Monetary Parallels between 9/11 and the Subprime Market Fallout

By John Lee       Aug 24 2007 4:34PM www.goldmau.com

From a monetary stand point, there are striking similarities between the events of 9/11 and the recent subprime market fall out.

1. Both events caused retreat of investment capital, a sudden flight to safety that caused demand to dry up in the equity and non-treasury bond markets.
   
   
2.  Both events required massive injections of liquidity by central banks: Upwards of $100 billion for 9/11, and $500 billion so far in August.
   
   
3.  Both events required central banks to aggressively lower interest rates to encourage borrowing and to spur investment demand back into equity and higher-yield, riskier bond markets.

Before proceeding though, let us be clear on the terms “lack of liquidity” and “drying up of liquidity”. Liquidity as defined by M3 or investable dollars is always present and ever expanding. The lack of liquidity in the subprime debt market however, refers to the lack of buyers, which makes banks, funds, and institutions unable to value their existing loan portfolios. The solution was the direct bailout by central banks to buy those mortgages at face value. This is what is referred to as the “injection of liquidity” or in plain English, printing money out of thin air.

Our research from various sources pegs the subprime market at between $1 to $2 trillion dollars, with about a 20% fallout so far. Initial teaser-rate and interest-only loans are not categorized as subprime, yet also carry a trillion dollar plus market value and are beginning to experience pressure. It is our view that the Fed must lower interest rates by another 100 to 200 basis point to prevent a complete collapse of these multi-trillion dollar markets. In short, we have to side with Mr. Cramer’s recent comments and urge Mr. Bernanke to assess the seriousness of the issue.

Moving on I want to focus on the effect of those events on the US dollar, gold, and gold stocks.

Feds Fund Rate History

2001 9/11 Era

2007 Liquidity Crisis

US dollar Index July 2001 to November 2003

XAU July 2001 to November 2003

You can see that “liquidity injection” and the lowering of interest rates have direct negative bearing on the dollar index, and a positive impact on gold and gold equities. Liquidity (or Money supply) is the lifeline of commodities and equity. Four months after the initial shock of 9/11 and the associated lowering of interest rates, gold and gold stocks staged rocket propulsion, with gold going from $250 to $330, and the XAU moving from 50 to 90 in the first half of 2002 alone. The dollar held up for 4 months after September then staged a dramatic 25% fall from 120 to 87 between 2002 and 2003.

If we were to count the subprime clock as starting in July, the history of September 11th tells us we should expect a further 1% rate cut within the next 4 months, followed by break out of gold and gold stocks by November. Gold has built a very strong base between $600 and $700. While the same can be said of the XAU between 120 and 160, the key for Gold is $700 and 160 for XAU. We fully expect those levels to be overcome by November, if not earlier. The dollar index is a tough call, because it is measured against the Euro and other fiat currencies. Those fiat currencies are the product of politicians. To paraphrase from Mark Rostenko of Sovereign Strategist: “The ECB own the Euro like I own my pants, if I want my pants to go down, it goes down.” Long message short, bottom fish for gold and gold stocks, or if you like optimal entry point, buy safely once XAU takes out 160.

Gold from 2006 to present.

USD from 2006 to present.

XAU from 2006 to present.

John Lee,
CFA john@maucapital.com

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