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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 cow-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 osmoticaly
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 see 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.
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