Europe unraveling.

Yes, I have written about the coming unraveling of the European Union, but now that it is almost upon us, we need to look at its history and mechanism. Many of the words that are involved have histories and concepts in them that are at the heart of the matter. Such as, bonds, bunds, basis points and point spreads.

Bund is a word that refers to several things: 1. a way by the water or just a road; 2. an organization or group of people (root is 'banda' a Sanskrit word) and 3. German government bonds. There were Jewish bunds (East European Socialist groups) and National Socialist bunds (such as Hitler's). World War One killed off the flower of French, German and English youth and left these countries with inflated currencies (the war was financed by printing currency). Rather than devaluing their currency in comparison to gold, these countries decided to withdraw currency, which created a Depression that lasted almost to World War Two. Europe became Socialist: Germany ruled by the Nationalist bunds and England by Fabian Socialists, while the US came under the spell of the Democrats of Roosevelt (an offshoot of Fabian Socialism). In the East, Russia came under the rule of a very virulent rule of Socialism known as Communism or Bolshevism. The Bolsheviks got their name from the Russian word "bolshe," meaning greater. The Bolsheviks came to claim majority status in the population, mush as the 99% er "OCCUPY" crowd does today. The Western brand of Socialism (beginning in England and spreading to the rest of Europe after WWII) left most of the Capitalist system in place, but established income distribution through high taxes and government programs of medical care, education and welfare. The Eastern brand of Socialism expropriated the means of production and established central planning by the Communist Party.

Communism cracked up first. People who were good at achieving political power were not good at running businesses. Fabian Socialism in Europe and in America lasted longer, because it allowed those with the talent to run business to to just that. European Socialism is cracking up, because Europeans are further along than we are. Europeans, for example, have government-run free medicine, free education and government-run retirement. All these things required financing. Since, Western Socialism is anti-growth ( higher earnings jack up your tax rate and that means you work for the government redistribution), the government programs were paid for by borrowing money via issuing government bonds.

There are two kinds of government bonds: plain govt bonds denominated in local currency and sovereign bond, denominated in some other currency. When the EU was formed, members of the EU had accepted the Euro as currency, so all their bonds became sovereign bonds. That is why we read about the "sovereign debt crisis." Still, we see the crisis moving from Greece to Ireland to Portugal and now to Italy. Why? Because these countries must roll over part of their debt and the new bonds reflect their credit worthiness. How? Italian bonds are compared to the German bonds called 'bunds' and the rate of interest the Market demands is higher for the Italian bond than the German bund. The difference is quoted in 'basis points'. One basis point is 0.01% interest rate. Thus, if the Italian bond pays 7.0% and the German bund pays 6.5%, then the difference is 500 basis points. The graph shows how the difference between Italian and German bonds has skyrocketed.

What's the problem? As the spreads widened for Greece, the European Central Bank and the IMF stepped in to essentially become the creditors of Greece, so they would not default. With Italy under the gun, the procedure of rescuing Italy will be impossible. Why? Because the Italian debt is too big to finance without printing up a bunch of Euros. Why is a default bad? Because a lot of Italian bonds are owed by European banks and if Italy goes under, the European banks go under. Why can't the European Central Bank (the ECB) print up enough Euros to buy up the Italian bonds, along with the Irish, Greek, Portuguese and Spanish bonds? They could, but Europeans still remember what happened to the currency of Weimar Republic and they are terrified of the prospect. Can the Chinese step in? Yes they can, but they demand trade concessions Europe can not live with. Besides, China does not have enough money.

Is there another way out? That is what the French and the Germans are looking for. So far, they are thinking about kicking out the dead beats and essentially ending the EU. Unfortunately, the Scandinavian countries and Belgium are soon to get under the same gun as Italy.

Could the US help? Yes, temporarily. With the election of Barak Hussein, the US is now running a deficit of $1.4T and growth has slowed as various Socialist schemes and impediments to growth plague the US economy. If another $3T is added the US will go into hyperinflation.

The only way out is to cut back on government programs, reduce taxes and encourage growth. By now, the electorates are so brainwashed with the concept of "free" government programs that they no longer can think of providing for themselves. Besides, the Media and Academia are run by the Socialists and they keep up the propaganda. Short of transporting these people to another planet little can be accomplished.

Ironically, the Chinese Commies understand and China is growing by leaps and bounds.

The Market that won't...

Fresh from missing the Summer rally in gold, Larry predicts that gold will fall hundreds of dollars/oz, to recover only after a big drop in the DOW to 9000 and QE3. Since, his prediction is now almost a month old, it is appropriate to examine the data.

The top graph shows the weekly gold prices. The graph shows a market that just won't quit. The MACD tells the story that we can now expect the blue columns to cross to the upside and keep going for several weeks before another high is reached, most likely above the previous high.

The second graph shows the DOW. The Industrials just broke out of a wedge on the upside. Granted the preliminary numbers for today show a 200 point drop in the DOW, the MACD shows a steady rise. So, there is no sign of an immediate drop.

