As the Global Financial Crisis Continues, Diversify Some of Your Assets into Gold

Although the gold price has languished for past year or so, and even though it has remained relatively flat for the first three weeks of 2013, the global currency war has intensified and the financial crisis facing the Eurozone, US, UK and Japan has deteriorated, despite the rhetoric of financial leaders who want us to believe that things are improving remarkably well.

While many banks and financial institutions have been saved from bankruptcy thanks to the various bail-out programs, economic growth is still very sluggish despite the easy monetary policies of the major central banks.  The major central banks of the world are now determined to weaken the value of their respective currencies in order to maintain a trade advantage against other competing economies.

The policies of the US Federal Reserve as well as similar programs by the ECB, Bank of England (BoE), Bank of Japan (BoJ), Peoples Bank of China (PBoC) Swiss National Bank and the Bundesbank, have created an unprecedented era of unlimited credit creation which will destroy the value of fiat currencies. As a consequence, we will see a loss of confidence in the purchasing power of many existing currencies, a rise in price of many essential commodities causing an inflationary scenario which will create the ultimate financial bubble.

In such an economic environment, it is imperative to diversify part of one’s assets into physical gold. The fundamental case for gold has not changed. Exploding government debt and deficit spending are unsustainable without solid economic growth. Today’s policy makers are simply compounding the problem by pilling more and more debt on top of an existing mountain of debt.

“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved” 

-Ludwig Von Mises.

Up until the end of December the price of gold was stuck in the low $1,660s, near four-month lows, but that abruptly changed when a US Congress vote on a Senate deal to avoid the fiscal cliff — $600 billion in tax cuts and spending increases that were set to kick in on January 1 was agreed upon. Under the agreement, Bush-era tax cuts will expire for single Americans who make more than $400,000 and couples earning over $450,000. Even though taxes are rising, the move is seen as a plus for businesses and consumers because it provided permanent tax brackets. However, the deal contains no spending cuts, which the Republicans feel are essential for dealing with the country’s ballooning deficit.

After the agreement, the global gold market came alive and prices soared to $1,695/oz., its highest level since mid-December. The price of gold gained along with prices of most commodities as well as global equities. Brent crude jumped to a two-and-a-half-month high and the Dow gained around 300 points — it’s best-ever first day of annual trading.

Only a week later, gold prices reversed its upward trend, and dropped sharply when minutes from the latest Federal Open Market Committee (FOMC) meeting showed that several policy makers were in favour of stopping the asset purchases well before the end of 2013. They cited concerns about financial stability and the size of the balance sheet.

Then, prices rebounded in the wake of the latest non-farm payroll report and unemployment figure. Currently, some three weeks later, the price of gold is back above $1690 an ounce and looks set to test the $1700 an ounce level. 

While the price of gold may remain particularly sensitive to any new development in monetary policy of the US Federal Reserve or the ECB, the underlying fundamentals driving the price have not changed as I have explained above. However, there are traders on Comex who base their decisions on any piece of economic news causing short-term volatility in the price.  In the short-term we may see an attempt to hold the price of gold below the $1700 an ounce level, but this situation will not last very long and prices will resume their upward trend once again.

While there are analysts out there who are calling an end to the bull market in gold as it experiences its 12th consecutive year of price increases, they fail to see the deterioration in the global monetary system which is set to worsen this year.

While the dollar gains in gold in 2012 were not as impressive as some of the gains we have witnessed in previous years one must bear in mind that the price of the yellow metal increased against practically every fiat currency. The price of gold rose 7% in US dollars and was 4.9% higher in euro terms and 2.2% higher in sterling terms. Some of the other gains seen in gold prices versus fiat currencies included the following:                    

During 2012 the price of gold fell in seven months of the year and rose in five (January and June to Sept). Interestingly, gold’s biggest monthly rise was in January when gold returned 11.1%. 

Despite weak economic conditions, global shares rallied in 2012. However, the prices of these were artificially boosted due to central banks flooding the world with money.  Another market aberration in financial markets can be seen in the global bond markets. An example of this is the situation regarding Italian government bonds. By the end of 2011 the Italian 10 year bonds had jumped to over the crucial 7%. However, by the end of December 2012, the yield had dropped back to 4.234%, yet the country’s public debt had risen to an all-time high of over two trillion euros.  

More recently, according to a report issued by the central bank, Italy’s public debt in October 2012 had expanded to 2.015 trillion euros (USD 2.64 trillion) from 1.995 trillion euros in September. The figure shows a 3.7% rise compared to January of 2012. And, despite a worsening scenario in Spain, bond yields have also dropped substantially.

Under normal economic conditions, the deteriorating situation in countries such as Italy and Spain would see yields rise not decline. But, as the ECB has been buying this government debt, yields have been kept artificially low while bond prices are being propped up.

Only last week the euro gained against the US dollar after another successful Spanish bond auction. Spain managed to sell its maximum target of EUR 4.5 billion worth of bonds yesterday at lower yields. EUR 1.6 billion in five-year bonds were sold with a yield of 3.77%,  while EUR 2.4 billion in 2015 bonds were also sold with yield of 2.713%,  and on the long end, EUR 0.512 billion in 2041 debt was sold with yield at 5.696%. Also data from Bank of Spain showed that net borrowing from ECB dropped for the fourth consecutive month to EUR 313.11 billion in December, down from November’s EUR 340.84 billion. The data suggests that Spanish banks’ dependence on ECB funding continues to decline. Yet, unemployment in Spain is currently around 26% meaning some 6 million people are unemployed.

According to the Bank of Spain, missed payments as a proportion of total loans at Spanish banks rose to a record 11.38% in November, 2012. And, in an interview with La Razon newspaper Luis de Guindos from the Economy Ministry said GDP declined between 1.3% and 1.4% last year and will be flat or positive in the second half this year. Yet, despite this dismal news, Spanish bonds are being snapped up. Frankly, I would feel a lot safer with my money in gold.

As we enter this year, I urge individual investors to diversify some of their assets into physical gold. For as long as this financial crisis has been going on for, there have not been any signs of improvement. And, while gold trades at around $1700 an ounce level, buy as much as you can. For I believe that this time next year, prices are going to be considerably higher.

Please note that physical gold refers to gold bullion bars and coins, not numismatic items or limited edition medallions.

TECHNICAL ANALYSIS

As gold prices recover from the lows seen at the beginning of this year, they still need to break above the $1700 an ounce level.

By David Levenstein

About the author
David Levenstein is a leading expert on investing in precious metals . Although he began trading silver through the LME in 1980, over the years he has dealt with gold, silver, platinum and palladium. He has traded and invested in bullion, bullion coins, mining shares, exchange traded funds, as well as futures for his personal account as well as for clients.

His articles and commentaries on precious metals have been published in dozens of newspapers, publications and websites both locally as well as internationally. He has been a featured guest on numerous radio and TV shows, and is a regular guest on JSE Direct, a premier radio business channel in South Africa. The largest gold refinery in the world use his daily and weekly commentaries on gold.

David has lived and worked in Johannesburg, Los Angeles, London, Hong Kong, Bangkok, and Bali.
For more information go to: www.lakeshoretrading.co.za

Information contained herein has been obtained from sources believed to be reliable, but there is no guarantee as to completeness or accuracy. Any opinions expressed herein are statements of our judgment as of this date and are subject to change without notice.