages in the secondary market and that the Fed isn’t going to buy mortgages with maturities of more than one year. Not long ago, the Fed never bought anything but Treasury notes.

Gold bulls are going to attempt to raid Comex’s vaults by forcing delivery on their December futures contracts (Dec. 19). Who can tell how that will go? I can’t. But it’ll be interesting to watch.

Facts: The open interest in futures contracts on the Comex has fallen to its lowest level since summer 2005, breaking a general uptrend in place since 2001. From a contrarian standpoint, the short-term bottoms in these data tend to favor the buyers over the sellers. However, the statistic went into orbit during the last half of 2007 – it broke away from the upper channel on the charts, creating a bubble in appearance. The current extremity could simply be a symmetrical reaction to that extreme.

Nevertheless, this is a bearish fact, technically speaking, if it represents a lasting new trend.

It is tempting to suggest that the threat of a raid in futures contracts is causing a short squeeze.

It is true that the commercials are liquidating their short positions promptly. But the funds are increasing their short bets, and the liquidation of longs is such that the net short ratio has hardly budged off its mid-September low – which, incidentally, is a level that has coincided with strategic buying points at seven other junctures since the bull cycle began in 2001.

However, the record of this statistic in gold is unique in that during bear markets, the commercials tend to be net long (wrong) most of the time.

So the fact that they are covering their short interests on net does not necessarily presage a rally if a bear market has set in. A bear market would mean that gold prices could fall as far back as US$500.

Fundamentally, the conditions just don’t look ripe for a bear.

I don’t believe the COTs (Commitment of Traders report published by CFTC) have any real predictive value. They tell us only whether the market is too much extended one way or another; they don’t tell us how long those conditions will last. Right now, the structure of the market is healthy. The commercials are covering their shorts, the funds are getting short and the numbers basically favor the bulls. The contraction in open interest worries me a little, but it could be explained in terms of a collapse in spread trades linked to various index products.

In its most recent report on gold demand, the World Gold Council said as much in trying to explain the drop in the gold price in the context of soaring physical demand. In its third-quarter report on gold demand, the WGC noted growth in both jewelry and investment demand across the spectrum relative to both the last quarter and the year-ago quarter. I don’t want to go into a critique of the method here, except to point out that it chronically understates investment demand and overstates jewelry demand.

The inclusion of ETFs all but proves the point.

In just one year, investment demand has grown in importance from under 15% to over 30% of total gold demand, causing the deficit (supply shortfall) to grow nearly tenfold. The WGC interprets this deficit as supply coming from speculative sources, like futures trading or changes in inventories at the various exchanges – like at Comex. Thus, it calls it “inferred investment.” Formerly, it called this the “balance.” But as it grew, the WGC decided it meant something. What is causing it to grow, aside from growing demand in general, is that while the WGC is “identifying” new kinds of demand, it has not kept up with the various sources of supply. Gold bugs have argued for years that the supply of gold is not limited to mine production, officialdom or scrap…that it is not like other consumable commodities.

It is more useful to assume that most of the gold ever produced is held as a reserve, or store, aboveground. And if this is true, then investment demand must be much larger than the WGC calculates, or the price would, frankly, never go up. If the WGC is smart enough to include producer hedging (or dehedging) in the equation, it should also include a measure of demand that expresses itself through all the exchanges and bring itself up to speed on all the sources that supply the market. It assumes that jewelry demand dominates the market, which is incorrect, but even if it were, it still has the wrong idea.

Jewelry demand may be price sensitive in the short term, yet it has grown every year, at successively higher prices, since the bull market began. Despite my objections, however, I am in total agreement with the council’s explanation why gold prices have fallen despite the evidence of soaring gold demand:

“Notably, the selling captured by the [inferred] investment category was mainly by investors with a short-term focus. It largely reflects the fact that gold was caught in the downdraft of other commodities and other assets – it does not reflect a questioning of gold’s value or role as a safe haven. The strong buying in the ETF and bar and coin markets during the quarter, which reflects investors with largely a longer-term focus, suggests that investor belief in gold’s role as a safe haven and store of value is stronger than ever.”

No wonder the commercials are covering. The establishment is getting hot for gold.

JP Morgan’s gold analysts “urged” investors to stock up on gold this month, citing counterparty risk and tight supplies.

Citigroup’s foreign exchange group also put out a bullish tout.

