Will Gold Benefit from Calmed or Crippled Confidence?


Some believe that the repairs being done via de-leveraging are all that is necessary to repair the damage fully. We disagree strongly... Consequently expect the gold and silver market from now on to become increasingly attractive for good reasons.

The gold price has continued to look solid in the $650 area. Confidence in the banking, not just the mortgage system was given quite a blow last week. The $ rallied, but is in the process of turning down again. What lies ahead and why? Here are some of our views, which were published in the latest edition of the Gold Forecaster last week. These views are now being expanded there, with a closer look at the two types of “liquidity” supply.

Continued reliance on the consumer.

But we are led to believe that the U.S. residential property market has not yet found its bottom and may yet experience a ‘shunt effect” still as the tightening restraint on homeowners is still to be felt and could spill over into less consumer spending. [Reports coming from Wal-mart appear to confirm this] As consumer spending has driven the entire growth of the last few years, in the U.S. and across the globe there is no reason to believe this will change. So when the consumer pulls in his spending horns growth will undoubtedly suffer. The last attempt to resuscitate the consumer was lower U.S. interest rates and vast tax breaks in the States. Paradoxically, this led to stimulation of cheap imports first, and to rapidly increasing growth in Asia, before it benefited the U.S. What will the Fed and the Administration do when they see consumer exhaustion again?

For political reasons expect more of the same. The Fed and the Administration will do all in their power to calm confidence and accelerate slowing growth. They will have to be vigorous about this too.

For the simple reason that it is so much more difficult to bring rising growth back into the economy after confidence is shaken, expect the Fed to drop its anti-inflationary stance and to stimulate by dropping interest rates heavily over time. A deeper or persistent credit crunch might well lead to an interest rate cut. In the futures market, traders went from predicting that aninterest rate cut was unlikely next month to forecasting that it was all but certain by September.

The $ going forward

What was not fully appreciated last week was the fact that there were two financial tsunamis. The first saw a flight from emerging market assets back to the $ and the second was a flight from the $ back to the Yen. This softened the rise of the $ considerably when you consider the $ rose 74% but the Yen rose 7%. Imagine if there had been no withdrawal from the $? Imagine then that after the $ had shown its full strength, the flight to the Yen pulled it down. But we were spared this, with the $ rising only 4%. It seems that the picture is changing back to the fall side again.

Once the de-leveraging flow of the U.S. $ back to the States is complete and the tide turns, leaving the $ affected by lower investments from foreign national, the pressure from the Trade deficit, we then expect the $ to resume its fall from the new opportune levels.

Confidence has broken down in debt markets. Has it been crippled? Banks have tightened credit standards. In our penultimate issue we wrote about the dangers of re-financing, the rising cost of insurance of these funds, so warning our subscribers of the dangers coming. An injection of liquidity does not restore confidence it takes the sting away yes, but once bitten, twice shy. The breakdown in trust is threatening to spread to other markets, but the Central Banks are trying to contain it, but can they?

There is no reason to believe that the authorities are going to take the necessary action to repair confidence other than to support the banks and bank products. Other leveraged investment areas will have to look after themselves, we believe.

The Investment climate going forward

What is this climate from hereon? — The bulk of markets will continue skittish, often overreacting on bad news with dealers and speculators making matters worse. This should lead to unabated high volatility in most markets.

— Easily lost confidence in all leveraged markets. But the dropping of investments in these sectors will lead to the taking up of assets that do well in times of crisis and low confidence periods.

— Gold and silver [making current levels very attractive] will benefit in a slowly increasing charge as the extent of the structural fractures become clear. The continuous worry, after the dust has settled in the banking and hedge fund sectors, will prompt the wisdom of investing in gold and silver.

— The fundamentals on the falling $ will encourage foreign investors to look across the globe for safer homes than the $ and Treasuries [possibly to the € and German bonds and the like]. This is the beginning of many financial Tsunamis we have been writing about for some time now.

— Whilst most Central Banks will intervene in the foreign exchange rate market to hold exchange rates within target ranges, there remains the danger of huge pressures on exchange rates, as the “carry trade” unwinds or switches to new countries. Initially we are seeing the $ strengthen as ‘riskier’ and more liquid assets are sold and the proceeds return to the States to find a home in Treasuries. But then we could well see the further unwinding of the Yen “carry trade” and pressure hit the $ as the $ is sold and the Yen bought.

— Thereafter, expect to see flows out of the States to places like the Eurozone.

— The U.S. Trade deficit will continue to undermine the $, so we must keep our eyes on the Capital account of the States to see foreigners reactions and actions on the $ [albeit after the event]. With a lower confidence level in the $, the deficits will have greater impacts on the $ exchange rates.

— Banks with their heightened awareness of the growing risks, will impose harsher credit criteria and make even business loans more difficult to raise or to keep in many developed nations across the world, not just the States. This will exert downward pressure on growth.

— We firmly believe that despite all of this the Fed will fight a downturn even at the expense of inflation.

— The growing prospect of a fall in U.S. interest rates followed by those overseas [it has begun to show up in short-term rates. This could turn the markets around strongly to the upside if it is a sufficient drop in interest rates. But this will not be enough to repair confidence unless the falls are large and sharp. The price for this will be a plummeting $ exchange rate, setting off crises elsewhere.

— The realization that this is not just a U.S. liquidity crisis but a global one is apparent by the actions of the European Central Bank in supplying hundreds of billions of the € to markets starved of liquidity.

Is this liquidity crisis a temporary situation, no, not at all! Since the inception of Gold Forecaster – Global Watch we have pointed to the development of systemic problems across a broad front. Some believe that the repairs being done via de-leveraging are all that is necessary to repair the damage fully. We disagree strongly, saying this is a systemic problem that is now being patched up only. Consequently expect the gold and silver market from now on to become increasingly attractive for good reasons.

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