The terrible pile-up on the world's financial highway has left us all in shock. We check to see if our fingers move. We look in the rear-view mirror to see if there is blood on our face. And then we crawl out of the car.

Thank God, we can still walk! No broken bones.

What's our name? Count back from 10.... Okay, no brain damage.

But oh...look at our ride! The car is totaled. There's only about $100 trillion worth of wealth in the world. At least, that's the figure we read recently. We've also read that the total loss of wealth from the global financial crisis could be as much as $50 trillion. That was Rupert Murdoch's estimate. And he's probably not far off. Half the world's stock market value. Twenty percent of property values. Trillions in derivatives, SIVs, CDOs and IOUs. It adds up fast.

But wait...what luck!...we're still in one piece. And there, on the side of the road, there's still a gas station...a pizza shop...a mall. Life goes on. Most of the wealth that was lost was only imaginary wealth - confections spun out of sugary dreams. Put a little water on them and the melt away... But the real wealth is still there...more or less.

So cheer up. It's not so bad!

Those who feared the 'end of the world' can relax. A financial crack-up doesn't mean that real assets disappear. Houses are still right where they were before the crack-up began. Factories are there too - with their assembly lines and heavy machinery. Every backhoe and tractor-trailer is still just as ready-for-service as it was before the crisis began.

So what's the problem?

Who said there was a problem? We don't have a problem...do you have a problem?

It's just that the world economy is going through a major re-examination of its life. It was shaken up by the accident. Not just physically... emotionally too. It stared death in the face - or so it explained to friends, a bit too often and too dramatically, after the crash. So, it's decided to take a long vacation... After many years of working day in and day out...buying, selling, investing, speculating, leveraging, borrowing...whew!...it is ready for a rest. So, it's taking some time off. Thinking about things...re-evaluating things.

'What am I really doing with my life?' it wants to know.

'Is this the right way to go?' 'Does this take me where I want to be? Maybe I should have gone to law school like my mom wanted.'

'And my marriage...what the heck is going on there? Evelyn was so nice and sweet when I married her. Now, all she thinks about is redecorating the house...and hanging out with her friends. And look what she did to her face! She's got those cardboard lips that never crack a smile... And now, she's mad at me because I lost money in the worldwide financial meltdown. But who didn't?'

While all this deep reflection is going on, the world's income is falling rapidly. Businesses are closing their doors. Working stiffs are working a lot less. Machines are slowing down. The capitalists are just trying to hold on to what they've got - forget about making more.

On Friday, the Dow fell another 100 points. It's headed down to the 3,000-5,000 level. Could there be a big rally first? Could it fall like a stone...even lower than 3,000? You bet.

And look at what's going on with gold - up $25 on Friday to close over $1,000! The Dow is on it way to 3,000...and so is gold. Remember our 'Trade of the Decade?' Never mind...of course you do. Buy gold on dips...sell stocks on rallies. So far, so good...and only 10 1/2 months left to go.

(More on gold, below...)

Gradually, a stark and uncomfortable realization is setting in. It's like a middle-aged man who suddenly realizes he's wasted the best years of his life...

The world's enterprises are set up for an economy that no longer exists! Factories were built...along with a whole chain of production, delivery, and sales...to provide too many things to too many people who can't pay for them.

And now, in these moments of soul searching...of walking along the beach and hearing the seagulls speaking each to each...comes another realization: almost nothing is worth as much as it used to be. Take IOUs from people who can't pay their debts, for example. Houses lived in by people who don't have jobs. Shares in companies that sell stuff to people who can't afford to buy it. The 'wealth' that these things represented was mostly imaginary. And now that imaginary wealth is disappearing - poof!

Dear reader, we are in a period of discovery - 'price discovery,' as economists call it. It's a time of growing self-awareness...of dawning reality. At moments...it is terrifying. For all of a sudden, it occurs to us that we have been dunderheads. We have paid too much...saved too little...

We have misspent our time...mislaid our fortune...and misunderstood everything...

...and now, terrible truth strikes us like a Mac truck. We have been rear-ended, so to speak. Our life is a wreck...a wasted opportunity...a dead end.

Is it too late to start a new one? A new career...maybe as a bankruptcy lawyer. And a new love in our life - maybe with one of these young surfer bunnies from California. Or perhaps a local girl...?

*** Our intrepid correspondent, Byron King, with his thoughts on the recent gold rally:

"I'm bullish on gold. Actually, I think that gold could go to $3,000 per ounce in the next 30 months. Really bullish.

"There's no fever like gold fever. Right now, we are on the cusp of a great run-up in gold. I believe that there's still time to get into some excellent stocks. The gold miners have room to grow. They should benefit from rising gold prices. And we might see higher dividends down the road.

"Is there a caution? Always. Could gold prices tumble? Well, yes. That would hurt us. But for gold prices to tumble would take a lot of investor dishoarding. That is, people would have to hit the 'sell' button en masse. And that would require some tectonic shifts in worldwide tax, fiscal and monetary policies by a host of socialist-leaning governments. For the moment, I think we're safe from any counterrevolutionary antics like that. As Charles de Gaulle once noted, 'People get the history that they deserve.'"

*** Colleague Manraag Singh brings us up to date on what's going in the monetary experiment known as Zimbabwe:

"The Cato Institute estimates Zimbabwe's inflation rate at 89.7 sextillion percent. That is 89.7 million million million, or twenty-one zeroes behind the number.

"Putting that into perspective, the official count of stars in the universe is about 70 sextillion, apparently...

"On the plus side, Zimbabwe's share index is expected to double this year now that are re-opening it with trading in US dollars...

"Gideon Gono had shut it down about three months ago after accusing some traders of using fraudulent cheques worth '60 hexillion' Zimbabwe dollars to buy shares. I haven't been able to find out how much a hexillion is..."

Bill Bonner
for The Daily Reckoning Australia

• The Kind of World the Next Generation Will Inherit
• Markets Rise While the Economy Sinks
• Children Growing Up in a Different World
• Gold is in a Bull Market
• Sweden Remains an Occasional Trail-blazer in Monetary Matters

BY THE TIME the War of the Spanish Succession was finished in 1715, the French King - who admitted that he "loved war too much" - owed the equivalent of £300 million.

Across the Channel, Great Britain owed only £49 million. Which might have looked a little like financial victory. But then, the United Kingdom's population was only one-third the size of the French. And those debts - priced in "hard money" weights of gold or silver, both in even tighter supply than they are today - were almost 20 times the sum England had defaulted on four decades before.

But hey, that's inflation for you! Or more properly, that's inflation as it's commonly understood - an absolute rise in the price level. In this case, the cost of running the state and murdering Frenchmen.

Whereas in 2009, three centuries later, the UK Treasury will extend its debts by £118 billion this year alone. That's not only 2,500 times what it owed in 1715 in nominal pounds. It's also twice the entire national debt that forced the last Labour government to beg an emergency loan from the International Monetary Fund (IMF) thirty-three years ago.

Now that's real inflation for you! And for everyone else too, unfortunately.

"From the time the United States went off the Gold Standard in 1933 the wholesale price level has gone up by 760%," noted Professor Roy Jastram, author of The Golden Constant, in December 1981.

"Since England abrogated the Gold Standard in 1931, her price index number has risen by over 2,000%."

