The greatest lesson of the still young 21st century is proving to be that governments are the primary source of systemic risk to the economy, our standard of living, and our liberty.

The latest case in point is the European government debt crisis, with Greece once again running out of money and threatening to trigger yet another financial crisis. The government’s debt now totals more than 150% of its GDP, and continues to grow. Last year’s bailout by other European governments was supposed to give it the time needed to reduce its budget deficits so that next year Greece could roll over its maturing debts, as well as finance additional deficits at interest rates under 6%. However, the government’s austerity plan of tax increases and budget cuts has not reduced current or projected government deficits because the economy in 2010 contracted by 4.5% and the unemployment rate jumped to 15%.

The combination of a contracting economy and rising debt levels has driven the market yield on Greek two-year notes to near 25% and on its 10-year debt to around 15%. Since these loans are in euros, rates this high reflect the growing risk the people of Greece will not be able to make good on their collective debts. They also effectively shut the government out of the capital markets. Last week, S&P downgraded its rating on Greek debt to B from BB-, well into junk bond territory.

The downgrade reflects the increasing possibility that Greece will restructure its debt by forcing current debt holders to accept longer maturities, or do what demonstrators in the streets of Athens are demanding, which is to force its creditors to take a loss on their loans.

Normally, this would be a matter between a debtor and its creditors. However, European Central Bank (ECB) Executive Board Member Juergen Stark warns that the effects of restructuring “could overshadow the effects of the Lehman bankruptcy,” which is associated with the beginning of the 2008 financial crisis.

At the heart of that financial crisis were government policies including Federal Reserve efforts to manipulate the economy by keeping interest rates artificially low and a weak dollar policy that fueled the housing bubble, federal government rules and regulations that de facto required banks to make loans to high risk borrowers, and two government sponsored enterprises, Fannie Mae and Freddie Mac, who stood ready to purchase hundreds of billions of dollars of sub-prime mortgages if only Wall Street could figure out how to turn them into high grade bonds.

In the case of Greece, government actions and regulations also lie at the heart of what threatens to be a European financial crisis.

Greek social security funds hold nearly two-thirds of their liquid assets in government bonds. Thus, any default would undermine these funds’ ability to meet their obligations to pay promised health and pension benefits. Such an outcome understandably would create massive political unrest that could reduce government revenues and the government’s ability to make good on its debts.

This risk is amplified by special rules created by politicians that encourage banks to lend freely to governments.

Here’s how it works. Governments require banks to hold capital against the loans that they make, anticipating that in the normal course of business, some of the loans will not be repaid. The riskier the loan, the more capital that needs to be held in reserve.

However, under international rules negotiated by government representatives through the Bank for International Settlements (BIS), government loans fit into a special category that has a 0% risk requirement. That means European banks do not have to hold any reserves against loans they make to European governments. That’s right, politicians implicitly promised banks that governments would never default. And, given the opportunity to make “risk free” loans that require no capital commitment, bankers purchased mountains of government debt.

According to Reuters, Greek banks own nearly 60 billion euros ($ 84 billion) of Greek government debt, and would almost certainly need additional capital and potentially a government bailout in the event of a government default.

In addition, the European Central Bank has increased the risk of systemic failure by becoming one of Greece’s largest creditors. As reported by The New York Times, J. P. Morgan estimates that the ECB owns 40 billion euros of Greek debt. In addition, it has lent 91 billion euros to Greek banks, with much of that backed by Greek government bonds.

That means any Greek default would cost the ECB billions of euros in losses and potentially impact the value of the euro, disrupting European and international financial markets, and the conduct of European monetary policy.

In a television interview last Friday, ECB Vice President Lucas Papademos warned: “…the adverse consequences both on the banking system in Greece as well as on financial stability in the euro area as a whole can be far reaching and undesirable. So all in all, I think that Greek debt restructuring should not be on the agenda.”

One possible “far reaching and undesirable” consequence of such a disruption to European financial markets would be follow-on defaults by Ireland, Portugal, Spain and Italy. According to AEI Scholar Desmond Lachman, the combined debt of the first four countries alone is about $ 2 trillion, a large portion of which is held by European banks. As a consequence, a write-down of 30% of that debt could lead to a European financial crisis not unlike that which struck the US banks from subprime mortgages.

Thus, the systemic risk created by the political class has put the citizens of Europe on the hook for irresponsible levels of government spending. Wealth producers are faced with the lose-lose choices of bailing out governments, bailing out bankers who were induced into buying government debt, or suffering the economic consequences and losses associated with widespread bank failures.

The brewing European debt crisis demonstrates again that the greatest source of systemic risk is believing politicians when they promise government guarantees are costless, and that elite public servants are capable of protecting us from systemic risks in the first place. The lesson is that giving governments more power over the economy and financial system is itself a source of potentially catastrophic financial and economic instability.

Regards,

Charles Kadlec,

GOLD

LONG TERM

Gold remains within a long term up trending channel. It is, however, near the upper resistance line and one might expect a reaction towards the lower line about now. Having said that, there is not much more negatives from the long term perspective. All is roses at this point.

