Diary of a Financier

Return of Reflation: Modern Manifest Destiny

In Economics on Wed 8 Feb 2012 at 12:41

So much to say on this matter, but one chart really captures it all. Overlay Gold and the S&P 500, wherein you’ll notice a persistent increase in correlation that’s consistent with all previous cyclical bull markets (within the heretofore secular bull market):

GC v SP- increase in correlation indicates reflationary resolve.

That’s the manifestation of reflation.

This is all good & well, but it begs the question, ‘when will it all unravel?’ To wit, I turn to the 2007-08 analogue. Therein, I find the last chronological summit of GC/SP correlation, conveniently within the confines of what’s being dubbed a secular bear market starting 2000:

GC v SP (2007-08)- analogue for the unravelling of reflation.

A brush of Gold’s 261.8% Fibonacci retracement appears to have served as the first trigger in 2007’s reflation unwind. At the same time as that resistance in Gold, equities made their own cycle highs. Gold then went parabolic to its next Fibonacci level in 2008, while stocks simultaneously failed to break resistance toward new highs. Deflation quickly set in, yanking everything down with it.

Today, we sit just above that 261.8% Fibonacci level in Gold, having originally failed to breach that resistance. Stocks made their cycle highs at the same time… again. There will be some bumps along the way in this secular bull (Europe/PIIGS), but I’m holding on for Gold to reach that next 423.6% resistance (~$2096/oz). This time around, notice that the correlation upswing is reaching its late innings:

GC v SP (2012)

Considering the overwhelming liquidity pumped into the US & Global systems, Gold (and equities) should theoretically exceed that next Fibonacci level around $2100–unless the EU-17 suddenly refrain from monetization.

I’m not even a gold bug, but I’ll be a bigger buyer of Gold* once I’m confident Greece & Portugal will accept bailouts (along with the austerity/indentured servitude riders). Again, I don’t think they should go this route–EMU dissolution is far more pragmatic on the long-run–but a century of Keynesian infrastructure compels them such.

–Romeo

*With the exception of the 1990’s period of organic growth, the SP:GC ratio has favored Gold outperforming equities throughout our fiat regime (since 1971’s Nixon shock).

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