The last week has been a fright fest for the gold “community”.  But these are the financial markets, not a community.  There is a world outside of what ever is going on in gold and silver.  A macro economic backdrop filled with entwined and correlated assets and markets all trying to form a message when taken as a whole.

Sure, gold – as a monetary metal – is a big one when it comes to macro indications, but what is really important is the great question that has been ping-ponged about for many years now between intellectuals on either side of the debate; inflation or deflation?

This post dials things out from the hysteria of the gold bear market (it is a savage cyclical bear, and we will certainly deal with it in a constructive way on the market’s terms) to the big picture and the eternal debate between ‘inflationists’ and ‘deflationists’.  Really, as I have felt all along, we have inflation and we have deflation… all along the continuum, as illustrated by the monthly chart of the 30-year T bond yield.

30 year yield, monthly

The continuum of gently declining interest rates on long-term T bonds implies a deflationary backbone spanning decades.  Against this firm disinflationary signal, policy makers have had license to print money at various times and with varying intensity.  The MACD trigger on the chart above implies that a new inflation phase is trying to get started, but this is restrained by what looks like the second of two bear flags that have formed just below resistance at a 3.5% yield.

As long as rates remain below that resistance level, the deflation argument is alive and well.  The last time the ‘continuum’ hit the red line (100 month exponential moving average), which has been the limiter of inflation expectations for decades, the second phase of the commodity bubble was exploding to new highs, Bill Gross made a highly publicized short against the long bond (in essence, meaning he was bullish on inflation) and the CCI commodity index topped in early 2011; 2 years ago.

CCI, weekly

While commodities have not experienced the drama that is the gold market, their persistent weakness has encompassed important ‘indicator’ commodities like copper/base metals and crude oil.  Technical damage is being done in those areas.  We have been following the progress of this degradation each week in NFTRH and asking ourselves the question ‘could it be deflation on the horizon?’

Folks, that is a breakdown on the weekly CCI chart above.  Not only is the index losing a channel, but a moving average cross (red dots) has taken effect that has signaled strong bear phases in the past.  Respect the deflationary argument.

But the post is titled ‘Gold and Silver as Macro Sign Post’ so let’s get down to it.

US dollar & Gold Silver Ratio (GSR), weekly

The gold silver ratio (GSR, bottom panel) would indicate market liquidity contraction and associated deflationary forces.  That is because though gold obviously gets hurt badly with a coming deflationary phase silver, the cross-dresser precious metal/commodity gets hurt worse.  So is the breakout of a trend that has been in force since 2008 a warning to deflation?

Just as we watch the T bond ‘continuum’ for indications on yields, we need to watch the GSR for its would-be signals about liquidity, which after all is what the current QE operation is all about.  So far, the GSR ain’t buyin’ it (QE 3, ‘to infinity’, etc.) as it did in 2010′s inflationary kick off.  No, the GSR is rejecting the policy and hammering gold (but silver worse).  Gold is a monetary asset that recovered first in the 2008 crisis.  This time gold and silver are declining first and hardest and their relation ship (GSR) should be watched as an indicator to coming events.

The deflationary case has not yet been confirmed, but it is strengthening.  Likewise, all of this going on today could be a prelude to the mother of all inflation problems.  But it is so vitally important that we subordinate ourselves to the market and its indicators because there are super smart people on either side of the ‘i’/'d’ debate and half of them are going to be very wrong.

If the GSR remains on this signal (in breakout mode), then watch for the US dollar to become strong – not because of any intrinsic value it may have – but because it is a claim on liquidity, which is intensified by its reserve status.  Remember how they knee-jerked into gold during the euro crisis and how they knee jerked into USD and then gold during ‘Armageddon 08′?  That is what happens in a rush for liquidity.

As for the USD’s technicals, it is actually losing one of its weekly moving averages, but a new bear signal would not come unless the moving averages cross down.  The most recent cross down (first yellow shaded area) was a fake out, as could be the current cross to up, prior to silver beginning to out perform gold and commodities regaining lost support.

But the signals are the signals and if deflation is in the near future – as currently indicated by T bonds, precious metals and the commodity complex, then the USD is going to ramp up.

It is a complicated situation, and that is why I say you have got to be willing to do the work to stay on the right side of it.  Or, if you are a normal person with a normal job and life, then associate yourself with people who are willing to do the work with an open mind subject to the many twists and turns that this wonderfully complex macro situation is going to present.  People should know by now that nobody has all the answers.  This is a work in progress on the macro.  Dogmatic beliefs will be (and have been) punished.

It would be my pleasure if you’d join me – if you so desire – at the hardest working newsletter (and dynamic interim ‘in-day, in-week’ update) service I know of if you are so inclined.  We are not trying to predict anything.  We are simply using hard work, discipline and open minds to remain on the right side of a complex situation.

Otherwise, I’ll keep writing these public articles and I hope you’ll keep reading them.  Tuning out the usual hysteria, what is happening on the macro is happening and we have all got to be willing to realize we do not have all the answers and there is always learning to do.

Biiwii.com, Notes From the Rabbit Hole, Twitter, Free eLetter