With the worsening Eurozone crisis and the failure of government to manage the U.S. debt responsibly, markets are fearful of a meltdown. Traders are driving prices down in the knowledge that many positions are geared [leveraged] and exposed to margin calls. Other positions are protected by ‘stop loss’ instructions, so can be triggered by prices moving down through support levels. Potential buyers are in no hurry to enter the market, either because they feel there is further to fall or because the volumes dictating price moves are too thin to get the sort of positions they want. Overall, the investment climate is very wintery from the bottom of the financial structures right up to the markets themselves.
In this investment climate, the market forces that should prevail are not doing so. The rational approach has been sidelined as markets are blown this way and that by emotions, fears, and knee-jerk reactions.
This has always proved to be short-lived with investors kicking themselves afterwards because they did not act rationally. Falls become too extensive just as price ‘spikes’ do so too. Hindsight is an exact science but useless when looking forward.
Now, we have to look forward. The way we do that is to look at the forces in play beneath the surface and see their direction. Take a point in the future and see what should happen if these forces keep going in that direction. What place are they taking us to?
THE ‘BIG’ PICTURE
The long, slow process of the globe’s wealth moving from the west to the east has been going on for years now. There is no sign that this will change in the next decade. China and India have low-paid, highly intelligent people who will continue to do the job cheaper than, and as well as, in the west. Capitalism, by its nature, takes work to the lowest cost place it can. So the west is directly helping this process along. The first to suffer from this process is the developed world workers who are seeing their jobs go east. The U.S. and European (with the exception of Germany, so far) unemployment figures testify to that.
With growth fading fast in the developed world, the days of live now, pay later have come to an end. Now it’s pay now and live later as the developed world looks at the debts it has incurred and the falling cash flow with which to repay them. As with individuals, when you have to repay debt, you don’t spend, so the economy must lower its performance levels until the process is over. It is naïve to think that you can have growth and repayments when economies rely so heavily on consumer spending. It’s with horror that the developed world sees just how much their borrowings have overshot acceptable levels.
Hence the traumatic situation the U.S. and the E.U. find themselves in. We may well be looking at a battle to save the euro itself as France as well as Greece, Spain, Portugal, Italy and Ireland see the yields on their government bonds shooting up to unacceptable and unsustainable levels. It’s a little better across the Atlantic where the U.S. has the advantage of fiscal union (which we do not believe the E.U. will be capable of achieving) and one overall government supposedly capable of correcting debt levels.
The single government and federal financial structure was supposed to have relieved much of the trauma in the U.S., but the failure of the super-committee to lower debt voluntarily bespeaks a deeper malaise that goes to the heart of the mix of democracy and financial management. It’s becoming apparent that the U.S. government will not be able to function properly until the next election in a year’s time and then only if the elections produce a government with a dominant majority.
As a consequence, the currencies of the developed world have a time limit on their global dominance. It is unavoidable that if China continues on its path to power and wealth, that its currency will become a global reserve currency with the dollar and the euro moving into second place, or alongside it. When it suits China, the Yuan will be thrust into the global scene and bring tremendous uncertainty to the monetary system. It is unlikely that China will kow-tow to the developed world then. Whatever the pressure placed on the monetary system in the future, the level of uncertainty in values will grow. The current climate of volatility will worsen as the current accord between the E.U. and the U.S. on currency matters will diminish as another global power brings far less cooperation and much more self-interest to the system.
By extrapolating these currents, we see a picture of greater uncertainty and instability than we see now. Along the way we will see dramatic casualties, which may undermine the ability of the E.U. and possibly the U.S., to influence matters. We may well see either minor or major financial accidents before China shares monetary power with the west.
THE PRESENT SITUATION
The current market falls are not just the result of a single event, such as Spain’s debt costs moving above 7% or the super-committee’s failure to cut spending agreeably. These are symptomatic of the big picture. Fears of the collapse of the euro and the eventual E.U. are very real now. If Greece gets its bailouts, then other nations cause fear to remain high. France has now joined the ranks of nations having to pay to borrow. It’s the underlying undermining of the value of the monetary system that’s causing one symptom after another to burst on the scene on an ongoing basis.
Tragically, the governments of the developed world are looking to protect their power. Junker of the E.U. put it this way, “We know what to do, the problem is being re-elected after doing it.” The fear not growing is that democracy is not capable of putting financial matters right because of the unpopularity it will bring. This is equivalent to taking the rudder out of the water. The drift towards financial accidents appears inevitable.
THE INTERCONNECTEDNESS OF THE GLOBAL BANKING SYSTEM
It appears that the debt events of the last 18 months in the developed world are moving almost osmotically to a banking crisis as banks fear to lend to one another, uncertain of the sovereign debt values and the holding of those debts by the banks they would normally lend to. This is threatening to freeze up the banking system and not simply that of the E.U.
The fall in the gold and silver prices may well appear inconsistent with its preserving qualities, but when one takes into account the need for immediate liquidity to protect the investor, it is consistent. Once the immediacy of finding liquidity is satisfied, then we see investors returning to the precious metals as they did after the first strike of the credit crunch in 2007. This time round, liquidity needs are not so pressing as then.
The threat of a fall in the gold price to $1,500 appears real at the present moment. Because the fall is being driven by short-term traders and the triggering of stop loss positions with buyers waiting for new support, the situation is a short-term one not affected by the fundamentals of the precious metals markets, which remain excellent. Just as we can have a ‘spike’ to the upside, so we can have a ‘spike’ to the downside. Right now we have seen falls from the $1,900 area back to around $1,677 a fall of around 12%. A fall to $1,500 is a fall of 21%, which would be justified if the market fundamentals had deteriorated. But they haven’t. If investor meltdown becomes severe in the precious metal markets to the extent of a fall to $1,500, then it implies the same to the entire global financial markets. Investor meltdown will affect all markets as it has done recently and in 2007. This would paint a disastrous picture for global equity markets for sure. This is possible!
But in the last few days, we’ve seen good buying of gold into the U.S.-based SPDR gold ETF as well as a flight to U.S. Treasuries as last resort paper – if the U.S. bonds sink then everybody’s bonds will sink.
Russia has just reported an 18.6 tonne purchase of gold in October as part of its ongoing gold buying. Several other central banks are following their path. This confirms the excellent fundamentals of gold. Even in the current deteriorating global financial scene, expect investors to soften their flight to Treasuries with expedient buying of gold as we are currently seeing.
Will this hold off the fall from reaching $1,500? We feel it would be foolish to specify a specific price having seen so many such forecasters prove wrong when they do this. While it is possible, if it does go there it will be only briefly, but more likely by then the tide of investment into gold that we have seen in the last decade will return to gold before it does. But we will have to wait and see.