Finally, the daily gold price. We see gold rising toward 1,800.

Today, we see counter moves everywhere. The Left prevailed in Ohio and unions were successful in repealing the new labor law, Mississippi turned down a constitutional amendment to protect babies from conception and Berlusconi is promising to resign. The debt avalanche has finally reached Italy and Italian bonds reached 7% - an interest rate the country can not sustain. The ECB intervened to reduce the rate, which raised the value of the US Dollar and restrained gold, if temporarily. Eventually, the ECB will have to print more money to help Italy roll over a total of 1.9T Euro debt.

I think Larry is wrong again. I believe that the FED is printing again and it is not waiting untill the Stock Market crashes. The DOW will stagnate untill we see the next phase of inflation that will cause dramatic rise in equity prices and PM prices.

Gold and silver continue their rise.

It is time to review the situation re gold and silver. Are we in fact at the beginning of a steep rise (as experts on KWN predict), or are we at the beginning of a steep drop as Larry predicts? Fresh from missing the Summer rally in gold, Larry now predicts a sharp pullback in the DOW to 9,000 and a pullback in gold to maybe as low as 1,100. So, it is time to look at the charts again.

The top chart shows the weekly price of gold. In line with previous predictions of a faster rise, weekly gold rose at the steepest rate since 2008. The MACD hit a low and has entered into an up phase and it, too, predicts a fast rise ahead.

Along with gold, silver began to rise as well. Since, silver rises faster than gold, this shows up in the gold to silver ration falling again (second graph down). This is again an indication that both gold and silver are rising again.

The next graph is the actual silver price. Note that it has kissed the 50 DMA, so further confirmation on the upside is required.

The final graph is the weekly silver price. It, too, shows a breakout on the upside. One of my gurus has issued a BUY rec on silver.

The DOW has also skyrocketed, so Larry's prediction of DOW 9,000 does not look so good. You may say that the big day Thursday was on the false premise that the European crisis has been fixed, but classical use of charting data ignores economic data, it only treats technical data.

Coupled with the sudden drop in the US Dollar, we can confidently say that the financial world has entered a time of inflationary expectations. Precious metals have risen and oil also. The Dollar has dropped and the DOW stays elevated. The latest round of meetings in Europe confirmed a printing of at least 1T Euros and the rollover of Italy's bonds next year may require the printing of possibly as much as 2.5 T Euros. The Markets are again in sync.

PM fails, at least for now.

In the Silver market, the paper trade and the actual trade of metal are grossly out of sink. You can buy paper silver, but getting actual silver for delivery - you have to wait. For end users, the silver they use is relatively minor, so a price squeeze is developing.

There was also an attempt last week to knock the gold price down. Some entity was walking the price down by offering gold for sale. There was a ton at 1,613 and some more below 1,590. The Chinese swooped in and scarfed up a ton at 1,613, upon which the price went back up to 1,643 and the orders below 1,600 disappeared.

The general rule of the Market is that the longer the price is held down by manipulation, the larger and sharper is the rise when the manipulation no longer works.

Gold: coming out oif the correction.

Gold is coming out of its correction. The actual gold prices are shown in the top graph. Note the volatility of prices, which is typical for a market changing directions. The second graph shows the break in the US Dollar. UUP tracks the US Dollar. The third and fourth graphs show weekly gold prices and end in the bottom of the correction.

The last graph shows the gold price plotted on a weekly basis. We now have two consecutive weekly rises, which is a confirmation of the end of the correction.

Three aspects of the graph are noteworthy: 1. The MACD lags the weekly gold price though it is bottoming out; 2. we are seeing the beginning of acceleration in the gold price, similar to what we saw at the end of 2009 and 3. we now expect a sustained rally in gold that will last into next year.

What about Larry's predictions of gold dropping back maybe as far as 1,100? Not going to happen. Gold is migrating to the East and is getting permanently sequestered there. Tremendous quantities of Euros will be printed to recapitalize European banks and the FED will continue injecting money into the pot. It is not in US interests to drive up the price of the Dollar, so we already see a drop in the Dollar. It is at a tipping point and if it goes below 76 a further downward drop can be expected.

The coming Treasury Bubble.

I offer you this article that explains why "Operation Twist" is a failure. What the article does not say is the Operation TWist ensures the necessity of QE3, more inflation and a popping of the Treasury bubble.


Fed Unable to Prevent Rout In Long-Term Treasury Market

by: James A. Kostohryz October 12, 2011 , From Seeking Alpha.


Long-term Treasury yields have spiked above the levels that they were at before the Fed announced Operation Twist.

