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Concerned at the fall in the gold price

Concerned at the fall in the gold price?

Since September 2012 to date the gold price has gone from 1384 euro all the way down to the sub 1200 euro area now (22cd Feb). Today an ounce of gold costs 1195.44 euro and we’ve seen gold tumble down in roughly 20 euro increments every few months. At the same time the Dow Jones index has rallied since the 15 November 2012 from a low of 12496 to 13946 today – that’s a rise of almost 1500 points or more than 10%.

Accompanying the stock market rise in the last 6 months we seen a rise in bullish sentiment among financial commentators and analysts so along with metals, treasuries have suffered as investors look for ‘risk on’ higher yield investments. This is all predicated on the idea that the US economy is racing out of recession and there are blue skies ahead. However when the herd all rushes to one side of the room a degree of scepticism should be employed. There are some serious problems with the idea of a resurgent US economy unfortunately. One of those factors (which everyone is trying to explain away) is that US GDP actually shrank in Q4 2012 by -0.1% the first time we’ve had negative reading since Q1 2009.

Areas such as housing which have shown resurgent strength are also the areas where the Federal Reserve has been most directly involved – who believes US housing would be showing any pricing strength without the Fed’s QE3 monthly 40 billion dollar purchases of mortgage backed securities? This is a problem, because what happens when the Fed tries to ease back on these purchases? A real free market would continue to drive down real estate prices until they represented outstanding value for investors and this would allow prices to reach a stable equilibrium – but the Feds actions are encouraging the banks to begin writing more mortgages and more business than would be the case in a true free market potentially creating even more problems down the line. Unless of course the Fed is committed to QE forever but that will lead to a crisis in either the currency markets (dollar collapse) or the bond markets (international investors lose confidence in Treasuries). There is no way out of this trap.

If you ignore factors such as negative GDP numbers last quarter or artificially propped up housing market you might well conclude the present stock market rally is built on rock solid foundations but it is worth considering that perhaps the Fed’s money printing has something to do with the run up? Also ask yourself if 14000 dollars (Dow Jones now) today buys you more than 10000 dollars (Dow Jones 2000) in 2000 (the end of the greatest bull market in stocks in history). The answer (no!) tells you that, at best stocks have been trading sideways for 13 years – that looks more like a great bear market a la the 1970’s than the any sort of bull market from history! Based on the current economic fundamentals it seems clear that the half year run up in stocks that we’ve seen since November, is, at the very least, standing on some shaky foundations. That has coincided with a period of weakening metals prices. However the fundamental factors driving gold and silver to outperform stocks and property for the last decade remain very firmly in place. With sentiment so firmly against the metals this is a great time to pick up bargains. Metals may well go lower from here but as soon as sentiment in the stock market is shocked into realising the US economy is still mired in excessive debt with a wobbling currency the markets are likely to reverse in a big way. What will happen to the price of gold and silver then? Draw your own conclusions and base your investment decisions on fundamentals, not on sentiment!

A New Gold Standard - Robert Zoellick

A New Gold Standard?

Robert Zoellick Head of the World Bank since 2007 has called for a discussion on a new Gold Standard in an article in the Financial Times this week. Since 1971 when the US effectively declared bankruptcy by ending the Bretton Woods peg between the dollar and gold ($35 dollars equaled 1 oz gold) the global financial system has been a floating currencies system based on a paper dollar as the global reserve currency.

Zoellick suggests using gold as ‘an international reference point of market expectations about inflation, deflation and future currency values’. Even more significantly, and in our opinion, accurately,  Zoellick suggests that ‘although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today’.

The suggestion that we have been operating under a system Zoellick calls ‘Bretton Woods 2’ since 1971 is perhaps slightly misleading. To call the structure that international currencies have operated under as a system of any sort is very generous. ‘Organised chaos’ might be a better way of defining currency management since 1971. With no restraint on how much of the global reserve currency they printed the US has been on a printing spree with unintended consequences across the entire globe as deflation was exported abroad to developing countries in the 1990’s and then inflation on a vast scale was seen in both housing and stocks in the US and around the world.

As it becomes clear that this use of the dollar as a global reserve currency at the same time as the Federal Reserve uses and abuses the currency to try and ‘pump prime’ the American economy is becoming more untenable and less and less beneficial to other countries around the world the era of dollar hegemony appears to be drawing to an end. Despite this, the reaction to the idea of a new Gold Standard has been mainly negative. Almost none of the commentary reacting to Zoellick’s FT article has displayed any knowledge of how a Gold Standard actually works. Many of the critics of the idea have said it’s simply not practicable because the quantity of Gold available is not sufficient to support the modern world’s rate of growth etc.

A real functioning Gold Standard can operate on a single Krugerrand. All that matters is that governments set a credible price peg for their currencies against that single ounce of Gold. If the currency’s value falls below the peg then remove currency from circulation until the currency’s value rises to its pegged value again. If the currency’s value rises above it’s peg then do the opposite, and print more paper currency to reduce the value of the currency back to its peg (think QE2 with a purpose and end point). Economists, governments and central banks around the world, under the influence of Keynesian thinking seem to have forgotten that any government with a printing press has total control over its currency’s value  – reduce supply/increase value & increase supply/ reduce value. Simple, but far too straightforward for the brain boxes in the US Federal Reserve and the IMF. Defending currency value with interest rates is an invitation to speculators to put a currency to the sword.

What about a Gold Standard’s capacity to allow for rapid growth in an economy such as China’s or any other around the world today? Demand needs to be considered in relation to how much currency is produced. But consider this, if currency demand starts at 100 dollars and then rises to 200 dollars in a given economy then government can print an additional 100 dollars and double the paper money supply without any disruption to the Gold Standard price peg. Demand for Gold itself will not vary sharply in a well managed paper currency where the government’s promise to maintain the peg makes that currency as ‘good as gold’! This means that a proper Gold Standard can easily accommodate and facilitate any level of growth in an economy contrary to the misinformed commentary from so many economists today on CNBC, Bloomberg et al.

It is encouraging to see the beginnings of a debate around a new global economic system which will involve ‘hard’ currencies and will reduce the chaos a soft money system underpinned by a falling dollar causes. But Zoellick’s comments are only a beginning. And the outright rejection of his comments certainly highlights the fact that this debate will take years to resolve as governments and citizens around the world begin to recognise the need for a new Bretton Woods type agreement. And all the while this debate rages the precious metals bull market will continue to run and run.