Gold Up as the $500 Trillion Derivatives Time Bomb Keeps Ticking

By: Mark_OByrne

Gold was up $4.10 to $974.30 per ounce in trading in New York yesterday silver was down 3 cents to $19.64 per ounce. In Asian and early European trading gold has traded sideways to slightly up. The London AM Gold Fix at 1030 GMT this morning was at $975.75, £483.26 and €630.90 (from $980.50, £485.47 and €633.40 yesterday).

Gold may continue to consolidate prior to the much anticipated rally to the $1,000 mark. But given the continuing weakness in the dollar (se FX below), record high oil prices and the continuing credit crisis, gold will likely continue to surprise to the upside.

Stock markets have again greeted the latest Federal Reserve “throwing money at the problem” panacea with glee and rallied strongly. However, this latest bout of irrational exuberance will likely be short lived. This is a another mere band aid which will not mend or heal the  gaping wound that is the housing, banking and credit derivative crisis. Indeed it may worsen things in the long term by making U.S. creditors increasingly unlikely to buy assets, including US Treasury's, denominated in the much printed dollar.

Support and Resistance
Gold's support is now at $960 and below that at $950. Resistance is at the recent high at $987.15.

FX Commentary
The Fed announcement yesterday did more for risk appetite than it did for the dollar itself. As a result as the Dow rallied and risk appetite in FX markets returned. The dollar rallied strongly against the Yen and against the Swiss Franc, however its effect on the Euro and Sterling was muted and appears to be short lived. The single currency had reached a new all time high against the Greenback (1.5496) and after falling back to the lows of the day post Fed announcement, it has again returned to the uptrend, trading just above 1.5400. With the Fed moving in to the “Landlord” business and the faltering economy and higher oil prices, next week's expected rate cut out of the States will help the Fed in further badly damaging the dollar and jeopardising the international monetary system.

As commodity prices consolidate and some areas of the market call an end to the “commodity bubble”, the commodity currencies are also consolidating at their higher levels. The Australian, New Zealand and Canadian dollars are taking a breather before resuming the inevitable uptrend as they follow the underlying commodity markets higher.

All eyes will be on Alastair Darling this afternoon as he presents his first, and possibly his last, UK budget. The FX markets will be no different and any criticism of what he presents will immediately be seen in the currency markets. This could be the fillip the Euro needs to return to the uptrend against the British Pound.

Federal Reserve ‘Pushing on a String'
The Fed's latest intervention is moral hazard writ large. In effect the Federal Reserve is bailing out irresponsible hedge funds and banks at the expense of U.S. citizens and the U.S. dollar. It increasingly looks like the free market is being subverted and a new form of financial socialism is afoot. As seen with Northern Rock in the UK, the end game is likely to be bankruptcy or nationalisation for some of the banks. The Federal Reserve is pushing on a string and these interventions are very unlikely to alleviate the liquidity, solvency and systemic problems that elements of ‘casino capitalism' Wall Street has created for itself.

Reuters recently reported the US housing market "is in the worst downturn since the Great Depression of the 1930s". Unfortunately there is no simple cure for the bursting of a massive housing bubble and as no amount of palliatives can rectify the credit crisis and the coming serious recession.

The Austrian School of Economics is instructive in this regard. Von Mises sums it up very well when describing the "crack-up boom".

“The boom can last only as long as the credit expansion progresses at an ever-accelerated pace. The boom comes to an end as soon as additional quantities of fiduciary media are no longer thrown upon the loan market. But it could not last forever even if inflation and credit expansion were to go on endlessly. It would then encounter the barriers which prevent the boundless expansion of circulation credit. It would lead to the crack-up boom and the breakdown of the whole monetary system.

The credit expansion boom is built on the sands of banknotes and deposits. It must collapse. If the credit expansion is not stopped in time, the boom turns into the crack-up boom; the flight into real values begins, and the whole monetary system founders. Continuous inflation (credit expansion) must finally end in the crack-up boom and the complete breakdown of the currency system."

$516 Trillion ‘Ticking Bomb'
Paul Farrell in Marketwatch writes in an excellent article ‘Derivatives the new 'ticking bomb'' that both Warren Buffett and Bill Gross have warned that the $516 Trillion derivative bubble is a disaster waiting to happen. ( http://www.marketwatch.com & http://www.bis.org)

Unlike the many US dollar denominated paper instruments that have been created in an unprecedented fashion in recent years and continue to be – gold is finite.

Gold bears the confidence of the world's millions particularly in the non western world, who value it's intrinsic value far above the promises of politicians and bankers and far above the unbacked paper issued by governments as money equivalents. This has been the case throughout our history and will remain so in the future. Especially in a world of unprecedented and massive credit and money creation and $516 trillion worth of opaque and exotic derivatives that exist in our new shadow banking system.

Silver
Silver is trading at $19.74/19.78 at 1030GMT.

PGMs
Platinum is trading at $2042/2052 (1030GMT).
Palladium is trading at $484/490 per ounce (1030GMT). 

By Mark O'Byrne, Executive Director

Gold and Silver Investments Ltd. have been awarded the MoneyMate and Investor Magazine Financial Analyst of 2006.

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