The Goldwatcher

Professor Bernanke’s problem: In alarming testimony to the House Financial Services Committee this week Fed Chairman Ben Bernanke declared:  ‘We have a problem … the spreads between the Treasury rates and lending rates are widening, and our policy is essentially, in some cases just offsetting the widening of the spreads, which are associated with signs of illiquidity.’   

Maybe Bernanke’s real problem is that he is essentially a Professor and Professors we are told  can be  absent minded.  He has forgotten what John Maynard Keynes said about inflation:

.

‘The best way to destroy the capitalist system is to debauch the currency. By a continuing process of inflation, governments can confiscate,  secretly and unobserved, an important part of the wealth of their citizens.’    

Probably the most prescient and informative commentator on the house price bubble and bust in the US  Calculated Risk  conclude  today we now have a Bernanke Conundrum. This is it : ‘In the short term, the more he cuts short rates, the more certain long rates may rise.’ The calculated risk comment comes with an excellent video clip on Bernanke’s testimony and the associated economic woes facing the US – and by association the rest of us. 

The dollar is diving: The Goldwatcher book includes analysis on the economic consequences of 9/11 and George W. Bush. In spite of the terrifying trillions borrowed and lost over the last few years  part of me has always believed that the strength and resilience of the US economy would survive a few terms of unprecedented blunders.  But the plunging dollar suggests otherwise. Charts produced by Sharelynx even point to a risk of a free fall.

 Gold’s stateless money franchise is thriving:   Absent minded Professor Bernanke needs to refresh his memory. Otherwise instead of George Bush and Alan Greenspan,  who deserve the lion’s share of the blame, he could become the scapegoat for damage done to the capitalist system.  Because it affords  protection against uncertainty, the dilemmas that haunt central bankers and politicians, their collective amnesia and at times reckless actions gold’s stateless money franchise is thriving

Barack Obama and Matt Santos:

’Back to reality and the 1930s:When we move from fiction to reality similarities between 2008 and previous US Presidential contests end. There is no comparison with the election in 2000 when Governor George Bush campaigned on a platform promising federal surpluses in the trillions with a trillion dollars coming back to taxpayers. Or 2004 when Bush was re-elected after his political ally Governor Arnold Schwatzenegger branded critics  ‘economic girlie men’ and convinced voters ‘The American economy is the envy of the world. Pimco’s Bill Gross concludes in his February Investment Outlook that the US and global economies may ‘sleepwalk’ until a new a new administration is elected in late 2008. But ‘a resumption of prosperity as we knew it will be dependent on reforms of monetary and fiscal policy resembling the 1930s more than our past decade.’The Goldwatcher alerts readers to the prospect of economic and social problems to an extent resembling those Franklin D. Roosevelt confronted in 1933 with a solution on similar lines - massive dollar devaluation.

Martin Wolf, Financial Times Associate Editor and Chief Economic Commentator on $920 gold.

The consensus opinion on cheap oil and gold in 1999:  Headlined ‘Drowning in Oil’ a March 1999 Economist cover feature article, illustrated with a picture of oil gushing out of the ground,  distilled the key ‘facts’:# Oil was headed for $5  # It would stay there for a long time # Saudi Arabia would flood the world with cheap oil. When the Bank of England announced it would sell half of Britain’s gold in 1999 the price dipped to $252  from an average for the year of $280.

21st century oil price realities:  A Houston based  investment banker servicing the oil industry,  Matthew Simmons,  has for some years advanced  a different view to the consensus on where the oil price should be. In his book ‘Twilight in the Desert,‘ a key information resource for The Goldwatcher, Simmons made the case that Saudi Arabia did not have the capacity to expand production everyone took for granted. Simmons’s opinion is that over most the 20^th century oil was so cheap it was almost given away and that situation was bound to change.   In his 2008 presentation ‘Peak Oil – Is it real – when will it occur’  he poses  the question ‘Is $100 unfair?.’  In his opinion no - it’s not unfair. It equates to $0.149 per cup and is still ‘dirt cheap.’  And motor gasoline in the US at $0.20 a cup?   ‘It’s a bargain.’  After all how much do we pay when we buy a cup of coffee?   In a Bloomberg interview last year Simmons would not rule out the possibility of $300 oil.

