In the same year we saw the arrival of emerging nation’s central banks into the gold market as buyers. Since then they have set a pattern of buying gold that continues as a driving force behind the gold price even today. In this article we look at these events and other monetary developments in the gold market to see what to expect in the days and months ahead.

Which Central banks are buying gold and why?

As you have seen in our newsletter in the Table of central banks buying and selling gold it is the emerging nation’s central banks, whose reserves have been growing strongly that have led the way in buying gold for their reserves. Their aim is to diversify away from the U.S. dollar and other leading world currencies and to buy gold as a counter weight to those currencies.

These central banks are based in Asia, the Middle East, South America, etc. They include:

Russia – Bangladesh – Philippines – Saudi Arabia – Thailand – Belarus – Venezuela – India – Sri Lanka – Mauritius – Mexico – Bolivia – Colombia – South Korea – Turkey – Kazakhstan – Tajikistan – Serbia – Ukraine – Mongolia – Malta – Greece  – Argentina.

The underlying reason why all of them are buying and why the European signatories to the Central Bank Gold Agreement stopped selling is because they all consider gold to be an important Reserve Asset and as the head of the Bundesbank put it, “gold is a counter to the swings of the dollar”. Neatly put, but isn’t there more to this than simply countering the swings of the dollar. Since gold was at $300 an ounce in 1979 right through to 2005 gold has been at that level or higher. Now it is at $1,660 five and a half times higher and the dollar is not five and a half times lower than other currencies. Gold has risen in all currencies including the euro which was well below €300 to an ounce of gold and is now at €1,321 more than four times higher than then. It has risen from $35 an ounce since the sixties a rise of 47 times!

Clearly, gold adds further ingredients to national reserves as these numbers demonstrate in part.  The emerging world is as aware of gold’s value in their reserves as are the developed world’s central banks and are doing something about it before there are potentially devastating developments in the global monetary system.

Why do the central banks of the U.S., Germany, France and Italy hold 70%+ of their reserves in gold?

Having stated that they were sellers of gold from 1999 onwards through until now, Europe’s signatory central banks to the CBGA gave the impression before 1999 that their gold holding weighed heavily above the gold market. This combined with accelerated mining of gold then as the price was dropping, forced the gold price down and pushed the developed world to more and more dependence of the dollar then the euro. But in reality central banks were not trying to get rid of their gold holdings. Some aimed at selling 20% of their reserves in total, while others like Germany, did not sell any of their gold, despite being signatories to the agreement.  Some like the U.K. and Switzerland appeared to gullibly sell half of their reserves.

Then in 2009 all the signatories stopped selling except for small amounts for the minting of gold coins. This left the holding of European banks at these levels: -

For such an archaic reserve asset, it is doing very well in terms of its price moves. But the governments of the developed world knew that if their 40-year long experiment with un-backed paper money were to go wrong then gold could come to their rescue and, my goodness, it has!

The now incumbent money managers may well feel surprised at the way we have described currencies [as an experiment?], but since Nixon cut the link of gold to currencies back in 1971 that’s what we’ve had. Now, the money experts and leaders of the world, looking at the way governments across the developed world have abused this paper money and particularly national debt levels, they too can see the sinking level of confidence in such money both inside and outside the developed world. What can pull them from the brink of disaster if confidence in the two leading developed world currencies [and leading reserve currencies] collapses? What can pull the world’s leading commercial banks, particularly those fused at the hip to government [in their asset portfolios], from collapse?

Having watched the credit crunch morph into the Eurozone debt crisis and potentially return across the Atlantic by year’s end to see the U.S. once again fighting over-indebtedness, developed world central and commercial banks realize that whatever their dislike of the discipline of gold and its unmanageability, it will allow them to harness a confidence that currencies are failing to do. Gold is also facilitating loans and liquidity that goes far beyond its price.

The structural benefits of gold are now showing clearly in gold and the need to side-line it from the monetary system is now proving a dangerous handicap for the monetary system. Hence Basel III discussion taking place now, to be implemented from January 1^st 2013.

In the second part of this article we look at: -

-         Basel III and its implications for gold and its price.

-         How gold is returning to the monetary system right now in the banking system.

-         Will the ‘powers-that-be’ continue to allow gold to be privately owned [including in gold ETFs?

-         How can you protect yourself against confiscation of gold, even if held in Switzerland or elsewhere?

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 Legal Notice / Disclaimer

This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment.  Gold Forecaster – Global Watch / Julian D. W. Phillips / Peter Spina, have based this document on information obtained from sources it believes to be reliable but which it has not independently verified; Gold Forecaster – Global Watch / Julian D. W. Phillips / Peter Spina make no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of Gold Forecaster – Global Watch / Julian D. W. Phillips / Peter Spina only and are subject to change without notice. Gold Forecaster – Global Watch / Julian D. W. Phillips / Peter Spina assume no warranty, liability or guarantee for the current relevance, correctness or completeness of any information provided within this Report and will not be held liable for the consequence of reliance upon any opinion or statement contained herein or any omission. Furthermore, we assume no liability for any direct or indirect loss or damage or, in particular, for lost profit, which you may incur as a result of the use and existence of the information, provided within this Report.

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Since then the process has moved forward with 28 Spanish banks downgraded by Moody’s ratings Agency, while the Spanish government has formally asked for financial assistance from the E.U. Cyprus now makes the fifth E.U. member to put its hand out for a bailout. Italy’s borrowing cost jumped to new highs too.

What are we really looking at in the Eurozone crisis? We ask this question knowing that this story is being played out in Europe first, to be followed by the U.S. then the rest of the world in time, as they are part of the same global monetary system. The Eurozone crisis is a confidence crisis among banks and nations, followed by asset and debt deflation, as the loss of confidence is priced in.

Filling Money Holes Isn’t the Answer

A look back over the past five years shows that we have seen central banks and governments use quantitative easing in an attempt to stimulate economies while ameliorating the loss of asset value that started with the housing bubble bursting in the States, then mortgage linked securities losing huge value, dragging down the owners of those now-toxic debt assets, including banks, into bankruptcy.

The Fed has been careful to simply fill the hole left by the deflation and add no more new money than that. As it is, the Fed’s intention was the business would then be as usual, but instead these banks did not lend to the economy, they lent back to the government. The same happened in Europe, but there some governments approached junk status as borrowers, sending interest rates for those nations rocketing to unsustainable levels. Thus the noble purpose of quantitative easing was perverted by prudence, caution and the need for self-preservation. Now we sit with a healthier U.S. banking system, but a barely growing economy. In Europe we see a far worse picture where confidence is sapping by the day.

Gold, Silver’s Performance During the Last Five Years

During these last five years, what impact did this have on gold and its price? Firstly, after the initial impact of the ‘credit crunch’ hammered investor’s abilities to invest and pulled the gold price down to $1,000 from $1,200. It then turned around and for the next four years soared up to $1,900, before correcting again in the face of a greater ‘credit crunch’ back to $1550, where it is close to now. The Eurozone crisis is that ‘rose by any other name’, a ‘credit crunch’. And it is not being resolved, but worsening.

Silver, being the long shadow of gold, moved in a more spectacular fashion, moving in since 2005 from $6 up to a [false] peak of $49, before pulling back to a low of $26 today.

Gold, silver thus performed their age old role of broadly ‘measuring’ and holding ‘value’ during these tempestuous times and will do so in the future.

Not only did Christine Legarde, head of the I.M.F., refer to the need for value to be determinable at all times, but the head of the World Bank, Mr. Robert Zoellick, last year suggested that gold should be a value-anchor for the global monetary scene. We cannot stress enough the need for measuring rods that are reliable and beyond the ability of the political and monetary authorities to debauch. Without it there can be no stability or foundation for real growth and enterprise.

Mr. Zoellick and we suspect Mme. Legarde will be ignored by the central bankers of the world, except for those of the emerging world who started to buy gold in significant tonnages since 2009. Why haven’t the developed world central bankers said anything with regard to gold? They don’t need to because gold in the reserves of the leading nations in the world reaches as high as 70% of those reserves, with the E.C.B. requiring 15% of its reserves to be held in gold. It is higher now, because of the recent price rises of gold.

While silver is not a monetary metal in the eyes of bankers worldwide, it’s considered a hedge against paper money by the poorer investors worldwide and has performed accordingly. It’s also likely to stay off the central banker’s radar screens until the monetary system reaches the brink of collapse. But expect it to rise alongside the gold price during that journey.

New Money a ‘Cure’?

So to understand this entire process properly, we have to understand the ‘cure’ put forward –namely replacement of value by additional sums of newly-printed money. The principle applied was that, if the loss of value was replaced in bank’s hands, then the problem would be solved, provided some adjustment was made to the regulations governing banks. The banks subsequently recovered and prospered but they did not carry on business as usual, within the broad economy.