Both in the US and UK, the general price level since Jastram spoke to the Security Analysts Society of San Francisco has more than tripled again. All told, here in London, the British Pound has lost 98% of its purchasing power since that fateful September day when the UK government lost its nerve, and the The World Lost Sterling's Gold Standard forever.

"Before that, the two countries had a combined history of 350 years of long-run price stability," Jastram went on. "The price level was the same in the United States in 1930 as it had been in 1800. In England the price index stood at 100.0 in 1717 (the first year of her gold standard) and it was at that figure again in 1930."

And all thanks to the magic of gold - that "golden constant". Right?

To be sure, the gold-backed Pound did a phenomenal job of preserving its purchasing power for the 200 years starting when Sir Isaac Newton - he of the Laws of the Motion, but also Master of the Royal Mint in 1717 - established the Pound Sterling as a certain weight of silver.

Newton thus, since the two were interchangeable as cash payment, also set the Pound as a smaller weight of gold ("a pound weight of fine gold is worth fifteen pounds weight six ounces seventeen pennyweight & five grains of fine silver" to be precise) which over time, won out over silver as the arbiter of currency value worldwide.

As our chart shows (hat tip to Statistics.gov.uk for the long-run inflation data), tying money to gold delivered ups and downs in the price level. But overall, costs stayed remarkably steady for the 70 years starting in 1844 - back when the Bank of England was granted monopoly power to issue the currency.

Then the guns of August blew a hole in the Pound's convertibility. Despite a brief rally after the ill-advised move to restore the old Gold Standard in 1926, Sterling's long-run value just continued to tumble, as Jastram points out.

As for gold, its purchasing power also suffered during Europe's second "Thirty Years War" (in Winston Churchill's phrase), at least when held outside of government hands. Banned from owning it in the United States, private individuals could scarcely trade it for profit in London. Pretty much all of Britain's bullion had already been nationalized long before (right as the Gold Standard Reached Its Zenith, in fact) and now it was needed to buy arms and munitions from across the water.

Don't you know there was a war on? Or as Marc Faber put it in his Gloom, Boom & Doom Report last fall (Is there a way to preserve wealth?, Oct. 08), "I can see the gold bugs jumping off their seats and protesting that gold has kept its value (purchasing power) over the course of history. But the problem is that the owners of the gold also changed over time.

"So, when Timur sacked Aleppo and Damascus in A.D. 1400, it didn't help to have your savings in gold," the Swiss private-client fund manager adds. "You lost your life and your gold. Women had a better chance of survival and got a one-way ticket to Samarkand."

Luckily for investors and savers with something less than their lives or liberty to lose 500 years later, the US and UK governments liberalized gold ownership just in time for Gold Prices to shoot higher on a tide of government-wrought inflation in the 1970s. (It's also worth noting that, in line with how gold owners could survive the four-decade US ban starting at the depths of the Great Depression - and actually benefit from the revaluation of gold that accompanied it - Marc Faber advises holding physical gold overseas, free from the political and/or social risks of your own domestic jurisdiction.)

Finally cut free from artificial government values by Richard Nixon in 1971, gold broke back above its old Gold Standard par in terms of UK purchasing power in 1973. It then spent almost 16 years - after accounting for inflation and changes in gold prices - worth more than it had been throughout the late 19th century, the high-water mark of gold's international power as the only true, single, irrefutable currency.

And amid the current bull market in gold, its real value for UK investors only just broke back above that level again, just as 2008 turned into 2009. For US investors, gold recovered its 1900 value at the start of 2007.

That's the nature of a mean-reverting asset, of course. It reverts, if given time (and free ownership, priced in a free market) to its long-run average value. But that does also mean that the average itself will have to revert as well.

Because the starting point of any particular data series - not least if pegged by mankind, even the genius brain of Sir Isaac Newton way back in 1717 - might not necessarily be "correct" for the long run that follows. We can't judge the "true" value of gold simply from its historical start.

Adrian Ash

for The Daily Reckoning Australia

• A Gold Standard, Without Gold
• Gold is Money
• Gold and Silver!
• Gold Standard Doubles as the Greenspan Fed Makes Real Interest Rates Negative
• Where Do the Feds Get Any Money?

Symmetrically, a decline of the AUD/USD makes gold more expensive for them. This foreign currency (FX) effect (also known by traders as currency risk) is a real matter for local investors.

FX markets in general and the Australian Dollar in particular had impressive volatility in 2008, especially during the second half of the year. If it continues in 2009, you'll want to understand the relationship in order to devise your own gold strategy.

On the chart above, the black line represents gold in Australian dollars (we called this composite "Aussie gold"), while the green bars represent the currency pair AUD/USD. There are three different phases that are distinct.

1) Phase 1 from August 2007 to March 2008 where "Aussie Gold" climbed sharply despite the fact that the AUD/USD exchange rate was rising too. It means that at the same time, gold prices in USD were rising faster than the AUD/USD.
In details, it means that, the AUD/USD ( how many US Dollars for ONE Australian Dollar) rose by 11% roughly between September 2007 and March 2008. For the same period, gold (therefore how many US Dollars for ONE ounce of Gold) rose by 31%
As a result, both the AUD and gold appreciated against the USD, but gold appreciated much faster. That's why the Aussie gold price (how many Australian Dollars for ONE ounce of gold) also climbed sharply. What does it all mean? It means that gold appreciated against AUD!
The Aussie gold price is a function of the velocity of the AUD/USD compared to the velocity of gold. If AUD/USD appreciates faster than gold, then the Aussie gold price declines. If gold appreciates faster than AUD/USD, then the Aussie gold price rises.

2) Phase 2 from March 2008 to September 2008 where the "Aussie gold" was cheaper as gold in USD was correcting while the local currency jumped to historical highs until July, then crashed.

3) Phase 3 from September until now where gold prices on the international markets are consolidating and rising again whereas the AUD/USD has been falling to low levels not seen since 2003. As a result, the "Aussie gold" is soaring.

Since last October, we can see that the Aussie gold price is reaching historic highs. Because of the crash of his currency on the FX markets, a local must pay today $1,250 AUD to buy an ounce of gold. At mid-August last year, the cost for the same ounce was only $917 AUD. It's a 36% increase in 5 months!

What is the conclusion of that?

Well, we have calculated the correlation between gold and the Australian currency, both the strength of their relationship and the degree of their relationship. From 1991 to date, this correlation is equal to 81%. Gold and the Aussie are positively correlated, as they typically move in the same direction because they are both traded against the US Dollar. But they don't move at the same pace. And this is that difference of pace or velocity that drives the Aussie gold price.

On a historical basis, a strong Australian dollar is NOT a 100% guarantee of a cheaper gold for local investors, but it is clearly often the case.

That's why if you want to buy gold, I would suggest you to wait for the Aussie gold price to correct. Currently these are the historical highs. If we have a look at the Aussie gold itself on a weekly chart (above), the MACD shows that the bullish momentum is likely to be over. It has peaked at unprecedented high levels on early January and has already started to curve downward.

Historically a similar configuration happened twice, in May 2006 and March 2008 (circled on the chart). If the MACD crosses below its signal line, it would be a clear signal of trend reversal, and would drive the Aussie Gold much cheaper. We will keep an eye on that in the coming weeks!

