THE BIG GOLD PICTURE
by Christopher Laird
PrudentSquirrel.com
June 15, 2006

WE have certainly had some big weeks for precious metals. As of Tuesday this week, gold is down $40 in one day, to 560. Silver down well over a dollar, to under $10.

What gives?

Did gold correct under a normal retracement? Did gold react to some normal Fibonacci retracement, did the speculators just cash in again?

No. The answer to Gold’s price action and the action in the precious metals lie in what I call the Big Gold picture. The Big Gold Picture is a macro economic and political view on the economic news and events. Gold and precious metals react instantaneously to financial economic and political news.

I’m going to cover some of the major reasons for Gold’s price action in a moment, but I want to explain a little more of what the Big Gold Picture is. I use the Big Gold Picture for 95% of my gold-precious metals writing and research.

What is the Big Gold Picture?

Gold reacts to any major economic financial and political news. It is a world currency that is accepted for just about anything you could want. Gold is immune from economic collapses, currency crises and so on, because it cannot be created for nothing.

Rather, currencies find themselves pivoting around gold and having to pay attention to what gold prices are in themselves.

Also, every time there is an economic crisis, a war, or financial event good or bad, gold prices react instantaneously.

It is this characteristic of gold (reacting instantly to everything important) that makes gold a pivot point for the world economic and political economy. You could also call gold a fixed point for the world as well.

Now, silver closely follows gold, its ratio changes to gold, but the general monetary aspects of gold apply quite well to silver. The big gold picture would then apply to silver to a large extent.

However, an industrial metal, such as copper or zinc is not a pivot point for the world economic and political economy. We are in a commodities bubble now, and those metals reflect that, but they are not pivot points for the world economy. Sure, commodities are in a short supply and so on, there is a commodities super cycle right now, and shortages relatively for these metals. But they are not pivot points for the world economic reality.

When I started the Prudent Squirrel newsletter, I just started writing about gold from a macro economic standpoint. That approach has been developed over some time since, when I realized that that is what I really do – macro economic precious metals analysis.

I have found this approach to be very fruitful in predicting in advance major changes in the gold-precious metals markets and the world economy that is yield based. I do not use charting methods, or mathematical derivative arcana. Now, I am a mathematician, but I have found that charting methods and other like systems are only good for predicting what is, not what is changing.

Rather, I focus 95% of my time tracking currencies, the bond market, interest rates, and the various stock and real estate markets, and a host of other economic indicators. Obviously, this is a very time consuming process, and not something that can be picked up at the drop of a hat.

Certainly, I am not going to waste my time calculating Fibonacci ratios if I am looking for major trend changes in the gold markets.

Now then. I have made a number of very timely calls in the gold-precious metals markets.

I’ll give you an example, and this example comes from my Big Gold Picture analysis.

About a month ago, when gold was over 700$, I stated that gold would correct as much as 100$ within two weeks because the gold market was up 250$ in a very short time. That proved true because the following week gold dropped over 40$ the very next Monday.

Now that call was not macroeconomic, it was just based on the bubblish behavior of gold up to that time and I believed a correction was called for.

Now, Two weeks after that, I put into the newsletter that gold was going to go to 550$ if the Fed was going to be aggressive in hiking US interest rates. We are looking at that happening now, and the markets, seeing US inflation at 3 plus percent, and that the Fed was talking about stopping US inflation no matter what, gold rapidly dropped just about 100 bucks in a couple of days. As of this writing, gold is now about 560$.

Now, the reason gold dropped so fast, and silver with it, is because the gold market had already had a huge gain in the last 6 months. And that, combined with the Fed’s clear intention to maintain US bond yields at their 3% premium over Japan and 1.5% over the EU, caused gold to tank hard.