On both sides of the Atlantic they took the new money and pushed it back to government and did not send it out into the broad economy. On both sides of the Atlantic growth stalled and while a recovery was trumpeted, it was a hormone-free recovery that is barely recognizable as such, five years on. Many nations are in recession if not depression and in the best of the developed world have a recovery that can barely keep up with population growth. Please note that the central bankers have done a good job, but one that could never succeed without the governments supporting that efforts by driving the economic growth. They haven’t and as is the wont of people today, they are targeted for blame by politicians, who have done an abysmal job of promoting growth.

Quantitative easing has certainly stopped an economic collapse, but has not produced growth. Growth is needed if the developed world economies are to truly recover and there is little sign of true growth. Yes we see money growth but that isn’t the same as the broader economy will tell you. It’s on-the-ground-production that gives growth. Money growth should produce that but if government-generated Q.E. is where the growth is coming from then it is serving merely to mask a slow, osmotic, shrinkage of the economy and economic confidence. We’re seeing a ‘stalling’ of economic growth in the U.S., a recession in the U.K. and several national recessions in the Eurozone. A much better measure of growth comes in the form of such measures as factory capacity usage, employment figures, disposable income expenditure levels and the like. These define growth in the broad economy down to the consumer.

If a bank balance sheet is healthy but they are reducing lending out into the broad economy that is a sign of economic shrinkage, which leads to a compounding of that shrinkage. This’s what happened to all that new money added to the system through Q.E. It’s still in the banks and in government bonds and bills.

It has not reached the on-the-ground producer of wealth, the consumer. In the U.S. it is the consumer that accounts for 70% of the economy. He is still struggling with the loss of wealth in his house and his business and getting little help from the top. While the government and banking industries are looking relatively sound, they are unlikely to contribute effectively to the broad economy for years to come.  While the objectives of government and finance are so separate, this won’t change, it’s structural.

Political Solutions

It is with amazement that the vaunted political systems on both sides of the Atlantic have failed to produce united governments capable of producing economic growth that would have resolved the money crises of the last few years.

• The U.S. has been mired in a political gridlock that has emasculated government throughout its present term and promises little more in the next term.
• In Europe, the political nationalism of each member has shown a degree of disunity that prompt and effective solutions have evaded all their attempts to rectify their debt crises.

There is little in the somewhat bureaucratic actions in both blocs that inspire sufficient confidence that can steer the developed world back to economic prosperity. Meanwhile, confidence continues to decay alongside the monetary systems at banking and sovereign levels.

We feel that the path forward is more loss of confidence and value for national assets and currencies, until it gets out of control and turns into the “Black Hole” of deflation that this series is about.

Member’s only:

Part 3

• ·         The “Black Hole” of Deflation turns into runaway Inflation
• ·         Loss of asset value hits cash too
• ·         Demand for liquidity blossoms
• ·         What happens to gold and silver during this time?
• ·         Measures of value and eventual confiscation

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Legal Notice / Disclaimer

This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment.  Gold Forecaster – Global Watch / Julian D. W. Phillips / Peter Spina, have based this document on information obtained from sources it believes to be reliable but which it has not independently verified; Gold Forecaster – Global Watch / Julian D. W. Phillips / Peter Spina make no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of Gold Forecaster – Global Watch / Julian D. W. Phillips / Peter Spina only and are subject to change without notice. Gold Forecaster – Global Watch / Julian D. W. Phillips / Peter Spina assume no warranty, liability or guarantee for the current relevance, correctness or completeness of any information provided within this Report and will not be held liable for the consequence of reliance upon any opinion or statement contained herein or any omission. Furthermore, we assume no liability for any direct or indirect loss or damage or, in particular, for lost profit, which you may incur as a result of the use and existence of the information, provided within this Report.

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For the last few years we've watched as the Credit Crunch morphed into the Sovereign Debt crisis in Europe, which may re-cross the Atlantic to hit the U.S. Treasury market. During that time, we have watched a series of patch-up jobs on the crisis that have only succeeded in prolonging the crisis without any real structural remedies. We've also watched how central bankers have seen the 'buck' passed to them, when their role is strictly in support of government action that should have led the way. Central bankers are running out of tools to tackle the task they should never have been asked to tackle alone.

Political leaders (who usually act only in concern of the consequences to their political careers) have only been willing to provide hormone-free measures that have yet to see any convincing success. Much as people look for someone to blame or an interest to protect, the fault lies with the underlying structure of national affairs. Not only do we find banks bound by the interests of their shareholders to achieve profits, but politicians working in a democratic set of national systems guarding their voting base with future elections in mind. These diverse objectives are not consistent with the needed objectives of targeting global growth at all levels to the point that national debt levels can be reduced while national cash flows are boosted to provide the needed funds to achieve these goals.

Almost five years after central banks took the first actions to buoy the world economy, political leaders are being forced to react to a third successive annual fading of recovery hopes as Europe's debt crisis threatens to engulf Spain and Italy, hiring in the U.S. stalls and China slows. Estimate for growth worldwide this year have fallen to 3.2% from the May forecast of 3.4% and it continues to slow.

Developed economies are running into the limits of monetary policy, the Bank for International Settlements said in its annual report last week. Central bank balance sheets now contain $18 trillion of assets, about 30% of global gross domestic product, double the ratio of a decade ago, and interest rates are as low as they can go, the B.I.S. said.

Governments have "cornered" central banks into prolonging stimulus, and have dragged their feet on restoring fiscal order, said the B.I.S., which holds currency reserves on behalf of global central banks. Monetary policy only "buys time" in the short run for leaders to act, and leaving an easy stance for a prolonged period poses economic risks, it said.

The failure of politicians -or should we say in fairness the political system?– to apply vigorous, focused measure to achieve these goals over such a long period of time is causing a fundamental loss of confidence in the financial and monetary systems of the developed world. The emerging world is patterning their newer systems on those of the developed world and ultimately reinforcing that failure.

Amazingly we are now hearing talk that the emerging world should be becoming the driving force in the global economy, when the entire pattern of Asian development has been to replace the manufacturing industries of the West. In addition, China's targeting the internationalization of the Chinese Yuan, an objective which inevitably will have the same impact on the dollar as Chinese manufacturing is having on the West. The net result is inexorably, the continuation of the shift of power and wealth to the East that undermines the power and future of the developed world.

Christine Legarde of the I.M.F. and other realistic financial leaders are warning that there is less than 3 months to save the euro. If they fail to do so, we move to the next catastrophic phase of deflation, the Black Hole. We have seen this in the past, and it's the greatest fear a central banker can have.

Gold as an Alternative Day-to-Day Currency

Many gold supporters believe that gold can replace fiat currency as money. We're not one of those believers. We realize that it's not a matter of being right, but in the current powers that be, it is a matter of accepting its use in the system. At this moment, they're showing no inclination or support for the idea of gold as money. But they do see it being used in a critical way. (Which we will discuss in the next part of this series.)

Fed, Central Bank Fears

For several years now, observers have reported the great 'black beast' feared by the financial world has been inflation. Central bankers fear deflation far more and have done for the entire five years. Inflation has remained extremely subdued during this time.

Indeed, their present stance still appears to be focused on keeping deflation at bay. But that policy is one that keeps central bankers -particularly the Fed– right up on their toes…Why you may well ask?

Deflation's a Process

What really is deflation? In practical terms, it's a process. In this last five years, we saw it start with a puncture of the housing market in the States, spread to mortgage backed securities, to bank balance sheets then onto their borrowing abilities. In Europe, the same happened but hit the banks hardest, then sovereign debt. As securities lost their value we saw a Domino Effect of asset shrinkage leading right through to the collapse of the institutions holding that toxic paper as asset collapses undermined their solvency.

As this started, fear kicked in as lending dried up, with banks fearful of lending even to other banks, where they might be unpleasantly surprised by defaults. Short-term fear morphed into loss of confidence in the future, prudence stepping in to replace overspending and the velocity of money's circulation slowed, as values fell. As confidence was eroded so was growth and endeavor. In turn, this produced more deflation.

Central Banks attempted to defeat this process by adding liquidity to the system in the hope that lending and borrowing might be resuscitated, but because government was caught in political gridlock in the States and failed to act decisively and quickly in Europe, doing nothing to support central banks quantitative easing, these new funds ended up back in government bonds as banks feared creating more toxic assets that would come back to haunt them.

Meanwhile the economies of the developed world barely grew, causing more loss of confidence. With interest rates at new lows and becoming a medium term phenomenon, here we are at the brink of another stalling of the developed world's economies. This time though, the emerging world is starting to slow its frantic pace of growth, telling us just how far the developed world is slowing. Because the emerging world needs to export to keep its growth high and are now seeing these slow down, they're being forced to turn inwards.

The horrible feature of deflation is that it can't be measured accurately because of its subjective, or emotional, content. It doesn't move at a strictly defined pace and it must be killed early, before it turns an economic summer into winter, where stimulation just won't work. It is truly a "black beast".

This economic direction we now find ourselves in is what the central banks fear the most.

Gold Forecaster regularly covers all fundamental and Technical aspects of the gold price in the weekly newsletter. To subscribe, please visit www.GoldForecaster.com

Copyright 2012 Authentic Money. All Rights Reserved. 

