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Wanted: Rabbit-Proof Fence

By Jon Nadler       Printer Friendly Version
Oct 10 2008 5:54PM

www.kitco.com

Good Afternoon,

  Global markets continued to go totally haywire all day long, as confidence became harder to find than Waldo himself. As a result, lemmings. headless chickens, and rabbits galore made for the exit doors en masse today. Despite the televised address they got from a lame duck. Bulls or bears were invisible. Pigs were at some spa in California. Vultures circled overhead.   The data table of the day just might become this one:

Global gloom

Exchange

Loss

Nikkei 225
Hang Seng
ASX 100

FTSE 100   
CAC 40
DAX 30

9.6%
7%
8.3%

5.5%
6.4%
8%

To the above, we could have also added the Dow today - but only earlier in the day. As this is being written, the BIG dip to the 8,000 level is no more, and the market is UP by about 300 points - at 8867.00 - It has become a pointless exercise to try to write an article on market values anymore.

Values have changed 250 points between the time it took to write the word UP - and this period. Our suggestion: Take any sentence where values are mentioned, like, say, this one: Gold was _________________   at $ ______________ and insert your choice of words: UP / DOWN and numbers such as $825 or $933 or anything in-between. You are quite likely to get it right at any given time. That's the kind of day we have just had. (That 300 point gain we wrote about above? Oh, it's gone. The market is flat to down once again..

  The mass-stampede for the 'EXIT' doors by individual investors trying to salvage anything better than half of the former value of their retirement and investment baskets continued. It was about as frenzied as the sales of home safes at the local hardware store.   Who's to blame for all of this decapitated poultry-like behavior now? A number of behavioral economists have their fingers currently pointed at...you and me. Bad financial habits, fueled by the quest for "McStuff" plus the tendency to make decisions when aroused (in every sense of the word) turned many into the lemmings hurling themselves off the cliff these days. (Mind you, real lemmings have more brains than to do such a stupid thing.)  

Various governments have -by now- stopped tallying the cost of all of this and are trying bold new experiments in their quest to stem the bloodletting. This time, it really is the economy, stupid. The global one. Mr. Bush spoke to the lemmings this morning, and offered...more words. If only he had any credibility left. For now, ``The world is going to cash,'' said Frank McGhee, the head dealer at Integrated Brokerage Services LLC in Chicago. Investors are selling gold to raise dollars. There's just massive selling across the board.''

  Should it also fail, along with the imminent move to recapitalize the banks, the weathervane points towards more stern measures. Like, say, bank holidays. Interesting that Italy's Mr. Berlusconi heard it 'on the radio' that the G-7 were considering market holidays at some point in the future. Interesting. At some point -we do not know when- the word 'gold' will also come into play, in one form or another. Let's see who uses it first, and in what context. 

  This weekend's meeting of the " Magnificent (G) Seven" is likely to feature cucumbers on burnt toast and spring water as a side-dish to the heaping bowls of crow to be served. You can forget the caviar. No leader of any country in crisis wants to pull an "AIG spa orgy" at this juncture. The masses are watching. And seething.

  Gold turned negative -really negative- once again, in the midst of this Sturm und Drang. Maintenance of the $900 level became a moot point in the final trading hours of this darkest of Fridays in recent memory. The objective became to maintain the $800 level by late afternoon. Lows in late New York dealings came in at $825 per ounce, showing an $86 on the day. Not good. Not good at all. 

  If stock markets continue their current trend (the worst weekly loss in history for the Dow) then there is little doubt that margin call liquidations will continue to negatively impact gold and oil. The US dollar rose to more than 82.30 on the index. Oil? What's that? Fossil fuel trading at $79. No comment possible. Silver lost two and half dollars, sinking to $9.48 per ounce. Platinum fell $65 to $972. Palladium dropped $10 to $189 per ounce. In order to have industrial demand, we have to have some industries left. Right now, that very fact appears to be in doubt.

  Let's just be brutally honest and recognize that the ultimate "doomsday" scenario seems to have done very little for the metal thus far. Not to mention the white metals - most of which are heading for the basement on the above-mentioned economic apprehensions. We remain extremely skeptical about and are in disagreement with observers who are attempting to explain that which ought to be obvious by creating a putative "disconnect" between paper and physical prices. Make no mistake about this; the price of the gold Maple Leaf fell by the same $86 dollars that the spot price of gold fell by, today. And yes, they (the gold and silver Maple Leaf coins) will shortly by re-listed on this very website. For sale. Also, in case you missed it, The Perth Mint, producer of 10 percent of the world's bullion, doubled output in the past six months, joining a global push to boost production as investors seek protection from the credit crisis. Full story at: http://www.bloomberg.com/apps/news?pid=20601012&sid=asmvRlbfitV8&refer=commodities  .  Shortage of gold and silver. Aha.

  One of the clues we must take into account at this juncture continues to be quite visible in India. Locals are facing a festival season of very high prices as far as they are concerned. If they deem current price levels as unsustainable, they might abstain from shelling out their rupees. Forbes' Susan Lee ponders: " So what's up with gold?" (Thanks to our reader, Mr. Stear, for finding this piece -fresh off the printing presses.)

  "The last few weeks ought to have been stellar in the gold market. And, sure, as of yesterday, gold was decisively up from the mid-$700s a troy ounce, where it had been trading when the black days began. But that increase hides some weird goings-on.

