``One day the price of gold will be higher than the Dow Jones.”-Dr. Marc Faber
As gold nears its all time high see figure 7, public awareness in gold seems to be snowballing.
Figure 7: World Gold Council: Two Remaining Currencies Where Gold Has Yet To Establish Record High
There are only two major currencies wherein gold trades below its record high; one is the US dollar and the other is the Japanese Yen.
The chart above courtesy of the World Gold Council was last updated February 13th. But as of last Friday’s close, Gold in US dollar terms was seen nearly leveling on its previous high at 1,004.
When gold rises across all currencies, this is symptomatic of a systemic monetary disorder than just mere inflation. There appears to be an accelerating realization that paper currencies issued and guaranteed by the global governments are becoming less sacrosanct, or people have been exhibiting diminished “faith” on the present financial architecture or this has been reflective of paper money’s “race to the bottom” or the effect of the collective efforts by governments to debauch or even destroy their currencies.
Nonetheless, a recent article at the Financial Times had this unusual observation; it noted that rising gold prices seem to be operating under the auspices of governments.
This from Mr. Steve Ellis of RAB Gold Strategy at the FT.com,
``Speaking to central bankers, this is the first time I can recall them actually favouring a high gold price. Normally they see high gold prices as a lack of trust in the financial system (not to mention their ability as central bankers). Alan Greenspan, the former Fed chairman, for example used to target a gold price of around $400 to $500 an ounce.
``Recently, the central bankers have become more enamoured of higher gold prices as it would suggest that their attempts to stave off deflation were starting to work.
``Central bankers in favour of higher gold prices? Things really have changed.”
Gold’s moniker, the “barbaric metal” had been contrived by interventionists because it functioned as rabid nemesis to elastic currency or the ability of authorities to inflate the system to appease the political gods.
Thus, could central bankers truly see gold as an ally against their campaign deflation?
Three reasons why we think this is possible.
Inflation Expectations Needs To Be Reshaped
One, for central bankers, it’s all about signaling channels. This is usually known as the managing of inflation expectations, where the central bank communicates to the markets their policy intentions as to project stability.
In a recent speech, US Federal Reserve chair Ben Bernanke said, ``increased clarity about the FOMC’s views regarding longer-term inflation should help to better stabilize the public’s inflation expectations, thus contributing to keeping actual inflation from rising too high or falling too low.”
You see central bankers believe that inflation can function like a light switch that can be turned on or off, or like a genie that be called in and out of his lamp.
Unfortunately, this is an academic and bureaucratic delusion. In as much as authorities failed to predict the catastrophic consequences of a bursting bubble, they’ve nonetheless equally botched any attempt to rein its deflationary reaction. So they are now hoping that by unduly taking on the inflation risk, they can manage to steer it successfully once the crisis pasts. But like the recent activities, the inflation genie will most likely elude them, until the next crisis surfaces.
Yet by pushing and maintaining interest rates at near zero levels, and the policy shift to adopt the tactical measures of “quantitative easing”, most major central banks (US, Swiss, UK, Japan) appear to be communicating their desire to reignite inflation as means to restore the credit flow.
However, this hasn’t been the entire truth, as we have repeatedly pointed out- the colossal debt structures of the bursting bubble economies require governments to inflate away the real debt levels.
In addition, government’s use of the fiscal medicine to deal with national or domestic economic malaise serves as a parallel approach to stoke inflation in the economy regardless of how ineffectual such efforts are.
Nevertheless, we have almost every government in the world today rehabilitating their domestic economies by instituting inflationary policies. Thus, if gold’s rise should signify as resurgent “inflation” then governments are likely to reticently “cheer” on it.
Enhancement of the Balance Sheet of the US Federal Reserve
Two, if the aim of the US Federal Reserve is to enhance its balance sheet, a revaluation of gold reserves might be necessary.
Using the “backing theory”, which means that the currency’s worth is determined by the underlying assets and liabilities of the issuing agency (wikipedia.org), the Federal Reserve’s attempt to debase its currency is done by absorbing more toxic assets to its balance sheet.