Julian Phillips – was receiving his qualifications to join the London Stock Exchange. He was already deeply immersed in the currency turmoil engulfing world in 1970 and the Institutional Gold Markets, and writing for magazines such as "Accountancy" and the "International Currency Review" He still writes for the ICR.

What is Gold-Authentic Money all about ? Our business is GOLD! Whether it be trends, charts, reports or other factors that have bearing on the price of gold, our aim is to enable you to understand and profit from the Gold Market.

Disclaimer - This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment. Gold-Authentic Money / Julian D. W. Phillips, have based this document on information obtained from sources it believes to be reliable but which it has not independently verified; Gold-Authentic Money / Julian D. W. Phillips make no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of Gold-Authentic Money / Julian D. W. Phillips only and are subject to change without notice.

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While the B.R.I.C.S nations are contributing to the I.M.F.’s funding with the purpose of shoring up the global financial system, they’ve stipulated that they want more power in the I.M.F.  China is contributing $43 billion, so as it races to become the world’s leading economic and financial nation it wants a bigger part of the decision making process, commensurate with its rising power. So the first question to be asked is, “Will it get it?”

The emerging countries –China, Brazil, Mexico, India and Russia— announced contributions to the IMF’s global firewall, nearly doubling the fund’s resources to $456 billion, at the G-20 summit in Mexico this last weekend as global efforts to restore confidence in the euro were discussed. The others will contribute $10 billion each and South Africa $2 billion.

I.M.F. Structure of Power

The International Monetary Fund is subject to the will of the U.S. Some may have believed that it’s a truly Democratic institution where true consensus has to be reached on issues before the body can agree. This is not so. For any Resolution to be passed, 85% of the members must be behind it.

The U.S. has 16.75% of the votes at the I.M.F. So for an 85% agreement to be reached, the U.S. must agree. If they don’t, the Resolution will not be passed.

It’s true that if all the members of the E.U. have around 25%+ of the votes, but this is irrelevant if the U.S. opposes the Resolution. To emphasize the point –all the member’s votes of the I.M.F. amount to 83.25% of the votes and an 85% of votes must be achieved to get a Resolution through.

This reflects the Balance of Global Power going back to the last World War. To most observers that may still be the case in terms of global financial power, but in the emerging nations, we don’t have supportive, subordinate economic powers. They walk their own road. As economic power grows in China and it finds ‘satellite’ nations becoming dependent on it, so it’s growing a substantial power base, one that will have to be recognized in global financial institutions such as the I.M. F.

Don’t expect the U.S. to willingly hand over their voting dominance, but to draw off voting rights from other nations, if they wish to accommodate China in their demands. Indeed, until China and its ‘satellite’ nations are the dominant economic power, we don’t see the U.S. budging on the issue.

When, If at All, Will This Change?

Right now, the B.R.I.C.S. are setting up an alternative to the World Bank, focused on their interests alone. This appears to precede the full internationalization of the Yuan. China is acting away from the developed world on this. It does set a precedent we can expect China to follow in the future and on other issues.

Once it has established a economic power base rivaling that of the U.S. (not necessarily the developed world in total) it may well challenge the U.S. at the I.M.F. or set up a developing world equivalent, as it is doing with the potential rival to the World Bank.

China, as always, will be driven by its own interests, solely.

Current I.M.F. View of Gold

The IMF holds 2814.1 tonnes of gold [90.5million ounces of gold] valued at today’s market prices at over U.S. $165.44 billion. The I.M.F. values these at $4.9 billion in terms of their rules. The I.M.F. acquired its holdings from member states through the original Articles of Agreement. The Articles were amended in 1978 eliminating the direct use of gold in the exchange rate system. These holdings are after the 403.3 tonnes were sold.

It currently holds this view on gold:

“It is an undervalued asset held by the IMF, and provides a fundamental strength to its balance sheet.  Gold holdings provide the IMF with operational manoeuvrability both as regards the use of its resources and through adding credibility to its precautionary balances. In these respects, the benefits of the IMF's gold holdings are passed on to the membership at large, to both creditors and debtors.   The IMF should continue to hold a relatively large amount of gold among its assets, not only for prudential reasons, but also to meet unforeseen contingencies.”

Mobilization of Gold

In the last century, Mexico and Brazil sold their gold to the I.M.F. This totaled 403.3 tonnes and was sold over time, recently, both directly to individual central banks and in the open market under the auspices of the Central Bank Gold Agreement (after those signatories to the Agreement had completed their sales). At the time of selling it to the I.M.F. it was to allow them to get the full market price of their gold by paying them this price directly. Thus the I.M.F. acquired gold in its own name –not as part of member’s holdings at the I.M.F.—enabling it to improve its own funding and ongoing finances.

But the I.M.F. did not agree that this mobilized gold in their hands. The initial purchase from Brazil and Mexico was called a “one-off” exception to their rules that had effectively removed gold from the monetary system.

So the current policy of the I.M.F. is that gold is no longer freely traded between nations but simply held for the purposes stated above. There’s no visible reason why the U.S. or other members would want to change this policy as it stands; however, in the case where a member State needs support to continue trading internationally, then on the decision of the I.M.F. they may get added support by way of loans or indirectly through the guarantee from the I.M.F. whose credibility is enhanced by the gold held by them.

Member’s only:

Will China and the emerging world want to change this view?

How will I.M.F., Chinese and other nation’s Gold Reserves be mobilized?

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Legal Notice / Disclaimer

This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment.  Gold Forecaster – Global Watch / Julian D. W. Phillips / Peter Spina, have based this document on information obtained from sources it believes to be reliable but which it has not independently verified; Gold Forecaster – Global Watch / Julian D. W. Phillips / Peter Spina make no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of Gold Forecaster – Global Watch / Julian D. W. Phillips / Peter Spina only and are subject to change without notice. Gold Forecaster – Global Watch / Julian D. W. Phillips / Peter Spina assume no warranty, liability or guarantee for the current relevance, correctness or completeness of any information provided within this Report and will not be held liable for the consequence of reliance upon any opinion or statement contained herein or any omission. Furthermore, we assume no liability for any direct or indirect loss or damage or, in particular, for lost profit, which you may incur as a result of the use and existence of the information, provided within this Report.

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For many months now, gold and silver have not simply acted as a counter to the dollar but linked on a day-to-day basis with the euro. It's reasonable, one would think, for them to have that relationship because the euro is the second most important currency in the world. But when the euro itself has problems with its value then the relationship must surely become suspect?

What we've seen lately is gold and silver prices moving with (and often faster, both ways) than the euro, but the link remain solid. With concern for the future gold and silver prices in mind, it's time to examine this relationship to see where it's taking these precious metals. With the Eurozone crisis moving to potential 'runs' on Greek and Spanish banks, the future of the euro is now on the line. A look at a precipitous fall in the euro and the potential for gold and silver to follow is warranted. Investors should be prepared for very volatile and surprising gold and silver price moves.

MEANING OF 'COUNTER TO THE DOLLAR'

It would have been better had the saying included currencies in general. With gold respected worldwide as alternative money to currencies, the presence of the two in national gold and foreign exchange reserves enabled the balance of changing values in the two to allow the net value to remain relatively constant. As the gold and silver prices fell against currencies, so the value of currencies rose. Central bankers hold these reserves to ensure that a nation has reserves with which to continue trading internationally in the event of a national disaster preventing international dealing by the state. The maintenance of their value in all weathers is a fundamental necessity.

With the U.S. dollar being around 63% of global reserves, it's appropriate for European nations to hold gold in large quantities. The table below shows the percentages that the developed world holds as a percentage of their reserves:

World Official Gold Holdings as at May 2012

COUNTRY           TONNES HELD    % OF RESERVES

United States    8,133.5                  75.9%

Germany             3,396.3                 72.8%

Italy                       2,451.8                  72.6%

France                  2,435.4                  72.6%

Switzerland        1,040.1                  17.5%

Netherlands       612.5                     60.9%

E.C.B.                    502.1                     33.85%

Portugal               382.5                     90.9%

Spain                     281.6                     31.3%

Austria                  280.0                     56.6%

Greece                 111.7                     82.2%

The gold holding will only have significance when the financial weather turns very stormy, not on a day-to-day basis. That's why when central bankers buy, they are relatively price insensitive. Their target is to acquire volumes of gold because it's that volume or the number of ounces that counts when push comes to shove. When they buy they simply accept direct offers of gold that the market makes to them. Chasing prices is out. The long-term steady acquisition of ounces and tonnes is the objective. A look at the figures in this table again highlights what we mean in a market that supplies only around 4,400 tonnes a year. Of this 36% is recycled gold, which can prove a heavy variable. Another 700 tonnes never leaves its country of origin. Thus the daily gold price depends upon less than half of the annual gold supply reaching the international gold market. So central banks are cautious, price insensitive buyers.

As we have seen in the market place, traders mainly have been linking the euro to the gold price's moves. There's a danger that readers of this article and subscribers will think it right to make decisions on the basis of the moves in the euro against the dollar only. To do so from now on may be the wrong moves.

