``Gold, on the other hand, is a much-needed safeguard against the barbarism of monetary authorities. Historically, the international monetary system, imposed after World War II by the Bretton Woods agreements, gave the dollar a central role. It was considered "as good as gold" because it was the only currency that maintained a link with the yellow metal. Gold thus acted as economic actors' safety valve against American monetary authorities' abuse of inflationary expansion.” Valentin Petkantchin Gold and the Barbarians
I have always emphasized that gold has proven to be quite a reliable thermostat of the global equity markets[1].
Gold has not escaped the short deflationary episode in 2008 nor has it eluded the recession in the early 2008. Thus gold, as we have repeatedly argued here[2], isn’t likely to function as a deflation hedge for the simple reason that gold isn’t part of the incumbent monetary architecture unlike during the Great Depression days of the 1930s. In short comparing gold in the 30s and gold today would be like comparing apples to coconuts.
The implication of this is that a sustained fall in gold prices could suggest of contracting money supply or a resurfacing of recessionary (deflationary) forces. Thus, a sustained fall or a dramatic collapse of gold prices should be mean alarm bells for us.
As a side note, not all recessions have been deflationary as alleged by some, and this has been evident in the stagflation era of the 70s (see figure 4).
Figure 4: Economagic: Stagflation
In the 70s, even as the S&P 500 (green line) fell, the consumer price (blue line) index continued to surge. Meanwhile, precious metals (red line) peaked amidst the 1980 recession.
But of course, like money, gold is also subject to demand and supply balanced by prices. Thus given the 10 successive years of gains, gold is certainly not immune to plain vanilla profit taking.
The point is—we should ascertain if any fall in the price of gold constitutes structural or countercyclical forces at work.
Monetary Disorder Remains The Dominant Theme
When we learn that China intends to issue 1 trillion yuan ($151 billion) this year[3], the the Central Bank of Ireland is financing €51bn of an emergency loan programme by printing its own money[4] and that the US monetary aggregate M2 has been surging by biggest weekly amount since 2008[5], we don’t seem to see any substantial or structural changes that should impact the long term price trend of gold materially.
In short, global central banks continue to pump money like mad, and this should be bullish for gold.
Figure 4: St. Louis Federal Reserve: Bank Credit
To add, as I have rightly been predicting[6]; the steep yield curve would influence the US credit markets positively, though at a time lag, as I previously wrote “the US yield curve cycle has a 2-3 year lag period from which we should expect it to generate “traction” by the last quarter of 2010.”[7]
And they seem to performing as expected (see figure 4), as the US credit market appear to show signs of improvements.
The risk here is that with record “excess” bank reserves or banks' base-money holdings minus required reserves that is either held in their vaults or on deposit with the Federal Reserve, given the fractional reserve system, these reserves can multiply credit and money supply that may amplify or accelerate the rate of inflation.
In other words, even what may be read as a positive ‘economic’ sign could represent a prospective hazard—an offshoot to the previous policies.
Thus, the recent volatility in gold prices for me would account for profit taking and certainly not a reason to see a reversal.
Yet part of the recent fall in gold prices has allegedly been traced to a speculator-trader, who massively levered up on huge (long- short) gold positions, which turned out to be unprofitable and had been forced to liquidate.
The ensuing liquidation resulted to what the Wall Street Journal reports as the biggest single reduction ever[8]in gold contracts.
So with the possibility that this event may have already passed and or could have been discounted, gold could regain its lustre over the coming sessions.
Gold And The Web Enabled Middle East Political Revolutions
Friday’s huge rally in gold, which media attributed to Egypt’s worsening political crisis and had likewise been adduced to the heightened risks of a regional political upheaval—where dictatorships and the entrenched aristocracy appear to be facing a comeuppance from the long disgruntled populace, a revolution apparently enabled by the web[9] and partly triggered by surging food prices—appear more like rationalization.
Figure 5: Bloomberg[10]: Political Tremors In The Middle East
Although, stock markets in the Middle East had indeed been rattled by such fears (see figure 5).
Perhaps the embattled aristocracy could be scrambling to safekeep their wealth overseas by buying gold for laundering purposes or for absconding it, similar to reports where the First Lady of the deposed President of Tunisia was alleged to have fled with 1.5 tonnes of gold (worth $55 million)[11].
The spike in oil prices should be more of a natural side effect over concerns of supply side disruptions once political standoffs become exceedingly violent. But given that the political turmoil account for as domestic issues, I am sceptical over the prospects of prolonged violent stalemate.
For me, these so-called uncertainties are icing in the cake for gold.
Yet in my view, we should see these ongoing revolts as positive.
People appear to be emboldened in asserting their sovereignty over an increasingly derelict political structure built upon vertical hierarchies predicated on central planning and or political-economic fascism.
In short, the web has functioned as a pivotal instrument in counterbalancing or levelling or reducing the concentration of political power to a few or to the once powerful elite. The likelihood is that the rule of autocrats will be diminished, unless governments would be successful in introducing and imposing controls and censorship on the cyberspace.
With over 2 billion people now wired or connected online or “With the world's population exceeding 6.8 billion, nearly one person in three surfs online”[12], add to that the 5 billion mobile phone subscriptions or about 73% of the global population, it’s no wonder how the political playing field is being reconfigured to adjust to these new realities.
Governments in the future are likely to be more attuned to the public and would likely shed a lot of bureaucratic fats.
And these ongoing revolutions represent the aforementioned structural adjustments in the political process. Hopefully, these people power revolts will be alot less bloody than their counterparts in the early to mid 20th century.
And if there should be any major force that could influence the current trend of gold it would likely be gold’s reversion to the new monetary framework which will likely be brought upon by people’s realization and intolerance of the abuses of central banking system.
So I unlike those who see a surge in the “event risks” from the current string of upheavals in the Middle East as a reason to sell, I see gold rebounding from these uncertainties, fed by the inflationism in central banks and eventually a rally in most of the global equity markets, including the Phisix.
[1] See Gold As Our Seasonal Barometer, February 23, 2009
[2] See Gold Unlikely A Deflation Hedge, June 28, 2010
[3] People’s Daily Online Central bank to print 1 trillion yuan in paper currency, January 20, 2011
[4] Independent.ie Central Bank steps up its cash support to Irish banks financed by institution printing own money January 15, 2011
[5] Durden, Tyler M2 Surges By Biggest Weekly Amount Since 2008 As It Hits Fresh All Time Record, Zero Hedge, January 27, 2011
[6] See Influences Of The Yield Curve On The Equity And Commodity Markets, March 22, 2010, See What’s The Yield Curve Saying About Asia And The Bubble Cycle?, January 17, 2010
[7] See Trigger To The Inflation Time Bomb, October 7, 2010
[8] Cui Carolyn and Zuckerman Gregory Small Gold Trader Makes Big Splash, Wall Street Journal, January 28, 2011
[9] See The Web Is Changing The Global Political Order, January 29, 2011
[10] Bloomberg.com Bloomberg GCC (Gulf Cooperation Council) 200; The Bloomberg GCC 200 Index is a capitalization weighted index of the top 200 equities in the GCC region based on market capitalization and liquidity. The index was developed with a base value of 100 and is rebalanced semi-annually in April and October.
[11] MoroccoBoard.com Tunisia: Ex First Lady Absconded With 1.5 T Of Gold Bullions, January 17, 2010
[12] Physorg.com Number of Internet users worldwide reaches two billion, January 26, 2011
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