Updating the Charts

2009-MAY-25

I present below the two charts highlighted in the last alert. Both are updated through the close on Friday, May 22nd.

The key observations from these charts are:

1. The US dollar has broken down badly. While a bounce can of course occur at any time, particularly because the dollar is so oversold on a short-term basis, the recent technical damage suggests that the bear market rally in the dollar that began last July has ended.


2. Gold’s reverse ‘head & shoulders’ pattern continues to develop nicely. It has been a good run for gold over the last couple of weeks, so some ‘backing and filling’ may occur. But the important message from this chart is that gold will move up to the neckline of this pattern around $1,000 in the weeks ahead.

I also present another chart with an important message. It shows the yield on the 10-year US T-note from 1962.

There are two clear trends on this chart. Yields rose during the 1960s and 1970s as inflation worsened. Investors required the higher yields to offset the loss of purchasing power from inflation. Thereafter, yields declined as inflation lessened, eventually falling to multi-decade lows last year.

Note the two arrows on the chart. In the early 1980’s, the T-note and other US government paper was sold heavily and widely avoided because of the perceived inflation risk. Note how yields broke above their long-term uptrend for a time, which actually marked the peak in yields. It was a mania of sorts, as worries about the outlook for the dollar overlooked the reality that real yields (i.e., the interest rate less the rate of inflation) reached record highs.

Recently, the opposite occurred. After the collapse of Lehman Brothers, T-note yields collapsed as US government paper was bought because of the perceived safety it offered. Note how yields broke below their long-term downtrend for a time. This chart suggests that the low in T-note yields has now passed. It was another mania, as worries about the declining stock market and insolvent banks overlooked the reality that real yields were less than zero because the inflation rate was greater than the interest one could earn on this paper.

In short, T-note yields have made a huge round-trip. The trend is again turning toward higher yields as the outlook for dollar seems to get worse by the day. Expect more dollar debasement and higher yields on US government paper.

Some say that T-note yields are climbing in spite of the fact that the Federal Reserve is buying Treasury paper, but they have grabbed the wrong end of the stick. T-note and T-bond yields are climbing precisely because the Federal Reserve is buying Treasury paper.

Hyperinflation is caused by the central bank buying the debt of a government for which spending is out of control, and then turning that debt into currency, which describes what is happening in the US today. So falling dollar exchange rates as we have seen in recent weeks is a normal response to the Fed's actions. And the more Treasury paper the Fed buys, the lower the dollar will fall in the foreign exchange markets and more to the point, the higher gold will rise.