TIED TO THE EURO?

The Eurozone crisis has seen remarkably little change in the €: $ exchange rate considering the extent of the sovereign debt crisis inside the Eurozone. Its peak was at €1: $1.40 and its low today at €1: $1.2550. This is only a move of 10%. Much of this narrow range of movement has to do with the swap arrangements between the Federal Reserve and the European Central Bank who have actively 'managed' the exchange rate to ensure as much stability as they can. If it had been left entirely to market forces, the picture would have been very different.

If a financial panic ensues in the Eurozone's banks, it's possible that we see the euro fall back to its start point around €1: $1. Will the gold price follow it down? Take a look at the second table below and see what happens to gold if it follows the euro.

€1: $ rate                 $ Gold Price            € Gold Price

€1: $1.2535                 $1,560                         €1,244.52

€1: $1.2000                $1,493.42                    €1,244.52

€1: $1.1750                 $1,462.31                    €1,244.52

€1: $1.1500                 $1,431.20                    €1,244.52

€1: $1.1250                 $1,400.09                   €1,244.52

€1: $1.1000                 $1,368.92                    €1,244.52

€1: $1.0750                 $1,337.86                    €1,244.52

€1: $1.0500                $1,306.75                    €1,244.52

€1: $1.0250                 $1,275.63                    €1,244.52

€1: $1.0000                $1,244.52                    €1,244.52

Let's take the current gold price of $1,560 as the start point for the projections and move the gold price with the decline of the euro.

Please note that it's the euro that's falling alongside all those currencies that look to the Eurozone as their key trading partner and to whose currency they are determined to adhere in a tight trading band (by interference if necessary). This does not reflect U.S. dollar strength; the dollar has been steady against other currencies and will likely remain so.

Before we answer the question, 'Will gold follow the euro down?' it's good to ask what the gold prices have been in both the euro and the dollar over the last decade.

In 2005 the gold price in the U.S. dollar was around $300 and around €240.

Today we see the gold price in the U.S. dollar at $1,560 or over five times higher than it was then. As to the euro price the same multiplier of over five times is true again at €1,244.52.

So our dilemma is that traders who have been driving the gold price of late will attempt to move the gold price with the euro's fall. Will investors from other nations follow suit?

To answer this we have to look closely at other buyers using other currencies. USD investors look at their dollar based Technical analysis and project price patterns in the dollar gold and silver price.

With somewhere close to 60% of the world's gold demand coming from China and India, we must recognize that those investors look at the gold price in the Indian Rupee and the Chinese Yuan.

The Chinese government wants their people to buy gold so are not happy to see the Yuan appreciate, or see their own people's gold investments suffer losses in the Yuan.

In India, the scene is different -the Rupee has been very weak, having fallen over the last year from Rs.42: $1 to Rs.56: $1 a fall of 33%. Accordingly gold prices in the Rupee have risen as the dollar gold price has fallen.

Right now, Indian demand is weak, being supplied mainly by sales of locally held gold, suffocating gold imports, so Indian demand is almost absent from the international market, at the moment. This leaves the weight of demand on Central banks and the Chinese with developed world demand at present lows.

This gives traders the reins over the gold prices on a daily basis but for how long and at what price?

Indian gold investors are very price conscious. Their buying pattern is to wait for a floor to be established so that when they buy, they won't see prices fall afterwards. They believe that the gold price in the Rupee will go up after that. They are not so wise, yet, to see that the Rupee's value is not likely to increase, bringing Rupee gold prices down. All they see are Rupee prices rising, as the Rupee falls.

What we will see if the above table is seen in the next few weeks is the gold price in the dollar falling faster than Rupee gold prices are rising. This will give the appearance of a Rupee 'floor' price and they will enter the market and support Chinese and central bank buying.

If the Reserve Bank of India does succeed in halting the fall of the Rupee this probability will happen faster. If they succeed in strengthening the Rupee by 'managing' (i.e. interfering in the forces driving the Rupee) it then Rupee gold prices will fall. That will bring out Indian buyers for sure.

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In this the first part of a series on the subject we look at the picture that led to the confiscation and look at factors that caused the confiscation to see if there are reasons why it can happen again, today!                   

At the left, you will see the actual executive order in which U.S. citizens lost the right to own gold. From May 1^st 1933 until 1974, U.S. citizens could no longer hold gold as a protection against paper money, which also lost its gold backing at the same time.

Foreign central banks could continue to exchange the U.S. dollars that came into their possession –known as Eurodollars for decades—for gold and did so particularly when the U.S. dollar was devalued and then floated against the gold price in 1971.

Why?

The “why” is critical to our understanding of the current, global monetary system! There were two distinct phases to the process that began in 1933.

1.       The U.S. monetary and banking system contributed to a large extent to the depression. As Mr. Ben Bernanke has aptly demonstrated by his Quantitative Easing, a reduction in the money supply shrinks economic activity significantly and breeds deflation. After four years of such shrinkage, it was realized that a huge increase in the money supply was needed to invigorate the U.S. economy and make assets preferable to cash. The monetary system was based on the Gold Standard, a system that set the gold price at a fixed level against the dollar and other currencies across the developed world.

One gets the wrong perspective if you look at the gold price as having been subsequently raised as opposed to the reality that it was the U.S. dollar that was devalued. In an instant, the money supply of the U.S. was increased by 75% in 1935 when the gold price was raised from $20 per ounce to $35 per ounce. This was a devaluation of the dollar. It brought a tsunami of liquidity to the banking system that saw deposits leave the banks and flow into industry again. We stress that this was not a gold event, but a money event –gold being money at the time. As you can see on these dollar notes where gold was an integral part of the money system then.

2.      The second phase of the confiscation of gold was to place gold under the control of government out of the hands of private holders, as storm clouds gathered over Europe. Government was then in a position to control the recovery and direct funds to where government felt they would be best put to use. Despite the proliferation of dollars in the system, confidence in it remained high as it remained linked to gold. The belief that, somehow, this restrained the issue of money also remained inexplicably strong. So long as confidence remained in currencies the value of the dollar remained solid.

Had gold been left in the hands of individuals and private institutions, such an issue of money may well have led to it being sold for foreign-held gold. This would have defeated the government’s purpose in devaluing the dollar. The U.S. government had to confiscate the gold of its citizens to ensure the focused success of the increase in the money supply.

The success of dollar devaluation and the “governmentization” of gold was successful as it fueled a recovery that was also invigorated by export demand for U.S. goods ahead of the Second World War.

Fixed Exchange Rates, then “Floating”

An ingredient that is often overlooked today is that the world back then was a world of fixed exchange rates only. That’s why it took one government decree to change the quantity of money. That hasn’t changed! Today, Quantitative Easing does the same.

Chairman Ben Bernanke is a scholar on those times. He used his knowledge of those days to forge the policy he follows today to avoid either deflation or depression. So far it has worked to the extent that the U.S. economy has entered neither. It’s clear though that he needs the vigorous support of a very focused U.S. government and the U.S. citizens to turn positive, before he can see his policies produce a convincing recovery. He has neither!

But something fundamental has also happened that will allow for the confiscation of gold, but not for the purpose of a simple devaluation of the dollar and increase in the money supply. We now live in a global world of supposedly floating exchange rates. Exchange rates are driven by market forces to reflect their value against other currencies. Central Bank intervention does happen on a wide front, either directly through exchange rate management or the supply of currencies between governments to ‘manage’ exchange rates, almost behind the scenes. After all, it would be far too expensive an exercise to let currencies find a free market level in the global, competitive world we now live in. But there is a point where market forces are strong enough to defy government wishes, through falling confidence. Such falls in confidence can and will affect the exchange rate of a currency in the face of the best efforts of central banks to counteract such “management” of currencies. This is when it needs the support of its gold and foreign exchange reserves. The argument that gold cannot be used because ot would have a deflationary impact on the monetary system, ignores the ingenuity of monetary authorities.

We feel that, contrary to nearly all the work we have seen on gold’s role in the monetary system, a floating gold price would have the flexibility to prevent its price from having a deflationary impact!

The U.S. Dollar Controls Money

The U.S. dollar is the least vulnerable to a proper reflection of its true value in major exchange rate changes and small nation’s currencies, the most vulnerable to them. With the currency world having the shape of a tree, with the U.S. dollar as its trunk, it will take far more than falling confidence in the U.S. economy to make the dollar tumble. We’ve seen that confidence in the U.S. dollar fall heavily over the last few years but remains as the pivot point for the world of currencies. As the only oil currency of note (only a small part of the oil market prices itself in other currencies) the U.S. is in a position to ensure its use and the need for it in the global currency system.

There’s a point where this’ll change radically. We’re seeing this change now. With Asia up and coming, and sucking the wealth of the West into itself through direct competition, it’s only a matter of time before the U.S. pivotal position in the monetary system changes.