21st century  gold price realities: Though the oil price surge on the 19^th February to above the psychologically important level of $100 was spurred by speculation on OPEC planning to cut output, reports  of a refinery explosion in the US and other current news, rising gold prices have reflected supply and demand realities.  We need to shake off the delusion that inflation relates only to the narrow consumer price inflation measure used by central bankers. Inflation is when things cost more and money buys less.  It’s arguable that over most of the 20th century gold was also so cheap it was almost given away.  .  RGE monitor have noted that since 2001 oil and gold prices have been rising in tandem. Oil by 267% and gold by 239%. Gold’s stateless money franchise hedges against inflation, financial market and security risks.

Gold and banking crises:   A sound reason for owning gold is the protection gold’s stateless money franchise assures against any systemic failure in the banking system. But what adds up to a systemic failure in the banking system? 

The banking crisis President Franklin D Roosevelt faced when he took office in 1933 is a benchmark.  A string of bank failures had led to a frantic run on the nation’s banks and the withdrawal of all available cash pushed the remaining banks to the brink of disaster. On March 5^th 1933, the day after he was sworn into office, Roosevelt ordered a “bank holiday” closing all the nation’s  banks for five days. An Emergency Banking Act passed by Congress on March 9^th gave him a firm grip over bank dealings and “foreign transactions.” Within a few days after the bank holiday ended almost 1,000 banks were back in business. The process of credit creation started all over again and prosperity was restored within a few years after Roosevelt devalued the dollar to gold by almost 70% in 1934.

The run of Northern Rock Bank :  When the British Northern Rock Bank’s flawed borrowing short term and lending long term business plan came unstuck in September 2007 we experienced the first run on a United Kingdom Bank in over 150 years. To prevent court liquidation the Chancellor was forced to fund the Bank with £55 billion (about $110 billion)  using taxpayer’s money. The fate of Northern Rock and the UK taxpayers billions still hangs in the balance. In Parliamentary enquiries on Northern Rock the Chancellor explained that Northern Rock’s failure would on its own not have amounted amount to systemic failure in the banking system. But, if there were runs on other banks as well a systemic crisis would  have followed. That’s why billions were lavished on saving Northern Rock. The UK Chancellor even guaranteed that no Northern Rock depositors would loose any of their money.  This afternoon the Chancellor announced Northern Rock will be nationalised as negotiations to reach a deal with the private sector have failed.     

Problems with the regulated monolione insurers: US monoline insurers that guaranteed duff US sub prime mortgage loans are now headline news. Their position is as dickey as can be. They must surely be part of the systemic risk jigsaw puzzle. But hope springs eternal and markets have taken the crisis in stride. Surely the US Fed, Treasury and Wall Street power brokers will sponsor a credible private setor  saviour to avert a crisis?  May be - may be not. Efforts in the UK to engage the financier Richard Branson and others in a deal to save Northern Rock and repay the Treasury failed - presumably because the package was not an interesting enough proposition for a private sector investor. Therefore if the UK Treasury values their $55 billion loan to Northern Rock at market value, as any private sector lender would have to, the Treasury will be showing a frightful loss. 

Regulatory Failures: A big un addressed problem hidden on the back burner concerns systemic failures in our regulatory systems that allowed the Northern Rock, sub-prime mortgage and debt securitisation fiascos in the UK, US and elsewhere to occur. A blind regulator would have recognised the house price bubbles on which much of the lending depended. But until Eliot Spitzer’s article,  quoted in the post below,  and his testimony to a House Committee in Washington on the same day it wasn’t clear why the authorities were so myopic. Now we know why. Big government budgets need big tax revenues and, given a free rein,  investment bankers in Wall Street and the City of London produced the mega profits that boosted tax revenues. 

