This past week, gold and silver
experienced one of their steeper drops in recent months. After gold had
touched a four month high, and silver came close to a six month high, prices
abruptly reversed course. By the end of the week gold had sold off more
than 5 percent, and silver was down almost 10 percent (down 6.5 percent
on Leap Day alone). Often, such sudden price falls create downward
momentum. And it looks as if that may be the case this week. Thus far
this week silver has dipped 3 percent.
Based on these sharp movements it
would have been logical to assume that some great piece of economic news
had been issued that kindled hopes of a strong and sustainable economic
recovery either in the U.S. or in Europe. In such case, investors would
be expected to pull money out of "defensive" metals and into
"aggressive" stocks. But the news on that front was far from
reassuring. Alternatively, a selloff in metals would normally be expected
if central bankers were to move to tighten monetary policy. That did not
Instead, this selloff was sparked
not by a development, but a non-development. In his address to Congress,
Fed Chairman Ben Bernanke offered no clue as to when the Federal Reserve
would unleash its next round of quantitative easing. Despite pressure
from curious legislators, Bernanke kept his lip buttoned on that very
sensitive topic. (See
more analysis of the Fed's current predicament in the latest edition of
the Euro Pacific newsletter).
The markets took this as a sign
that the monetary madness is coming to an end, which would bode poorly
for precious metals. Metals are increasingly seen as substitutes for continuously
debased fiat money, and tend to do well when new liquidity injections are
Bernanke's failure to telegraph
more printing means nothing. Investors are craving a return to normalcy,
which means more prudent monetary policy. As a result, many are grasping
at straws. But I believe these hopes are premature, and that gold will be
buoyed by easy money for quite some time.
In addition, gold will likely be
favored by the greatest financial struggle of the coming decade: China's
plans to replace the United States as the dominant economic power. As
President Reagan remarked, a great country needs a strong currency.
Clearly, China shares this creed. Based on its history, fiscal
discipline, and its aversion to some of the excesses of Western economies,
I feel that China has plans for a gold linked Yuan. If China indeed has
these ambitions, the buying pressure placed on gold would remain in place
regardless of Mr. Bernanke's intentions.
In the past year, China has
become the world's largest producer of gold, mandating that all domestic
gold production stay in the country. She has secured major holdings in
gold mining companies worldwide and, this year, will likely become the
largest international buyer of gold. Recently, China allowed its citizens
to own gold and now actively encourages them to do so. Already, China has
surpassed India as the largest buyer of gold jewelry.
The West understands as well that
the days of unrestrained monetary expansion must come to end. The
Anglo-American dominated International Monetary Fund likely favors the
ultimate emergence of a new reserve currency, possibly only partially
convertible into gold, exclusively for central banks, and run by the IMF.
China appears to be pushing for a
fully gold-based Yuan, universally convertible. To accumulate the same
8,400 tonnes supposedly still held by the
United States, China would have to accumulate gold for several years. If
she continues on this path, it should place a substantial floor under the
gold price in the years ahead.
Regardless of who wins the
reserve currency race, a key issue will be the gold conversion price. To
accommodate the world economy without being recessive, many have
concluded that the price of gold would need to be far higher than it is
today. In any case, if China continues to pursue a path towards a fully
convertible Yuan, investors might be wise to pursue a buy and hold
strategy. This of course discounts the possibility that their holdings
are not confiscated by debtor governments with plummeting fiat currencies.