Perhaps the most interesting
development during the intensification of the credit crisis is that the price
of gold did not climb higher than it did. Upon the initiation of the crisis
in August 2007, the price of gold surged reaching a high of $1002.95 on March
14, 2007. Since then the cost of the precious commodity has fluctuated with
the most recent price action sending it to recent lows of 725.74. However,
given the pervasive uncertainty in markets we think that this represents a
strategic buying opportunity on the back of our bullish call for gold to
spike towards $1100 in 2009 with the potential for a much larger move over
the longer term.
Given the sheer volume of
liquidity that has been pumped into the global economic system over the past
year it is an understatement to say the least that the price of gold has
trended downward. A look at the adjusted money base of the US indicates that
the money supply is up 18.6% year over year. The Fed alone has pumped over 1
trillion dollars into the economy and the US federal government will do well
to avoid running a 2 trillion dollar deficit during fiscal year 2009.
The enormity of the steps
taken to prevent a complete meltdown of the global banking system will put at
risk years of hard won credibility of global central banks and keep the
specter of inflation at the forefront of the minds of the investing class.
Although, we are currently poised to observe a dis-inflationary moment as the
deleveraging that is already underway has ushered in a period of intense
declines in the values of assets across just about every class. With the
velocity of money in decline, the contemporaneous increase in the supply of
money should not stimulate an increase in inflation in the near term.
However, over the longer term the independence of the central banks around
the world will be severely tested by governments and publics beset by
extraordinary levels of debt and increasing rates of unemployment.
Moreover, the increase in the
supply of gold will fall well short of the increase in the supply of paper
money over the next few years. In the context of a profound economic
uncertainty, financial instability and geopolitical turbulence gold will
slowly begin to reassert itself as the preferred safe haven of savvy
investors, probably at the expense of the US dollar.
The risks to this scenario are
two fold. First, the current dis-inflationary moment quickly unwinds and
evolves into a Japanese style deflation for the US and the major economic
powers, which would depress the price of commodities further and limit the
upside on gold. Second, that the financial stress in the EU, Asia and
emerging markets could turn out to be more pronounced than that of the US.
This could cause the dollar to continue to appreciate, which would limit the
upside of the move in the price of gold.
Given the volatility in the
price of equities and the uncertainty in fixed income markets over the intent
of the Federal Reserve at this time, we are much more confident in the
direction of the price of gold over the medium term than we are that of
stocks and treasuries. The steps taken by global central banks have begun to
thaw credit markets and interbank lending appears to be in the process of
recovering. But those, steps may be difficult to reverse and increase in
dollar denominate reserves we think is a bullish signal on gold going
forward.
The unwinding of positions in
a panic and the intense period of deleveraging ahead has stimulated many
market participants to move smartly into Yen and quite interestingly, into
the dollar as a safe haven moves. Given the stability of the Japanese banking
system, the move into the Yen makes sense. However, we see the recent
strength of the dollar an understandably reactionary move by global investors
after a half-century of a dollar hegemony, to find shelter in a global storm
where no safe havens appear to exist and instead have turned to a deeply
indebted US government out of habit. Thus, once the tide begins to ebb from
the storm and investors can begin to evaluate the extent to which the US, EU and
global governments have moved to stem the tide we do expect that gold will
replace the dollar as the preferred hedge against uncertainty ahead.