The big question mark –  Unregulated Credit Default Shadow Insurance Exposure

An article in today’s New York Times written by Gretchen Morgensen highlights another pending systemic crisis. The under and unregulated credit insurance market. The numbers are alarming. The market grew from under $900 billion at the turn of the century to $45.5 trillion.  By comparison that’s more than double the $30 trillion capitalisation of the US Stock Market – 10 times larger than the $4.5 trillion US Treasuries market & about 7 times larger than the $7.1 trillion US Mortgage Security market. IT IS UNDER REGULATED AND TO AN EXTENT UNREGULATED.  An inkling of what can go wrong in this market came last week when the insurance company American International Group made a provision for a loss of $3.6 billion to cover credit default swaps it had incorrectly valued. The NY Times article outlines problems with credit default swaps that include uncertainty about the status of counterparties, not even knowing who will actually foot the bill if there are claims and parties in the chain still unidentified 30 days after a transaction. 

Morgensen includes this comment from an insurance executive in her article: “This is just a giant insurance industry that is under regulated and not very well reserved for and does not have very good standards as a result. I think unregulated markets that overshadow, in terms of size, the regulated ones are a real question mark.”

The Goldwatcher agrees.

 # Note at 8 p.m. GMT -  As the above posting went on line the announcement of the Nationaisation of Northern Rock was made. The posting has been modified to accomodate the news.

How the Bush Administration aborted efforts to protect borrowers: In an op ed contribution published in the Washington Post today New York Governor Eliot Spitzer wrote: ‘When history tells the story of the subprime lending crisis and recounts its devastating effects …the Bush administration will not be judged favourably..it will be judged as a willing accomplice to the lenders who went to any lengths in their quest for profits. So willing, in fact, that it used the power of the federal government in an unprecedented assault on state legislatures, as well as on state attorneys general and anyone else on the side of consumers.’ Spitzer recounts that when investigations on predatory and unfair lending practises were initiated the Bush Administration went as far as to prevent them from protecting their own residents ‘from the very problems to which the federal government was turning a blind eye.’ 

An 1863 Law with new rules promulgated to protect banks:  When State Officials set out to combat lending abuses,  at the height of the predatory mortgage lending crisis in 2003 , the Bush Administration invoked a clause from a 1863 National Bank Act and promulgated new regulations to outlaw their initiatives. As a result States were even precluded from enforcing their own consumer protection laws against national banks. 

 A Chapter in The Goldwatcher addresses the economic consequences of 9/11 and George W. Bush. In a nutshell his administration needed, aided and abetted the activities of banks profiting from inflating the housing bubble.  Spitzer writes that ‘the mantra of the banks and their defenders was that efforts to curb predatory lending would deny access to credit to the very consumers the states were trying to protect.’ The Goldwatcher would rephrase Spitzer’s comment and say putting  the brakes on the economic growth it touted to support its claims of successful economic management would not have suited the Bush Administration . So,  instead of protecting consumers,  they protected themselves. Another reason why people are now protecting themselves by including gold in their holdings. 

Frank Holmes explains in a posting on his Frank Talk Blog yesterday that  the wise crowd around the world, including institutional and private investors,  ‘have been buying gold as a safe haven from currency risks and the trillions of dollars invested in derivatives, and as a way to recycle petrodollars.”

He charts the growth in holdings of gold through Exchange Traded Funds to illustrate a pattern of increased activity that can be tracked to the inception of the funds in  2004 - long before our current economic woes erupted.

Differentiating the ‘wisdom of crowds’  to often flawed consensus thinking Holmes notes:  “Believing in gold does not derive from a fixed formula and it is not a managed process. Investors acting in their own best interests take in what they see as relevant information from a variety of sources and analyze it to arrive at an individual viewpoint that they can act on. This independence minimizes the chances of crowd madness.”

Gold price expectations:

 Global catastrophists see $10,000 on the horizon for gold.  Raging bulls are looking north of $2000. Even the tamest of bulls have $1000 in their sights. To be sure, there hasn’t been a time in living memory when supply and demand fundamentals for gold were as positive as they are now, but in 1980 and 1981 there were some similar conditions to 2007 and 2008.  Lame duck US Presidents in office till the imminent end of their disastrous administrations (Carter and Bush). Global economic problems.  Geopolitical insecurity in Iran  and Afghanistan. Surging oil prices. Rising inflation and a falling dollar. 

