Fed obliges all, goes all out to save big banks

Gold is back in buying territory after its dramatic correction back to key intermediate trendline support. In the last update we were looking for gold to break out above the $1,000 level. It did and briefly got to about $1030 before it turned tail and dropped precipitously.

Interestingly, the short-lived run at $1030 occurred last Sunday at the time of the Bear Stearns emergency, and the time when the crisis was at its most acute was the point at which gold topped out, which is what one would expect.

The action in both gold and silver early last week was short-term bearish, with gold backing off rapidly after its run at about $1030, leaving behind a bearish "gravestone doji" candlestick on its chart, and silver backed off from a run at its highs early this month, thus marking out a small Double Top. These bearish omens were noted and a warning that a possibly heavy reaction was imminent was posted on the site.

The size of the drop last week appears to have been due to the market suddenly becoming aware of the Fed taking action over a period of time to curtail money supply growth behind the highly publicized faade of big interest rate cuts. If they were and are in fact doing this, it would of course have deflationary implications and deflation is the kiss of death for commodity bull markets.

This issue several very important questions. If they have been and are continuing to do this, then a tug-of-war situation must surely exist between deflationary and inflationary forces, for into the foreseeable future boatloads of new electronically created money are going to have to be created for the line of dominoes of collapsing major banks and other financial institutions, in addition to which other countries and trading blocs are likely to continue their policies of competitive devaluation, and even if the Fed succeeds in curtailing the rate of growth of liquidity it would be a Pyrrhic victory, for the current mess and mayhem in the global financial system DEMANDS rapid liquidity growth, and if it doesnt get it the result would be an almost instant credit gridlock leading to a deflationary implosion. This brings us to the next important point, which is just how much control the Fed actually has in the present situation. One thing is clear and that is that if the Fed does have control of the situation, it has done a decidedly poor job of showing it these past 6 months or so.

The Fed is thought to have about as much control of the current situation as a trucker does whose brakes have failed halfway down a steep canyon - he doesnt have control, he has influence. The truck is going to go over the cliff, we know that, but by skillful handling, he can significantly delay the point at which it hurtles over the cliff. So lets stand back and review the 2 main scenarios; the Fed succeeds in curtailing liquidity, which inevitably leads to a credit freeze and deflationary implosion.

The Fed obliges all comers and goes all out to save the big banks, brokerage houses and mortgage institutions from going under by manufacturing as much electronically created money as they need to avoid insolvency. This, given the gravity of the crisis, would lead to hyperinflation. However, there is a third route, which is a highly unsavory and prolonged period of stagflation, that would involve recession coupled with high inflation. This is essentially a muddle through situation in which deflation and inflation exist side by side - we have already seen this with house prices collapsing even as gasoline prices rise. This would be a situation in which most everyone loses. At this point it is of course not at all clear which of these scenarios will play out, and everyone involved in this giant mess appears to be taking it one day at a time, but what is clear is that gold is certainly set to continue to advance in both the hyperinflation and stagflation scenarios, and even in the deflationary implosion scenario, after a possible initial shock drop when most everything goes into the tank, it should then ascend as it would be "the only game in town".

While the correction in gold and silver was an accident waiting to happen, on account of their being extremely overbought with record levels of bullish sentiment, it appears to have been exacerbated, as we have already noted, due to the deflationary implications of the recent liquidity drain that has caught the markets attention and led to the vicious sell-off this past week. It is the Catch 22 situation with regard to the money supply and the eventual chaos that will result, which should ensure an ongoing bull market in gold and silver as safe haven investments, even if commodities as a whole tank due to a global recession/depression. Lets not forget that gold and silver are REAL MONEY, despite the comprehensive and largely successful campaign over many years by the mainstream financial press to relegate them to the status of mere commodities in the minds of investors.