The Bullion Buzz – September 15, 2009
“The fact is that the Great Depression, like most other periods of severe unemployment, was produced by government mismanagement rather than by any inherent instability in the private economy.”
CHART OF THE WEEK
“Gold could very well be discounting a further bloating of US debt levels relative to GDP. As seen above, gold either corrects sharply or undergoes a period of consolidation once the FSO Gold Indicator #1 reaches levels north of 2, which was the case after the 2006 peak and early 2008 and 2009 peaks. Since the early 2009 peak, which saw the indicator reach the most overbought level since the 1980 peak in gold, the indicator’s overbought condition has been resolved by time rather than price as gold simply consolidated and recently reached a level that has marked major bottoms in gold in the past.”
Reasons for Major Gold Breakout
Since the beginning of the current gold bull market, analysts and the media have been stymied as to the reasons for gold’s rise. Willie attributes this to the fact that the global financial system is wedded to paper currencies, and is blind to the shift away from the US dollar. He, however, has 13 reasons for gold’s advance: a paradigm shift away from the US dollar; irresponsibility of major central banks with expanded balance sheets, money creation, and credit growth, endorsing their government’s profligacy; failure of the central bank model, as evidenced by the ongoing credit crisis, insolvency of banks, and desperate attempts by the Fed to serve as the global bank; ruined global monetary system from the complete debauchery of money itself; perversion of the US dollar; proliferation of OTC derivatives – over $1 quadrillion’s worth – with no prospect of resolution, no hope of regulation and deep corruption; a US finance ministry that involves official channels of slush funds, bond counterfeit, and narcotics money laundering; dishonour of financial contract law, chronic lapses in financial market integrity and constant intervention in those financial markets; mammoth price inflation ahead, unless central bank balance sheets inflate Weimar-style; anticipation of a banking system meltdown in at least the US and UK, likely to result in bank holidays that may be used for consolidations; gradual economic disintegration and the decline of global trade; a trend toward commodity stockpiles, especially in gold and oil; the possibility of wars and nuclear events as chaos spreads and nations exploit the confusion. Willie discusses the global monetary system breakdown; myopia and the golden tide; gold price breakout begins; China declares a subtle financial war; and Saudi banks ready to topple.
A Hedge too Far for Barrick
Barrick Gold recently raised $3.5 billion in a matter of days; unfortunately, the money will go to paper over a mistake. As of June 30, Barrick had retained earnings of about $3 billion, or roughly the cumulative profit it has generated over time. Now that the company is winding down some of its hedges, it will be taking a huge charge in the coming quarters that will wipe out those earnings and more. Fans of hedging say the stock has held up well, but stockholders haven't made much money owning Barrick long term, despite the fact that it enjoys an enormous market capitalization relative to its profitability. Analysts point to a big dilution in earnings, but are otherwise enthusiastic. If the overallotment of 14 million shares sells, and it likely will, total funds raised will be approximately $4 billion. But although the fixed-price hedges will, in theory, be gone within a year, these are hedges that deprive Barrick of upside (and protect it from downside) on gold prices. Barrick will either give the counterparties gold from its mines or buy gold in the open market to end them. That will cost, at current prices, about $2 billion. Barrick will also eliminate some of its floating-rate hedges, which represent a liability of $3.7 billion. These allow the company to participate in the price of gold. Yet when gold goes up, the liability does too. Some believe that gold prices must be set to rise if Barrick is unwinding its hedges, but if it knew where gold was going, it could have unwound at $300, or $400, or even $800, saving investors big bucks. Barrick also sold some of its future silver production for $625 million. If it’s bullish on gold, why not on silver? And if it’s bullish on silver, why sell? Perhaps it had to. Barrick insists that lenders and counterparties had no say in its decision to unwind, but counterparties may have had some influence. “I'm sure there's an explanation,” Taylor writes, “but if you want gold, buy gold, not complicated trades.”
A Light Goes on in Russell’s Brain
The fight is on between the primary forces of overproduction and deflation versus the Fed’s obsession to fight deflation and produce asset inflation. Rising gold prices mean inflation, however, and the central banks do not want the world to see that. Gold above $1,000 is anathema to them. What the Fed wants is asset inflation in housing, which is collateral for almost everything. But you can threaten gold with central bank sales, you can sell it in quantity, you can smother it with short sales; the primary trend of gold will win out, and the primary trend is upward. Word is that China wants to accumulate gold while diversifying out of its huge Treasuries position. China’s problem is buying gold without driving the price up. This has led to “the China gold put” – every time gold dips, China is there to scoop up what is offered. In addition, China is urging its citizens to buy gold and silver. China, in its patient way, is preparing for the future. Russell has never seen a bull market such as the current one in gold end without a highly speculative third-phase explosion, and that breakout will come if gold can make a new high above $1,005. At that point, there will be a global scramble for gold as the world realizes it has been hoodwinked by the central banks’ creation of paper wealth. Wealth cannot be created by a keystroke; gold represents hard work, capital expenditure and risk taking. No central bank has ever produced a single element of true, sustainable wealth. In our hearts, we know this. Which is why, writes Russell, in experiment after experiment with fiat money, gold has always been “the last man standing.”