Gold remains well above its positive sloping long term moving average and the momentum indicator remains well inside its positive zone. Looking at a daily long term chart the momentum indicator is turning lower and has crossed below it trigger line but the trigger is still sloping upwards. The indicator is pushing very slightly into new higher ground but just slightly below it previous high in late 2008. The difference is not enough to justify any negative divergence view. The volume indicator, on a weekly basis, is heading into new all time high territory. On a daily basis it is also at new high levels but one can discern a possible topping activity in this indicator. Still, when all is put together we continue to have a BULLISH rating for the long term.

INTERMEDIATE TERM

In the past few months gold has touched its intermediate term moving average line and bounced right back to the up side. It remains well above the line on the Friday close but a couple of volatile negative days could just see gold dropping below the line. The intermediate term momentum indicator remains in its positive zone but the action over the past few weeks suggest a very labored upside move. The topping is quite evident here. The indicator is now well below its lowest level over the past couple of weeks and heading down aggressively. It has moved below its trigger line and the trigger has turned to the down side. Still, it is some distance from dropping into its negative zone. As for the volume indicator, it remains above its positive sloping trigger line but in a topping trend. For the intermediate term the rating remains BULLISH but with more risk of turning negative than the long term. This rating is confirmed by the short term moving average line remaining above the intermediate term line.

SHORT TERM

Looking at the short term chart the indicators are literally screaming “topping”. Both the short term momentum and the more aggressive Stochastic Oscillator (SO) are now in their negative zones and seem to be heading even lower. The question now is not if gold is in a topping mode but how long it will stay there and how low will it go. Although I often do try to guess how far a trend will go I am more of a follower determining where we are now and what is the present direction of the trend. In the end I fall back on the tried and true technical concept that “a trend in motion remains in motion until a reversal has been verified”.

So, where are we now as far as the short term perspective is concerned? Gold has just closed below its short term moving average line and the line has turned to the down side. Gold is now at its lowest price in two weeks. As mentioned, the short term momentum indicator has now moved into its negative zone and is below its negative sloping trigger line. It did give us a short term negative divergence warning and has been making lower lows and lower highs for the past two weeks. As for the daily volume action, that has been pretty light over the past couple of weeks and remains below its 15 day average volume line.

Volume action is a tricky thing to try and assess. Too often it is not acting as the text books say it should act. I have found the volume action too often contrary to what one would expect. As an example, low volume action of down price moves is NOT necessarily bullish or bearish. It is just what one would expect from the actions of the masses who halt their activities during down days. Increased volume on up days is also not necessarily bullish. The masses just normally increase their activities when they see prices moving higher. They are afraid of missing out on the move. If one can determine what the NORMAL volume is on these up and down days then one can decide if the actual volume is increasing above the norm and is bullish or bearish. This norm is almost impossible to determine as it changes with time so to try and assess what the low volume action is telling us is next to impossible. How is that for a cop-out in not assessing the import of volume action?

Anyway, getting back to the indicators, they all are telling us that the short term rating is now BEARISH. However, the very short term moving average line has not quite crossed below the short term line so confirmation of this bear must wait another day.

SILVER

I have just returned from two weeks on the move (some call it a vacation but it just seems like you work harder during a vacation trying to relax than you do during normal days). Today, I am a little behind time so I will cut the rest of the commentary short and return with a full commentary next week.

Silver has been under performing relative to gold ever since the plunge. Although the long term rating is still BULLISH both the intermediate and short term ratings are BEARISH. Just a personal view but it does look like silver will continue to under perform gold for some time still. It has over performed for some time so this may just be a getting even trend.

PRECIOUS METAL STOCKS

Gold declined 0.9% during the week but the stocks tumbled by 5% or more. Silver was up on the week but both silver Indices were lower, the Spec-Silver was down 7.5%. This disconnect between the performance of the commodity versus the performance of the stocks is not unusual. In fact I would say that one should consider such deviation as normal, on the up side as well as the down side.

One point to keep in mind, it is not unusual for the stocks to be LEADING indicators as to where the commodity is heading in the future, so traders in gold and silver should be very cautious when trading on the up side. One would be taking an extra amount of risk if one were trading in stocks on the up side at this time. It’s just not that bullish of an environment. Better to wait for things to turn around before jumping into the market, unless one is a short sell trader.

Well, that’s it for this week. Comments are always welcome and should be addressed to mervburak@gmail.com.

By Merv Burak, CMT

Silver has been on fire for the last three years – substantially outperforming its spotlight-grabbing cousin, gold.

Because we believe this bull run is far from over, we advise investors to always maintain exposure to the precious metals markets. But the question every investor faces in a bull market is: Do I buy now, anticipating prices will continue higher – and chance getting clobbered if a correction arrives? Or do I wait for a pullback and possibly miss out on big gains?

There’s risk either way.

But we suggest using temporary price declines to steadily accumulate the best silver stocks and your preferred form of bullion. Looking back, after this bull market has finally run its course, we think gold and silver will have amply rewarded those who bought smart, had meaningful exposure, and stayed the course.

There are numerous factors that influence the direction of silver prices, but there are two key trends regarding supply and demand that are critical to understand.

