Financial Mayhem to Fuel Gold’s Next Surge?
Commodities / Gold & Silver Nov 26, 2008 - 01:45 PM GMT
Last week, I wrote about how our oil-rich friends in the Middle East are buying gold hand over fist. It turns out they're not the only ones. The latest figures from the World Gold Council show a frenzy of activity in the most recent quarter.
And gold ended last week with a bullish move to the upside that set off “buy” alarm bells for technical traders around the world.
But you know what? I think the best is yet to come for gold. Because it's likely that the WORST is yet to come for the U.S. economy.
And these economic forces could send investors charging even faster into gold just as fundamental forces also align for a move much higher.
I'll get to some of those fundamentals in just a bit. First, let's look at what Washington's insane clown posse is doing to make gold look good.
I Remember When a Trillion Dollars Was Real Money
1) The Fed Pledges $7.2 Trillion of YOUR Money. Bloomberg News reports that the U.S. government is prepared to lend more than $7.4 trillion — approximately half the value of everything produced in the nation last year — to rescue the financial system, which has been in cardiac arrest since the credit markets seized up.
How much is that? The pledged money is equal to $24,000 for every man, woman and child in the country. And $2.8 trillion of that has already been spent, according to Bloomberg.
Now brace yourself for the bad news …
2) The Government Has Already Spent $4.3 Trillion Bailing Out Wall Street. According to CNBC, as of last week, the Federal government had already spent $4.3 trillion in bailouts, from $900 billion for the Term Auction Facility … to $112 billion bailing out AIG … to $540 billion backing up Money Market funds … to $700 billion for the Treasury Asset Relief Program (TARP), and more.
$4.3 trillion — that's more than America spent on World War II, adjusted for inflation. And it's all going down a black hole created by Wall Street bankers.
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| The Federal government has already spent $4.3 TRILLION in bailouts and has hardly made a dent in the financial crisis. |
All that money has to come from somewhere. Investors are stuffing their money into Treasuries with no yield, and the government still has to go out and borrow more. The U.S. Treasury is on course to borrow $1.5 trillion this year, and it's still not enough ! Next year's budget deficit will easily top $1 trillion; more than double this year's deficit.
The overall impact of what the bailout will cost ultimately should be very negative for the U.S. dollar … and that should be bullish for gold.
3) Wall Street Is Probably Going to Need $Trillions More! The financial crisis is really the death of a thousand cuts. Let's take the Citigroup fiasco as an example. You may have heard that Citigroup is getting a $20 billion equity injection on top of the $25 billion it got in October.
But Citi will also carve out $300 billion in troubled assets, which will remain on its balance sheet.
- The first $37-$40 billion in losses on those assets will go to Citi.
- The next $5 billion in losses will hit Treasury.
- The next $10 billion in losses will go to the FDIC.
- Any more losses will go to the Fed.
These assets are crap-tacularly bad, so basically Uncle Sam is on the hook for another $260 billion in assets, in addition to the $45 billion in liquidity poured onto the desert of Citi's balance sheet.
And do you notice that the clowns on Wall Street are balking at giving Detroit a $25 billion bridge loan to save America's auto industry (and prevent a chain of dominos as all of the Big Three's suppliers, finance units and vendors go belly up) but Citi — a zombie of a bank that is probably lurching towards failure — gets $45 billion without even a debate.
That brings me to point #4 …
#4) Obama's Administration: More of the Same? Treasury Secretary Hank Paulson has set the bar pretty low as he limbos past barriers of logic and fairness to bail out his fat-cat friends. So you might think that the new administration, and Obama's nomination for Treasury Secretary, New York Fed President Tim Geithner, would be a welcome change from the crony capitalism at work now.
The widely respected Big Picture blog has a post by institutional risk analyst Chris Whalen titled: “What Barack Obama Needs to Know About Tim Geithner, the AIG Fiasco and Citigroup.” I highly recommend you read Whalen's post. He makes the following point:
By embracing Geithner, President-elect Barack Obama is endorsing the ill-advised scheme to support AIG directed by Hank Paulson et al at Goldman Sachs and executed by Tim Geithner and Ben Bernanke. News reports have already documented the ties between GS and AIG, and the backroom machinations by Paulson to get the deal done. This scheme to stay AIG's resolution cannot possibly work and when it does collapse, Barak Obama and his administration will wear the blame due through their endorsement of Tim Geithner.
If Whalen is right, the crisis of confidence already shaking the financial markets is nothing compared to the tsunami of trouble that will follow.
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| Is Tim Geithner – President-Elect Obama's choice for Treasury Secretary – a welcome change or more of the same? |
And What If the Doom-Sayers Are Wrong?
