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Theoreticallly Speaking...

By Jon Nadler       Printer Friendly Version
Jan 16 2009 2:09PM

Good Afternoon,

New York spot gold prices enjoyed a 2.2% gain on this final trading day of the week, rising to and testing resistance at the $840 area. Participants were seen squaring their books and preparing for the long weekend. Advancing global stocks offered some relief to gold buyers and the government guarantees on toxic bank assets gave further room to maneuver in riskier assets to speculators. The IEA forecast a two-year slump in oil demand, while pundits forecast a Dow at 6K if the lows of 2008 are taken out. Interestingly, yesterday was the day when we saw an 8K Dow and $800 gold.

At this rate, the old Russell theorem of a crossing in the Dow and gold might yet be plausible. Meanwhile, crude oil fell again, to very near $34 per barrel, off by more than $1, held in check by the aforementioned IEA report and by a 2% slump in US industrial production. The US consumer price index recorded its smallest yearly gain in more than half a century and actually went into negative numbers last month. What inflation? That's so...June of 2008 it's no longer funny.

Silver gained a more impressive 53 cents to reach above $11 and was last seen at $11.11 per ounce. Platinum and palladium rose as well, the former adding $18 to $937 per ounce, while the latter climbed $5 to $183 per troy ounce. Chrysler is said to be seeking TARP money. The US dollar cut its earlier losses to 'only' 0.50 and traded at a hair under 84.00 on the index. But, hey, the Russian ruble enjoyed a devaluation practically every day of the last week. Nice going, comrade. 

The seemingly unstoppable hemorrhage of losses in the banking sector was back on the front pages of most papers and financial websites overnight. Bank of America lost $1.8 billion due to a $15.3 bleed at its newly-acquired Merrill unit, Citi managed a fifth straight quarterly report full of red ink - to the tune of $8.3 billion. Following that, the bank announced cell division was underway and that it would split into 'core' and 'non-core' entities. In fact, the idea of a "Superfund Bank" has already been floated and it might just become a reality if Mr. Paulson and Ms. Bair have their way eventually.

BofA, meanwhile, got a big, fat, $20 billion from Uncle S. and toxic asset guarantees of another $118 billion. Now, its loan officers can put stamps of approval on any request they might have doubts about, as the deal cannot go sour. Ever. Okay, so much for today's nationalization news, one day after the FDIC's head saw no possibility of such a process ever taking place.

Elsewhere, Intel's profits fell by 90%, Hitachi was to report a $1 billion or larger loss, Toyota, Honda and Mitsubishi are cutting more staff and car production, Sony Ericsson swung to a loss, a second round of UK bailout talks began, and Anglo Irish Bank was...nationalized. The trend towards government ownership of domestic financial institutions appears to be taking hold. A double-edged sword, this. The process could restore confidence and unfreeze the lending glacier, or it could undermine faith in banks and end up swelling mattresses around the world in a significant way.

The price dip to the $800 level stimulated a modicum of demand in the all-important Indian market, and proved once again that the price-conscious Indian buyers are gifted with market savvy. More of the same was also seen in the professional pits, where some buyers emerged ahead of the long weekend in the US market. News that South African production fell was largely offset by increases in Russian output and a significant drop in the gold market's vital demand component; jewellery fabrication.

Increasingly, the 2009 question shapes up as one that asks whether investment demand can offset slumping core demand and carry the day for gold prices going forward. For quick reference, please note that in 2007, some 2800 tonnes of bullion were absorbed by jewellery fabrication and industrial offtake. Investment demand -good as it was- took 933 tonnes from the market. No need to dwell on ratios, but it is clear that investment demand has some way to go before it becomes the dominant force in this little market.

Other dominant forces keep being wished for, mainly by newsletter vendors with a sales agenda. Mineweb's Lawrence Williams takes a closer look at some scenarios and tries to separate fiction from science fiction:

"Gold analysis and theorising is a hazardous exercise with the metal price seldom seeming to follow what would appear to many to be the logical path to new heights - and on the occasions it does surge dramatically, it then tends to come crashing down again, burning the fingers of many.  This is not to say that gold is not a good investment as has been shown by its overall performance against markets in general over the past year, and is not to say it will not regain its upward trajectory before too long, but some of the admittedly well thought out, and perhaps economically logical, theories put out by gold proponents, which would lead to a huge gold price increase, are still, in our view, unlikely to come about

Notable amongst these theories are two, very logical moves either of which would increase the gold price dramatically, but will they in fact ever happen? 

The first of these ‘solutions' is that China starts buying substantial amounts of gold in place of U.S. dollars for its huge currency reserve surplus, the logic being that long term dollar parities are likely to fall against most other currencies and this would be a way for China to protect its reserve position.