Well, that’s an understatement, actually. “[Gold] continues to look like a bull market to us. We continue to believe that a move of similar percentage to that seen in the 1976-1980 bull market can be seen, which would suggest a price north of $2,000,” Citigroup’s FX group said last week.

What I found particularly intriguing, besides the timing of these calls, was that they both discounted the dollar. That is, they noted, as I have in the past, that the foreign exchange value of the dollar may not be important at this stage. Morgan said, “It is not an absolute given that a rally in gold means a falling U.S. dollar,” while Citigroup pointed out, as I also have, examples of just such a situation during the 1970s.

Anyway, it’s not a sure thing yet, and it all makes great fodder for the bull market in gold.

Source: Gold Looks Bullish as Dust Settles

This from The Daily Reckoning:

Occasionally I hear the odd guest on CNBC or Bloomberg Radio who lays blame for the crisis in exactly the right place – the Federal Reserve System in the U.S….or central banking more broadly.

These extremely influential institutions ostensibly exist to regulate prices, employment and interest rates by way of control over the money supply. They do this by inflating bank reserve credit, on which the banks can pyramid, thus essentially abrogating the role of interest rate determination by the market.

That is, the central bank tries to determine interest rates as far as it can. The rationale for this policy is to attain full employment and price stability, and to otherwise manage economic affairs.

Any economist whose lenses aren’t blurred by the fatal errors of the neo-classical doctrines is immediately capable of spotting the problem with that policy foundation. Unemployment could scarcely exist on a free market, where the government did not interfere with the price of labor. Just like shortages of goods cannot really exist in a market where their price is free to adjust to the reality of existing conditions, there can be no excess labor unless the government intervenes to artificially boost its price. It’s the same principle. It is a simple economic fact – free of political considerations. Labor is an economic good primarily because it is scarce.

Moreover, whether we are talking about labor legislation or the central bank trying to manage growth, prices and interest rates, it amounts to economic management, even planning.

The apparent effect of the policy is to bring about a boom in investment and consumption… the building up of bubble companies and uneconomic enterprises relying on the continued increases in the selling prices of the goods they deal in – be it widgets, homes or securities.

These price increases are afforded by regular money debasement, which is one of the economic consequences of an increase in the supply of money in particular. So it is illusory.

In reality, as Rothbard points out, the boom “is actually a period of wasteful misinvestment. It is the time when errors are made, due to bank credit’s tampering with the free market”.

So this policy, and the booms it engenders, crowds out real savings (by pushing rates below market), and investment comes to rely on the continued “stimulus” of money creation or from borrowing overseas.

Ultimately, it further lays the seeds of its own demise because the process invariably arrives at a point at which the central bank must desist if it does not want to prompt a run of confidence in its notes, leading to hyperinflation.

This is why we say the policy is “unsustainable.”

Thus it tries to withdraw the stimulus or “tighten” money and credit – explaining that the overheated economy might produce inflation. The error in its thinking is that it is managing a delicate balance between price stability and growth…that it checks market failures, and can know the unknowable (the future).

In fact, almost all economists would agree, it cannot produce growth. It’s like the analogy of pushing on a string.

The Fed’s policy can only increase employment by decreasing the relative cost of labor through inflation (the expansion of money supply relative to demand). And as one of the largest of interventions conducted by government policy, it only produces more instability – i.e. the boom-bust cycle as well as interest rate and foreign exchange volatility eventually.

Technically, tampering with the rate of interest produces disequilibrium as a mismatch between consumer preferences and producers’ investment plans – during the boom phases. Effectively, it taxes long run growth, and is but a massive redistribution of wealth from savers to borrowers and speculators.

The bust, which often begins with the onset of a financial crisis, brings much pain, and threatens job losses on a wide-scale. But this is because the artificially low rate of interest produced by the previous policy, which could not be sustained, produced waste, a “cluster of error” as Rothbard called it. This “malinvestment” or uneconomic activity is essentially exposed as the subsidy is withdrawn.

In his book, America’s Great Depression, Rothbard posits the error in Marx’s reasoning,

“In the purely free and unhampered market, there will be no cluster of errors, since trained entrepreneurs will not all make errors at the same time.”

What you see then is basically the widespread failure of parasitic enterprises that could not survive on their own – without the handouts and support of the central bank. This is the empirical evidence that should indict any inflation policy. But, the bust still merely represents a return to natural market ratios.

