Monday, November 9, 2009

2 conditions of gold breakout are met

This will be a short post simply to observe that 2 of the 3 conditions that I listed for a sustainable gold breakout have now been met. First, gold broke above nominal highs back at the beginning of last month. More recently the dollar broke important support at 76 and has now confirmed the break, touching 75 and "rejecting" a rally above 77. There is heavy selling in the dollar this morning.
The final condition - silver and the HUI index breaking to new decade highs- has not yet been met, but the HUI is looking particularly strong this morning, and is at a 20 month high. I expect silver to play catch up if and when doubt fades about the reality of our economic recovery.
There are plenty of reasons to think that economic recovery could continue for another few quarters. As I posted last month, the last 40 years of data show that moderate input prices lead to above trend growth. I define moderate input prices as quarterly prices that are below the local three year high. For example, crude prices reached an average of ~$120 in 2008Q2. As long as prices stay below that level, I would guess that the effect on the economy would be positive. Translating this to physical reality, prices below their old highs indicate the presence of slack in the system - in this case the ability of Saudi Arabia and the UAE to increase oil production by 1 to 1.5 million barrels a day.
The contraction of consumer credit is worrying but the increase in government debt can substitute for this. The economy can grow in spite of being run poorly and/or in an unsustainable way.
Until there is some sort of crisis in the interest rate market, or a major shift in the faith placed in the US dollar, the economy can continue to grow in an unsustainable way. And so long as this is true, it is very likely that the gold:silver ratio will continue to fall.
Since gold has already advanced so strongly, I am thinking of buying silver on a break out. Thus if silver breaks above $21.5 I would expect it to advance strongly and play "catch up" to the gold break out.

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