The Effects of Central Banking on Gold and Paper Currencies

“When will the gold bubble burst?” CNBC’s Larry Kudlow wondered aloud this morning.

A question to which your California editor would reply, “We know what gold is and we know what a financial bubble is, but we don’t see any gold bubbles.”

Perhaps Kudlow is referring to the fact that the gold price is rising…in response to the Central Banking Bubble. On its face, the idea is ludicrous that one man can steer an entire economy, simply by adjusting one little interest rate. The idea is a doubly ludicrous that one institution can nurture economic growth, simply by printing money. And yet, a nation of investors places its faith in the Cult of Central Banking, as folks like Larry Kudlow pay homage to Ben Bernanke every business day.

So far, the true believers have profited from their faith. It has paid well to embrace this cult and to trust the Delphic utterances of its high priests like Alan Greenspan and Ben Bernanke. But this whole central bank thing is getting a little out of hand.

The early central bankers admitted their fallibility. They would adjust interest rates up or down, depending on the prevailing economic circumstances, then hope for the best. But the more that the central bankers’ tinkering and meddling appeared to succeed, the more they tinkered and meddled, and the more they believed in the power of their tinkering and meddling.

Eventually, the central bankers not only believed in the power of their intrusions and manipulations, but also in the wisdom of them. Before long, the central bankers considered their activities to be not merely a responsibility, but an imperative, a social duty; perhaps even a “calling” – a kind of Divine Right of Central Banking.

Armed with these potent delusions, central bankers around the world continue to meddle, day by day, month by month. And the investor-flock continues to trust in their mystical powers. This nearly universal faith in a priesthood of monetary medicine men is an extreme idea…taken to an extreme. It is a bubble – the effects of which are as varied as they are non-quantifiable. But one effect is very clear: currency values are perpetually in decline.

The more the medicine men prescribe their remedies and elixirs, the faster the purchasing power of their paper currencies erodes. Observing this trend, rational, forward-looking investors scout around for assets the central bankers are not trying to protect – assets that require no protection whatsoever. Gold is an obvious choice. It is the timeless choice of all investors who reject the Cult of Central Banking and who, therefore, distrust paper currencies as a store of value.

Gold is rising because Central Banking is in a bubble. But the gold bubble, itself, will not arrive until the Central Banking Bubble bursts – the moment when investors universally spurn the cult of Central banking as heresy, and rebuke central bankers, themselves, as agents of wealth destruction. At that moment, when gold is trading north of $10,000 an ounce…or $20,000…or $100,000, the gold bubble will have arrived. And when it does, we will be there to issue a “sell” recommendation.

Speaking of “sell” recommendations, Jay Shartsis, a seasoned options pro at R.F. Lafferty in Lower Manhattan, warned his clients on Wednesday, “A big stock market decline is coming.”

To support his bearish call, Shartsis has highlighted a variety of market signals and sentiment indicators. Late last week, for example, Shartsis noted that the “CBOE equity put/call ratio hit .27 – the lowest in my memory. And now 8 days in a row, this ratio has been sitting below .60 – that’s a sell signal.”

Then earlier this week, Shartsis observed, “With the stock market near the highs for this move, there are only 127 new highs on the NYSE and 88 new lows. The new lows number is way above where it would be if this market was in good underlying shape. Yesterday saw 3% of all NYSE stocks at new lows – a condition that has happened only 36 times in the past. Two months afterwards, the S&P 500 was lower on 32 of those 36 instances.”

Options Speculation Index
Chart Source: SentimenTrader

Lastly, Shartsis called attention to the nearby chart, as he remarked, “The chart displays the Options Speculation Index. It is a measure of total call buys plus put sales (those are bullish transactions), divided by total put buys plus call sales (bearish transactions). So this is a very comprehensive gauge and it now reflects the most bullish option trader sentiment probably ever recorded. No fear at all. Note that the index is considerably higher than it was before the flash crash last May. A big market decline is coming!”

Shartsis has been wrong before, of course. But he has also been right. We predict he will be one of the two this time around.

Eric Fry
for The Daily Reckoning

The Daily Reckoning