One of the first signs of this will be China taking a significant role in the I.M.F. while the voting power of the U.S. reduced to below the point at which it has a controlling vote. (Currently, the U.S. has 16.8% of the votes and the I.M.F. needs an 85% majority to pass any resolution.)

The next sign will be when China prices its goods in the Yuan and not in the USD. Then the USD will slip back to the role of any other leading currency, where its value reflects its Balance of Payments.

To prevent a massive drop in the U.S. dollar exchange rate, the U.S. economy will need to restructure, exporting more than it imports on the trade front, while attracting foreign surpluses through the value foreigners will get from their dollar holdings. This is far from the case now!

(We are informed that there is now an entity that whose objective is to counter any attempt to confiscate citizen’s gold that is soon to launch. We will be informing Subscribers about this. Enquiries to gold-authenticmoney@iafrica.com  for more information)

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This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment.  Gold Forecaster – Global Watch / Julian D. W. Phillips / Peter Spina, have based this document on information obtained from sources it believes to be reliable but which it has not independently verified; Gold Forecaster – Global Watch / Julian D. W. Phillips / Peter Spina make no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of Gold Forecaster – Global Watch / Julian D. W. Phillips / Peter Spina only and are subject to change without notice. Gold Forecaster – Global Watch / Julian D. W. Phillips / Peter Spina assume no warranty, liability or guarantee for the current relevance, correctness or completeness of any information provided within this Report and will not be held liable for the consequence of reliance upon any opinion or statement contained herein or any omission. Furthermore, we assume no liability for any direct or indirect loss or damage or, in particular, for lost profit, which you may incur as a result of the use and existence of the information, provided within this Report.

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In the last week, we have seen global market confidence buckle in the face of slowing growth and what may already be a recession. This is not the time that poorer nations can use falling cash flow to repay mountains of debt. Talk of a 50% haircut on Greek debt should be lifted to as high as 60% to 70% for the Greeks to be able to manage its remaining debt in light of future, Greek cash flows.

To get a handle on the Eurozone debt crisis we have to imagine that each nation is an individual. If an individual is bankrupt an offer of compromise is made that usually is 50% for the debt to be written off. It’s not a ‘haircut’ of 50% of the debt with the remaining balance to still be repaid. But such a haircut is a ‘managed default’. The banks that have to take a haircut see their balance sheets drop by this amount, often making the ratios by which it has to maintain too. This reduces the amount it can lend and often puts it in a dubious financial position, bringing its own creditors down upon it. With the global banking system so interwoven, the spread of such fears reaches far and wide. We saw this last week in the downgrade of Societe Generale and Credit Agricole, two of France’s largest banks, because of their exposure to Greek debt. If the Eurozone crisis finds other nations following Greece, then expect much more of this type of downgrade.

What’s happening to Confidence in Currencies?

At this stage it doesn’t matter which way the crises go. Confidence has fallen worldwide in government debt situations and the banking industry, with fears of more to come. The very fact that the developed world is in the financial state it is, has caused the fall in confidence. If the Greek situation leads to a convincing bailout, the weaknesses in the Eurozone will still remain. Confidence in the euro has fallen and won’t return to the previous year’s levels. With money fleeing the Eurozone, it only found the dollar as an alternative. The Swiss Franc and the Yen have ceased to be safe-havens because their central banks have intervened to weaken those currencies. This left the ‘tree trunk’ of the currency system, the U.S. dollar, as the only really liquid place to go. This was not because of any value that could be retrieved, but because it’s the only remaining currency that remains standing under pressure. Right now the euro is gaining against it, as the world hopes that Greece will get a sufficient bailout. But tomorrow it could weaken again. As to the dollar, its debt crisis is more severe, but not as immediate.

Now stand back a pace and ask…

“Can we have confidence in the value of the Dollar, the Euro, the Yen, the Swiss Franc or the British Pound?”  

We all appreciate that their values have fallen, but we have to use them as the only available way of paying for things. Do we believe that the governments of these countries are capable of restoring any inherent value in these currencies? Are their structures and that of national balance sheets solid enough to want us to hold our wealth in them? If your answer was not as positive as it was four years ago, you have a measure of how their values have suffered. Looking forward, do you believe that your confidence in these stores of wealth will grow to the extent you want to hold them, or will you do so with a careful eye on them, preferring an alternative, but not being so certain where to go?

What has floated to the top of national priorities for currencies is a global need to have international prices –for the exports of goods from those nations—retain their global competitiveness. This means a persistent weakening with the rest of the world’s currencies following the weakest. In itself this guarantees dropping values for all global currencies. There’s nothing to be gained through a strong currency over time. This structural shape of currencies is not likely to change. In fact, it’s likely to produce more and more financial discord in foreign exchanges. Price competition through exchange rates has to destroy value slowly, but surely.

Debt and Bank Crises

We may be tempted to see the debt crises as a short-term problem, but as the world’s leaders agree, they’re scaring the world and threatening global financial stability. So this isn’t a case of the passing flu; it describes a congenital weakness that needs a structural solution. Nowhere can we see evidence of structural reforms likely to shore up confidence and repair the global financial system. The system is flawed and most expect such crises to persist for the foreseeable future.

So why not just write off the entire world’s toxic debt, print the equivalent amount of money to fill the holes and start all over again? After all if you look back at the Fed’s QE exercise, doesn’t that amount to the same thing? Well, almost. Now add to that a good dose of inflation, and debt diminishes in value and asset values rise. Well, that would destroy all confidence in the Capitalist system and money itself, wouldn’t it? No, the world is locked into resolving these problems and ensuring the continued working of the global economy in such a way as to retain confidence. We’ve not seen such a dire financial scene since the Second World War, (according to the outgoing head of the European Central Bank) and close to the scene seen in the early 1930s.   Then the answer was to massively expand the global money supply, through the devaluation of the U.S. dollar against gold by 75%.

We have no doubt in our minds that the global, financial authorities want a similar expansion of money for the purpose of diminishing the impact of the current crises. But they have to do it in such a way as to convince people everywhere that the system remains viable and healthy, despite such a debauching of money. They cannot do it without convincing people that money has become cheaper and less reliable. This favors precious metals.

Effect on Gold, Silver Prices

Investors were shocked when gold dropped from $1,850 to below $1,600 in an almost straight line. When they saw silver drop from $40 to $28 they were even more shocked. After all, since 2005 gold has come from $300+ and silver from $6+, so a $250 drop and a $12 drop seemed to be huge. Since then we have seen the silver price recover $4 in one day and the gold price $60 in a day, with more recovery to come. In percentage terms, when compared to other markets, we see similar falls there and in similar percentages, but not the same vigor in recovery. The big picture confirms that falls, in most markets, were investors raising liquidity to lower leverage and protect against the falls, just as we saw in 2008. This is something market observers cannot see ahead of time. They accompany major shifts in investor perceptions about the structure of global financial markets.

Just as we saw in 2009 and onwards, the loss of confidence in global financial markets doesn’t recover. In the gold market, since the pullback from $1,200 to $1,000, we’ve seen gold rise to $1,910 and silver to mid-$40 area, a tremendous gain since then. What’s there to prevent a similar shape to the precious metal markets going forward?

Take a look at the function of gold and silver. Gold, in particular, is an international asset and international cash. It can be used when all else fails. We saw that in the recent falls. Investors could liquidate holdings quickly and take good profits to cover losses, loans, and margin calls in other markets. Once there’s a moderate stabilizing of markets, that lesson is remembered. Investment house strategists factor that into their policy decisions, realizing that in bad times, future profits lie in precious metals.

In the emerging world, the fall in precious metal prices is seen as speculators getting out of the market and giving them an opportunity to buy at prices they feel will allow for certain rises. Their faith in gold and silver remains completely unshaken by the falls, which they see as part of the ongoing suspicions about the developed world banking system and markets speculation. To them the value of gold and silver remains untouched and certain. Falls are seen as an opportunity to buy cheaply into the precious metals.

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 Legal Notice / Disclaimer

This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment.  Gold Forecaster – Global Watch / Julian D. W. Phillips / Peter Spina, have based this document on information obtained from sources it believes to be reliable but which it has not independently verified; Gold Forecaster – Global Watch / Julian D. W. Phillips / Peter Spina make no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of Gold Forecaster – Global Watch / Julian D. W. Phillips / Peter Spina only and are subject to change without notice. Gold Forecaster – Global Watch / Julian D. W. Phillips / Peter Spina assume no warranty, liability or guarantee for the current relevance, correctness or completeness of any information provided within this Report and will not be held liable for the consequence of reliance upon any opinion or statement contained herein or any omission. Furthermore, we assume no liability for any direct or indirect loss or damage or, in particular, for lost profit, which you may incur as a result of the use and existence of the information, provided within this Report.

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Yet again the Yen is barely changed at Yen 77.07 slightly weaker than yesterday and the Swiss Franc stronger again at 0.7998.   Intervention continues to fail.

Gold ahead of New York fell back slightly after rising initially to $1,822.60 and in the euro at €1,279.53 €10 stronger today.