The second is that the U.S. Treasury and world Central Banks will impose a huge revaluation of gold vis a vis the dollar as a contributory element in easing the world's economic ills - a neat solution according to some well respected economic theorists.

The China point would seem logical to the investment community as this sector is so geared to material growth that it cannot see that other institutions do not necessarily think the same way.  From the Chinese point of view what is a trillion dollars here or there when one is sitting on so much?  One doubts that they are actually too bothered about maximising values here.  Politically, buying large sums of gold to replace the dollar would further destabilise the dollar and the U.S. economy, but this would undoubtedly also impact adversely on Chinese industry. 

To some extent this option has already been overtaken by events as the U.S. economy has contracted, and is still contracting, dramatically and China is catching a severe cold as a result.  If anything may convince the Chinese not to further destabilise the U.S. economy by buying huge sums of gold and thus add another major element to dollar devaluation too, then this would be a strong sign that it might be very foolish to follow this route.

The second theory which has surfaced is that, after years, so the theory goes, of conspiring to hold the gold price down, the U.S. Treasury and Central Banks may now be looking to very substantially revalue gold and control its sale.  This may not be as far fetched as it may sound to those used to operating in a supposed fee market economy as it mirrors steps taken by President F.D. Roosevelt to end the Great Depression.  Roosevelt ordered U.S. citizens to sell all their gold to the U.S. Treasury in 1933 - and then in 1934 ordered a 70 percent increase in the gold price from $20 to $35, with the U.S dollar fully backed by the U.S. gold holdings.

With President elect Obama a keen student of Roosevelt's policies, so the theory goes, he may well consider the same kind of dramatic move which would put huge amounts of cash into the U.S. economy, at the expense of printing more money, and huge amounts of gold into the U.S. treasury in return which should help prevent further dollar destabilisation despite the potentially inflationary impact of the enormous money supply increase.  The subsequent gold revaluation would, at a stroke, substantially improve the U.S reserve position.

For this to have an effect globally would require other Governments and their Central Banks to do something similar - the revaluation part of which would no doubt be approved of by those who have long berated as a conspiracy the supposed Central Banks' consensus in gold price manipulation to keep the price down.  But a ‘conspiracy' to manipulate the price upwards is, of course, another matter altogether!  However restrictions on the individual's right to hold any gold at all is perhaps a move too far for most to accede to in today's political environment.

It is doubtful whether a number other countries, though, could quite follow suit in terms of gold ‘confiscation', although there might be some kind of consensus in terms of gold price revaluation.

To an extent one would consider these ideas as ‘clutching at straws' by the gold bull theorists, however economically neat the latter solution may be as a help in curing the world's financial ills.  Given the recent unprecedented, and seemingly unsuccessful, moves by governments worldwide to try and kick start economies again, one cannot rule out such a dramatic move by an Obama administration looking for another financial experiment to try and stimulate the economy.  Politically, getting something like this through Congress has, to say the least to be problematic, but in these days where ‘free world' government controls over what citizens can and cannot do are continually increasing - who knows?

For the medium term, the global financial meltdown, and its continuation, will likely see a rise in gold price over the next half year, and possibly beyond, although a decline in jewellery fabrication and sales has to be a worry from a fundamentals point of view.  Global gold output, though, is still falling - a trend which is likely to continue - and with the gold majors all expressing confidence in the metal price, some dehedging will likely continue, although here the requirements of financial institutions to protect themselves on new project risk may see some forced hedging too which will mitigate the overall dehedging position.

Most of these factors are positive for gold, but as always its price progress remains unpredictable and may well be as dependent on the strength of the dollar as ever.  And the dollar has defied logic by rising despite the U.S. economy's travails.  Whether this will continue or reverse may be the ultimate bellwether for the gold price.

Having returned from China three weeks ago, we can dismiss the first theory based on first-person talks with local officials.

The second one, well, let's just say that back in the Roosevelt era, only 17 to 20 percent of the population turned their gold in as requested. Much of it found its way into Switzerland and into The Great White North. The rest keeps popping up in various gardens and attics where great-grandma stashed it. Today, an American investor can buy gold from a gold dealer in Canada, ask for his gold to be stored in Australia, sell it for euros, and take payment in Vanuatu or Barbados. Enforce this. Not unless you make it a worldwide all-out recall/confiscation. In which case, the pitchforks are likely to come out in various capitals.

We will not lose sleep over either theory at this time, thank you.


Jon Nadler
Senior Analyst
Kitco Bullion Dealers Montreal



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