According to Philipp Bagus and Markus H. Schiml, ``Since the crisis broke out, the Fed has continuously weakened the quality of the dollar by weakening its balance sheet. In fact, the assets the Federal Reserve holds have deteriorated tremendously. These assets back the liability side of the balance sheet, which mainly represents the monetary base of the dollar. The assets of the Fed, thereby, hold up the value of the dollar. At the end of the day, it is these assets that the Fed can use to defend the dollar's value externally and internally. Thus, for example, it could sell its foreign exchange reserves to buy back dollars, reducing the amount of dollars outstanding. From the point of view of the buyer of the foreign exchange reserves, this transaction is a de facto redemption.” (bold highlight mine)
Hence, under the backing theory, it isn’t just quantitative easing (printing of money) that determines the currency value but also the qualitative aspects (or what it buys for the asset side of its balance sheet).
Again from Mssrs Bagus and Schiml, ``Despite of all these efforts, credit markets still have not returned to normal. What will the Fed do next? Interest rates are already practically at zero. However, the dollar still has value that can be exploited to keep the experiment going. Bernanke's new tool is the so-called quantitative easing. Quantitative easing is when a central bank with interest rates already near zero continues to buy assets, thus injecting reserves into the banking system. In fact, quantitative easing is a subsection of qualitative easing. Qualitative easing can be defined as the sum of the policies that weaken the quality of a currency.”
Simply said, as the Federal Reserve increasingly digests poor quality of assets into its balance sheet, this effectively reduces its equity ratio from which would eventually translate to its insolvency.
Hence, this would leave the US Federal Reserve with only two options, according to Mssrs Bagus and Schiml, ``Only two things can save the Fed at this point. One is a bailout by the federal government. This recapitalization could be financed by taxes or by monetizing government debt in another blow to the value of the currency.”
``The other possibility is concealed in the hidden reserves of the Fed's gold position, which is only valued at $42.44 per troy ounce on the balance sheet. A revaluation of the gold reserves would boost the equity ratio of the Fed.”
High gold prices would eventually be required for gold to be revalued to enhance the balance sheet of the US Federal Reserve.
End To Gold Manipulation?
Lastly, the surging gold prices suggest an end to possible gold manipulation.
It has been long contended by groups like the GATA that central bank gold reserves has been unofficially “sold”, through lease, swaps and derivatives to the markets, hence gold stashed in the central bank books have simply been accounting entries.
Mr. Robert Blumen of Mises.org cites a report from where a broker endorsed the suspicion of gold manipulation; says Mr. Blumen, ``The major conclusion of the report is that the western central banks have sold a larger fraction of their gold reserves than they acknowledge in their official statements. The gold has entered the market through derivatives such as leases, swaps, the writing of call options against the gold. The sale of the gold is obscured in the central banks books through the representation of leased, swapped, and otherwise encumbered, aggregated together with actual physical gold held in vaults as a single asset on their books. An estimated 10,000-15,000 tons of gold has entered the market since 1996 (compared to an official number of 2,000-3,000) through these mechanisms, according to the report. The purpose of these covert gold sales is part of a larger effort to disable the functioning of inflation indicators, which operate to limit central bank credit expansion.”
Gold’s recent rise has been primarily investment demand driven, see figure 8.
Figure 8: gold.org: Surging Investment DemandThe implication of which is a shift in the public’s outlook of gold as merely a “commodity” (jewelry, and industrial usage) towards gold’s restitution as “store of value” function or as “money”.
The greater the investment demand, the stronger the bullmarket for gold.
If the estimated number of 10,000 to 15,000 tons, is anywhere close to being accurate, then this translates to 40-50% of world central bank gold reserves of 29,697.1 tonnes (gold.org as of December 2008) as having been “shorted”.
Therefore, “short” positions in a rampaging gold bullmarket will extrapolate to additional national balance sheet losses. This implies that world governments, whom are net short positions, will likely be net buyers in the near future.
Although I haven’t been totally convinced about the “gold manipulation theory”, I am, however, open to it, in the understanding of the political nature of central banking. Central bankers don’t want competition or interference from gold, thus, the odds that price controls may have attempted in the past.
The implication is that the bullmarket in gold will possibly be accelerating once governments’ covers open short positions. And if we see $100 dollar a day moves, perhaps this theory might be validated.
And since the gold market is an iota or about 6% or $5 trillion (165,000 tonnes of above ground gold) relative to the overall financial markets, this suggests that a bullmarket market will likewise spillover to important key commodities as silver, copper and oil.
Moreover, any panic into gold will likewise see a panic to own producers, which functions as proxy to gold by virtue of reserves.
For now, central bankers would likely to be “sleeping with the enemy”.