Gabriel Andre
for The Daily Reckoning Australia

• Prices of Gold in the Top 10 World Currencies
• The Aussie Dollar as a Measure of Global Risk Appetite
• September is the Best Month for Gold
• Aussie Dollar Ready to Storm Past US Dollar
• Price of Gold Communicates U.S. Monetary and Fiscal Policy is Lousy

This is very good news. It means you will have a chance to buy gold at lower prices before it goes up higher later this year. Much higher, in fact, according to the 2009 forecast made by Diggers and Drillers editor Al Robinson. Look for Al's special gold forecast issue later today in your in box.

Not everyone agrees that gold is going higher, mind you. "The deflationary scenario is still incredibly intact, even though the government has thrown trillions of dollars at it," one Leonard Kaplan told Bloomberg. Kaplan is the president of Prospector Asset Management in Evanston, Illinois. "Gold has a long ways to go down," he added.

Daloob. Seriously daloob. Daloob is a word that means whatever you'd like.

But what does it mean to say that the deflationary scenario is "incredibly" intact? Does this mean that the scenario is "not credible?" Or does it mean the scenario explains and predicts what's ahead? The statement is incredibly opaque.

Either way, the deflationary scenario that Kaplan refers to is worth a few lines. The scenario is one where commodity and stock prices fall as the credit depression gets its hands around the neck of the economy and squeezes. Under that scenario, gold would fall. And under that scenario, the cost of paying off debts would rise massively as cash gained value. Old debts would become economy-killing burdens for households, businesses, and, dare we say it, governments too.

In fact, the real economic consequences from this kind deflation are so destructive that we would bet our left big toe that the Federal Reserve is going to do everything in its power (and perhaps some things not in its power) to prevent it. It's not a risky bet. The Fed is firmly moving down the path to monetary weirdness. We are well and truly down the rabbit hole in 2009.

In the meantime, falling commodities prices are telling you that the forecast for the economy in 2009 is not good. Gold, oil, metals, and grains all moved down yesterday while the U.S. dollar moved up. It will be worth watching if commodity shares follow commodity prices down. Commodity shares, as we know all too well, were decimated in 2008.

But based on some analysis from our old friend Dr. Marc Faber in his latest Gloom, Boom, Doom report, commodities as an asset class are about the only stocks actually in a similar position to where stocks found themselves in 1987. That is, while the entire market was savaged last year, commodities may be the only sector worth taking a punt on in 2009, based on Dr. Faber's analysis of previous bull and bear cycles in various asset classes.

What cycles? Faber says that the length of the cycle immediately preceding a correction or crash has a lot to do with what you can expect next. "If an up-cycle was brief," he writes, "the down-cycle is also likely to be brief. If the up-cycle lasted a very long time and was accompanied by huge excesses, the downturn from the peak of such a cycle is likely to be lengthy-as was the case for gold after 1980, and for the Nikkei and the Japanese economy post-1990. Similarly, if a down-cycle lasted a long time (20-30 years), the up-cycle is also likely to last for an extended period of time."

The bull market in commodities began in 1999 and was preceded by an infamous 20-year bear market. Equities, on the other hand, enjoyed an 18-year bull market from 1982 to 2000, but have been in a bear market since then (with a robust, credit-induced bear market rally from 2003 to 2007).

By that logic, the down-cycle in equities should be a lot longer because the up-cycle preceding it lasted so long. On the other hand, the down-cycle in commodities should be shorter because it was preceded by a much shorter up-cycle and a very long down-cycle. Stocks down. Commodities up. Got it?

But is it right? The reasoning makes sense, especially if you compare it with the historic numbers Dr. Faber presents (which we will not replicate here for the sake of space). But there is a simple objection that must be dealt with. What if the commodities cycle is itself a function of an even larger cycle, namely the credit cycle?

If you argue that the bull market in credit began in 1973 and a world of floating exchange rates and competitive currency devaluations (or 1913 when the Federal Reserve was founded, or 1694 if we want to go all the way back to the Bank of England again), then the direction of asset prices would be dictated by whether credit was in an up-cycle or down-cycle.

It's pretty safe to say that credit appears to be in a down-cycle, starting in August of 2007. What's more, it was preceded by a massive "up-cycle" in which the supply of money and credit grew globally. That "up-cycle" drove up all assets in all countries simultaneously. We will find out this year if another "up-cycle" can be artificially by Obama and Bernanke.

But if we are now in the "down-cycle" for credit-the Credit Depression-then how can commodities possibly outperform equities and rally while stocks fall?

Well, the only possible way for commodities to go up in price during a credit depression when global economic activity shrinks...is if we experience massive, central-bank backed money printing and the inflation that ensues. Not that this is an outcome we find desirable. But it's clear as day from the Fed's actions and words that it will produce inflation at any cost to prevent being crushed by debt and deflation. For all its real wealth destruction, the Fed appears to prefer hyperinflation to credit depression.

And don't worry that the Fed is out of interest rate bullets in its pursuit of reinflating the credit bubble. There are other weapons. It will mail checks directly to people or buy assets directly on stock markets. You can expect the debt-to-GDP ratio in the United States to approach and exceed 100% before Obama's first term is over. You can also expect to see more direct government asset purchases and intervention in markets.

How can we be so sure that we're on the verge of a brave new world of government-managed markets and economies? It's simple. Central banks and national governments the world over face an existential crisis-the loss of public confidence in paper money. Action must be taken to restore confidence or real economic activity (lending, borrowing, spending, and investing) will grind to a halt.

Perversely, the monetary authorities will destroy public confidence completely through massive inflation. It will also unleash a great deal of social and political disorder. But the authorities appear to prefer this chaotic result (which they can then police and manage with new rules) to another Great Depression characterised by too little money and price deflation. The excesses of the credit bubble will not be liquidated. Instead, they will be perpetuated and subsidised. The resulting economic and social disorder will be met with more State activity in your personal and economic life.

All of this is a long way of explaining why the current lull in the gold price is a great buying opportunity. You know the tactics and strategy of the central bankers. And you have a pretty good idea that any rally in the stock market is a fake out rally, not sustainable based on the economic forecast OR previous cycles (where markets are coming off 20-years of rising prices). What you don't know is if gold prices are going to fall further before eventually heading higher.

To find the answer to that, you can consult 1974. At that time, stock markets looked oversold and gold had begun to move and was on the verge of a correction. "If someone really felt that the similarities between the 1974 low and the current market conditions are overwhelming," Dr. Faber adds, "he should consider purchasing gold and oil rather than U.S. equities (and also shorting U.S. bonds)...Gold corrected between the end of 1974 and the summer of 1976 by 40%, while the stock market surged. But from its August 1976 low, the gold price increased eight-fold."

"If we are really in an environment such as we were in at the 1974 lows (and I have serious reservations about this assumption), then we should expect some further weakness in gold prices when equities rebound. Such weakness would then provide an excellent buying opportunity."

"However, keep in mind that even if you bought gold at its 1974 high at US$196 per ounce, by 1980 you would still have quadrupled your money, which was far better than the return the stock market provided. So even if you endorse the view that we are in a similar situation as in 1974, I would be reluctant to stay out of the gold market entirely in the hope of buying it at lower prices."

"Another reason why gold may not sell off as much as it did between 1974 and 1976 is that governments' interventions with monetary and fiscal measures around the world are unprecedented. ..Therefore, based on my time/cycle analysis above, commodities and commodity-related shares would also seem to be in a far more favourable position to resume their up-trend than broad U.S. equity indices, which (a sharp rebound aside) are unlikely to enter a sustained longer-term bull market."

