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There is a well known expression, related to classical opera, which
goes something like this: "It isn't over until the fat lady sings".
This relates to the most famous arias sung by sopranos prior to them dying by
various means, often suicidal, at the close of Italian operas. The analogy to
the main theme of this short essay could hardly be more appropriate. In an
economic sense, gold is taking the place of the fat lady and it is now her
time to take centre stage having been relegated to the sidelines of our
25-year long opera called "FIATO", composed by the great American
composer Sir, Dr, etc Alan Greenspan. People have been in love with Dr
Greenspan's music for a generation. However, of late, since vacating his role
as Chairman of the Fed Grand Opera House, the great composer has taken to
blaming those who have developed convoluted and enigmatic variations on new
financial instruments apparently beyond his comprehension. One has to beware
of those harsh notes and tragic Italian endings!
Jokes aside, the recent 50 basis points interest rates cut by the Fed
caught this writer's attention and
brought him out of a 12-month self imposed silence. It is no doubt obvious to
the reader that the US
economy "lies between the devil and the deep
blue sea". If the Fed had not cut interest rates the Real Estate market
would have rapidly worsened, with the Sub Prime based mortgage sector leading
the next tier of the mortgage market, the ARM's,
comprising much of middle America, into an all out slump, with many high
street banks horribly exposed. Given rapidly rising real inflation,
represented by the core CPI variables such as food and gasoline, this would
have caused a catastrophic
collapse of consumer confidence and spending, causing
in turn a major stockmarket crash. Add to this out
of control overruns in the National, State and Public Sector budgets and the
exploding costs of Education, Public Health, Pensions and the Iraq and
Afghanistan Wars, and one has the recipe for a perfect financial disaster. The
Fed accordingly bit its lip and did the only thing they could do given the
awful scenario that confronted it, they dropped interest rates by a full 50
basis points to buy vital time for the colossal hedge funds to continue to
unwind their dangerously exposed positions. However, one should be under no
illusions that the inbuilt problems in the world credit - debt system have
been resolved. Unsurprisingly, the markets took such an interest rate
reduction, at this juncture, for what it really was and for what it means
going forwards. It was a major signal for the markets to junk the US dollar
in favour of other stronger currencies, gold, platinum, silver and other
vital assets, and that is precisely what has happened and continues to
happen.
To the key holders of US debt, and supporters of the US economy:
China, Japan, Middle Eastern States, Taiwan and Korea, via their regular and
massive purchases of US Treasury Bonds, this was an expected but nevertheless
unwelcome development. Simply stated, it means that US debts to these
countries have been and continue to be devalued away, with these economies
being totally defrauded, as are US
pensioners and savers whose life savings and pension funds are being
destroyed.
The US
has quite simply hitched the entire world economy to its economic and
financial locomotive in the finest example of the "prisoner's dilemma
game" in economic history; i.e. you have growth but eventually on our
terms. No one dared break ranks in this high stakes economic game and ditch the
global currency, the US Dollar. However, one should remember that no FIAT
currency in history has ever stood the test of time. Most have never lasted
even 50 years. The only real money is GOLD. This is because
man, for all his ingenuity and vast and rapidly increasing store of
knowledge, has not added one iota to his wisdom. Quite simply man, at the
governmental level, is too venal a creature to be trusted with other people's
money. The true gold standard, whilst rigorous and inflexible, kept Kings and
politically elected leaders relatively honest. Even then, Kings and Princes
hired alchemists in an attempt to transmute lead or other elements and
substances into gold because they
could never control their own finances, due either to profligate conspicuous
consumption, orgies of grandiose construction of ever more tasteless palaces,
or costly and often idiotic wars or creation of empires. Had they succeeded,
the alchemists would have been the first architects of FIAT. However, the
modern USA
is the undisputed all time "King of FIAT". Now the Economic Piper
has to be paid for the potentially "Hyperinflationary Genie" the US
has visited upon the world.