“The ‘depression’ is actually the process by which the economy adjusts to the wastes and errors of the boom, and reestablishes efficient service of consumer desires. The adjustment process consists in rapid liquidation of the wasteful investments” (Rothbard)

It follows then, that “Attempts to interfere with free and flexible prices, wage and interest rates prevent recovery and prolong the depression period” (Mises Made Easier)

Efforts to stabilize the bust with even more inflation effectively prevent the liquidation of uneconomic enterprises necessary to return the economy to equilibrium, where markets reflect actual conditions.

Now, I’m not a policy maker. I don’t want to suggest the best way to fix the world or argue why these theories are true. My chief concern is the future. And the evidence that most people would side with Marx on this (over Mises et al) is all I need to predict more inflation, war and higher gold prices.

Joe Public can’t for the life of him figure out why it matters if interest rates are 1.5% or 1%.

He cannot connect the escalating price at the pump to the process of money creation required to bring about such a modest change in the interest rate. The tech bust was the fault of irrational speculators, and greedy investment bankers. The housing bust is blamed on Wall Street’s larceny, his mortgage and real estate brokers, or the thrust toward deregulation. The painful increase in commodity prices is caused by too much growth. The growing trade deficit is caused by new competition from foreign countries. And so on.

For, Joe takes his cue not from Mises, but from the media and political classes under heavy influence by the progressive institutions.

Political leaders in Europe, meanwhile, are taking full advantage of Joe to wage a new war on capitalism from the left on grounds that American style capitalism is in dire need of more regulation.

This is the great evil of the inflation policy.

It is insidious. The great economists have all recognized this truth. It only produces the opposite of what it claims to accomplish. It also funds the growth of government and anti-capitalist sentiment, and other confused ideas that may lead, ultimately, to the general disintegration in the division of labor, the fabric of society. It promotes moral degradation and corruption, conflict, and finances wars. It is 80% of what’s wrong with the world.

But for the most part, the voices of reason that point to this cause are trampled over by the rhetoric of the larger political class, which fear mongers people into clamoring for more money and credit.

This truth is evident in the Fed’s actions. It has abandoned any remnants of conservatism, as have the other central banks worldwide. The helicopter blades are in full swing. So any enthusiasm about the world having reached this place where it is ready to turn a new leaf must be tempered by this fact.

The voices of reason, though on the beltway, are still only voices in the wilderness.

This alone suggests we are going to continue to see more inflation, taxes and government. The scary part is that this process is accelerating.

The next bubble may well be in gold.

Source: Voices of Reason Still in the Wilderness

More from Whiskey & Gunpowder:

There are only two things gold bulls should worry about from this point forward, now that the general commodity correction is out of the way and the froth has been worked out of the market: deflation in the strict sense of the term (monetary, not asset deflation) or a suddenly brightening economic outlook, both of which, in this writer’s opinion, would require a political austerity hardly imaginable these days.

As far as deflation goes, we saw that the Federal Reserve inflated its balance sheet by an astonishing U.S.$600 billion (almost 70%) in September, $170 billion of which ended up as an un-sterilized liquidity injection into the financial system — also unprecedented any way it is measured.

It is almost as much as the entire U.S. banking system created in the 12 months ending August 2008. It is about 20% of the cumulative amount of reserves the Fed has directly injected into the banking system since its inception in 1913. In one month, the Bernanke Fed “printed” MORE money than the Greenspan Fed in its entire easing campaign from 2001-03 — on top of which the banking system created $1.5 trillion.

Let me be the first to tell you that this represents a deliberate and abrupt change in monetary policy.

The Fed is no longer sterilizing its liquidity injections by selling off assets — probably because it doesn’t have any left. No one else seems to have caught on yet. The Fed is now printing with abandon, as literally as that can mean.

However, that isn’t enough to convince the deflationists. They point out that banks aren’t lending and that credit markets have frozen all over the world.

This is obviously true. However, it does not follow from this that there will be deflation. Let me reiterate that first, whether deflation comes about or not (I think not), the financial crisis is deepening precisely because, up until last month at any rate, the Fed had not created much money, despite the massive rate cuts. This policy was unconventional and deliberate. It was aimed at gold.

It has produced many things that the Austrian business cycle theory would predict from the policy.

The enterprises that are failing today are boom dependent. They have come to depend not only on the artificial stimulus of lower interest rates, but on a continued expansion in credit and money supply.

