Current Global Financial System Fragility Sends Gold Higher

JOHANNESBURG – Gold prices continued to advance last week as more investors around the world gradually become more aware of the fragility of the current global financial system. The price of spot gold traded as high as $1763 an ounce before it slipped on Friday after the US non-farm payroll report showed a much larger than expected expansion in US job market figures in January 2012.

Greece has still delayed its decision on whether to accept the terms of a new bailout for yet another day. Greece has already gone beyond the deadline for finalizing talks on the second Eurozone bailout and the International Monetary Fund financing package.

German Chancellor Merkel and French President Sarkozy proposed setting up a separate account for Greek debt payments to reassure creditors. Merkel said sequestering aid in such an account would give the Greek government guaranteed access to funds to finance its interest obligations. Sarkozy said it will “allow us to assure that the Greek debt is dealt with,” as both urged Greek leaders to agree to conditions set out by international creditors.

While financial leaders continue to struggle with the problems of Greece, it is now more than a week since the World Economic Forum Annual Meeting in Davos.  At the meeting, the only thing all the financial leaders were able to agree on was that there is a global problem. However, and as to be expected, and although more than 2,600 of the world’s richest, most powerful, influential or entrepreneurial people attended the meeting they  were unable to agree on any solutions as to how to solve the problem.

The managing director of the International Monetary Fund, Christine Lagarde, warned the Davos leaders that this was “not just a Eurozone crisis, it’s a crisis that could have… spill over effects around the world”.

“What I have seen and what the IMF has seen in numbers and forecasts is that no country is immune and everybody has an interest in making sure that this crisis is resolved adequately,” she said… what amazing revelations!

In the meantime, gold burst through the key psychological level of $1700 an ounce and has continued to trade above this level for more than a week. Spot gold gained more than 10% in January, its biggest monthly gain since August 2011. The price of the yellow metal has now broken above a key Fibonacci retracement level and the 100-day moving average. Gold rose above its 200-day MA last week.

The strong rally in gold prices was prompted by the US Federal Reserve that signalled that the interest rate environment would likely stay near zero for the next two years. After the latest Federal Open Market Committee (FOMC) meeting held on January 25, the Federal Reserve announced that the Committee decided to keep the target range for the federal funds rate at 0 to ¼% and currently anticipates that economic conditions – including low rates of resource utilization and a subdued outlook for inflation over the medium run – are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.

The Committee was also of the opinion that inflation at the rate of 2% as measured by the annual change in the price index for personal consumption expenditures is most consistent over the longer run with the Federal Reserve’s statutory mandate. In the most recent projections, FOMC participants’ estimates of the longer-run normal rate of unemployment had a central tendency of 5.2% to 6.0%.

It is not altogether surprising that the gold price spiked higher on the news of extending the zero-rate policy through 2014 as keeping rates low requires the Fed to print new money to buy Treasuries. As the dollar weakened against the euro,

Central banks around the world are printing money at an unprecedented rate. While they will use a series of new euphemisms in an attempt to fool the general public, the fact remains that, the balance sheets of these central banks are simply exploding. The term currently used for their expansionary monetary policies is quantitative easing (QE). But no matter what they will call it, the balance sheets of The US Federal Reserve, European Central Bank (ECB), Bank of Japan (BoJ), the Bank of England (BoE), the Bundesbank (Germany), the Banque de France, the People’s Bank of China (PBoC), and the Swiss National Bank (SNB) are all exploding. In fact the combined size of these eight central banks’ balance sheets has practically tripled in the last six years from $5.2 trillion to more than $15 trillion. And, it seems that they will continue to expand at an even faster pace over the next few years.

The repercussions of this monetary policy will ultimately lead to the debasement of these currencies, much higher inflation and of course higher prices in gold and silver prices.

But, in addition to their expanding balance sheets, central banks have taken a more active involvement in the currency, commodity, equity and bond markets. This deliberate covert interference will not help stimulate economic growth or reduce the high levels of unemployment as we have already witnessed, and will only save the troubled financial institutions as well as falsely inflate the prices of certain asset classes. Ultimately, it will erode the purchasing power of money and destroy the savings of millions of middle class people.  However, being prepared can help one avoid the prospect of being totally wiped out. And, one of the best ways to protect your wealth is by owning gold and silver.

While many individual investors get duped into believing that they will be saved by the actions of their central banks, countries such as China and Russia are not so gullible. Russia has been increasing their gold reserves each month, and while there are no accurate figures about the amount of gold held by the Chinese, I have no doubt that they are accumulating the precious metal and diversifying out of their dollar denominated holdings as quickly as possible.

The problem that they have is that since they are the largest foreign holders of US Treasuries, they cannot dump their holdings onto the market as this would dramatically push the value of these instruments lower. And, at the same time, I believe that they do not want to broadcast the fact that they are buying gold for fear of driving the price of gold much higher too soon. The Chinese government are also encouraging their citizens to buy physical gold. I also believe that this year we will also see a resurgence of demand out of India as well, and thus I urge investors to accumulate physical gold.

As I have stated many times in the past, it is important to build a core holding of gold bullion bars and gold bullion coins. Limited edition medallions, commemorative medallions and other medals are not bullion coins and should not be confused with gold bullion coins. Nor, should they be purchased instead of gold bullion coins.  Do not be beguiled into believing that these limited edition medallions will become rare one day because a limited number of these medallions are being minted. A typical sales strategy of dealers who promote these medallions is to try and equate them with some rare coin that has been sold for an astronomical price. A limited edition medallion cannot be compared with an extremely rare coin and there is absolutely no guarantee that one day they will be in such huge demand due to the limited number minted. In all probability all they will be worth is the intrinsic value of the gold. So, it is much better to simply hold bullion coins.

TECHNICAL ANALYSIS

Gold prices broke the $1700 an ounce level, and the upward momentum looks set to continue. The next level of resistance is $1750/oz. while $1700/oz. now looks to be a support level.

About the author

 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. 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.

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