Monday, April 15, 2013

Dow Theory special issue: Random thoughts about gold and silver

 Lessons learned and probable outcomes

Gold and silver precipitous fall has taught us (or better said re-taught) some valuable lessons. Technical action was right on the spot whereas fundamental-based readings of the precious metals markets have been proven wrong. If you have been following this Dow Theory blog for some time you will remember than in many instances, I “felt” that a change of trend was close at hand. However, the strict application of Dow Theory rules prevented me from declaring a change of the trend. In fact, the literal application of the Dow Theory prevented me from even declaring a change of the secondary trend. Thus, since December 20, 2012, when this Dow Theory blog declared a primary bear market in gold and silver (as you can read here) prices have fallen down in earnest and not even a modest secondary reaction has been staged.

The lessons learned (or re-learned) are clear:

1)     One thing is  to pontificate about the markets ex post facto (after the event). However, in real time, even the most hardened technical analyst may be tempted to make market calls based on extraneous factors like fundamentals. So we should start by acknowledging our weak nature and accept that sooner or later we will be tempted to derogate from our technical rules.

2)     As with sin, temptation is not sinful in itself. What is sinful is to yield to temptation. By the same token, I resisted temptation in many occasions since December 20, 2012. GLD was suggesting a bottom by the end of February, Jim Sinclair wrote that in March, gold would bottom, etc. All these arguments seemed compelling. However, followers of this Dow Theory blog know that, day after day, tenaciously I refused to call a bottom and insisted that technically the primary and secondary trend remained bearish.

3)     Trends tend to get much farther than initially expected. Sooner or later gold will arrest its decline. However, until this happens, the trend has been definitely bearish.

Leaving aside technical considerations, I see that the gold universe is at a critical juncture.

As I have written here, not all gold is created equal. Thus, when talking about gold we have to be mindful of “paper” versus physical gold. However, until or if they decouple there is only one price for both kinds of gold and by this token owners of "physical" will suffer together with "paper" holders until or if they finally part ways. This is why I see two distinct and extreme scenarios playing out in the next few years. Both scenarios will be painful and entail lots of suffering for “gold longs”

a) Either paper gold (GLD, comex, etc.) after a nerve wrenching correction finally goes up to ca. 3500-4000 (Sinclair's view, until recently, because of late he is echoing Fofoa). If paper gold doesn't die and we don't get a full-blown reset, then it may manage to eventually go to 4000 and beyond as Sinclair is fond to say.

b) Or Fofoa is right, and, accordingly, all "paper gold" will burn. In such instance, gold holders (be it of “paper” of “physical must be prepared to see the price of paper gold collapse near its intrinsic value (that is near zero given the massive leverage). Currently the tail wags the dog (paper gold leads the price for both kinds of gold) and thus, those in possession of physical gold must suffer together with paper holders as there is only one price. If Fofoa is right eventually "all paper will burn" and thus GLD, comex, etc. will never recover. Then the markets will close and after some time physical-only gold will re-emerge at ca.
USD 50,000 . A huge reset which implies the whole revamping of the financial system.

No pain, no gain: if Sinclair is right, then eventually GLD will stabilize and we will likely see a repeat of the seventies and from that point, it will go to 4000. This is less painful than Fofoa's scenario, namely the obliteration of GLD, Comex, etc., closure of the markets, reset and after some undetermined time physical gold at $ 50 K. That would be a huge gain for physical gold holders, but it entails lots of "pain" in between, and the dislocation of markets and even the world as we know it.

In any instance, this is going to be a tortuous road.

Once again, I insist that serious readers should acquaint themselves with Fofoa, as this is not a Freegold blog.


The Dow Theorist

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