Financial Market Turmoil Leaves Gold Undervalued

JOHANNESBURG – During the last few weeks the price of gold has been consolidating between $1475 an ounce and $1525 an ounce. Yet, with all the current turmoil in the financial markets, it seems totally undervalued.

On Monday May 16, the United States hit its $14.3 trillion borrowing limit. Treasury Secretary Timothy Geithner told Congress that issuing $72 billion in bonds and notes would push the deficit to its legal cap and he would have to suspend deposits into federal pension funds to free up room for more borrowing.

The government now has until about Aug. 2 before it begins to default on its loans, which have ballooned as the country spends more than it takes in. Although Congress has increased the debt ceiling dozens of times over the years, this time around, Republicans and some Democrats are demanding that a hike in the ceiling be accompanied by measures to cut debt and slash spending. Last Sunday, President Obama warned that failure to boost the cap could send the country into an even worse recession than the recent downturn.

In response to this dilemma, several politicians have suggested that US sell some of the gold held by the US Treasury. Currently, it is reported that the US has the largest gold holdings in the world purported to be more than 8,000 tons. Evidently a report from the Heritage Foundation on the sales of US assets outlined how a “partial sales of federal properties, real estate, mineral rights, the electromagnetic spectrum, and energy-generation facilities” might garner the federal treasury $260 billion over the course of the next 15 years. The report did not mention the possibility of selling the government’s holdings of bullion, though the 261.5 million ounces of gold the Treasury Department lists in its reserves would, at a recent price of $1,492 an ounce, would theoretically fetch $390.2 billion.

Officials of the Obama administration have taken notice – and disagree. The assistant Treasury secretary for financial markets, Mary Miller, wrote in a posting on the Treasury Department’s Website May 6 that “fire sale” of the government’s financial assets, including gold, would not be a “viable option.” She urged instead a raising of the debt limit.

A study of gold reserve sales in the late 1990s noted that seven nations – Australia, Austria, Belgium, the Netherlands, Portugal, and Sweden – had then recently sold off substantial portions of their gold reserves. After the sales, which amounted to 48% of those reserves, there was a 26% devaluation in their nation’s respective currencies. Between 1999 and 2002, in 17 separate auctions, Britain sold off half of its gold reserve, netting $3.5 billion. What Britain sold is now worth $10.5 billion.

Frankly, and as far as I am concerned the US will never sell its reserves, simply because it doesn’t have the quantity it claims to have. In fact I would be surprised if it even have half of what is reported.

In August 2010, Ron Paul, a leading figure in the monetary debate in Congress, called for an audit of the federal government’s gold reserves. “If there was no question, you’d think they would be very anxious to prove to us that the gold is there. . . . ,” Dr. Paul then said, “In the early 1980s when I was on the gold commission, I asked them to recommend to the Congress that they audit the gold reserves – we had 17 members of the commission and 15 voted no to the audit. I think there was only one decent audit done 50 years ago.”

“If we ever get around to deciding we should use gold in relationship to our currency we ought to know how much is there,” Dr. Paul added, “Our Federal Reserve admits to nothing and they should prove all the gold is there. There is a reason to be suspicious and even if you are not suspicious why wouldn’t you have an audit?”

The crisis regarding Greece remains unresolved and now new phrases such as “reprofiling” or “soft restructuring” of Greece debt are being used to describe a possible solution. But, no matter the new phrases, the meaning is the same; the European Central Bank has threatened to stop lending to banks using Greek government bonds as collateral if Athens changes the terms of the debt, a move which could bring down the country’s banking system. Fitch downgraded Greece’s rating by three notches from BB+ to B+, four notches below investment grade. Fitch warned that any move to extend the maturities of Greece bonds is considered a “default event” while the current B+ ratings incorporates expectations that “substantial new money” will be provided to Greece by the EU and IMF.  The interesting point here is that usually, by printing government bonds countries such as Greece have been able to create money. The government bonds are bought by financial institutions that are seeking high yield returns. They in turn use these bonds as collateral for new loans from the ECB. But, it now seems that the ECB are concerned about the “real” value of these bonds and the ability of the government to pay this debt.

S&P cut its outlook on Italian government debt to negative from stable over the weekend. As the concerns about contagion continue, some market participants are watching whether Belgium may become the next to be downgraded.  However, as I have often stated, I believe that Spain poses a much bigger threat than people like to suggest.

Protests have been raging in Spain since Sunday, May 15. In addition the unrest seen in Madrid,  in the famous Costa del Sol, there were protests in sixty other locations. The protesters aren’t associated with any political party in particular and, instead, the movement is serving as a catch all for those upset over the current economic situation in Spain. The country has a 21% unemployment rate and a 43% youth unemployment rate. Its inflation rate is above the Eurozone average and its growth remains low. Spanish Prime Minister Jose Luis Rodriguez Zapatero’s Socialist party suffered its worst defeat in more than 30 years in local elections amid a backlash over austerity measures.

Japan’s economy shrank by almost double the margin economists had expected in the first three months of 2011, as the March disaster pushed the country back into recession. Gross domestic product contracted by 0.9% during the January-March quarter, marking a 3.7% annualized drop, the Cabinet Office reported Thursday. The result showed a far greater drop than a median forecast for a 0.5% quarter-on-quarter contraction in separate surveys of economists from Reuters and Dow Jones Newswires.

As the situation regarding the US debt deteriorates, and as the financial crisis in the Eurozone deepens, the US dollar is rebounding. However, it does not take a financial genius to see that this current rally is due to the weak euro. There are problems with the US dollar, Euro and Yen, three of the most heavily traded currencies in the world, and I expect these currencies to continue their race down the slippery slope of burgeoning debt. For this reason it is important to accumulate precious metals in particular gold and silver and I strongly suggest building a core holding of the physical metal in bullion form, and stay away from limited edition medallions which I maintain do not offer any investment value whatsoever.



David Levenstein began trading silver through the LME in 1980, over the years he has dealt with gold, silver, platinum and palladium. He has traded and invested in bullion, bullion coins, mining shares, exchange traded funds, as well as futures for his personal account as well as for clients.

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.


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