Here is a quote from the last Prudent Squirrel Newsletter on this scenario:

“Case 1: Rising US interest rates would hit gold and silver hard

I would like to point out that, any significant change to the US interest rate environment has a thousand times the leverage on gold and silver prices of any usual factor, excepting perhaps a middle east war, or an advanced stage of US hyper inflation. We are not in an advanced stage of hyperinflation or even the late 1970's type of inflation at this time…

However, if the US economy can handle interest rate increases gracefully, then inflation will indeed raise its ugly head from now on. I surmise that the Fed may indeed consider maintaining the US interest rate differential of about 3% over Japan to keep the US T bond markets healthy. The US also has about a 1.5% interest rate premium over European sovereign bonds as well. Since the EU and Japan are either raising interest rates or moving to do that, the US is faced with having to raise interest rates merely to maintain that yield edge over them, and thus maintain the UST bond market…

Therefore the Fed can easily get ahead of the US inflation curve if it wants to.

A half point increase in US interest rates could hammer gold to the 550 range.

Alternatively, a war in the Middle East will push gold well over 700.

But why would US interest rates have such an effect? Because the world has a total dearth of yield prospects, and as long as the USD does not totally collapse, any significant rise in US interest rates will maintain or exceed the 3% premium over the Yen and somewhat less the Euro bonds. 

What the Fed does care about is the US T bond market and its ability to finance the deficits for the federal government. I suspect they believe that the US housing bubble is already in trouble and since inflation would be a nice target to support the USD then they could go ahead and provide us with a .5% rise in the next Fed meeting.

If this is the case the USD will strengthen significantly. Gold and silver will tank hard because of the leverage that the speculating community has with gold and silver ETFs and the general love of leverage they have with options and so on. “

Now what I am trying to get at in this article is the necessity to use what I call the Big Gold Picture to ascertain major changes in the precious metals markets. I have written for years now that charting is good to get a good picture of what IS but not of what is changing.

I am a mathematician, and I could easily become a great chart analyst. However, I also know the limitations of charting (it is past centric) and so I focus my time on macro economic trends and then ascertain where gold is heading. (remember I use ‘gold’ interchangeably with precious metals).

The big gold picture is a macro economic perspective that looks for major changes in the environment that gold will then use to force the world to pivot around.

As far as I know, I am one of the very few who even attempt such a scope of gold market analysis. But that is proving fruitful again and again. The only problem is it is very very time consuming. But I like this method.

Why gold and silver are down so hard right now.

I have already stated many of the reasons for gold and silver down action this last week in the above quote.

They are:

• Any major change in world interest rates and the USD affect gold a thousand times more than any other factor except a major war. The reason is because the amount of USD is so huge that a mere half percent increase in US interest rates adds about a half trillion dollars yield to the world yield market. US interest rate trends are calling the shots for the gold market at this time.

• As long as the US can maintain a 3% interest rate differential over Japan and a 1.5% over the EU gold will find this combination a suppressing force. This will only happen as long as there is not flight out of the USD and that is not happening now.

• The Fed has clearly stated that they intend to remain very inflation aware and that means we are looking at several .25% interest rate increases to come and possibly even a .5% increase.

• The Fed is more concerned about the US T bond market staying attractive than worrying about the effect of higher interest rates on the US housing bubble and the US stock market. The Fed already has stated they want the US housing bubble slowed down big time. That is happening.

• The usual pundits saying the Fed will immediately loosen interest rates should the US stock and housing bubble slow or crash could be quite wrong- the Fed is more concerned about the viability of the US T bond market and keeping US interest rates at high premiums over Japan the EU and the rest of the world.

According the Big Gold Picture, that means that Gold and silver will be suppressed for a time by the increasing US and world interest rate environment.

However, in the longer term, I still foresee gold and precious metals accelerating because for one thing the US and the world will find themselves in higher fiscal deficits if the world economies cool.

And, If there is a war with Iran, that will accelerate gold by 100$ at a minimum and possibly over $200.

© 2006 Christopher Laird
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Chris Laird
PrudentSquirrel.com
Los Angeles, CA USA
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