If Faber is right, what will it mean for Australia's broad equity indices? Well, you'd expect them to go higher as commodity prices react to the increase in global money supply. It certainly seems like most of the deleveraging is done in commodity stocks, meaning it would take something monstrous for mining shares to retest the 2003 lows.

Monsters are real though, so we can't completely discount the possibility that 2009 will be worse for resource shares than 2008. However, one needn't be a raging bull on Aussie resource stocks to see that the case for gold looks good. It's distressing that gold looks so good because the outlook for the economy is so bad. More on that tomorrow.

Dan Denning
for The Daily Reckoning Australia

• Krugman Warns That the Run-up in Stocks Can’t Be Justified By the Fundamentals
• Oil Was Down and the Banks Were Up
• Less Gold is Being Sold by European Central Banks
• Why the Bull Market in Commodities Isn’t Over
• Teach Your Children Chinese Because China is the Next Great Country

My outlook for this period is very bullish. Having spent both the peace and productivity dividends of the last few decades, the current direction of government policy - increasingly interventionist - threatens to set in motion the forces of capital flight... into gold. The effect of this on the dollar will be historic. There is no more honest a measurement for this forecast.

However, it is a three-five year outlook. It may start to unwind tomorrow, or perhaps not for two or three years.

Technically, the long-term chart contains no great knowledge. I don't put much stock in the charts of any price trend spanning more than 10 years. My calls would lag major turning points by about five years. But as far as the long-term chart goes, the gold price is still in a long-term bull market.

The last highest low in the eight-year bull trend lies at around $540, which is just above the final resistance point of the previous bear - the break out point after which the gold price accelerated in 2005...the year that Bernanke was chosen to head up the Fed. Go figure - turns out gold was right about him.

However, the more normal "primary" trend support lies at around $700.

The "primary" trend is the sequence that shows up most prominently in the five-10 year (weekly or monthly) chart.

In the case of gold, it is the trend that began back seven or eight years ago.

In a normal trend, the correction lows stop at previous highs, or resistance levels, which are at the $700 mark here. Note that the bulls bumped up against that level a few times during 2006 and 2007, before ultimately breaking out. That just makes support that much more significant at this level.

However, during a correction to the primary sequence, the normal support points might fail, and it becomes difficult to figure out whether it is still a bull market at all. In other words, it is possible to see gold prices fall to $600, or even $540, even if the general bull market is still on.

Percentagewise, a correction of just such magnitude occurred in 1975. Gold prices fell from around $200 per ounce at the 1974 peak to just above $100 a year later, before soaring to new highs, and to over $600 by 1980. So the long-term technicals tell us almost nothing, except that there is room on the downside whether or not the bull market is still on.

There are two facts, however, that argue against a correction of the same magnitude today.

One is technical, sort of, and the other is fundamental.

From a technical standpoint, it should be noted that the advance in gold prices leading up to 1975 was larger (percentagewise) than the advance from the $260 low in 2001, and occurred over a shorter time frame. I don't know how much that may be worth, but it's something to consider.

Fundamentally speaking, moreover, simply comparing the Federal Reserve's policies today with those of 1973-74, when it was similarly trying to rescue the world economy from a crisis that saw a 40% decline in the Dow, it cannot be denied that the current policy is far more inflationary... more bold... more off the charts, if you will. If the Fed underestimated its contribution to the inflationary events of the '70s, as Bernanke argued in a speech about inflation last year, what is the 2008 Fed doing?

The Medium-term Outlook, One-Two Years

My outlook for this period is also quite bullish for gold, as the positive short-term effects of the government's current policies begin to wear off and the negative effects start to set in sometime in this time frame. I know this is counterintuitive to anyone who believes what the government is doing today is beneficial, but that is really the only way it can work. In this period, you will see asset prices recover, along with commodity prices, and maybe even a fleeting boom (bubble) somewhere, like in biotech, or public works - wherever. However, the rising tide won't come in fast or high enough to keep all the boats rising like in other bull markets, or even in significant bear market advances.

Let me distinguish here between a recovery in the economy and reflation.

I expect significant deterioration in the economic fundamentals in the medium term. However, much of it is priced in, and the effects of monetary debasement will underpin the dollar value of the soundest assets. Indeed, only the soundest equity or real estate assets will provide real protection against the confiscatory policies of governments over this period. These include gold-related assets, and some of the other important commodities, though it isn't certain whether gold will outperform in this time frame.

It could take a full year for inflation expectations to recover from their current trough.

Moreover, although the Fed has been a leader in the reinflation program in 2008, it had not inflated nearly as much as the other central banks between 2003-2007. This fact created the illusion of a global boom that would sustain even as the U.S. economy recessed. Now it is being liquidated.

That is one of the reasons the commodity liquidation was so excessive, and also why the dollar rallied this summer. I don't know exactly what to expect from the dollar in the next year or two, but at best, trade should continue to be choppy.

Currency markets won't offer much opportunity for most people until the dollar's bear market resumes - sometime after 2009, in my judgment. However, this should not hinder gold's performance. Moreover, my feeling is that the Fed will pursue a low interest rate policy for longer than other central banks, which will eventually be the catalyst that undermines the dollar and sets it up for the final chapter in its bear market - the one that leads to a brush with hyperinflation.

Technically, the intermediate trend (i.e., the nine-month trend) is still down. The bulls have bounced off normal primary support at $700 nicely, and October tends to herald correction lows, seasonally speaking. Most of my leading indicators, including gold shares, moreover, suggest the low is in.

The technical objective of the seven-month top formed January-July 2008 was also already achieved at $695, plus or minus, suggesting the bear leg is complete. However, until the last lowest high ($940) in the downtrend is cleared, we have to tame our enthusiasm. What's more, the current rally has stalled at the downtrend line, which intersects the current time horizon at about $890.

If the bulls can't make it back up to at least the $940 high of September/October before the market falls back through $830, then I would worry the market MIGHT either retest its $690 low, or go lower.

The Short-term Outlook, One-Three Months

My outlook for this period is neutral to bullish, with the possibility of one more test of support in the mid-high $700s if bullish sentiment returns to Wall Street prematurely. Although the policies governments are pursuing are fundamentally and relatively bullish for gold, it is more than possible that they engender a recovery confidence in the short term that may hinder the performance of gold.

Technically, the objective of the October-November ascending triangle (bottom) in the chart below has completed at $875-880.

The last highest low in the short-term sequence is around $830. If the market falls through this level before extending the current rally to the $940 area, as mentioned above, there is the slight risk that there is something wrong with my bullish medium-term (or intermediate) outlook above.

But this risk is not that great considering all the bullish permutations that could still take shape on the chart. Still, the most likely scenario in my mind is for a pullback to somewhere between $750-800, whether or not the current two-month sequence extends to $940 in the next few weeks.

If the pullback starts now before a higher high, I'd put it at the low end of the shaded area in the chart ($740); if it starts higher, say from $940, it could stop a little higher, like $775-800.

But until we get over $900, the $830 handle should be watched, as a break through it before a higher high could trigger the liquidation of the two-month advance and start a correction to at least $775.

Ed Bugos
for The Daily Reckoning Australia

• An Oil Price Correction is on the Horizon, When and Where
• CRB Index Correction Likely to Go Further
• Today’s Current Gold Price
• Profiting From the Copper Indecision
• Platinum Ready for New Bull Leg

The rally was a no-brainer. There is a strong line of support at $700, which was resistance during 2006 and the first half of 2007. Moreover, the market was, and is, oversold.