Gold isn’t expensive at  $900 or $1000 dollars  compared to 1981. The $460 average gold price for 1981 equates to $1000 in 2008 dollars after allowing for consumer price inflation. The price spike in January 1980 to $860 equates to $1900 in 2008 dollars!

In 2008 we must add to our serious worry list nuclear and other risks from Pakistan. We must also add to our list of the virtues of gold’s stateless money franchise a U.S. Fed Funds rate now below the rate of inflation and surging wealth in regions traditionally addicted to gold. They include Middle East, Russian and other petro dollar mega rich oil exporting countries and,  of course China and India,  the world’s most populous nations and fastest growing economies

The LBMA price forecasts for 2008:

Where is the gold price going from here? The 2008  London Bullion Marketing Organisation annual survey of analysts is a useful guide to prospects. The average of the forecasts for 2008  is $862 – up appreciably from the $652 forecast for 2007. Over half the contributors also expect gold to reach prices above $1000 in 2008. Forecasts in the LBMA survey are all supported by reasons for conclusions reached. The track record of the forecasters over the last few years can also be reviewed. 

Commentary from the experts:

BlackRock Merrill Lynch Managing Director Evy Hambro manages  the $15 billion World Mining Fund. The fund rose the most among Europe’s 10 largest stock funds last year. Hambro gives a clear account of the powerful supply demand factors supporting gold in an interview in the February 2^nd  edition of Money Observer.   He describes the prospects for gold as beating anything he has seen in his career and expressed similar views in an interview with Bloomberg Television early in January.

Frank Holmes, co-author of The Goldwatcher, presents comprehensive analysis on supply and demand for gold in a web presentation ‘What’s Driving Gold.’   Contrarian investors have consistently scored the best results with gold and Frank Holmes’s recent comment on being an ‘Intelligent Contrarian.’ is a must read. He warns on market over reactions ‘when the media works itself into a frenzy—either bullish or bearish’ and advises investors in gold shares to buy at ‘wholesale prices’ and sell at ‘fairytale’ prices.

As issues are seldom black or white different perspectives on a subject are essential. The Economist January 24^th edition features two perspectives on the global economy. Commentators have latched on to the dire story ‘It’s rough out there’ addressing the scary panic in financial markets.  However another article in the same edition ‘Somewhere over the rainbow.’ has been ignored. In that article The Economist looks behind the headlines and finds  a world  unexpectedly prosperous and peaceful.

Gold price overshoots and undershoots:     

The average price for gold over 2006 and 2007 was $540. With gold at over $900 it is up about 70% on that average. Nothing to say it won’t go higher fast if there is a catalyst for a further  rise - or if buyers or speculators are enthusiastic enough to drive the price further regardless. But,  while fundamentals certainly support strong prices,  gold may not continue to surge at a breathtaking pace. Price overshoots and undershoots are par for the course in currency and commodity markets and,  with over fifty e-mail messages on the death of the dollar and future astronomical gold prices coming in the e-mail every day, gold may no longer be a pukka contrarian investment opportunity. Prospects for the gold price are certainly good. But following the herd to the bandwagon doesn’t always pay.

Part One of The Goldwatcher comprises Ten Chapters with background information on  when gold prices make sense and when they don’t. Yes, there is a danger of a Wile E Coyote moment with the dollar falling over a cliff and plunging,  but the market has known about it for some time and the dollar has already fallen considerably.  A February 2007 video interview with Paul Krugman delves his views on risks to the dollar including a plunge.

Publication of The Goldwatcher.  

 Thanks to the evolving sub prime mortgage, securitisation, shadow banking and regulatory failure crises that evolved over the second half of 2008  it took me much longer to write my contribution to The Goldwatcher than was expected  - or intended.The book is in production now and will be on sale by May