The first is industrial use. Demand from a number of industries that use silver has been flat or falling. Household demand for silver like cutlery, flatware, and candlesticks hasn’t risen in ten years. Jewelry fabrication is up but a blip. With the shift to digital photography and image storing, use in photographic film processing continues to fall. And yet, total demand from industrial users keeps climbing.

So what’s driving industrial demand?

Since 1999, consumption in electronics has increased 120%. Silver use in solar panels began in 2000, and usage is up 640% since. Silver was first used in biocides (antibacterial agents) in 2002 and, while still a small percentage of total silver use, it has grown six-fold. Taken together, these three industrial uses of silver are consuming about half of all the silver mined each year!

Furthermore, the Silver Institute forecasts that total industrial use of silver will rise by 36% over the next five years, to 666 million troy ounces/year. That’s a lot of silver, meaning this portion of demand isn’t letting up anytime soon.

To put it another way, ten years ago, jewelry and silverware consumed twice as much silver as electronics applications. Today, electronics applications consume much more silver than jewelry and silverware. The point is not only that the number of industrial uses for silver is growing, but also that the demand within each of those usage categories is rising as well. These increasing sources of demand are now more likely to keep a floor under the silver price in the future.

The second issue is mine supply. Silver mine production has been increasing over the past decade, largely due to rising prices, allowing companies to ramp up production and bring more metal to the market. In fact, global mine production is up 33% since 1999.

But despite miners digging up more and more silver, production alone can’t meet global demand, and the gap has to be filled by scrap silver coming to market.

But there’s a catch with scrap. Traditional sources of old silver scrap are depleting. Meanwhile, the new industrial sources of future silver scrap do not lend themselves to recycling as easily as, say, silverware. While scrap metal comprises about 20% of silver’s total supply, many of these new applications are difficult to reclaim. Some applications contain such small amounts that they’re uneconomic to recapture, such as many biocidal and nanotechnology applications. With others it’ll be a long wait. Solar panels, for example, have a 20- to 30-year life. Still others are waiting for more effective recovery programs; more than half of all silver in cell phones, TVs, computers and other electronics, for instance, still ends up in landfills.

In other words, a growing portion of the silver that’s consumed today won’t be returning to the market anytime soon. And that may be one very good reason why the bull market in silver won’t be ending anytime soon.

(RussiaToday) – America’s credit rating is at risk, the unemployment is up and the residential real estate market has double dipped. Is it time to change the way the world economy works? “We are heading for a huge disaster,” says Euro Pacific Capital President Peter Schiff. As the US dips from a recession to a depression, Schiff says, America needs to stop borrowing money if they want to prevent driving off the proverbial cliff.

At the start of last week, I showed the “Arc Pattern” trendline boundaries that were forming at the peak of the intraday arc in gold prices, and this week, the arc continues right on schedule.

Let’s take a look at the updated/current “Arc” pattern and then see where that structure takes us on the daily support chart.

As I noted last week, the upper boundary was roughly $ 1,550 while the lower boundary was $ 1,525.

Price continued to respect these boundaries appropriately, giving intraday traders quick opportunities to play ’scalp’ moves off these developing trendline boundaries.

Not much has changed, as the boundaries now have defined themselves clearer this week to $ 1,545 and $ 1,525/$ 1,530 as seen above.

The analysis is the same – as long as price continues to respect (bounce between) these levels, then you have your “roadmap” or game-plan for intraday/short-term trading opportunities.

Should price break firmly through either of these boundaries, then it would suggest pattern completion and a breakout/impulse phase would emerge, allowing for Breakout trading strategies.

I had a fun post last Wednesday – “Wednesday with Wyckoff” – regarding basic breakout trading tactics.

So that’s the intraday structure – the “Arc” – but let’s take a look of where that leaves us currently on the Daily Chart:

Before discussing current levels, I wanted to show the example of the prior “Arc” pattern from February into early March 2011.

Though the ‘rally’ phase was longer than present, daily (and intraday) gold prices formed a similar arc with negative divergences inside the pattern (as we have now).

The downside action continued, culminating in a strong sell-off bar that slammed the rising 50 day EMA at the confluence of the $ 1,400 “Round Number” support zone.

The test of the confluence support ended the retracement phase, and price quickly broke the upper ‘arc’ trendline, triggering a breakout buy signal that preceded the April rally.

And now to the present – we have a well-defined arc that is now coming into the support at the rising 20d EMA at $ 1,530.

It’s possible buyers enter here to support prices at the 20 EMA, but if they fail to do so, expect a similar retest (deeper retracement) of the rising 50d EMA as what took place in March.

It would then be up to buyers again to try for a retracement buy at the confluence of the 50d EMA and the $ 1,500 “Round Number” support (strange how structure aligns like that again).

In other words, watch the current price at $ 1,520 and if there’s no rally here, then expect the ’rounding arc’ to continue, leading to another retest of the rising 50d EMA. Watch what happens at the 50d EMA at $ 1,500 for clues as to what to expect from there.

Continue watching gold on the hourly/intraday timeframe with regard to this arc formation and trade appropriately (don’t get ahead of the arc!).

Corey Rosenbloom, CMT