The Fed does not control long-term interest rates. It never has; never will. The Fed cannot even control yields on long-term Treasuries (^TNX, ^TYX), much less long-term borrowing rates to the private sector (LQD, JNK, HYG)

On September 22, 2011, one day after Operation Twist was announced, I warned investors: Nobody is bigger than the bond market; not even the Fed. Consider why:
Operation Twist is not big enough to matter. Operation Twist purports to buy up $40 billion or so of long-term US Treasuries (TLT, IEF) every month. That is relatively small change in a market of this size. The global market for fixed income is over $90 trillion USD. By my reckoning, yearly traded volume is well in excess of $300 quadrillion USD. On a monthly basis Operation Twist would represent about 0.4% of the total global bond market. And it would represent 0.00002% of global bond trading volume during that period.

Quality more important than quantity. Ultimately, long-term inflation expectations and long-term interest rates are a function of confidence in the currency (UUP). The quantity of bonds purchased by the central bank is an ambivalent force. On the one hand, under specific circumstances Fed purchases of long-term Treasury securities could exert downward pressure on the yields of these securities. However, under a different set of circumstances Fed purchases could have the opposite effect. For example, when the Fed purchases long-term Treasury bonds at negative interest rates (T-Notes at 2.0% and inflation currently at 3.8%) it is clearly “debasing” the currency for reasons spelled out in detail here. In this case, the debasement – the difference between the real (inflation-adjusted) NPV of the bond and the face value of the currency issued-- is of a magnitude of about 17%. This sort of operation has consistently served as an inflection point in the evolution of inflationary expectations in the history of inflation crises in various nations. Thus, Fed purchases of long-term Treasury securities in these particular circumstances could actually precipitate a bond market selloff and a spike in yields.

Fed risks “put back.” If investors begin to lose confidence in the US dollar they will begin to “put back” long-term Treasuries to the Fed en masse. There are currently over $15 trillion in US Treasuries with remaining maturities of over six years. Even if a small percentage of holders sell their bonds on the secondary market due to a loss of confidence, the Fed’s $40 billion per month program could become overwhelmed very quickly.

Market could force QE3 or rate cap. If the volume of sales of long-term US Treasuries were to become too intense (or demand for long-term Treasuries were to decline significantly) the Fed would be obligated to expand the asset purchase program in order to hold long-term rates down. This would require the creation of large quantities of money and a further dramatic expansion of the Fed’s balance sheet. This in turn would tend to fuel further skepticism towards the USD (UUP). History suggests that the situation could very quickly spiral out of control.

Conclusion
Ten and thirty year Treasury yields have pierced the levels that they were at prior to the Fed’s announcement of Operation Twist. This has occured despite the fact that there are no significant signs of economic acceleration and the fact that equities (^GSPC, ^DJIA, ^IXIC, ^NDX, SPY, DIA, QQQ) remain mired in a bear market.

Having said this, is still too early to say that Operation Twist has failed. However, there is no gainsaying the fact that less than one month after the policy was announced, a key benchmark of failure has been registered -- long-term rates are higher than they were prior to Operation Twist.

The potential loss of credibility on the part of the Fed that could arise as a result of a failure of Operation Twist could have momentous consequences.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Tracking the gold price.

This is the time to examine the behavior of the gold price. Larry's forecast calls for a fall in the DOW to 9,000 and the PMs to crash right along with it. Since, we saw a movement in the DOW to below 11,000 and the serious drop in the PMs, do we accept Larry's analysis or, is there an alternate explanation, i.e. an alternate forecast?

The first graph shows gold price plotted on a semi log scale along with the 30 DMA and the 200 DMA. The graph is very similar to the graph of GLD in the previous post. In fact, I chose the 30 DMA to show that the correction bottoms fall on the 30 DMA.

In the next graph, I used the 50 DMA and labeled the rallies. There were 7 of these. A couple of features are worth mentioning: 1. the 50 DMA and 200 DMA were converging up to rally #3 and then began to diverge, so that the 50 DMA began to run faster that the 200 DMA. This indicated a rising price in gold; 2. Another inflection point occurred in the last peak (rally #7), which indicates that gold prices will now accelerate. Note that peak #2 was short and peak #3 was almost 6 months in duration, therefore, we expect now a long period of rising gold prices. Note also that when the MACD rolls over to a negative number, it indicates the beginning of rising prices. That is, the MACD may remain negative even when gold prices already are rising.

Peak #7 (or rally #7) is of particular interest. First, it was larger than the other peaks and was followed by a .6 Fibonacci retracement. Also, the bottom of the replacement was intraday (about $100) and the downward move successfully tested the 50 DMA.

The first two graphs are semi log, showing gold price on a logarithmic scale. This tends to reduce changes toward the higher numbers, so I replotted gold prices on an ordinary numbers scale. This does not change the conclusions, but lets us see some trends more clearly. For example, the inflections during peak #3 (when the 50 DMA began to accelerate away from the 200 DMA) shows up better and so does the inflection point in peak #7. If this trading pattern holds, peak #8 should be even bigger than peak #7 and take gold prices past 2,000.

Could Larry be right that PMs will crash along with the stocks? Sure. As YB said 'it is hard to predict things, especially the future.' However, Larry had already missed the Summer rally and he said that if gold hits 2,100, he will go in. The next two weeks should be interesting.