One of the great benefits of trading charts is that they are able to convey information on months of activity within a single glance, as opposed to attempting to absorb days, weeks, months or even years of digital data. 

The gold chart reflecting the past few months provides us with an excellent example this morning.

The great question is whether the sharp decline of $400 per ounce from approximately $1,930 to about $1,530 constituted an end to the great bull market which has lasted since early in this century or whether that decline is nothing more than a disconcerting interruption to a powerful bull market which is still ongoing.

Charting text books offer us a suggestion in terms of what constitutes a ‘normal’ correction.  If a decline is followed by a rally of 50% and then resumes the decline, a new and bearish pattern would be strongly suggested and, vice versa, if the rally crossed above that 50% mark and continued upward, that could be regarded as a bullish indication.  In the present case, a 50% recovery from the $400 decline would occur near $1,730 and, it can be readily observed that the price of gold has soared well above that mark thereby offering a positive indication that the bull market is once again underway.

Another method of measurement is the saying that a correction of ‘one-third to two-thirds’ is normal. 

Therefore, if, following a sharp decline, the subsequent rally fails to recover even one-third of the prior move, that would be negative; if the correction reaches between one-third and two-thirds and fails to break out of that range, that would be neutral; but if the recovery exceeds the two-thirds mark, that would be bullish.  A one-third recovery from the $400 decline would occur at about $1,665 while the two-thirds mark would be close to $1,800.  By this system of measurement, gold is still in the upper part of the ‘neutral’ zone, but is closing in on a strong breakout to the upside.

Strangely enough, a similar interpretation can be offered to the world at large, but in a reverse sense since gold historically performs better during times of increasing crisis as opposed to periods of stable prosperity. 

We would suggest that the news background conforms closer to increasing instability and heightened concern - and therefore suggests a continuing golden bull market - as opposed to confidence in future stability.  In a similar manner, it appears to us that the chart of gold is suggesting, at least from our technical interpretation, that further price increases in the yellow metal appear to be forthcoming.

(Mr. Melman is a member in good standing of the Canadian Society of Technical Analysts)

Without attempting at all to be facetious (well, maybe just a bit), I would like to conduct a discussion regarding the relative logic between the belief that Greece will actually repay all its huge and defaulting debts with valid currency earned from its own economic activity compared to the childhood tale of the “Tooth Fairy.”

In the “Tooth Fairy” story, we learn that a mysterious fairy somehow learns when a child has lost a tooth and also knows which parents have been diligent enough to save the fallen dental item and placed it under the sleeping child’s head.  Then, by some sort of fiscal magic, money in the form of coinage is found the next morning by the delighted child.  Of course, in later life adults point out the logical fallacies in such a tale and it is reserved, like the Santa Claus story, to be re-told for the benefit of their later offspring.

Now, let’s look at the situation of Greece in terms of that country’s ability to repay debt.  It spends more money than it takes in.  It is burdened by a civil service grown immensely powerful, numerous and obstreperous through the decades.  Greece’s government debt has reached the towering level of almost twice the value of the nation’s economic output.  Their unemployment is near 16% and rising.  The interest rate cost of financing new debt has soared to over 20%, putting unbearable burdens on the interest payment costs of their federal budgets.  They are running deficits that can only be described as ‘monstrous’.

I would seriously ask this question:  What is more likely, (a) that a tooth fairy deposits coins under a sleeping child’s head, or (b) that the nation of Greece will suddenly fire virtually all its over-bearing bureaucracies; find employment for millions; balance its budget;  have the Greek citizenry docilely accept harsh and brutal reductions in their standard of living; have the private world of finance express confidence in Greek debt by purchasing government bonds at low interest; and, simultaneously, have all their industries, their tourism and their domestic consumer economy suddenly burst forth with battalions of unending prosperity?

I would suggest that the two questions resolve themselves into some form of equal probability.

But this matter is not just for joking.  If Greece’s situation is as apparently irresolvable and ownership of Greek government debt represents some form of financial death-trap, what is to be said of Italy and Spain, both afflicted with similar problems and where the stakes are punishingly more serious, given the fact that the combined total of Italian and Spanish government debt is a factor of twenty times greater than Greece?

The latest headlines tell us that the Greek President, Papandreou is in the process of failing and that an interim government, lasting about 15 weeks and to be headed by former European Central Bank vice-president Lucas Papademos, is to be established with the primary goal of enacting the European Union rescue package into Greek law – whether it is even remotely possible for Greece to actually service the mountains of new debt it will be taking on.

At the same time, over in Italy, that nation’s Prime Minister Silvio Berlusconi is rumoured to be ready to step down as it appears he is in the process of losing his party’s parliamentary majority in the face of an imminent vote on Italy’s new budget.

To place matters in context and show how utterly unstable the situation in the southern portion of Europe has become, can anyone even remotely envision the same type of political fiascos taking place in America or Canada?  Can you even contemplate waking up tomorrow morning to learn that President Obama is quitting and his party is to be cast to the sidelines; that Prime Minister Harper is also rumoured to resign and his ruling Conservative Party is to step aside because of a budget vote and that in either nation, a 15-week interim government is about to be established to be followed by who-knows–what?  Yet, on a comparative basis, that is EXACTLY what is happening in Europe at this moment.

As of 9:30 AM, financial markets are still trying to digest the weekend news and to separate those news items which can be interpreted as positive from those which are obviously negative.  Financial markets fell in overnight European trading, rallied in North America, but then fell back.  At present the Dow Industrials off by about 90 points while the TSX Index has given back early gains and is now virtually unchanged.  Precious metals are very strong with gold up almost $30 to the mid-$1,780s and silver is approaching the $35 per ounce mark.  However, base metals have turned weaker with copper down by about 4 cents per pound while mining share indexes are rallying about two percent on the precious metals’ gains.

In other markets, crude oil is once again near the $95 per barrel mark, long term interest rates are sharply lower and the US Dollar is trading higher in currency markets.

All quotes US$ unless otherwise indicated.

Next “Melman Minute” scheduled for Wednesday, November 9, 2011 when we plan to take a close look at the world’s petroleum markets.