Last week the gold price hit a new record high despite the European Union’s trillion-dollar rescue package.  In US dollars the yellow metal traded above US$1240/oz, and in euro and GBP terms, at €997/oz and £855/oz respectively. Shortly after the news about the rescue package hit the wires the euro rallied, but then selling quickly re-emerged to send the euro sharply lower against the dollar as well as commodity currencies. EUR/USD dropped to as low as 1.2352, a few pips away from hitting the 2008 low of 1.2329. While the default risk of Greece temporarily eased, there are still a number of concerns regarding the current developments in Eurozone.

There was talk that French President, Nicolas Sarkozy, threatened to pull out of the euro unless German Chancellor Angela Merkel agreed to back the European Union’s bailout plan at the meeting last weekend in Brussels. That triggered talk about Eurozone’s breakup. And, there is still a lot of skepticism that debt laden countries in the Eurozone will fail to improve their fiscal health even though Spain and Portugal both announced new austerity plans over the week. To meet EU deficit targets, Spainish Prime Minister, Zapatero, announced plans to cut civil servants pay by 5% this year. There will also be cuts on investment spending, pensions and 13,000 public sector jobs. Portugal’s finance minister Fernando Teixeira dos Santos said there will be new measures for deeper spending cuts and will make an announcement shortly. Now, there are concerns that when the austerity plans are implemented, they will hinder any economic recovery in the Eurozone. And, while the European Central Bank (ECB)’s Trichet has stated repeatedly that the bank is not adopting quantitative easing, in simple terms what is happening is that the central banks around the world are merely substituting debt with more debt.

In the meantime, gold priced in euros, British pounds and Swiss francs rallied to all-time highs on concern that the plan to rescue Europe’s indebted nations will slow the region’s economic recovery and devalue the 16-nation common currency.

What is evident is that people in the euro zone are moving out of their currencies and moving into gold. According to the Swiss refinery Argor-Heraeus, investor demand for small gold bars and minted products has jumped tenfold since the start of this year.

“We are seeing very, very high demand for smaller products. I would say 10 times more than the first two months of this year,” Bernhard Schnellmann, Argor’s director of precious metals services, told Reuters by telephone.

“It all started after the euro crisis,” he said. “The demand especially for small bars and minted products is extremely high, mainly from Europe.”

In another article published by Reuters on May 12, the Austrian Mint, which produces the popular Philharmonic gold coin, sold more gold in the two weeks from April 26 than in the entire first quarter of the year because of soaring demand in Europe, it said on Wednesday.

The mint sold 243,500 ounces of gold in coins and bars in that period, compared to 205,000 ounces in the entire first three months of the year, marketing director Kerry Tattersall told Reuters.

“Demand is exclusively from Europe, we haven’t had any orders from the United States and Asia in the last few weeks,” Tattersall said. “That’s a clear sign that there is panic buying because of concerns about Greece and the euro.”

Sales of its signature Philharmonic gold coin reached 108,000 ounces in the same period, also surpassing the 89,000 ounces in the first quarter, which Tattersall said had been an average quarter that did not live up to the previous year’s.

“In the last two, three weeks, it was pretty frantic again,” he said. The mint has started working in three shifts again, minting coins and bars around the clock to keep pace with demand, he said.

“Currently we don’t have anything in stock. We sell our entire daily production immediately,” he said.

Also, during last week the gold exchange traded fund (GLD) added another 557,785 ounces (17.3 tons) to its inventory. It seemed that last Wednesday was a very busy day for gold. The US Mint reported selling another 11,500 one-ounce gold eagles and 5,000 24k-gold buffaloes.

Now, while the ECB will spend $1 trillion (750 billion euro) bailing out Europe’s sovereign borrowers (like Greece, Spain, and Portugal) and while on paper the money is supposed to come from Europe’s biggest governments and the IMF, in reality, most of the money will be borrowed from the U.S. Federal Reserve, which just happened to re-open its trillion-dollar swap account with the ECB this weekend.

The problem is that these countries are not the only ones with massive debt problems. The U.K. government’s deficit is projected to be approximately 13 percent of GDP in 2010, which is even worse than Greece’s 12.5 percent figure.  Right now the public debt of the U.K. is at 68 percent of GDP, but three years ago it was sitting at about 40 percent. As you can see the national debt of the U.K. is increasing rapidly. In fact, it is now being projected that the public debt of the U.K. will exceed 100 percent of GDP within the next three years. 

Now what has all this got to do with gold? Well, all these currencies are simply fiat currencies. A fiat currency is a medium of exchange composed of some intrinsically valueless substance which the issuer does not promise to redeem in a commodity or a fiduciary money. And, because a fiat currency has no direct legal connection to a commodity money (in terms of redemption) and, therefore, no real economic cost to its production, the supply of a fiat money can never be self-limiting; and the value of a fiat money is always largely a matter of public confidence in the economic or political stability of the issuer.

Historically every major fiat currency has self-destructed in what is popularly called “hyperinflation” (that is, extreme decreases in purchasing-power) caused by either unlimited increases in the supply of that fiat money by the issuer or accelerating loss of public confidence in the continued value of the money or the economic or political fortunes of its issuer, or both.

And, when this happens and investors watch their currency become worthless, just like what happened in Zimbabwe, they wish they had something tangible and of value. This is why they turn to gold and silver. While the price of gold is influenced by many different factors, right now it is being sought out as a hedge against the declining values of these fiat currencies. It is not a new phenomenon; in fact this is one of the main determinants of the price of gold. So, as global currencies continue their downward slide expect to gold to trade much higher.

TECHNICAL ANALYSIS

For the last 5 months or so, we have been watching gold trade sideways. One of the key resistance levels which I have often mentioned was the price level of US$1180. Now, that gold has breached this level and established new historical highs, I believe we are going to see more record highs for the yellow metal.

About the author

David Levenstein is a leading expert on investing in precious metals .He brings over 30 years experience in futures, equities, forex and bullion. And, although he began trading silver through the LME in 1980, when it comes to gold, he has traded gold bullion, gold coins, gold shares, gold ETF, gold funds and gold futures for his personal account as well as for clients. www.lakeshoretrading.co.za

Information contained herein has been obtained from sources believed to be reliable, but there is no guarantee as to completeness or accuracy. Any opinions expressed herein are statements of our judgment as of this date and are subject to change without notice.