Silver was slightly stronger today but solid as a rock at $41.67 after yesterday’s $41.29, ahead of New York’s opening.

Gold _{(very short-term)}

The gold price should be steady to stronger, today in New York.

Silver _{(very short-term)}

The silver price should b e steady to stronger, today in New York.

Price Drivers

This gold price just does not want to obey all those Technical analysts calling for a pullback to $1,500.   Investors have to do more than just ask “why?”   They have to understand why.   These days it’s no longer enough to have a superficial knowledge of the gold market you must have your finger on the pulse or get them burned.   With swings of $100 up, $200 down then $100 up and for the gold market to go steady this week needs to be understood.   So will gold fall if the U.S. stays stagnant or moves into a recession?   We think not.   It is about the dollar, to some extent, but not as directly as you think.   It’s more to do with confidence in the dollar.   And not confidence that Americans or Europeans have in the dollar but about the confidence the rest of the world has in the dollar.   To understand that you need to take the U.S. flag from in front of you and take a hard look at the cold realities seen through foreign eyes.   After all, the gold price is a thermometer of the world’s monetary system not the global economy.   It’s about stability and the reliability of money.   Ask yourself, what’s the dollar worth?   Is the euro worth more, really?

Perhaps you have your eyes on the economic data coming out of the States for an indication of where gold and silver are going, but a glance back to 2005 up to 2007 tells you that in the boom years gold rose, so will a real recovery in the States cause gold to fall? To get a more complete perspective on gold and silver subscribe to the Gold Forecaster and the Silver Forecaster, now!

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Ahead of New York, it is pulling back slightly in the euro to €1,287.60.   In the dollar it is at $1,854.60.  

Silver in Asia stood at $41.06 and is moving quietly to follow gold.   Ahead of New York’s opening silver is trading at $41.44 up $1 on yesterday.

Gold _{(very short-term)}

The gold price should have a stronger bias, today in New York.

Silver _{(very short-term)}

The silver price should have a stronger bias, today in New York.

Price Drivers

Gold investors who are short of gold are certainly being caught short.   We are of the opinion that any ‘spike’ activity is due to two reasons.

-         Firstly, traders who thought that gold would fall with the equity markets and positioned themselves on the short side are being badly mauled.

-         Secondly new investors or those who buy on the rise, such as western and Chinese investors, are paying up to just get some gold.

It appears that the policy of ‘buying the dips’ is paying off handsomely as those investors get stock without paying up for it.   When buyers come in on the rise they are finding no stock there for them.   Bear in mind that the big jump before London opened did not come out of the developed world, but out of Asia!

London and New York will catch up for sure.

We are looking at the developed world’s economies weakening to the point that the veins and arteries of the system, the banking system [already suffering from a hardening of the arteries] is itself being weakened again.   Unless the entire financial body is invigorated an operation to improve the financial blood system will not be sufficient to right the body.

Perhaps watching Chavez of Venezuela switch his country’s reserves to the growth portfolio of BRIC investments plus gold with its own flow of oil has been seen as the path of wisdom and not the act of a loose canon President of a banana republic?    Take a look at our commentary in the latest issues of the Gold Forecaster and the Silver Forecaster, by subscribing to them!

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Over the weekend, gold slipped a little to $1,735 ahead of London’s opening.   The euro was stronger at $1.43: €1, but these days that only means that the euro is not falling as fast as the dollar.   In the euro the gold price was €1,212.65.   The Swiss Franc has been successfully weakened back to 0.7951 from its recent peak at 0.7296.

Today saw the gold price Fixed at $1,738.00 [$2 down on Friday’s Fix ] and in the euro at €1,214.11 [€5 down on Friday].   Ahead of New York, the gold price was holding around the Fixing prices and the euro weakening against the dollar to 1.4293.

Silver was Fixed at $39.18 and holding around $39.10 ahead of New York’s opening. Silver is immune to gold’s movements right now.

Gold _{(very short-term)}

The gold price should be relatively steady to stronger, today in New York.

Silver _{(very short-term)}

The silver price should be relatively steady to stronger, today in New York.

Price Drivers

Nothing has happened over the weekend to change the scene from last week.   What is of significance is the commentary by the head of the World Bank, Robert Zoellick who said that the lack of political leadership in resolving the crises and the economy has led to a loss of confidence was an understatement from a supportive party.   It was Mr. Zoellick who suggested last year that gold should be used as a ‘reference’ for the value of currencies.

We can quote individual instances that lead to the rise of the gold and silver price today, but the world must recognize that it is the world’s monetary system and how it is being handled from 1971 until now and we expect, in the future, that is the cause for gold and silver’s price rises.   Currencies are in a bear market!

The incorporation of new Asian demand for gold with demand rising from falling confidence will drive the gold price, overall, long-term.   When will such demand stop and change direction?   We are commenting on this in the next issue of the Gold Forecaster and the Silver Forecaster, so we again, suggest that you subscribe to them to understand the markets you are seeing!

This week the E.U. leaders are being watched carefully to see if they really can do something effective about the debt crises.   Germany is balking at greater fiscal union so much so that an E.U.-wide Eurobond to give greater financial unity to the Eurozone has been taken off the table.   Get ready for the next episode!

Meanwhile we are but a week or two from the start of the ‘gold season’!   What then?

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Many have blamed the unfortunate S & P ratings agency for the market dramas in the last two weeks, but they were simply the boy who said ‘the emperor had no clothes on.’ For months now, we have known and commented on the fact that the debt crises on both sides of the Atlantic would lead to trouble. One hopes that the news is not as bad as it seems, but we all knew it was. The build-up of parallel crises added weight to the drama so when the Dow suddenly sank it was simply a postponed reaction. The fact that a ‘head-and-shoulders’ had completed its formation made the market ripe for fall.

Everybody reacted all over the world as this postponed reality was publicly accepted. The oil price fell to below $80, the dollar and the euro fell like a stone, the Swiss Franc and the Yen soared to economy-destructive levels and eventually the Fed confirmed that the U.S. economy should see no growth for another 2 years. The Chinese government called for a new global reserve currency to replace the dollar.

All in all, the global economic scene experienced a gear-shift, down to a darker investment climate…

The$1,555 gold price had already signaled that it was going to take off in June, but the S & P trigger sent it soaring effortlessly to $1,800. Only now are these new realities being properly absorbed, although slowly…

Why?

We see the S & P downgrade as a judgment on the Congressional inability to properly assess the dire nature of the U.S. credit situation because of their fixation on party politics. It is the first time that the U.S. Congress has had to see the rest of the world react to the declining U.S. global economic dominance. It had to happen for the U.S. Congress to understand that the U.S. is responsible for its behavior and will face consequences if it does not adjust. It’s a change that has not happened for 40 years.

We do not see a change in the political behavior of Congress until more consequences force that change. There may be considerable economic pain before this happens, and the future brightens for the U.S. During this time the U.S. has to see that it is no longer the world’s economic axis, allowed to extract advantage from the rest of the world through its ‘exorbitant privilege’ of printing money to pull itself out of economic decline. As we forecast at the beginning of this year, 2011 would be a year of consequences!

The Future

As we move towards QE3, more dollar printing and the consequential inflation, we fully expect the reaction of the dollar to weaken much faster. QE3 will confirm that they have chosen inflation as a way out of a double-dip recession or deflation. The interdependence of currencies will prevent exchange rates from highlighting any currency’s weakness. We have seen this last week in the actions of Japan and Switzerland to weaken their safe-haven currencies. History will record that the announcement by S & P was simply a trigger for a new era of currency instability and the loss of currency values.

Only the gold price is now truly capable of measuring the weakness of currencies. The jump in the gold price over the last decade has been screaming this to all, but few outside of gold were listening. The leap since June of $250 reflected the acceleration in the speed of declining values.

It is natural for us to assume that the global monetary authorities will agree to a reformation of the monetary system that effectively addresses the mess it is in right now. Certainly we expect the mess to worsen considerably before this is accepted.

 After that, who will be responsible for putting it right?

What obstacles will they face?

 v  Politicians will have to please those who put them in power and cannot act independently of this power base, no matter how necessary a departure may be. It would be political suicide to do anything else –a consequence of democracy.

v  Politicians or Monetary Officials likewise will have to ensure they act in the interests of their nation even if it goes against the greater good of the international community.

v  The international pecking order will weigh in to give priority to measures put forward by the most powerful. The battle will likely impact the voting rights in the I.M.F. where the 16.83% of the U.S. –the I.M.F. needs an 85% vote to pass any measure—will come under fire and China will be given a share of the voting commensurate with its growing economic power.

v  All of the above has to be decided before China’s request for a new global reserve currency can even be contemplated.

v  A new global reserve currency would require either the diminishing of the dollar’s role in the global economy or its removal as its sole reserve currency.

The obstacles will prevent the much-needed structural monetary reform. Are the current powers-that-be impartial enough or be franchised to formulate a globally reformed effective monetary system? Not yet, if we look back at the efforts of the U.S. Congress to cut their budget deficit.