The catalyst was news that the U.S. government had to bail out Citigroup, the world's largest bank by revenues. The event has given way to new concerns about the economy, which weighed on stocks and gold this week, or at least provided an excuse to take some profits in the latter.

The big question now is whether it was just a retracement rally that ultimately gives way to new lows or whether we have seen the bottom in gold, with this rally being only the first of many to come.

I don't think the chart can answer that question alone. Technically, the structure of the market is healthy now, and as far as the fundamentals go, gold should not remain under $1,000 for very long.

Indeed, I sense the market is building up for a very bullish move.

Allow me to touch on some of the bullish factors coming into play.

"Notwithstanding the many developments on the bailout front during the past six weeks, The New York Times, like other media outlets, continues to quote Wall Street insiders who report" [that] "'You have a market that is frozen.' What planet do these guys live on? It certainly is not the same one to which the Federal Reserve's data apply. I've been singing this song for many weeks, but I'm going to keep singing it until somebody in the news media wakes up and realizes that these 'frozen credit market' tales are pure hooey. Look at the data, for crissake."

- Robert Higgs, author of Crisis and Leviathan, in a recent essay on the bailout programs

The fundamentals are significantly bullish for gold. I'd like to say they are bearish for the dollar, but in truth, they are increasingly bearish for all paper currencies. Outside of the Bank of Japan, everyone is inflating madly. In the G-7, narrow money (M1) is growing at 7-10% on a year-over-year basis in the U.S., Canada, the U.K. and Australia - more in developing countries like China. And this rate is picking up now.

October's data are not in yet for the ECB. Its balance sheet increased by some 400 billion euros during the month, which is the first big change since the second quarter, and will probably reflect in M1. The Bank of Japan started inflating M1 again in September too, after holding it steady for most of the year.

The broader monetary aggregates (i.e., those determined by the banking system at large) are growing briskly everywhere but in the U.S. and Japan, though even the latter are still growing.

Broad money in the U.S. is growing between 5-10%, depending on whether you rely on TMS or MZM or higher, if you like M3 (I don't).

The U.S. data are good through October. Up till the end of September, as far as we are updated, the year-over-year growth rate in broad money approached 20% in Australia, its highest rate in almost 20 years. In the U.K., the broader monetary aggregates are growing at close to 14% on a year-over-year basis, which is its highest growth in almost a decade.

These growth rates are almost as bad as China's, which is approaching 20% year over year too, again. Given these numbers, it is no surprise to me whatsoever that the yen is the strongest currency, followed by the U.S. dollar, or that the Aussie and the pound are taking the greatest beatings, along with all the other riskier currencies.

The actions governments are taking now are bearish for stocks and bullish for inflation. But they are not just bullish for inflation - they are remarkably bullish.

I don't mean to sound happy about it. It's just an observation that the market has yet to come to terms with. Since September, the Fed has expanded its balance sheet a total of $1.3 trillion. Of that total, it has created about $600 billion in reserves out of thin air.

Most of that is not counted in money supply, because it excludes deposits held by depository institutions. Total money supply is about $6 trillion, if you rely on the Austrian School definition (I do). It has, nevertheless, translated into growth of about $100-200 billion in new money created by the banking system since September already. Deflation is a no-show so far, and I don't think it will arrive at all. I think history will see this as just another scare.

The Federal Reserve just announced two new programs that commit it to another $800 billion, and that is even before President-elect Obama puts his stimulus package together.

Reuters cited Wachovia's chief economist:

"Some, however, are worried the mounting costs of the measures, which have the potential to reach several trillion dollars, could eventually fuel a troubling inflation.

"'It may mean (a) longer-run issue with inflation and inflation concerns,' said John Silvia, chief economist at Wachovia Securities in Charlotte, N.C. 'It may be too much of a good thing is a bad thing.'"

Ya think?

Even more inflationary, in my opinion, is the fact that the talking heads think the Fed's latest facilities are simply not enough. They are complaining the programs do not include direct purchases of credit card debt and mortgages in the secondary market and that the Fed isn't going to buy mortgages with maturities of more than one year. Not long ago, the Fed never bought anything but Treasury notes.

Gold bulls are going to attempt to raid Comex's vaults by forcing delivery on their December futures contracts (Dec. 19). Who can tell how that will go? I can't. But it'll be interesting to watch.

Facts: The open interest in futures contracts on the Comex has fallen to its lowest level since summer 2005, breaking a general uptrend in place since 2001. From a contrarian standpoint, the short-term bottoms in these data tend to favor the buyers over the sellers. However, the statistic went into orbit during the last half of 2007 - it broke away from the upper channel on the charts, creating a bubble in appearance. The current extremity could simply be a symmetrical reaction to that extreme.

Nevertheless, this is a bearish fact, technically speaking, if it represents a lasting new trend.

It is tempting to suggest that the threat of a raid in futures contracts is causing a short squeeze.

It is true that the commercials are liquidating their short positions promptly. But the funds are increasing their short bets, and the liquidation of longs is such that the net short ratio has hardly budged off its mid-September low - which, incidentally, is a level that has coincided with strategic buying points at seven other junctures since the bull cycle began in 2001.

However, the record of this statistic in gold is unique in that during bear markets, the commercials tend to be net long (wrong) most of the time.

So the fact that they are covering their short interests on net does not necessarily presage a rally if a bear market has set in. A bear market would mean that gold prices could fall as far back as US$500.

Fundamentally, the conditions just don't look ripe for a bear.

I don't believe the COTs (Commitment of Traders report published by CFTC) have any real predictive value. They tell us only whether the market is too much extended one way or another; they don't tell us how long those conditions will last. Right now, the structure of the market is healthy. The commercials are covering their shorts, the funds are getting short and the numbers basically favor the bulls. The contraction in open interest worries me a little, but it could be explained in terms of a collapse in spread trades linked to various index products.

In its most recent report on gold demand, the World Gold Council said as much in trying to explain the drop in the gold price in the context of soaring physical demand. In its third-quarter report on gold demand, the WGC noted growth in both jewelry and investment demand across the spectrum relative to both the last quarter and the year-ago quarter. I don't want to go into a critique of the method here, except to point out that it chronically understates investment demand and overstates jewelry demand.

The inclusion of ETFs all but proves the point.

In just one year, investment demand has grown in importance from under 15% to over 30% of total gold demand, causing the deficit (supply shortfall) to grow nearly tenfold. The WGC interprets this deficit as supply coming from speculative sources, like futures trading or changes in inventories at the various exchanges - like at Comex. Thus, it calls it "inferred investment." Formerly, it called this the "balance." But as it grew, the WGC decided it meant something. What is causing it to grow, aside from growing demand in general, is that while the WGC is "identifying" new kinds of demand, it has not kept up with the various sources of supply. Gold bugs have argued for years that the supply of gold is not limited to mine production, officialdom or scrap...that it is not like other consumable commodities.

It is more useful to assume that most of the gold ever produced is held as a reserve, or store, aboveground. And if this is true, then investment demand must be much larger than the WGC calculates, or the price would, frankly, never go up. If the WGC is smart enough to include producer hedging (or dehedging) in the equation, it should also include a measure of demand that expresses itself through all the exchanges and bring itself up to speed on all the sources that supply the market. It assumes that jewelry demand dominates the market, which is incorrect, but even if it were, it still has the wrong idea.