Indeed, Fed and Treasury officials, the media and Wall Street all talk as if the economy could not grow if the banks were not producing new credit. For them, boom and growth are one and the same thing.

The market is telling you that some operations are uneconomical in the absence of this “stimulus.”

If the Fed continued on its austerity program (with respect to the printing press), the dominoes would no doubt continue to fall. This would be a process of returning the economy to equilibrium, if you will.

That is the definition of a bust or recession. It would probably be deflationary.

The Fed wasn’t aiming for that. It wanted only to put the squeeze on inflation expectations building in the gold and currency markets without undermining the boom. It was a bold and new move, but naive. But its actions can only suggest that it is realizing this, and is not prepared to do what is right — nothing.

Lending strikes are not new. They are typical at the height of a crisis.

The Fed has published data on reserves only up until the third week of September, so it does not yet reflect the $170 billion net increase in reserves created by the Fed through the entire month, as I had reported last week. However, up to Sept. 24, the Fed created some $84 billion in reserves, while the figure for total reserves increased by $67 billion (from $44 to $111 billion) in the same period.

Excess reserves, meanwhile, increased by about the same amount.

Don’t get caught up in the numbers. These facts essentially support the view that banks aren’t lending out those new reserves. However, this fact is neither new nor typically long lasting.

U.S. depository institutions are required to have about 10% of their checkable demand deposits at the Fed as reserve. This amount peaked at a little over $60 billion in the mid-‘90s, declined to about $40 billion by the end of the century and has hovered around that number ever since, as if inflation did not exist. It pales in comparison with the more than $1.5 trillion in reserves that the Fed has pumped into the banking system in its entire 95-year history or the $4-5 trillion in deposits that the U.S. banking system has created on top of that in the same period (even after accounting for deposits destroyed).

This is leverage, but the Fed, not the stock market, controls the denominator.

The reason that total reserves have been shrinking has to do with reserve requirements. Although savings deposits are often checkable in practice and can be accessed by debit cards, banks are not required to keep reserves against them. Therefore, banks like to sweep (and create) as many of these deposits as possible into the savings categories. That’s why there is an upward bias to the underlying trend in the ratio of excess to total reserves. It does not reflect an increasing tendency for bankers to restrict lending voluntarily, but likely understates the inflation in reserves.

But while the figure on total reserves may have become obsolete and lost much of its relevance, big changes in the data are always important and shed light on things.

Today, the Fed is opening new windows through which to transmit policy. It can inject liquidity directly into money markets, and now commercial paper markets. It can lend directly to primary dealers. It can buy mortgages. It can pay interest on deposits, which will have two effects: exposing the hidden reserves (above) and luring money into the Fed. The latter is deflationary, but the interest payments are inflationary, if “unsterilized.” At every crisis that is bigger than the last, the deflation argument is always compelling. But it is fundamentally misguided if it is related to the idea of asset deflation or deleveraging. These concepts are not interchangeable with deflation.

Deflation, for instance, hasn’t occurred since 1933, but deleveraging and asset deflation have, often — last in the 2000-02 bear market, and even as the Fed and banking system created a bunch of money.

Banks don’t make money on the interest differential from lending out other people’s deposits. They make money by lending out more than they take in…by “creating” deposits (i.e., inflation).

This is what a fractional reserve banking system does. It will lend again once it is confident that the central bank is making funds easily available and stands ready to bail banks out. By not printing until last month and letting Lehman go, the Fed sent out mixed messages that it is only now clearing up.

Abolishing the Fed would be a great idea.

Your freedom would be secure. Recessions would be gone. Governments would not be able to increase spending without immediate retribution. Growth and equality would become synonymous.

Crazy?

Not really. It’s basic economics.

However, it appears somewhat utopian given the public’s attitudes about the market and politics.

Most of the world, led by its political leaders, believes that the economic crisis was caused by greed and excess in the private sector, that the market is inherently unstable or that deregulation was the culprit.

Even some Austrian School authors blame the repeal of Glass-Steagall — the New Deal-era legislation that prohibited bank holding companies from owning nonbank financial firms or competing with securities and insurance companies — for the crisis. That’s ironic for reasons I won’t get into here, but it is a qualified charge — meaning deregulation is a good idea only if the central bank didn’t exist. I personally don’t agree.

