The Long Awaited XAU Rally.

I thought I’d “touch base” with gold bulls. At the end of December, I was looking for a rally in nearly everything as the Fed’s printing presses went into warp speed and created a bear-market rally in stocks.

However, given the inflationary nature of any potential rally in equities, gold should have rallied even more and thus pushed the SPX/gold ratio below 1.

The S&Ps are actually down slightly on the month, but up from their lows. Meanwhile, gold has blown through the “monkey zone” on the chart like a bullet going through toilet paper and is up about 5% on the month. The fact that it has pierced this magic line on the chart should now trigger even more enthusiasm among those chart monkeys who hated the yellow metal passionately at $700 - but now can’t wait to buy it at $920.

As for the SPX/Gold ratio, it did in fact plunge below “1” last week as gold ($924) passed up the S&Ps (845) in price. The last time this happened was in 1973, and gold proceeded to nearly triple over the next 18 months.

Is history about to repeat? Probably not, but as is often the case, it will likely rhymes. Unlike 1973-1974, gold probably isn’t going to rally due to an oil embargo, but it is going to rally for a very similar reason to why it began to rally back in the early 1970s in the first place, which was because the Bretton Woods monetary system in place since WWII collapsed when Nixon was forced to close the US gold window.

Similarly, while I still tend to believe that gold’s rally is telling us something about the inevitability of more weakness in the dollar, there’s no doubt that there is something else “gold-specific” going on as well, given its continued rise since mid-December in the face of a firmer dollar vs. the other major fiat currencies.

For example, we know gold is breaking out to new highs in all the major currencies except for the dollar and yen, and gold appears to be set to make new highs in these 2 currencies soon as well.

What is gold’s rally in all these currencies really saying, though? Some will tell you it's “fear”, but that’s never the case. When gold rallies, it does so for rational reasons, just like any other investment class that's been rising for 8 years straight. There are extremely large secular fundamentals driving the rally in the gold.

I believe gold’s clear break from its typical linkage to the dollar is revealing a recognition by the market that the fiat dollar-based monetary system that has been in place since 1980 has collapsed, and it has collapsed for the same reason that the US credit markets collapsed (i.e. - enormous imbalances resulting from too much money printing by the Fed). Thus, we’re now seeing a general investor fear of debasement of all fiat currencies globally (i.e. a fear of future inflation and the loss of purchasing power).

For example, the British (and others holding pounds) see the pound sterling collapsing much like Iceland saw its currency collapse, but they know the dollar has its own problems, as does the euro (although I would argue the euro has fewer problems than the dollar or pound at the moment, even though I know others might disagree).

Thus those who hold pounds exchange them for gold. The same goes for those who hold euros and those who hold dollars. This is what's increasingly happening on a global basis, and it’s this demand that's being reflected in the across the broad rally in gold in all these fiat currencies.

When a monetary system collapses, like the fiat dollar-based one has, people simply don’t know what will be the eventual “winner” among government sponsored currencies that will be the basis of a new system (or if that new currency is even in existence yet).

As a result, people run to what they ran to in the mid-1970s when the Bretton Woods monetary system similarly disintegrated and what investors have always run to throughout history during periods of monetary instability. They run to gold (and to a much lesser extent silver and other precious metals and gems).

And they keep running into gold until there is more certainty as to what the new “rules of the road” will be as far as currencies go. And recall that we don’t have another G20 “Bretton Woods II” pow-wow until April (which is probably too soon for some sort of new system to be thrown together anyway). But when a new system eventually is put together, it’s a good bet that gold is going to be somehow involved for obvious reasons.

In any event, regardless of what one thinks about gold as money (although let’s not forget that the Fed sure thinks gold is money because it’s the Fed’s primary reserve asset), gold’s rally is rooted in the fact that there are only two options for the US in this mess: default or debase. By its nature, debasement is a much more creeping inflation than a default, which tends to be more sudden and violent, but both lead to the same place (i.e. – inflation). Thus, both are bullish for gold. As more people figure this out, the dollar may or may not collapse against other pieces of fiat confetti who’s governments are following similar policies, but the dollar will most certainly collapse against gold.

So, 2009 still appears to be setting up to a be a “golden year”, and I expect both gold and the gold mining shares to make new all-time highs in dollars sometime in the first quarter. In fact, the gold mining shares should have an even better year than the metal given their increased leverage to the rising gold price thanks to the collapse in their costs that occurred in 2008's fourth quarter due to the drop in the price of oil and ironically the decline in most foreign currencies against the dollar since most gold is produced outside of the US, meaning that costs in the local currency also declined in terms of their dollar price.

The market knows where this is going. It’s going to end with a lot more inflation, just as every episode of rampant money printing has throughout history.

Stim Ernot..?