Jewelry demand may be price sensitive in the short term, yet it has grown every year, at successively higher prices, since the bull market began. Despite my objections, however, I am in total agreement with the council's explanation why gold prices have fallen despite the evidence of soaring gold demand:

"Notably, the selling captured by the [inferred] investment category was mainly by investors with a short-term focus. It largely reflects the fact that gold was caught in the downdraft of other commodities and other assets - it does not reflect a questioning of gold's value or role as a safe haven. The strong buying in the ETF and bar and coin markets during the quarter, which reflects investors with largely a longer-term focus, suggests that investor belief in gold's role as a safe haven and store of value is stronger than ever."

No wonder the commercials are covering. The establishment is getting hot for gold.

JP Morgan's gold analysts "urged" investors to stock up on gold this month, citing counterparty risk and tight supplies.

Citigroup's foreign exchange group also put out a bullish tout.

Well, that's an understatement, actually. "[Gold] continues to look like a bull market to us. We continue to believe that a move of similar percentage to that seen in the 1976-1980 bull market can be seen, which would suggest a price north of $2,000," Citigroup's FX group said last week.

What I found particularly intriguing, besides the timing of these calls, was that they both discounted the dollar. That is, they noted, as I have in the past, that the foreign exchange value of the dollar may not be important at this stage. Morgan said, "It is not an absolute given that a rally in gold means a falling U.S. dollar," while Citigroup pointed out, as I also have, examples of just such a situation during the 1970s.

Anyway, it's not a sure thing yet, and it all makes great fodder for the bull market in gold.

Good Trading,

Ed Bugos
for The Daily Reckoning Australia

• Today’s Current Gold Price
• U.S. Dollar Bulls Rallying Behind Fed Statement
• Demand for Credit is Growing Less Fast
• Gold Price Outlook – the Long and Short of it
• Gold Ratios: Bearish for Gold Prices, Bullish for Gold Shares

"There's no such thing as a quadracycle," we replied.

"It's a car you moron, and you're ignoring the point."

"Which is,"?

"You blew it. You got the single biggest investment story of 2009 wrong. And now you won't hardly mention it or bring it up. You pretend like it didn't happen. But it did. Real people lost real money because you were wrong. What do you say to that, smartypants?" Our response is below.

First though, the controlled burn by the world's central bankers is clearly underway. At least they hope it's controlled. The Bank of England cut its key policy rate one full percentage point to 2%. It's the lowest level since 1939.

While the BOE goes on financial war footing, the precocious ten-year old European Central Bank snapped to attention and slashed its key rate by 75 basis points to 2.5%. The ECB, like the rest of the global banksters, fears rising unemployment, falling consumer spending and business investment. So do the markets, apparently.

The Dow was down over 200 points and the S&P 500 was down nearly three percent in New York. But the big shocker on the day was oil. It fell nearly seven percent to under US$44, its lowest level since 2005. Oil is down 70% from its highs. But a Merrill Lynch analyst says that if the economy is as bad as everyone expects in 2009, a barrel of crude may go as low as US$25.

Let's take a closer look at oil. But let's do it terms of gold, revisiting the gold/oil ratio.

If you're wondering what the inter-market relationship is between gold and oil, hold the thought. It's a good question. And the brief answer is that oil and gold both tell you things about what's going on in the economy (oil goes up with rising GDP, gold up when the USD is weak). The long answer would take longer than either of us has today.

So what is the chart telling us now? Well just to update it, the gold futures price is $765.50 and the oil futures price is $43.67. That leaves the current gold/crude ratio at 17.5. That means it would take you 17.5 barrels of crude to buy an ounce of gold.

You can see the chart is all over the shop. But 15 turns out to be the historic average for the ratio. So if the ratio is rising, what does it mean? It means either oil is oversold or gold is overbought. For the ratio to return toward its historic average, oil prices would have to rise, or gold prices to fall.

What do you reckon will happen? We reckon the ratio will increase, with the oil price falling more and the gold price holding steady or rising. There's no law of physics that says the ratio must return to 15, only that 15 is the average level.

But 2009 is going to be a strange one. Oil prices should fall to reflect a dismal world economy. Gold prices, we reckon, should rise, to reflect the inflationary fires being stoked all over the globe. There's no guarantee it will happen that way, of course. We erred in believing commodity prices and resource stocks would hold up (both absolutely and relatively) better than financial prices. But we badly underestimated the pyramid of leverage upon which all stock prices were built.

Gold could suffer from the further deleveraging of planet earth (both household and corporate balance sheets). But we like the way our friend Dr. Marc Faber put it in his latest Gloom, Boom, and Doom report, "I remain of the view that successful reflation of the asset markets will likely manifest in precious metals strengthening against all paper currencies and other assets. Consequently, I continue to recommend that investors accumulate physical gold and silver."

Does Dr. Faber think that the reflation of the asset markets will be successful? And what happens to gold if it isn't? More on that next week.

Some Friday fun.

Hi,

I love your work, and the entertaining way you write about the financial scene.

I've learned more from you than I did in my economics classes at Uni all those years ago.

Now that you're all buttered up and compliant, please take a look at this:

http://www.youtube.com/watch?v=28I0JK0byLU

It's a parody of the old song "Monster Mash", updated for the current financial situation. It's very well done. Did you guys write it?

Cheers,

Eric G.

Thanks Eric. We didn't write it. But it was a hoot. And now for the rest of our testy conversation over what went wrong in 2008 and how to make it right in 2009.

"See, you don't have anything to say," our sceptical friend continued last night. "Face it mate, you're a spruiker like the rest of them and you have no clue. You have no idea what to tell people to do in 2009. You should retire and go back to Uni and read books or become a secretary. At least you type well."

"Gee, with friends like you...but look, of course I see your point. I wear glasses, but I'm not deaf. We've been working around the office to figure out what we got wrong in 2008 and how we can make it right in 2009. It's about survival bias."

"Blah blah blah. More words. Deeds man. Not words. Deeds."

"Hear me out. Our fundamental thesis (resource scarcity, the Money Migration, collapse of the dollar) was all correct. But I believed resource equities, backed by tangible assets, would both relatively and absolutely outperform as the financial sector collapsed. And I thought the transition away from the American model toward whatever comes next would be more gradual."

"Blah blah blah. You blew it. Admit it."

"I just did. The idea that resource stocks would hold their value better than financials during a crash turned out to be hugely mistaken. I underestimated the amount of leverage in the system that supported resource prices and stocks. A lot of that leverage was hidden. But that's no excuse and doesn't change the fact that the resources were hit much harder than even some of the financials."

"Blah blah blah. So what? I don't care about any of that. Where do we go from here?"

"Well I think there are two parts to the story now. The first you're not going to like to hear. But I'm going to tell you anyway. A lot of these resource stocks are better value now than when I first recommended them. It could be the best time you'll ever have to buy them."

"Heard that one before. Admit it. It was all just a bubble like the dot.coms. BHP is a giant iron sock puppet. The only thing worse than the tech bubble was the resource bubble. You're a jerk if you don't admit it."

"Then I'm a jerk. The main difference between the commodities wipe out and the tech wipe out is that while there never was a big market to justify the earnings multiples for on-line grocery stores, there Is a real and big global market for nickel, lead, zinc, and other commodities. People use this stuff."

