Gold Pressure Near Breaking Point

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The demand pressure slowly yet consistently building over the last year has created some remarkable pressure to the upside on the price of gold. With recent announcements by Iran that their foreign reserve holdings are being converted to gold, and the record purchase of $3.5 billion by unidentified Saudi Arabians over a two week period, it seems remarkable that gold continues range-bound trading in the low 700s.

The demand pressure slowly yet consistently building over the last year has created some remarkable pressure to the upside on the price of gold. With recent announcements by Iran that their foreign reserve holdings are being converted to gold, and the record purchase of $3.5 billion by unidentified Saudi Arabians over a two week period, it seems remarkable that gold continues range-bound trading in the low 700s.

Recent coverage of the gold market by mainstream financial stations such as CNBC and Fox News indicate that the discrepancy between the COMEX spot price and the average price for gold bars and coins (US$900+ on Ebay, for example) is starting to make even the most stalwart feeble-minded news anchors see what two plus two equals.

So the forces building that will take gold through $1500 within the year and likely much further are compounding with every day that the global economy slides deeper and deeper into depression. The United States must continue its desperate efforts to saturate the economy with USD while its value is high because when the repatriation of those same dollars ebbs on the conclusion of the widespread and ongoing deleveraging-induced asset selling, the crash of the dollar will begin.

In my estimation, that will probably not occur until the New Year, because the Bush administration will be in full gear trying to salvage a favorable conclusion to 8 years of ham-fisted fiscal mismanagement.

Barrack Obama will inherit the messiest administration in terms of financial order since Roosevelt and will be faced with a conundrum: Stop the economic window dressing tactics of the Bush administration and let the inevitable unfold on his watch, or else continue the various ruses to buy time and perhaps find a miraculous solution.

It is to all of our advantage to stop the limp capital infusions as soon as possible and let the bottom rise up to meet us sooner rather than later. The natural corrective forces to start recovery will kick in only when the massive global over-capacity of production is allowed to contract through financial collapse. As painful economically as that will be, at least a recovery can begin when the U.S. Dollar is properly devalued to reflect its excess currency in circulation relative to the national balance sheet. G20 holders of the fragrant paper bearing the image of George Washington will have to bite the bullet and realize a massive devaluation in their foreign reserve holdings a condition they are reluctant to embrace. That reluctance is facilitating an artificially high dollar value, and also abetting the equally false low gold price.

The bailout tab for the U.S. economy alone stands at $4.3 trillion. Prior to the onset of fund asset liquidation, the U.S. Dollar was in serious decline thanks mostly to its malignant current account deficit that is so malignant as to be terminal.

If we now add another $4.3 trillion to the liability side of the balance sheet, such is the additional impact on monetary inflation. U.S. Dollar purchasing power will begin to decline in the new year, and that will add yet more underlying pressure to gold demand.

But the real explosive force is the still-swelling and still-unregulated derivative market.

Now at an incomprehensible US$ 684 trillion, this is the metaphoric elephant in the room.

There is little doubt the Obama will tackle this suicidal exposure with regulation. Much like the Great Depression that started with the stock market crash in 1929, overzealous bankers who at that time were buying securities from risky firms and then recommending and reselling them to their clients had to be reigned in after much of the banking in the U.S. collapsed by 1933.

Note that the height of the banking crisis occurred 4 years after the onset of the stock market crash. By 1933, 4,000 U.S. banks had vanished.

The Glass-Steagall Act of 1993 was passed into law and it prohibited banks from selling securities, and investment firms from becoming banks. In the present crisis, the opposite has occurred, and now banks can become investment firms and vice versa.

Glass-Steagall was repealed in 1999 and replaced with the Gramm-Leach-Bilely Act of 1999, which made significant changes to Glass-Steagall. The 1999 law did not make sweeping changes in the types of business that may be conducted by an individual bank, broker-dealer or insurance company. Instead, the act repealed the Glass-Steagall Act's restrictions on bank and securities-firm affiliations. It also amended the Bank Holding Company Act to permit affiliations among financial services companies, including banks, securities firms and insurance companies. The new law sought financial modernization by removing the very barriers that Glass-Steagall had erected.

In 1997, Brooksley Born warned in congressional testimony that unregulated trading in derivatives could "threaten our regulated markets or, indeed, our economy without any federal agency knowing about it." Born called for greater transparency--disclosure of trades and reserves as a buffer against losses.

Born was appointed to the CFTC by Clinton and served alongside Fed Chairman Greenspan, Rubin and SEC Chairman Arthur Levitt on the President's Working Group on Financial Markets.

Instead of heeding the advice of the very independent and tenacious Born, her powers were limited and she ultimately left the CFTC to return to private practice.

To individuals who have the bulk of their net worth in gold, this will come as a blessing in disguise. Since the derivatives notional volume continues to increase, the explosive pressure on gold is theoretically building at exactly the same rate. At some point, its going to blow, and the long-maligned gold supporters will have more than just their day in the sun. Many will conclude that they were right all along.

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