The Persistence of Paper Currency Faith

People are still convinced by central bankers it seems...

MARKETS UP, gold down. That's more like it! says Greg Canavan at the Daily Reckoning Australia.

Having digested the words of the world's latest and most supreme deity, Ben Bernanke, US markets broke out to new 5 year highs last night. The Dow Jones Industrial Index surged back above 14,000, although if you like 'non-confirmations', neither the S&P500 nor the Dow Transports could make a new high.

According to 'Dow Theory', if one market average makes a high, unconfirmed by another average, then you should remain cautious. In this case, the transports index has not yet confirmed the industrials' move. Nor has the S&P500. But it's just below the 2007 all-time high of 14,164 and it 'feels' like the market wants to get there.

More accurately, it 'feels' like Bernanke wants it to get there. Can you imagine the headlines and euphoria that a new all-time high in the Dow would bring? In central banking logic, it would create immense wealth and get people spending again.

But it's just a monetary illusion. The market advance is not due to good old fashioned investment in US plant and machinery and it's not the product of a sustainable rise in earnings (profits as a percentage of GDP are already at all-time highs). It's the product of the rise of the central banker and his all-pervading influence on the market.

In explaining last night's surge in the stock market, the Financial Times tells us that 'Stocks advance after Bernanke balm'. That's basically what it boils down to. Day after day, the market responds to central bank winks and nudges.

You can see this clearly in the Dow Industrials chart below. After looking like forming an ominous rolling over pattern, the two white bars you see on the right are a response to Bernanke's 'we won't take the punchbowl away' speech yesterday.

Source: StockCharts

Funnily enough, while equities gained, commodities didn't fare so well. Oil and copper both fell overnight, a tacit nod perhaps to the fact that actual economic activity continues along in its moribund way, while paper speculation remains hot, hot, hot. Soon, it will burn...

And gold! Stable, inanimate gold...

After watching the price of paper currencies fall in response to Bernanke's speech, gold must have chuckled today when those same paper currencies rose again. Gold doesn't care. It watches and waits for history to take its course.

What's behind gold's recent weakness (or more accurately, what's behind the strength in paper currencies)?

This quote from Jim Grant (of the renowned Grant's Interest Rate Observer) gives you a clue:

'The price of gold is the reciprocal of the world's faith in the likes of our modern central bank management. And as the faith recedes, as I think it ought, the price of gold might go up.'

That quote was from 2011. Grant got it right; he just miscalculated the faith bit. That is, you would expect faith in central banks to have receded by now. Instead, we've seen the opposite. Faith in the central banking fraternity has flourished. Because of the reciprocal relationship that Grant identified, gold is on the outer.

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