Back on Black Monday, when Lehman filed for bankruptcy and shares of AIG (nyse: AIG - news - people ) dropped like a stone, gold hardly budged. On Black Tuesday, when the Reserve Primary Fund broke the buck, gold only managed a medium-tepid rally. Finally, on Really Black Wednesday, as the SEC shot the messenger by cracking down on the shorts, gold zipped up 10%.

But then on Utterly Black Monday, Sept. 29, when market skidded 7%, gold closed barely above $900. On Oct. 6, with a huge global washout in stocks, gold traded in the $870s. And now, three weeks after the crisis started, gold is still weakly flirting with the low $900s.

Need I say it? Shouldn't gold--during the greatest financial crisis since the Great Depression--be performing better? Jeesh, it hasn't even gotten close to this year's high of $1,000. Gold has a history of being safe-haven investment, but rather than a safe haven, it's looking suspiciously like an afterthought.

OK, maybe this isn't totally persuasive. But how about gold's other chief function in life--as an inflation hedge. Strange doings here, too.

When core Consumer Price Index increases were rather tame all last year, gold zoomed. It topped $1,000 a troy ounce in early March. But then, even as price indexes started warning about steeper increases in inflation, gold prices started drifting down--with a sharp fall starting in July.

My own moment of confusion came in August. The Producer Price Index for July showed a 1.2% monthly increase--that's tacked on to a 1.8% increase in June--bringing the annual rate of inflation to 9.8%. Ummm, that's getting uncomfortably close to double-digits. But gold barely moved up.

True, the relationship between gold and inflation seems to have come unhinged over the past few decades. From the late 1990s to 2005, for example, the nominal price of gold was below the inflation-hedge price.

This decoupling has generated lots of explanations--some worthy, some not. One of the most interesting is a paper published in 2006 by the World Gold Council. Two economists, Eric J. Levin and Robert E. Wright, looked at gold prices and inflation using data from 1976 to 2005. They scrutinized factors that might cause deviations: changes in the U.S. inflation rates, inflation volatility, gold's beta, credit risk, exchange rates, the gold lease rate and political uncertainty.

The answer? A one-to-one relationship between inflation and the price of gold in the long term--a 1% increase in inflation accompanied by a 1% increase in the price of gold. But the economists also found "considerable" fluctuation in short-term prices, and these fluctuations endure for quite a while. On average, it took five years for two-thirds of these deviations to disappear. Read the paper at gold.org.

Of course, as Keynes famously observed, in the long run, we're all dead. So allow me to suggest another view--one that makes sense if you look at supply and demand in the gold market in a slightly different way.
Please check out the pie chart below. Demand for gold for use in jewelry makes up well over half of total demand--65% to be exact. That towers over the second-largest demand slice of 15% for coin and bar. The third largest slice is 14% for industrial and dental uses.

Gold Pie-Chart

Demand for gold jewelry from Asia and the Middle East has been gangbusting for the past several years. Put strong demand against the slide in supply (production has been declining) and prices are bound to go up. But jewelry demand is also very price-sensitive. Jewelry, after all, is a discretionary purchase. No surprise then that when gold prices started zooming early this year, demand went limp, falling as much as 25%.

In August, however, demand for gold started perking up. Most analysts attribute the bump-up to buying from India, the world's largest demander of gold for jewelry. September, October and November are big holiday months in India (and in China, the third-largest market). Gold bangles are exceedingly popular; they're usually worn in pairs on both arms.

All of this suggests it is retail demand that controls the price of gold, not investment demand. Unless, of course, there are tons of people who want to wear their safe-haven inflation hedges on their wrists."

Gold must make a swift gain to at least $975 per ounce and remain above that level on a consistent basis in order to reflect current financial market conditions. Until and unless bullion comes to be regarded as the only viable currency by all individuals, everywhere, the values being talked about in the perma-bulls camp are not in the cards. Whether or not the metal comes into play as an asset that central banks might seek to hoard or mobilize in their attempt to right the world economic ship, remains to be seen. At the moment, the metal remains vulnerable to margin call sales and to people seeking plain old, ugly, cash. To put into that shiny new Home Depot-bought safe.

Individuals are selling assets without being very discriminating these days. Bullion is in demand by buyers who have neglected to line their nest eggs with it previously - that, there is little doubt about. However, when we have the largest consuming country virtually absent from the demand table, and the we add the investors who are now resorting to mobilizing their previously acquired metal in order to offset losses in their equity portfolios, perhaps the current prices are not as unwarranted as they might seem. The clash continues. The crash...that's another story. One that the weekend talk shows will surely cover in great detail.

Hey, it could be worse. You could be a G-7 member sitting down to discuss what to do about the lives and livelihood of the billions of your compatriots. In the meantime, do not open the brokerage statement that came in today's mail. Not without a chair nearby.

Please note that Kitco Inc. will be closed on Monday, October 13, 2008 in observance of Canadian Thanksgiving Day and US Columbus Day. Also, please note that both US and Canadian banks and Postal Services will be closed for these holidays. This writer will likely remain horizontal for the day.

As precious metals markets will be open for trading, you will still be able to place on-line orders at: https://online.kitco.com/

Happy Thanksgiving to our Canadian readers ! Let's give thanks for being alive, healthy, and for being together with our families.

Jon Nadler
Senior Analyst
Kitco Bullion Dealers Montreal

 

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Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.