What is next? History shows that willing change, when not forthcoming gives way to unwilling change! Unwilling change climbs out of wars or rupturing, destructive, crises that remove the above barriers and which license the powers-that-be to undertake needed, sweeping reforms.

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The U.S, Eurozone Debt Crises

 Last Friday the S & P ratings Agency dared to downgrade U.S. debt from triple to double ‘A’, and quite rightly. It was not a reflection of the ability of the U.S. to pay their obligations, but of the politics that allowed partisan interests to take higher priority. The message was sent to Congress over the entire period of the ‘debt-ceiling’ soap opera, even by the most responsible of U.S. monetary figures, Treasury Secretary, Timothy Geithner and Federal Reserve Chairman Ben Bernanke –to no avail.When the wrangling finally stopped and an agreement was reached, it was totally inadequate –cutting spending by 1/2 % of GDP against a deficit of 10% of GDP—for addressing the U.S. debt situation. Confidence visibly withered last week ahead of the downgrade and when it came, the emerging world, the largest of U.S. creditors, ran for the hills and announced the world needs a new global reserve currency.

Add to this the decaying Eurozone crisis, which has progressed to the point where, through ‘contagion’, it may have to bail out Italy and perhaps Spain, as well as Ireland, Greece and Portugal. The German appetite for these additional crises is disappearing, as it wipes out the benefits the E.U. has brought it. The E.U. is now moving towards a crisis. The combination of crises on both sides of the Atlantic is just too much weight to bear for the developed world’s monetary system. Alongside these crises, expect a banking crisis.

Weakening of the Yen and the Swiss Franc 

As important as the S & P downgrade were the actions by the Bank of Japan and the Swiss National Bank last week. With their currencies seen as ‘safe-haven’ currencies by the world, the actions of the two central banks to forcefully weaken their currencies destroyed their safe-haven qualities. This has left the developed world without a safe-haven currency. You will see speculators continue to buy the Yen and the Swiss France because they have more inherent strength than other currencies. Every time these two central banks sell their currencies to weaken them, they offer their currencies at prices speculators believe are lower than they should be. This invites more buyers and speculation. The central banks eventually have to weaken their currencies until they have lost this inherent strength.

The ‘carry’ trade –investors who borrow in a weak, low interest rate currency and invest in a higher interest rate paying currency—were alarmed as the moves raised the risk levels in their trade. Every currency on the planet relates to another. The South African Rand moves against the euro, because the bulk of its trade is with the Eurozone. Canada’s trade is almost entirely dependent on the U.S. dollar. The Chinese Yuan is almost tied to the U.S. dollar, et cetera. But there still remain the ‘carry’ trade opportunities of interest rate differentials. These will only disappear when the volatility levels on these currencies wipe out such opportunities.

‘Bear’ Market in Currencies

What does this all add up to? Confidence in all currencies is withering fast. It has become more than apparent that all the world currencies are failing to provide a measure of value. For example, if the price of potatoes in the USD is $3 for 7kgs and then the dollar halves in value, it appears that the price of potatoes has doubled; however, it hasn’t. The price of the dollar has halved and the price of potatoes has remained steady. So when we hear people say that the gold price has shot up –it hasn’t. The price of the dollar, the euro, the peso, the Rand –have all fallen.

The 40-year long experiment of currencies with no backing other than their own economic and political performance is starting to reap its consequences.

It was, after all, the ultimate confidence trick!

That it has lasted 40 years is remarkable.

The credit crunch since August 2007 has brought un-backed currencies their greatest test to date, and it is threatening the developed world’s banking systems as well as the world’s leading nation’s debt positions. Manipulating the exchange rates of currencies will not resolve their underlying crises. At best such exercises are temporary measures, which usually end in failure.

After a currency ‘bull’ market lasting 40 years we are now in a ‘bear’ market.

Gold in a ‘Bull’ Market?

Like the potatoes mentioned above, the price of gold appears to be shooting up, but it isn’t. It provides a globally accepted measure of value, which in times of financial stress, appears to rise. But the fact that it takes more U.S. dollars to buy gold than before is an expression of the decline in value of the dollar. The acceptance of this reality takes a change of mindset. Such a change is brought about by one or more crises, which forces the change. Ten years of rising gold and silver prices has not brought this about yet, but now that the crises have reached a new plane, the change is coming. Why does it take so long? Our human nature is to look for and find easy and trusted ways to understand markets. Relationships and formulae are found that allow this and then our reliance on ‘experts’ kicks in. Only when these experts fail to produce the results we looked for, do we re-assess this way of working.

Often we need a swirl of confusion to force us to let go of the old ways of thinking. Once in the new investment climate we eventually find another ‘expert’ to guide us to a new way. This completes the change. Today we need to adjust to the fact that currencies are in a ‘bear’ market and gold is simply reflecting this, before we get it right. We were the only services to state clearly that the price of gold and silver would not fall on the signing of a new debt ceiling agreement.

There is a great need to understand that gold is far more than a commodity, far more than in a ‘bull’ market. There is a structural change going on in the developed monetary world that will entirely change the financial in which we live. If developed world central banks persist to ignore it, then the change will be forced on them in catastrophic ways. We are beginning to see this. The markets will accept the changes probably before the central banks do, but in the end central banks will have to accept them.

One of the key changes is that the gold price will not go into a ‘bear’ market, nor will a gold ‘bubble’ burst. So what does the future hold for gold and silver?

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Junior Mining Stocks and Risks

A junior mining stock is a mining company in its early days. It may have successfully explored and found a good deposit; it may have completed a feasibility study on the deposit and have raised the finance to develop it into a mine. The earlier an investor finds such a company (that does become a healthy profitable company) the more return an investor is likely to make. The risks on such a company are great so an investor needs to have his finger on the pulse of the company to keep and profit on his investment.

Risk Reward Ratio

One of the most commonly held perceptions on gold or silver mining stocks is that they should perform the same as the gold and silver price. So far they have not; however, eventually they should, under certain conditions…

Investors look for total return. This is a combination of income and capital gain. The gold price provides the capital gain; mining shares should add to that. Why should they? They can add to total return by providing an income stream; however, they must provide the same capital gain or more that the gold price itself to justify the additional risk to gold. Bear in mind that there is no opportunity cost in holding gold as opposed to Treasuries. Treasuries appear to rely on Congress, whereas gold has no counter party.

A mining company that does not intend to pay dividends, or is not doing so (despite already being in production) is unlikely to provide such returns.  

Bear in mind too that where mining companies do provide dividends, they do so based on the average gold price over the previous year or half year. Waiting for such an average price entails risk. These risks are many and can sometimes be so worrying that a substantial leverage to the gold price is needed.

The Risks

All mining companies are just companies listed alongside fellow companies on the Stock Exchange. All companies carry corporate risks. A ‘Junior’ mining stock is the share of a mining company.

It differs from the developed mining companies in that it should have better prospects. These risks include:

• Directors’ competence
• Health of the Balance Sheet
•  Level of company indebtedness
• Has it hedged its gold production to raise capital?
• Size and quality of the reserves from which future income will be derived
• Performance of the costs being incurred in producing the metal
• Political risks in the country where mining is taking place
• Potential labor problems
• Price prospects of the metals being mined as well as the accumulated income over the previous period
• Intended capital expenditure on future mining areas
• Expenditure in lengthening the life of the mine
• Dividend policy of the Directors
• Prospects facing equity markets, the economy and its investors, as a whole.

These are variables that are not solely dependent on the price of the mined metals. Moreover, they are factors that weigh heavily on the risk:reward ratio that investors must contemplate before they invest.

Investors, a Source of Risk

This week investors in general pulled markets down. The fear of a recession has grown so large that global equity markets lost 4-5% in one day. In the last month global markets have lost between 9 and 19%. Little of this had to do with the daily performance of these companies. The falls had to do with investor perceptions of the conditions (ie risks and potential rewards) that companies have to work in. The perception is that equities in general will have to endure stagflation or deflation.

Yet investors also become a source of risks to market prices. With losses facing investors, the need to sell good investments to repay the margin calls, weakens an investor’s ability to invest in the first place. When the credit crunch initially hit, it caused a broad, market sell-off including precious metals. It took time before the gold and silver prices themselves recovered, but it did and today there are far fewer leveraged investors in the market place.

Investors always react to their own personal conditions before they respond to the investments. While today there are leveraged speculators, they do not pose such a risk to gold and silver markets. This does not mean that gold and silver prices will not fall. It means that the gold and silver markets have matured and developed to the point that they will recover quickly, moving higher as the dramas increase.

Mining  Stocks Move with the General Market

The mining share risks must be equated to the risks investors face when investing in other equities. An equity market investor compares other equities to gold or silver mining equities. If investors can get a better total return by investing in soap-producing companies, then they will go there. But he will be used to corporate risks in companies in general and view them through those experiences. Markets often reflect that sector’s average risk, giving different earnings yields to different sectors commensurate with those risks. Sad to say, many gold and silver mining companies have not focused on their shareholder’s needs, but on their own. In those cases there is no reason why they should move better than the general market.

