In Greece, Gold Prices At US $1,700 Per Ounce!

In Greece, Gold prices are reportedly being traded at nearly 40% premium of current spot prices.

According to Coin Update News, (bold highlights mine)

``The fear running through the Greek populace is that the nation’s government may default on some of its debts."

``Since 1965, the Greek government has imposed restrictions on trading British Sovereign gold coins (gold content .2354 oz). Despite those restrictions, the Bank of Greece reports that it is selling an average of more than 700 coins per day to worried Greeks.

``In the first four months of 2010, the Greek central bank sold more than 50,000 sovereigns at its main downtown Athens office. Bank officials estimate that at least 100,000 other coins changed hands on the black market. The Bank of Greece has received as much as $409 per coin, which works out to a price of more than $1,700 per ounce of gold! Prices paid on the black market are reckoned to be even higher. A popular spot for street vendors to sell their coins is near the Athens Stock Exchange. There the traders wait for citizens to bring payments received from unloading their paper assets like stocks and bonds.

``The US government and some state governments such as California are in financial straits as bad as or even worse than Greece. How long will it take before American buyers will have to wait in lines to pay outrageous premiums for what are now bullion-priced gold and silver coins? More than one analyst thinks those days will come within a few months or sooner."

So how does "panic over default" translate to a stampede towards gold, considering that for the mainstream, these events are deemed as "deflationary"?

In a deflationary environment, gold isn't likely to be seen as 'safehaven' because gold isn't money in the sense similar to the function of paper money today, which have been imposed via legal tender laws, and subsequently used as the predominant medium of exchange by the consuming public worldwide.

Yet, one can't make an apples-to-apples comparison with the Great Depression era to highlight the case of gold's supposed refuge status under deflation. Then, gold was part of the medium of exchange known as the Gold standard. Today we have the paper money standard or the Fiat Money standard, where gold remains as reserve assets only for central banks.

In a deflationary environment, the real price of the currency or money's purchasing power increases or that the demand for cash relative to other assets is significantly greater. Hence, deflation and gold as an asset of sanctuary would seem inconsistent under the present fiat money conditions.

And Robert Blumen explains why the assumption that debt defaults leading to deflation isn't necessarily true,

``The only way that debt default is deflationary is if the debt that is defaulting was created out of nothing by a fractional reserve bank. The default of that sort of debt is deflationary. Because the price system is an integrated single market, all debt competes against all other debt, and all money supply changes affect all prices. So in a system like ours where some debt is created by banks as bank deposits, while other debut, such as bonds only transfers existing money, default of non-bank debt will eventually work its way through the price system and have some effect on bank debt." (emphasis added)

In other words, not all debts are created equal or derived from the fractional reserve banking, which is why it would be overly simplistic to account for deflation under concerns over debt default.

Moreover, following the monster Euro bailout by the Euro and the world, surging gold prices in Greece could likely exhibit symptoms of growing Monetary disorder, more than just inflation. Perhaps in the anticipation that a default may risk an expulsion from the Eurozone, which with the reintroduction of the drachma would extrapolate to massive inflation.

Another way to see this is that prices of Gold in Greece could be portentous of gold prices in all other currencies, as we see the same feedback mechanism applied by policymakers towards the global debt problem.

Rediscovering Gold’s Monetary Appeal

``Gold is a speculation. But it is a speculation on a certainty: the debasement of the currency.”-James Grant

For some rising gold prices has been gladly cheered upon. For the gold is “barbaric metal” camp, rising gold prices account for as an intense denial to the vulnerability of their interventionist doctrines.

For us, rising gold prices epitomizes a build up of monetary systemic stresses arising from an overdose of politicization of the US dollar- the world’s de facto substitute to the gold standard. This warrants more concern than either acclamation or denial.

The world has been operating on a monetary system that has been anchored on paper money since 1971 or 38 years ago, yet for the thousands of years of human civilization, paper money has unsuccessfully thrived as the sustained standard of global medium of exchange. This has been due to the cyclical or inherent self serving nature of the political leadership to profit from inflation or by taxing society in order to uphold, expand or preserve their political powers.