"And think about what didn't happen with this bubble. You did not see a huge increase in the productive capacity for minerals, oil, or energy. You got a big ethanol boom. Go corn! But did you get billions of new barrels of oil on-stream or trillions of cubic feet of natural gas or more coal, uranium, or rare earths? I don't think so. The housing bubble produced too many houses. Did the commodity bubble produce too much oil?"

"Less blah. But so what?"

"So you've had a whole boom and bust in the commodities sector without a significant increase in the world's productive capacity for raw materials. If and when BRICs demand replaces American demand-and I admit that could be longer than I first expected-the structural deficit in commodities still exists. Prices have probably finished falling and will certainly go higher. I just don't know when exactly. So you look at individual commodities and the supply/demand picture. Some things may be in oversupply next year because the economy is growing slower. But I don't think chronic resource over supply is our biggest problem of the next twenty years."

"But what should I do now?"

"Using your own brain would be a good start. Think about where we are in history and where we're going. What happened in 2008 was the blow up of a world-wide credit bubble. It caused huge collateral damage. What's going to happen in 2009 is an attempt to reflate that bubble. And it's not going to work, at least not in the way people expect."

"Why not?"

"You cannot step twice into the same river, for other waters are continually flowing on. That's Heraclitus."

"What?"

"What's done is done. The world is changed and changing. What you have now is a whole financial systembacked by the Wall Street Treasury Axisfighting for its very survival. They're going to fight hard and play dirty."

"But their system is irretrievably doomed. I reckon, at least for myself, the first big task for next year is to save yourself from going down with the ship. You can do this by owing physical metals, getting out of most but the very best shares, and increasing your cash percentage of your asset allocation. You may also want to duck and cover for a few months."

"But look, frankly, a lot of people-even you, as dumb as you are-knew the current system was unstable. But it's collapsing faster than any of expected. But we know from history is that markets move in cycles. History moves in cycles."

"Wash, rinse, spin, repeat?"

"Uh, no. Look, what you need to do now is prepare for the next cycle. That cycle is a world economy where American consumption is just a pile of used credit cards on the scrap heap of history. The events of the last six months have fast forwards us toward a world where America's economy is in far worse shape for longer than most people think currently think possible."

"Investors will NOT be able to preserve capital and profit if they think every thing's gonna be all right. The only way you can come out of this better off than you are now is to put some serious thought into what companies are going to be important in that changed world."

"You gonna try and sell me another newsletter now?"

"Not yet. I'm just saying, pay attention to the survivors and the destroyers. Why the survivors?

Because they survived! That's the great thing about survivor bias. It automatically focuses your attention on the competitive winners. THAT's where your focus needs to be today. It all comes back to the Austrians."

"Beer and lederhosen?"

"No. The Australian school of economics and entrepreneurship. For the neo-classicists and monetarists and Keynesians, it's always about models, statistics, and money supply. For the Austrians, economic growth and the business cycle don't naturally begin with credit. They naturally begin with human action. Every fortune begins in the human head and heart, you might say."

"I thought every fortune began with a great crime."

"False. Or maybe true, if you're a rich criminal. But irrelevant if you want to make your fortune ethically. You should focus on entrepreneurs. They are the ones that make it happen. It's not the invisible hand or the free market. Those are just words for motive and opportunity. If you don't take action, it doesn't matter."

"I'm taking action. I'm getting out of here. You're boring me to death. Besides, the free market is dead. It's all about the public interest and the general welfare now. Markets have failed. You had your chance. Now would you please shut up and buy me another round?"

Dan Denning
for The Daily Reckoning Australia

• General Motors: A Forerunner for What’s to Come for the Broader Economy
• Debt to GDP Ratio Will Return to Normal
• Price-to-Earnings Ratio of the S&P 500 Index
• Dr. Woody Bock’s Essay: The Future Evolution of the Debt-to-GDP Ratio
• Predictions for a Polite and Mild Recession

SO the SPOT GOLD PRICE sank in October, dropping right back to 13-month lows at $683 an ounce.

After failing to breach $930, this collapse marked the third step lower from March's all-time high of $1,032. And from a technical perspective, the Gold Chart looks horrible - recording lower lows and lower highs for the last six months and more.

Right? Well, fact is, the action has actually been greatly muted if we allow for the shocking volatility in gold's No.1 competitor for "safe haven" funds, the almighty US Dollar.

You see, like so much else, the market action just described only sets Gold in terms of the greenback (against which it has still tripled since July 1999).

Versus pretty much every other world currency, in contrast, gold in fact enjoyed a banner month this October - delivering gut-wrenching volatility plus new record highs - starting right here in London, home to the world's $60 billion-a-day trade in wholesale Gold Bullion Bars (a.k.a. the "spot market").

Mid-month, gold also leapt to new record highs for Australian, Canadian, Danish, Estonian, Hong Kong, Hungarian, Icelandic, New Zealand, Norwegian, South African, South Korean, Swedish, Turkish and Russian investors.

Oh, and the 350 million souls in the Eurozone. Plus the 1.1 billion people of India.

Prices of gold have of course slipped back - and sharply - against all major currencies since reaching €685 an ounce for European investors and savers on Oct. 10th. (That marked a near-tripling from the low of Jan. 2000.) In the spot market, gold's now trading almost 13% lower as the month-end draws near.

And notable by its absence from the rogues' gallery of fast-sinking currency zones listed above is the Chinese Yuan, as well. More spectacularly, the world-destroying Japanese Yen has squashed the prices of gold since turning sharply higher against everything - real estate, global equities, emerging-market debt, even the Tokyo Nikkei - in mid-July.

But if we really are witnessing a global currency crisis led by the destructive reversal of the Yen Carry Trade (and it certainly looks like it from inside a wallet of Sterling or Ne Zealand Dollars, let alone Forints or Krona), then just what kind of fight is gold putting up as the apparent "ultimate" safe-guard against currency shocks?

Regular visitors to this site may recall a chart we offered in August this year, a chart showing the Prices of gold in terms of the world's top 10 currencies by economic output. It's not perfect; the GDP weightings for 2008 will need revising, perhaps, when this year's full-year data becomes available early next year.

But as a measure of truly globalized gold price, it both softens the US Dollar's long slide of 2002-2008 on the currency markets, as well as tempering this month's intemperate highs in gold bullion vs. the Aussie, Loonie, HK Dollar, Forint, Kiwi, Krone, Rand, Won, Lira, Ruble, Euro, Pound Sterling, Rupee and various Kronas.

You can't help but spot the volatility - otherwise known as "My gold just crapped out!"

The way "quant jocks" figure the violence in asset prices, in fact, the daily volatility in this global gold price has more than doubled since August to a three-decade record.

You might also note, however, that gold really has risen sharply against all major world currencies so far this decade, not just the US Dollar. And no one should imagine it will be an easy ride - whether up or down - from here.

There's too much at stake when you try to measure that $60 billion daily turnover in physical gold against the $3.2 trillion daily turnover in official government currencies.

Adrian Ash
for The Daily Reckoning Australia

• Gold, the Aussie Dollar, the Greenback and You
• 4 Ways to Protect Against a Falling Dollar
• Price of Gold Communicates U.S. Monetary and Fiscal Policy is Lousy
• September is the Best Month for Gold
• The Aussie Dollar as a Measure of Global Risk Appetite

Ben won’t be there long, anyway, especially if he mucks this up.