Canary in the Coal Mine
Analysts are protesting that gold’s leap to $1,000 has nothing to do with inflation, which is dormant. But when people turn to gold rather than to interest-bearing investments, it is because they fear the interest will not be enough to compensate for any loss of purchasing power through inflation. The basic factor that drives gold appreciation will always be inflation. When governments finance wars or bail out investors or institutions, they create inflation (print money) to pay for it, transferring capital from prudent investors to speculators while undermining traditionally safe bonds and cash. Eventually, it becomes hard for investors to protect their principal, much less grow their wealth. When the price of gold rises sharply, it is a signal that inflation expectations are rising. The anti-gold camp points to the bond market, where things have been quiet. They maintain that since bond yields are steady, inflation must be dormant. The bond market is populated by ‘vigilantes’ who sound the alarm at the first whiff of inflation. But this argument ignores the fact that central bankers are the biggest bond buyers, and this has led to gross distortions. When the Fed or another central bank buys Treasuries, real returns are not considered. Purchases are made for political reasons rather than investment merit, making current bond market signals meaningless. Gold bashers also believe that reduced consumer demand arising from high unemployment will keep inflation suppressed for the foreseeable future. But inflation will reduce the supply of goods much faster than unemployment reduces demand for goods, sending prices up despite lower demand. Bottom line: The gold bull market continues, and those who dismiss it do so at their own financial peril. Gold is the canary in the economic coal mine. A spike in gold is a harbinger of reckless monetary devaluation. Since analysts can't see or smell the gas, all those canaries (gold prices, commodity prices) must be dying of natural causes. Good luck when the toxins flood the mine.
Gold Myths Cheat Sheet
An 8-year bull market in gold has given rise to countless erroneous theories and timing calls. This article lists the Top Eight Myths, then lists the gold price and the consensus opinion at the time: Gold $271: Gold will continue to decline as it has for 20 years to $200 or lower. Gold $310: Despite a modest rise due to increased gold demand driven by investors’ fear associated with the 9/11 attacks, gold will soon resume its decline to $200 or lower once the fear subsides. Gold $363: The rise in the gold price is due to a combination of temporary factors, such as investors’ fears about oil, inflation and a weak dollar. Soon the positive outcome of the war will be clear, the dollar will strengthen, and gold demand will drop off, pushing prices back down toward $200. Gold $410: Economic recovery is pushing up gold demand and prices. The Treasury has restated its strong dollar policy. Gold will soon lose its luster and fall back to $300. Gold $445: Gold prices increased only slightly this year over last year, indicating a top. Next year gold prices will fall to $300 or lower. Gold $604: The spike in the gold price is due to short-term dollar weakness. Look for the dollar to rally and gold to decline to more normal levels below $400 starting next year. Gold $695: Gold traded mostly sideways over the last year, indicating a top. Look for gold to decline to well under $500 next year. Gold $872: Gold is participating in a commodities bubble. When the bubble pops, gold will fall more than 50% along with oil and other commodities. Later in the year: Gold has crashed to $716 along with stocks and commodities and will continue to decline to $500 next year. Gold $924: The gold price reflects widespread concern about the financial system in the wake of the global financial crisis. As the system steadies, the gold price will drift down to under $700. Each popular consensus position has been completely wrong, and the predicted gold “bottom” is consistently ratcheted upwards. Gold is a buy as long as the US runs a finance-based economy, particularly while the government attempts to resurrect it.
Stiglitz Says Banking Problems are now Bigger than Pre-Lehman
Mark Deen & David Tweed
Joseph Stiglitz, the Nobel Prize-winning economist, said the US has failed to fix the underlying problems of its banking system after the credit crunch and the collapse of Lehman Brothers. “In the US and many other countries, the too-big-to-fail banks have become even bigger,” Stiglitz said. “The problems are worse than they were in 2007 before the crisis”. His views echo those of former Fed Chairman Paul Volcker, who has advised the Obama administration to curtail the size of banks. A year after the Treasury Department spent billions shoring up the financial system, assets at Bank of America have grown and Citigroup’s remain intact. While Obama wants to name some banks as “systemically important” and subject them to stricter oversight, his plan wouldn’t force them to shrink or simplify their structure. Stiglitz said the US government is wary of challenging the financial industry because it is politically difficult, and that he hopes the G-20 leaders will convince the US to take tougher action. The G-20 meets next week in Pittsburgh and will consider ways of improving regulation of financial markets, and in particular how to set tighter limits on remuneration for market operators. Under pressure from France and Germany, G-20 finance ministers last week reached a preliminary agreement that included proposals to claw back cash awards and link compensation more closely to long-term performance. Stiglitz said the world economy is “far from being out of the woods” even if it has pulled back from the precipice it teetered on after the collapse of Lehman. The Fed faces a quandary in ending its monetary stimulus programs because doing so may drive up the cost of borrowing for the US government, raising questions about who will be willing to finance it.
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