I'd be happy — very happy — if financial calamity is averted. But then we'll still have to deal with a system thrown off balance by trillions of dollars in newly created money. The hundreds of billions of dollars in a new stimulus package for Main Street — Obama's job #1 when he gets into office — will be icing on the inflationary cake. Once you start flooding money into the system, it's very difficult to know when to stop. We are in deflation now, sure, but I think government-fueled inflation is sure to follow.
That Brings Us to Gold And the Dollar
The U.S. dollar has its problems, but so far it has been winning a beauty contest in a leper colony. Emerging markets are falling into a ditch. Europe's economy is in the tank — Germany's business climate has dropped to the lowest level in over 15 years — and the European Central Bank will probably lower its benchmark interest rate by at least 75 basis points at its next meeting on December 4.
So far, the U.S. dollar has not been shaken by the massive amounts of bailout and stimulus money that Washington is throwing at America's problems. But again, $7.4 trillion is real money. And the financial world may be waking up to the fact that, no matter how many hundreds of billions of dollars you throw at companies like AIG and Citigroup, it's good money after bad.
Last week, the euro/U.S. dollar currency pair barely budged even as stocks sold off sharply. This is a change from recent months, when the euro had come under pressure as equities sold off.
I don't think the mighty U.S. dollar's bull run is over. But the U.S. dollar could move lower as it consolidates its recent gains.
And downward pressure on the U.S. dollar would only add to upward pressure on gold, powered by fundamentals.
Gold's Fundamentals Are Shining Even Brighter
I covered some of those bullish fundamentals last week, including new and massive buying in the Middle East, rising demand for gold in China in the first six months of the year, and a downward trend in global gold mine production.
And just last week, we got the latest third-quarter figures on global gold demand from the World Gold Council. Here are some of the highlights …
- Global demand rose 18% to 1,133.4 metric tonnes from 963.3 tonnes a year earlier.
- In dollar terms, the jump in demand was even bigger. Dollar demand for gold reached an all time quarterly record of $32 billion in the third quarter, a whopping 45% higher than the previous record … set in the second quarter.
- Identifiable investment, which includes purchases through exchange traded funds and of bars and coins, climbed 56% year over year to 382.1 tonnes.
- Retail investment blasted off. It rose 121% to 232 tonnes in the third quarter, with strong bar and coin buying reported in Swiss, German and U.S. markets. Gold inflows into ETFs surged to a record 150 tonnes. Gold ETFs added to their treasure troves at a rate that was 7.5% higher than the second quarter and up 31% from a year earlier.
- Jewelry demand gained 7.6% to $18 billion. Jewelry demand in India soared by 65% in dollar terms. The Middle East, China and Indonesia all saw jewelry demand in dollar terms rise by 40% (10% to 15% in tonnage terms).
- Sales to India, the world's largest gold consumer and jewelry buyer, jumped 29% to 249.5 tonnes from 190.8 tonnes. Meanwhile, demand increased by 18% in China and 15% in the Middle East.
If there was a party pooper for gold, it was the United States. U.S. demand for gold jewelry dropped 9% in value and 29% in tonnage terms. Great Britain also saw its demand slacken by 5% in value and 26% in tonnage terms.
In all, global consumer demand for gold rose 31% from a year earlier to 250 metric tonnes.
So we have this combination of forces: Powerful fundamentals on the one hand, and the potential for more financial chaos on the other. Put them together and you can see that gold could go much higher.
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Gold's fundamentals and the potential for more financial chaos make the yellow metal your best bet for profits going forward. |
I'd expect some overhead resistance around $900 an ounce. If gold can break through that level, it could be on a rocket ride for the New Year.
Add Some Leverage To Your Gold Picks
Gold's path higher will not be a straight line. In fact, I expect some corrections that could knock the yellow metal right on its shiny butt. But that's short term. Longer term, gold should march higher.
The way things are going in Washington, I like physical gold, and silver, too. Certainly, with the holidays around the corner, gold is the gift you don't have to make excuses for … and, as the old timers remind us, it can always pay your way to sneak past the border guards.
Last week, I talked about two funds that hold physical gold, the SPDR Gold Shares ETF (GLD) and the Barclays iShares Comex Gold Trust (IAU). They are fixed at 1/10th the price of gold, minus a small amount to account for fees.
That means if gold is trading at $800 an ounce, you can buy the GLD or the IAU for about $80. And they are backed up by gold bullion in a vault.
To them, I would add the PowerShares DB Gold Double Long ETN (DGP). It targets TWICE the return of the Deutsche Bank Gold Index, or basically twice the short-term percentage move in gold.
In these fast and furious markets, a leveraged fund is not for the faint of heart. But it can give you extra firepower for when gold takes off to the upside.
Yours for trading profits,
Sean
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