Maybe the new administration will replace him. Then he could write a book debunking gold bug myths about the Federal Reserve System, such as the one about how the Fed is “the engine of inflation.”

Anyway, the markets, overall, are performing as expected.

They are treating the gold correction as though it were a healthy mistake.

Not only did it weed out the weak hands, but it gave central bankers a false sense of security in the face of escalating energy costs. With gold in the doldrums, bond yields relatively low and stock prices recovering, all looked good for a relaxing summer vacation – at least until last week.

Gold bulls are popping with enthusiasm about the post-FOMC recovery in gold prices.

They should be.

After breaking through $920, the market almost shot clean through the May high of $940, staring the reversal point at $950-960 right in the face. The chart bias has turned bullish. I would expect to see support hold above the $900-920 level if the market were to backfill over the next few days – to validate my bullish outlook. But it’s not just technical. The market is doing all the right things, fundamentally.

It has realized that the Fed didn’t really mean what it said, and if it did, it isn’t all that, anyway.

The focus of the debate is shifting to areas that make the Fed uncomfortable: The Dow failed to breach 13,200 and the inflation story is heating up, despite ongoing cracks in the economy.

These things are driving gold now.

Bull markets are notorious for going much further than their earliest prophets ever imagined.

That’s the message in oil prices. As a gold bull, I am taking heed.

What the Fed didn’t anticipate was that the oil price rise would be so sticky that it would embolden the inflationary psychology with or without gold. And it cannot afford to lose control over bond yields.

On the other hand, it cannot afford to tighten.

It can only try to talk down inflation expectations.

A whole new generation has grown up since 1979. It is not used to a tough Fed. The toughest Fed it has seen was in 1994. And putting aside the character comparisons, I’ll tell you this – it was only after several years of inflationary fallout, when people finally began to worry more about inflation than deflation, that Volcker was hired with a political mandate to attack the inflation monster head-on. At the time, CPI inflation and interest rate levels were already high, and P/E ratios were half today’s.

The Bernanke Fed is nowhere near such a mandate. It cannot have anything more in mind than Greenspan’s gradualism. Yet even that is dangerous at this time.

The Greenspan Fed was raising rates during a period of economic stability (2004-2005). Today, the Fed is talking about raising rates in response to an inflation outbreak amid a financial crisis.

C’mon! How are you gonna ’splain that to the voters?

If Bernanke wants to survive long enough to secure another term, he’s not going to challenge the status quo, and the status quo is not willing to accept the kind of austerity package necessary to contain or defeat inflation. The Fed is damned if it does and damned if it doesn’t.

This means that prices will continue to rise until outright fear of inflation exceeds all others.

That’s why gold has the potential to catch fire here.

The market is beginning to understand this, too. It has seen Bernanke flip-flop from worrying about deflation to worrying about inflation a few times already. The Fed’s hesitation to act in last week’s Federal Open Market Committee meeting was like a starting pistol for this realization.

It’s too late to fix this break in confidence, and it’s too early for the Fed to really take it to inflation.

Watch gold prices double over the next year. My forecast is for gold to reach $1,200 by year-end, and $2,000 by next summer.

This may well be your last chance to buy the metal below $1,000 per ounce.

Ed Bugos
for The Daily Reckoning Australia

• Deleveraging Will Give Us a Bout of ’30s-Style Deflation
• Consumer Price Inflation has Spooked Investors Everywhere
• The Correction in the U.S. Housing Market Made Its Sharpest Move Ever
• From the Gold Pan… Inflation, Deflation and Precious Metals
• U.S. Bond Prices Rose and Yields Fell

Big institutional players in the New York futures market slashed their bullish betting on Gold in the week to June 10th. Data from the CFTC – the US regulator – shows a net reduction of 11% in the long gold positions held by what it calls "large speculators".

And this "reduction in the gross longs maybe a further sign that gold is losing its attraction," reckon analysts at the Swiss banking and wealth management giant.

But less pressure from large investment funds could alternatively signal more loss of froth from the gold market since it shot 54% higher in the seven months to mid-March.

Topping out at a new all-time record above $1,032 per ounce – just as the Federal Reserve lent $29 billion to support J.P.Morgan's fire-sale purchase of Bear Stearns – the Gold Price has gone on to drop 15% of its value against the Dollar.

Versus the Euro and British Pound, the loss has been just as dramatic. And looking at the technical action on its charts, "any meaningful bounce from the 200-day moving average could bring back a lot of money into gold," the UBS comment goes on.

That's what "happened last year," it adds.

The 200-day moving average, as the name says, measures the average price of an asset over the last two hundred days. It's called "moving" because, as time rolls ever onwards, so too does the average – used by chart-loving technical analysts to see what the deeper, underlying trend is up to.

And why 200 days? Because that's roughly the number of trading days during one year. So the chart here, therefore, shows both the daily Gold Price as well as its 12-month trend. And you can see how the 200-day average has indeed acted as "strong support" during the bull market so far.

Well, kinda. Most of the time.

Nine times since Gold quit its 20-year bear market in 2001, the price has either bounced off or moved sharply higher through its 200-day average. The following surge – lasting an average of 21 weeks – delivered a 28% gain before the price of gold tipped lower again, back towards that ever rising up-trend.

The leap starting in late Sept. last year was the most spectacular, as UBS notes. By the top of 17 March 2008, the Gold Price moved some 54% higher. Might that happen again now?

Two points to note if you're chasing the bull market in gold for short-term gains to shoot out the lights:

1. Summer Lull – as the chart shows, Gold typically moves flat to lower during the middle four months of the year. And even as the global banking crisis hit in August 2007, a hugely bullish event for Gold's Safe Haven Appeal, it still took another six weeks before gold started to vault higher;
2. Pre-Empting the Bounce – prior to last year's jump – sparked by the US Federal Reserve slashing the cost of borrowing below the rate of consumer-price inflation – the Gold Price had dipped below its 200-day average seven times during this bull market so far.

Buy Gold now, in other words, and a keen market timer might well have to endure a further drop first, even if the apparent magic of the 200-day average does come good once again.

But with the 200-day moving average now just above the $850 level, longer-term investors who've been considering a purchase – but were put off the huge volatility of 2008 to date – might want to stop waiting around. Precisely because larger investors are sitting it out, and precisely because technical analysts like the UBS team are pointing to a possible dip before advising you buy.

You see, that price of $850 marked the bottom of gold's fast & furious sell-off in March. It was also the previous bull market's top, hit just as Soviet tanks rolled into Afghanistan on 21 Jan. 1980. So a return to prices below that level might actually signal a longer term drop. If the price is to push higher from here instead, a drop below $850 might be a long time in coming.

Hanging on for another pullback from today's current Gold Price and so trying to nick a little extra off your investment outlay might prove expensive, in short. If you're looking to take a position in Gold for longer-term or deeper fundamental reasons, the kind of low-profile flat action we're seeing this June could offer your best chance to get in.

Just ask anyone who tried to wait for a pullback once the last surge in Gold Prices had started in Sept. '07.

Adrian Ash

The Daily Reckoning Australia

• CRB Index Correction Likely to Go Further
• Technical Analysts see the Market 80% Psychological and 20% Logical
• An Oil Price Correction is on the Horizon, When and Where
• Gold Price Outlook – the Long and Short of it
• Corn Prices on the Rebound