Historically, the "fat lady" (GOLD) sings when inflation is
headed into double figures and accelerates with the possibility of
hyperinflation. In 1980, following the first major explosion of credit, post
the end of the Bretton Woods Agreement, gold
approached its "melting point" of US$ 850 per fine ounce, or, in
today's CPI adjusted equivalent, US$ 2,700 per fine ounce. Paul Volcker, then
Chairman of the Fed, fought the potentially dangerous situation for the US
dollar by successively raising interest rates right up to 17% thus squeezing
inflation out of the market, and, in the process, bringing gold back down to
US$ 450 per fine ounce by 1986. However, under his successor Alan Greenspan,
the money supply has been allowed to balloon to astronomic heights. One
cannot but feel sorry for Mr Greenspan's successor, Dr Ben Bernanke, who faces a near hopeless and eventually very
painful task. Since Paul Volcker's day in 1982, the world has witnessed the vast
explosion in the use of increasingly complex debt based financial
instruments. These arcane vehicles are based on the burgeoning financial
science of risk management and diversification. They comprise mixes of
collateralized mortgage based debt, bond and equity derivatives and various
other instruments. However, the safety margin inherent in these instruments
has become ever slimmer as their engineers, the banks, have chased increasing
profits at the expense of greater risks. These comprise a web of complex
derivatives held by a host of Hedge Funds. Very few people outside the
banking world understand these financial instruments. The figures involved
held in these Hedge Funds are staggering and beyond human imagination. By
comparison, the GDP of the world's largest economy, the USA at 12
trillion dollars, is a relative minnow. The fact that major world governments
have failed to regulate these instruments to protect society from the
potential consequences will be debated by economists, financiers and
regulators for many decades to come.
So, you may be asking, where is all this leading? The simple fact of
the matter is that the Smart Money saw all this coming long ago and has been
accumulating physical gold, platinum and to a far lesser extent silver, and
Precious Metals stocks at bargain basement prices for the past five years. In
the past two months the obvious has become apparent, the writing is on the
wall for the US dollar and, eventually, the broader economy. Hence gold's
recent breakout from the trading range US$630 to
US$680. Gold's flight towards US$800 shows that the gold genie has at last
escaped the bottle and the central bankers have thrown in the towel. With Bernanke's interest rate cut gold's rise will now become
increasingly parabolic in a stupendous "blow off", which, as
Newmont Mining Ltd's Pierre Lassonde said at Australia's
"Diggers and Dealers" mining investment forum, "I know that it
will have three zeros behind the first number, however, I do not know what
the first number will be". This writer will not guess, but would be
surprised if this number did not reach US$3,000 per fine ounce.
One thing is for sure, demand for physical metal will far outstrip supply
by a factor of several times global production, as most significant gold
mines require between 5 to 10 years from discovery of a good project to plant
commissioning and production, dependent upon project size, location and a
host of other important variables. Current world production is some several
hundred tonnes behind global demand and has been so for several years. This
situation will worsen rapidly from here on.
Finally, Ben Bernanke will have little
choice other than to follow the same route as Paul
Volcker to save the US dollar, as this is of
paramount importance to the continuance of the USA as a global hyper power and
the major influence in global development. To allow the US dollar to collapse
and finally be rejected as the global unit of monetary exchange in favour of
another currency would be unimaginable and unacceptable. Therefore, gold's
great bull market will be the harbinger of a major global recession or, more
probably, a depression brought on by a sequence of massive defensive interest
rate rises required to support the dollar in its pre-eminent position as a
global currency, with all the benefits, political and economic, that this
brings to the USA.
In the meantime, if you haven't already done so, load up on quality
gold and silver stocks and maybe some physical gold and silver as well while
prices remain relatively low! The world to come looks at best volatile,
uncertain and increasingly dangerous. If the USA decides
to go to war, over the Iranian nuclear situation, this will only add fuel to
the coming conflagration.
By : Nigel H. Maund
BSc(Hons)Lond., MSc, DIC, MBA,
MIMMM, SEG
Economic
Geologist
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