Even commodity money had not been spared from the inflation taxation. This has been evident even during the Roman Empire, as Joseph Peden wrote ``In Diocletian's time, in the year 301, he fixed the price at 50,000 denarii for one pound of gold. Ten years later it had risen to 120,000. In 324, 23 years after it was 50,000, it was now 300,000. In 337, the year of Constantine's death, a pound of gold brought 20,000,000 denarii.”

And the same dynamics holds true today.

Essentially, the politicized nature of money eventually leads to its demise.

Inflation Is Dead. Long Live Inflation!

Gold have been rising for many valid cited reasons such as an inflation hedge (see Figure 4), supply demand imbalances, the shifting nature of gold ownership (as investment instead of jewelry), or central bank buying or reduced sales [see Four Reasons Why ‘Fear’ In Gold Prices Is A Fallacy]

Figure 4: US Global Funds: India-IMF Deal: Tipping Point for Gold

Gold’s record price surge appears to have resurrected its innate monetary appeal.

Over the years, gold had earlier been reckoned as headed for oblivion, as the political authorities along with their banking agents, whom are their chief associates, as well as their academic disciples imbibed on the fantasy that “inflation as an elixir” have allowed them to finally “domesticate” and “tame” inflation with modern and sophisticated mathematical tools.

In essence, the supposed conquest of inflation became a mainstream credo which operated under the principle of the philosopher’s stone- or the alchemy of turning base metals into gold! Prosperity can, thus, simply be achieved by Free Lunch policies! And supporting such beliefs were literatures that sprouted to claim the death of inflation!

Unfortunately today, reality has begun to sink in. To add, such bubble psychology has also commenced to unravel over the imbalances built beneath the surface by overweening overconfidence. Hence, the ramifications from the previous sins have started to emerge and become manifest in the marketplace. All these are being reflected in terms of changes in price levels.

The Role Of Scarcity In The US Dollar’s Diminishing Luster

So why gold’s role as money being revived?

Because the very important fundamental attribute of money is in the process of being perverted.

The basic and most important attribute of money according to Mr. Ludwig von Mises is scarcity, ``Media of exchange are economic goods. They are scarce; there is a demand for them. There are on the market people who desire to acquire them and are ready to exchange goods and services against them. Media of exchange have value in exchange. People make sacrifices for their acquisition; they pay "prices" for them. The peculiarity of these prices lies merely in the fact that they cannot be expressed in terms of money. In reference to the vendible goods and services we speak of prices or of money prices. In reference to money we speak of its purchasing power with regard to various vendible goods.”

When money fails to dispense of its role, then the public begins to question its existence and look into alternatives. The ruckus to replace the US dollar by key emerging market central banks reflect on these symptoms.

So it is of no doubt to us that commodities (particularly precious metals) will likely benefit from the uncertainty interregnum as the world continues to deal with the burgeoning tensions from the US dollar system.

Figure 5: stockcharts.com: Commodities versus the US dollar Index

Said differently, for as long as society hasn’t resolved on the dilemma of, or found a substitute for, the prevailing money (US dollar) system, these commodities will exhibit their innate roles as potential candidates as money, for the basic reasons of scarcity and their historical role as money.

As Professor Gary North wrote, ``Individuals in the past voluntarily adopted gold and silver coins as the preferred commodities to facilitate economic exchange. They did not accept these two metals as the preferred monetary units because of their commitment to economic theory. They chose those metals because there are advantages offered by these metals that competing commodities do not possess to the same degree. The main advantage is continuity of value (price) over time. Gold and silver became currencies throughout the world because they possess certain physical characteristics that facilitate their adoption as money. The most important aspect of both gold and silver is that they must be mined. It is expensive to dig these metals out of the ground. Silver is primarily a byproduct of the mining of other metals: lead, copper, and zinc. Mining firms must bear the costs of extracting these metals from the earth. This limits the production of these metals. They are comparatively scarce minerals, and it is expensive to dig them out of the ground.” (bold highlights mine)

Ergo, the pricing levels will exhibit on the relationship of precious metals’ role as money.

Does India’s Recent Gold Buy Herald A Watershed Moment?

In addition, India’s recent surprise acquisition of 50% of IMF’s inventory of gold for sale establishes two important points:

One, emerging markets appear to be intrepidly exhibiting a snowballing desire to accumulate less US dollars reserves and also less US denominated securities and channel most of their spare reserves into hard assets. It’s basically a vote against the US dollar.