Last night, in one of those rare moments when CNBC hosts restrain themselves and let their guests complete a thought, two interviews help frame the economic and investment climate quite clearly and, I believe, accurately.


The first interview was with Dr. Doom himself, Nouriel Roubini. To his credit, Mr. Roubini is one of the few economists who got the current crisis right for the right reasons. Yet spot-on prognosticators risk getting consumed in their moments in the spotlight and lose perspective. This, however, appears to be not the case with Mr. Roubini, as evidenced by today’s interview in which he stated his belief in a U-shaped economic recovery.

The second interview was conducted with PIMCO chief, Mohammed El-Erian. Mr. El-Erian described his “very bumpy journey to a new destination” thesis along with the advice that investors should “stop trying to call a bottom to the market”, that we are going to have “multiple bottoms”. Moreover, in the area of finance, Mr. El-Erian points out that the “short end of the funding market is working”. This is most evident in the TED spread now below 1% (down from nearly 5% just a few months ago).

Given the steady diet of bad news, the uncertainties regarding key elements of the government’s effort to restore economic and financial balance (concerns re: the Geithner nomination, for example), and the following partial list of woes:

-The US economy is in a deep recession.

-The global economy will trend toward zero growth and may even join the US and other.

-developed economies in the economic toilet.

-The financial sector is still under pressure.

-Government will have to play a more activist role for quite some time.

-Earnings results for the past and next two quarters will not provide a pretty economic picture.

It's understandable that investors will default to what they most recently experienced in 2008 and assume that 2009 will be similar. But it would be a mistake to ignore what El-Erian calls the “sequential healing process” underway and both his and Mr. Roubini’s view that, while we are far from out of the woods, the actions taken by government thus far should provide enough stimulus to stabilize the situation – and, hopefully, provide the catalyst for the private sector to rebound.

Investment Strategy Implications

Both Roubini and El-Erian bear witness to a more dispassionate perspective on the economy and markets and, in the process, help investors frame the current crisis in a proper context. Accordingly, a cautiously optimistic view toward equities does seem appropriate with a tilt toward high selectivity and prudent asset allocation decisions made – at least for the time being.

The real question is not whether the mountain of stimulus will or won’t work. It will. Rather, the real question is what happens if all that is being done fails to produce that necessary chain reaction in the private sector. If all that being done does not produce a sustainable recovery, it’s bomb shelter time.

The Long Bond Bubble.

In the chart on the left, please note the very simple channel in long bond futures going back to the beginning of the bull market. Prices seem to top every 5 years. And they topped again - right on schedule.

The "usual" correction is in the 18-25% range if it revisits the lower end of the channel. From the top, at roughly 142, a 25% move would be to 106 or so, which is still a whopping 4.4%. I think that's far too low considering a) what actually now sits in the Treasury and b) the sheer amount of global supply that's forthcoming.

Even in a slow economy, I think foreigners will need to be sellers, and they should be heading to more cash.

One more thing. The secular bull market in stocks, in my opinion, ran from 1974 to 2000, or 26 years. The bull market in bonds looks like it ran from 1982-2008, or 26 years and exactly how long I have been at this. And with the "blow-off" move we just had, my guess is that the top is in, perhaps for a very long time. Like a decade.

Using a Fibonacci analysis leads us to targets that are, well, nauseating - and could be a 50% retracement of the whole move. So buyers of long bonds beware. And if you want to refinance and actually can find a good program, I wouldn’t hesitate. That goes for individuals and corporations alike. And why the Treasury is buying bonds at these levels -- instead of selling long Treasuries -- is beyond me.

Swing high, baby !

One of the hardest things to do as a trader is to sit idle and remain patient while others are high-fiving and enjoying a run. I can’t recall a time when we started the year off with such a bang, and coming in with little to no exposure to the long side -- and just a few shorts -- hasn’t been easy. But I’m taking refuge in the fact that the 2009 ballgame is far from over; in fact, it’s only just begun.

If this is the start of the next great run, I’ll have plenty of time to play it as I quantify my risk/reward ratio and step in with a clear plan. As I watch the final hours of the Dow unfolded, I’m getting the sense that managers are already stumbling over themselves to get into the market, so as to not get left behind - panick buying.

The S&P, NASDAQ, and Russell 2000 are all breaking trend-lines and saying goodbye to their 50-day moving averages - all very positive technical moves. Volume is light though, which is to be expected, and the jury is still out as to whether or not the move is real.

The best play at this time is to remain patient. If you enter a long, do so with a plan, and not because you feel like you’re being left behind. If you enter a short, follow the same strategy - but don’t enter because you’re convinced this move is phony, and think you’re smarter than the tape.

Take a deep breath, don’t get caught up in the hype. That was just Day 1, and we’ve got a long journey ahead.