Gold To Break To Upside, USD To Collapse

Lance Lewis

November 13, 2008 3:05 pm

SPDR Gold Shares (GLD) isn't selling gold. The only selling is in the paper market (i.e. the futures).

click to enlarge http://tinyurl.com/5foux9

The physical market for gold continues to be tight and is getting tighter. In fact, the 3M Gold Forward Offered Rate (GOFO) fell another 13 basis points today to 0.20%, and one-month GOFO hit 0.07%.

click to enlarge http://tinyurl.com/6lnztz

When GOFO goes negative (which will likely happen tomorrow or early next week), then gold will be in backwardation, something that last happened after the Washington Agreement was announced in 1999 and there was a mad dash for physical gold by shorts.

I discussed this possibility in Mother of All Short Squeezes for Gold.

Unlike other commodities, gold very rarely goes into backwardation, and only when 1) the market fears a collapse in the currency, and/or 2) the market is worried about counterparties making good on their promise to deliver gold (which was briefly the case in 1999, when the Washington Agreement was announced and shorts were squeezed).

This tells us not only that gold is about to erupt to the upside, but also that the market smells the endgame for the dollar fast approaching too.

There's no way around the fact that the dollar will collapse. Either it falls because the Fed begins to monetize and rapidly inflate (which has always been my assumption), or because the asset-price deflation continues and the US government is forced into default.

Think about it: In what world does the biggest debtor nation on the planet become the epicenter of a financial and economic collapse - and also see its currency remain strong? These people looking for “deflation” into dollars are simply nuts: The only reason the dollar has rallied so sharply thus far is because the dollar is the world’s reserve currency, and therefore everyone’s liabilities are in dollars. And when people began to deleverage in a panic, they had to buy dollars to offset those liabilities.

We may well continue to see credit deflation if the Fed doesn't ramp up the printing presses even faster than it already has. I doubt that will happen, because I believe the Fed will print whatever amount is necessary (which should be more than obvious, given the growth in its balance sheet that has already occurred). But as always, anything is possible.

Even it the credit deflation does continue, it won’t end in lower prices for everything in terms of dollars. It will end like Iceland, with a government default and rampant inflation due to a collapse in the dollar.

The US is no longer the creditor nation that it was in the 1930s, or as Japan was in the 1990s. It’s a giant debtor with a world-record current-account deficit, totally at the mercy of its creditors (i.e. the rest of the world).

At the current rate of collapse and spending, the US government won't be able to service its debts . Eventually, the rest of the world will simply say “no” to continuing to fund more debt, just as the private markets did to the US consumer over a year ago when the mortgage market collapsed.

My bet: The first indications of that “no” are coming this weekend at the G20.

As for your last question, the answer is “yes." If we assume that property laws will continue to remain intact (thus making “equities” a viable investment), then the gold stocks must rise with the price of gold as well.

At the end of the day, earnings drive stock prices, and higher gold prices wil translate into dramatically higher earnings growth for the gold miners (especially given the collapse in oil, which is a major component of mining costs). And in a world currently starved for earnings growth, gold mining may just be the one bright spot out there for the next several quarters, if gold erupts to the upside in the very near future - and I believe it will.