This reinforces our “commodity-as-insurance” view and the potential role of commodity as part of the future money. According to Professor Michael S. Rozeff, ``There are only two kinds of solutions: inflationary and non-inflationary. A British pound as good as gold is long gone. A U.S. dollar as good as gold is long gone, but the dollar has hung on for 37 years now. A yuan as good as gold does not exist. A basket of currencies as good as gold does not exist. The inflatable dollar and inflatable currencies are ruling the roost at present. India’s action and some of China’s actions signal that they are inching – really groping – their way back to hard assets and a non-inflationary solution.”

Second, India’s gold purchases could be indicative of a monumental redistribution process or of a convergence of wealth between developed economies and emerging economies.

This quote from the Financial Times echoes such sentiment, ``Pranab Mukherjee, India’s finance minister, said the acquisition reflected the power of an economy that laid claim to the fifth-largest global foreign reserves: “We have money to buy gold. We have enough foreign exchange reserves.”

``He contrasted India’s strength with weakness elsewhere: “Europe collapsed and North America collapsed.” (bold emphasis mine)

Hence, India’s purchase of IMF’s gold could be interpreted as a watershed moment or a tipping point as this could mark the decline or the twilight zone of the US dollar as the international currency reserve.

Also, we’ve been asked if Gold at present levels is a buy today. While we have been serendipitous enough to have accurately called for a gold breakout last August [see Gold As Our Seasonal Barometer], market timing isn’t our forte.

Seen from seasonality patterns, gold usually peaks on February and will be on a downhill until August.

But it isn’t clear if such pattern will hold.

This would likely depend on how global central banks and global investors will react to recent fresh unprecedented developments.

As we have said, markets have been acting significantly less to exhibit the conventional mode. Instead, markets have demonstrated its unorthodoxy due to its Frankenstein state-being highly dependent on government steroids.

Figure 6: US Global Funds: India-IMF Deal: Tipping Point for Gold

And as figure 6 suggests, any bandwagon effect from India’s purchases could inflame a stampede for Gold!

With emerging markets holding the bulk of global currency reserves, ``IMF data shows emerging and developing economies hold USD 4.2 trillion of the USD 6.8 trillion in total reserves. China has over USD 2 trillion, followed by Russia with more than USD 400 billion and Brazil and India with above USD 200 billion each” (moneycontrol.com), and aside from central banks of emerging markets being vastly underrepresented in gold reserves relative to the US or Europe, a mad dash for gold can’t be discounted.

And we are not speaking of central bank alone, Adrian Ash of BullionVault.com recently estimated the gold market, ``Estimated at 165,000 tonnes, the total stock of gold-above-ground is now worth some $5.8 trillion. Research by BullionVault puts that sum at no more than 6% of global investable wealth, down from well over 10% throughout the 1980s and peaking nearing 30% at the points of extreme investor stress in the late 1970s and early '30s.”

Conclusion and Recommendation

To close, gold’s recent record run appears to have dramatically signaled a seismic change in the perspective of the marketplace and of governments in terms of gold’s role as money.

As strains or pressures on the US dollar standard remains unsettled, such uncertainty is likely to underpin the dynamics behind gold’s rise.

Rising gold prices represents global monetary stress than simple localized “inflation”. Moreover, because monetary stress is a structural issue, then it won’t just be central banks underpinning gold’s ascent but likewise the investing public, which accounts for a bigger share of ammunition, in the context of wealth preservation.

Moreover, the accumulation of gold by emerging markets signal wealth convergence aside from the watershed decline of the US dollar as the world’s reserve currency.

Since gold’s dynamics has been evolving from jewelry to investment and or central bank reserve demand, it would be futile to short term timing markets. The best is to buy on dips and await gold’s full transition of its bullmarket trend into the mainstream.

On the interim, the politicization of the monetary and fiscal policies will likely exacerbate the US dollar predicament. And as political faux pas compounds, gold’s functional role of money will likely expand.

Nevertheless, the end of the gold bullmarket will entail the resolution of the US dollar’s foreign currency reserve predicament, which is unlikely to happen soon. That’s because domestic politics and geopolitical issues serve as principal hurdles.

Do Governments View Rising Gold Prices As An Ally Against Deflation?

``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 13^th. 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 Demand

The 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”.