Still, people by and large do NOT see monetary and fiscal policy as interventions causing disequilibrium.

They see them as offsetting and stabilizing institutions — safety nets and tools of economic and social management — as they were supposedly envisioned.

For this reason, I posit, central banks and governments do not have the political will it takes to do nothing.

The change in Fed policy last month proves precisely that, which is why gold should soar.

I believe the markets are wrong again to perceive a deflationary outcome. It is an entirely different monetary system than existed in the 1930s, when the Fed could not simply print up reserves.

Deleveraging and asset deflation are not bearish for gold, as they don’t necessarily imply a contraction in money supply, and rarely have. They may be bearish for gold stocks, but they are bullish for gold prices, because they are the very factors that motivate the near-certain cries for new credit (or more money) arising from a bad understanding of the true causes of the crisis. They are not new and are ultimately dwarfed by the next crisis.

But maybe the deflationists will be right about the behavior of banks this time. They have been wrong at each point in history when the economy faced a crisis caused by inflation. The thymological (historical) experience is that when the Fed inflates, the banking system does soon after. The Fed has never inflated in one month as much as it did in September. So the odds are against deflationists.

Indeed, the money supply could grow 25-50% in less than a year if that liquidity isn’t taken back.

Ultimately, though, both the prior boom and the bust can be explained wholly by the Fed’s specific policies. As will the next boom…in gold mining!

Source: Stumbling into a Bull Market

“The market exists to discover value,” says gold bug Ed Bugos. Right now, it’s betting on deflation. But Ed says the feds will succeed in reinflating the economy. This means the gold market will shrug off the deflation scare and recover soon. There are three strong reason why the Fed will fail to tighten money supply.

This from Whiskey and Gunpowder:

I think the odds are very low that you will see deflation — outside of a short-term aberration. This is because banks can create money, and there is nothing restricting them from creating all they want.

There is no gold standard today.

Governments got rid of the gold standard so they could inflate without restriction.

Moreover, the central bank has only increased its control of the financial sector over the decades. If we ever had a real deflation (in the monetary aggregates), it would have to be deliberated. That is why the odds are low.

According to the True Money Supply, an Austrian School monetary aggregate, the Fed is currently no tighter than it was in the late ‘60s or mid-‘70s, or even 2000, for that matter.

It is not the 1980, 1990 or 1994 Fed, which was committed to disinflation — and had the public behind it. Nor is it as easy as Greenspan’s post-1996 or post-2001 Fed.

Still, the Fed’s policy could produce a deflation scare if it overshoots in its aim against expectations and allows some deflation in money and credit by some unforeseen accident…or moral hazard.

Such a scenario would probably make the chart right about $695, and boost the dollar.  And this could happen even if we are ultimately right about gold going to $3,000, or higher. It would be temporary, no doubt, Ben would quickly sport his helicopter hat in response.

But there is reason to doubt even a deflation scare.

I am skeptical that the Bernanke Fed will stick to its guns on the money supply for the following reasons:

1. The Fed’s current policy is already net bearish for the “boom” — That is, without money supply growth the “boom” will continue to falter.

2. The political mandate for a tight Fed is weak — In the current economic condition without a forced hand, the Fed will increase money supply.

3. The economy is in no shape for a tightening — At this point the economy is used to cheap money and a tightening of the money supply would cause a “bust” cycle.

However, as long as the Fed can bluff and withstand from increasing the money supply the gold chart will probably be right.

If the bulls cannot hold the Aug. 15 low at about $774 on the front-month Comex contract or recover the $850 handle anytime soon, we’re going to $695, plus or minus, over the next few months.

This risk will dissipate if the bulls can recover $850, especially on a strong dollar. In fact, we have to look back only to 2005 for an example of this bullish scenario. I have already remarked on the similarities in this correction to 2004.

The 2004 correction in the gold sector was the one that occurred ahead of the Fed’s last tightening. Six months after the tightening started, the US dollar began to advance. It advanced all year in 2005.

Likewise, I expect that the gold market will shrug off the deflation scare and recover soon here, as well, ultimately undermining the dollar advance. That is right: The US dollar is the dependent variable, not gold.

It is correct to say that the US dollar is gaining ground on the heels of gold’s correction; it is incorrect to say that gold is weak because the dollar is strong.

Gold is weak because the Fed is targeting it.

But the Fed is bluffing with a bad hand.

Source: The Market Is Always Right