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The Good, The Bad, and The Really Ugly

By Jon Nadler       Printer Friendly Version
Oct 3 2008 9:24AM


Good Morning,

Gold prices opened with a small $3.50 gain, quoted at $838 basis spot dealings. An otherwise robust 33-cent gain in silver to $11.18 has to be viewed in the context of the nearly dollar-and-a-half loss it sustained on Thursday. Platinum continued to suffer, dropping another $12 to $958 as the automotive sector looks increasingly vulnerable to the global economic contraction. Palladium was a small exception in the complex, adding $8 to $201 per ounce. Cash-starved banks were still seen hunting for dollars and finding them scarce.

Credit markets remain in a state of suspended animation, while equity markets remain as nervous as ever. All eyes will be on the US Congress and its bailout package vote later in the day. Headlines worth noting: Wells Fargo to replace Citi as Wachovia's new adoptive parent in a $15 billion stock deal that does not involve the FDIC. Switzerland's UBS exits the commodities business (how's that for being bullish on that sector?) and slashes 2,000 jobs. To be fair, the announcement comes at the end of a week during which copper - for example - put in its worst performance in two decades.

Following the severe beating they took yesterday, precious metals markets attempted to find some footing and found a [small] bit of it as the dollar slipped towards 80.25 on the index and crude oil found enough buyers to maintain it above $94 per barrel. Progress was slow during the overnight hours and the broken support of $850 now presents a resistance level. Fear not, all it takes is another day of hand-wringing in the global credit and equity markets and some more drama on the floor of the House of Representatives to get things moving. Trouble is, nobody really knows what direction and amplitude such moves may result in.

The air is still quite heavy with forecasts of recession, disinflation, deflation, and even the dreaded 'D' word has been used by some media outlets. George Bush may go down in the pages of history as a "war President" but the next occupant of the White House may well become known for being an "economic war President." Since the VP debate included precious few references to the on-going market mess, we will leave the punditry as to who is best-equipped to handle it to others. We suspect no one really is. Outside help will have to be called in sooner or later. The creation of a Patriotic Committee for Economic and Market Reform ought to be the first order of business for any new administration.

The Ottawa Citizen warns that -according to the IMF - "The United States, Canada's main export market, is likely headed for a deep recession, the International Monetary Fund warned yesterday in a report in which it notes that the current financial crisis there is the type that's most likely to lead to such a downturn, and suggesting the government's proposed bailout of the banking system is the right course of action."

It now also appears that the shot in the arm that the gold market expected to receive from seasonal Indian demand may well be in jeopardy - unless prices fall some more. We do recall fairly robust and early buying in India around the mid-$700's, but the latest from Reuters headline puts a damper on things, as it found that: " India's gold imports fell around 36 percent year-on-year in September as high prices curbed demand ahead of forthcoming festivals. Imports are estimated to be at around 64 tonnes, down from 100 tonnes last year, Suresh Hundia, president of the Bombay Bullion Association, told Thomson Financial News in a telephonic interview. The 'Navratri' festival, considered auspicious for buying gold, has marked the beginning of the festival season in India. Around 22 tonnes of unsold stock is still lying with the banks and will be carried forward to this month, said Hundia, adding prices will determine buying interest from the world's largest consumer of the metal."

In a sharp presentation at the LBMA Conference in Kyoto over the weekend, our good friend Philip Klapwijk from GFMS concluded that of the total gold fabrication demand of 3027 tonnes, fully 79% went into jewelry-making. Since the start of the breakout above $500 in gold prices, jewelry tonnage demand in the industrialized world has dropped from around 850 tonnes to near 600 tonnes.

Since travel plans may preclude the writing of an afternoon update, we follow yesterday's well-received Jonathan Weil piece, with...another one on the same topic. This one, gets right down to the nitty-gritty. Ponder it all weekend-long, as you prepare to start a "new/improved" week...

"If you think this bailout is expensive, just wait until you see the next one.

The $700 billion rescue plan approved by the U.S. Senate won't fix the core problem with the nation's ailing financial institutions. And it almost guarantees that you and I will have to pony up for an even costlier bailout someday, maybe soon, if the House of Representatives passes it tomorrow.

Treasury Secretary Hank Paulson has correctly identified the quandary: Lots of shaky banks and insurance companies are showing strangely high values for assets that aren't worth squat in the market. Many need more capital and can't raise it. And he's right in saying the outlook is grim if we don't get this fixed. What's stunning is how little the taxpayers would get in return for their money under Paulson's package, and how illusory much of the banks' newly minted capital would be.

Under the plan, Treasury would buy some companies' troubled assets at above-market values. To boost their capital, Paulson would have to pay the companies more than what their balance sheets say the assets are worth. Then other companies would use the rigged prices to write up, or avoid writing down, the values of similar holdings on their own books. So, the taxpayers get hosed on the asset purchases. Other banks use the trumped-up prices to cook their books. And investor confidence supposedly is restored.

That brings us to this question: Why would a smart guy like Hank Paulson -- the former boss of Goldman Sachs -- advance such a dumb, shady plan? Let us count the reasons:

No. 1: It delays our national reckoning until after the presidential election.

Paulson first floated a bailout Sept. 18, at the very hour when shares of Goldman Sachs Group Inc. and Morgan Stanley looked like they might go into a death spiral. It's not so much a bailout, as it is a timeout. He had to follow up with something, anything, to stop the freefall from resuming. It didn't have to make sense.

So it doesn't. The plan is about creating the illusion of stronger financial institutions, not strengthening them.

The banks know this. Otherwise, they would have stopped charging each other near-record rates for three-month loans by now. The reason they haven't is because they're still afraid their customers -- other banks -- might go broke.

No. 2: The reckoning will be worse than you can imagine.

If Paulson were serious about recapitalizing rickety U.S. banks, he would infuse them with hundreds of billions of dollars of fresh government money, in exchange for ownership stakes. And if he wanted to create market liquidity for all those troubled assets on their books, he would be ordering banks to disclose everything there is to know about them, so Mr. Market could figure out their present value.

He can't let that happen. Not now. If everyone could see how much the toxic waste is worth, the writedowns would be so huge that many banks would have to be declared insolvent.

Better to let the next administration deal with the clean- up. The trouble is, the longer the government waits to address the banks' lack of capital, the worse it gets, barring a miracle.

No. 3: He's helping his friends.

Is there any doubt? Let's see.

As of yesterday, Morgan Stanley Chief Executive John Mack owned 2.75 million shares of his company's stock, valued at about $67 million. If Mack can get Morgan Stanley to trade reams of sketchy paper for billions of dollars of our Treasury's cash, without diluting any of his stake in the company, who benefits?

Paulson would have us believe it's you.

No. 4: There's an excellent chance the Congress will pass it. Leave someone else to figure out the costs another day."

Latest news: Nonfarm payrolls dropped 159,000 - the largest such decline in five years. Demand destruction followed by job destruction. September's losses were double the average monthly loss for this year. Three-quarter million jobs have vanished in the US thus far in 2008. That is the really ugly reality to add to the already grim economic picture. Gold turned down on the news, and the dollar regained upward momentum. Safe bet: Many of today's voting Representatives will not be sent back to Washington to represent those with whom they will come face-to-face when they head home for the holidays. IF they return, they will be bearing some bruises.

Happy C-Spanning.

Jon Nadler
Senior Analyst
Kitco Bullion Dealers Montreal



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.