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The U.S. debt ceiling crisis has grown over the last few weeks into a drama of such proportions that the entire U.S. public is locked onto each scene of the political theater. Outside the U.S., other nations are riveted to the drama, getting to know politicians they have never heard of before. The fact that the U.S. government should put on a dangerous spectacle such as this is appalling and disorderly. After the debacle over the Eurozone crisis, the rest of the world is failing to see the shining example of government so long held up as the correct way to govern.

While we agree that the underlying structural, political, and financial problems are driving up prices over time, the sudden drama is not. If it were the case then we would expect the gold and silver prices to dive once the debt ceiling is raised. We don't see that happening. A closer look at prices over the last couple of weeks shows that they have not risen in line with the shortening time limit and rising tension. Silver has largely ignored the crises on both sides of the Atlantic. Gold has moved within less than a 1% trading range -governed more by the €1: $ exchange rates than by the buying and selling of silver.

In this fog of spin, smoke, and mirrors, it is important for subscribers to know what really is driving the gold and silver prices.

HYPE OR REALITY

TV presenters are good at their job; they have to capture our interest to keep us coming back for more. They would like to think that they are the key source of information and they often are. But very often, selling the story overwhelms a balanced perspective. The same applies to politicians -they need to be seen as solving major crises and should keep their positions because of their ability to deliver their people from awful events.   Over time they have learned just how to let a problem ferment until it is a crisis. If they solve the problem too early they could be guilty of interfering. So the art is to let it mature into a crisis just as we see lately on both sides of the Atlantic. There have been 74 such debt ceiling crises in the last 50 or so years, but this is the one where Congress has a split power base, so the time has arrived for the parties to gain some kudos. The trouble is that the collateral damage is happening now, and the U.S. continues to demonstrate its inability to govern, highlighting the weaknesses of Democracy to the outside world.

The crisis is real because politicians are playing games with the reputation of the country for party political reasons. The very fact that they are doing that makes it a serious crisis. The ability to pay or not to pay is not part of the crisis.

Gold and silver prices have not climbed on the back of the Congressional drama. Before it caught our attention after the latest Greek episode, gold was at around $1,610. As we write this it stands at $1,617. So the Congressional crisis premium is around $7 or less than 1/2 %.

If one looks at the shares of the gold Exchange Traded Funds in the last two weeks, we saw one day of buying in large quantities, likely from one large buyer. Indeed, speculative buying on COMEX has been large, but futures and options are financial derivatives of gold and not physical gold buying. Only around 5% of these volumes result in physical gold deliveries. As you can see below the major demand shift has been to the Middle and Far East from where more than 60% of gold demand comes.

It is fair to conclude that U.S. investors have not been taking positions against a U.S. debt default, so why should the market expect gold and silver prices to fall?

WHAT'S REALLY MOVING THE GOLD PRICE

We are at the beginning of August, right at the end of the gold year. In the past this was the time gold stood at its lowest levels. Indian farmers were busy in their fields about to bring in their harvest. These people were responsible for 70% of Indian demand, the largest demand source in the world for gold. During the last decade the Indian sub-continent has urbanized to a growing degree, reducing the dependence of Indian demand on the agricultural sector of India. Likewise, the period of the year called the "Doldrums" has lost a good part of itssignificance to the gold price and gold seasons.

Gold Demand by Region

[Jewelry, coin & bar demand only]

India…………………………32%

Greater China……………20%

Europe and Russia…….13%

Middle East & Turkey..12%

North America……………8%

Others……………………….15%

While this was happening another non-seasonal, but growing influence was felt on the gold price -that of China's mushrooming middle classes. Last week we also mentioned central bank buying, which at least contributes to limiting the downside corrections in the gold price.

These are considerable forces that make any speculative buying on the back of the U.S. or Eurozone debt crisis pale into insignificance in today's precious metal markets.

In the quiet season of gold, have we seen the gold price hit the low for the year? No, we have seen it reach record highs in all currencies. After the long shallow consolidation below $1,555, we have seen it break upwards to pierce the $1,600 level.

We now move into the heaviest demand season for gold and are keenly aware that the supplies from mines are tight and unlikely to rise. Some scrap may come onto the market, but we do not expect this to nearly satisfy demand. The result is almost inevitable…

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Are we now certain to see a default by the U.S. government?

If so just what will that mean to precious metals?  

The Overall Consequences

Bear in mind that theU.S.is not the hub of the global gold market. In fact, in terms of jewelry, bar and coin demand, the entireNorth Americais only responsible for 8% of global demand. Europe andRussiais responsible for another 13%. In other words, these markets are not driven by the financial affairs of the developed world.

The developed world is responsible for the provision of the distribution networks and the markets of the gold world. Physical supplies primarily come intoLondonand bullion banks, sent from the refineries that refined gold and silver, which the mines supply. Then the bullion banks –mainly through theLondongold Fixing—supply investors, manufacturers, industry and central banks with the gold they want.

The developed world also provides the speculators and traders who are constantly dealing either in gold itself, shares of gold Exchange Traded Funds, or in the financial derivatives that can influence the gold price.

It is the global speculators and investors that have the most dramatic affect on the prices, but their effect is primarily short to medium term. The daily pressures these professional have on the market have a similar effect as the immediate waves do at the seashore. There is a constant ebb-and-flow of prices, because a price rarely, if ever, goes straight up. Where there are seasonal flows of demand and supply these have the same impact as the daily tidal changes on the sea shore. But the most dominant price pressures come from forces similar to the currents in the sea. A look at a long-term price chart shows the sum total of all these pressures on prices. In both the silver and gold markets, these flows are far more complex than a simple commodity For instance, the effect of the debt ceiling impasse had on the gold and silver price today had nothing to do with the gold or silver fundamentals, but on the threat to financial stability and the U.S. dollar. Precious metals act as a counter to the main cash and currency markets; therefore, we have to take a look at the sum total of the influences on the gold and silver prices, not just the short-term speculative ones. These are simple and clear –gold and silver prices have been reflecting the uncertainty and instability of the currency worlds and the undermining of the value of paper currencies.

In the Far East there has never been that kind of trust in paper money systems. In the developed world there has been absolute trust in paper money systems; however, this century we have witnessed a decline in this trust, which accelerated from the first point of impact of the credit crunch. This decline has widened and deepened since then, as it progressed from the banking system across to European sovereign debt problems and now is a victim of political ploys in theU.S.The most disturbing aspect of this degeneration is that the problems have not been rectified properly, leaving national economies wallowing in or close to stagflation.   With the buying power of currencies waning in the hands of people who cannot do anything about raising their incomes, the loss of confidence is moving towards desperation. With no sight of political or monetary reform, the instability and uncertainty we are witnessing is becoming deeply entrenched.

It is strange that the least sophisticated parts of the world have the greatest appreciation of the value of precious metals. It is also strange that the most sophisticated sides of the world are taking so long to recognize the dangers facing the present monetary system. We are caught up in what is a “normal” money system that we deny the dangers because they threaten our “normality”.

Aren’t we capable enough to put matters right when necessary?

So why are they getting worse?

Against this backdrop, we can now see that the main impact of a default by theU.S.would be a further fracture in the developed world monetary system, pressuring investors to seek alternatives over the long term. This damage will not be repairable.

• One of these long-term consequences will be the acceleration of the internationalization of the Chinese Yuan, so that China reduces its vulnerability to the undermining of the dollar, internationally.
• Another consequence will be the long-term diversification of national assets out of the U.S. dollar to incorporate a broad spectrum of other currencies and government bonds.
• Stagflation or worse will be another global consequence.
• Over time there may be a far greater fragmentation of the global economy, leading at worse to Protectionism and Exchange Controls.

The Specific Consequences

By specific we mean immediate to medium (up to 1 year) consequences. With the Eurozone crisis so fresh in our minds, the consequences seen there can act as our guide.  The main difference is that instead of member nations being the problem, the equivalent of the Eurozone itself is the indecisive problem –theU.S.government itself. The consequences that flow out from theU.S.become more dramatic for that reason.

1. A significant weakening of the U.S. dollar is the first hard blow to be felt globally.
2. The second is the impact on the currency world, in total, as currencies whose economies cannot afford to see their currencies strengthen further take action to weaken them. Take the Yen, for instance.   Earlier this year, the Bank of Japan intervened to weaken the Yen as its economy reeled from the tragedies that struck it and the diminution of international trade because of the strength of the Yen.   The Swiss Franc is in the same boat. Previously it also acted to weaken its currency to support local exports; however, each nation favors one or the other major blocs (Europe or theU.S.) and so manages its currency against that major currency. For instance you will see the South African Rand move against the Euro and not the U.S. dollar. If the euro is strong then theRand will be strong. Expect a solidifying of these relationships perhaps to the exclusion of others.
3. The third impact is that interest rates will rise in theU.S.and weaken the bond (Treasury) markets. If this holds then we will see the next major financial crisis in the U.S. Treasury markets just as we saw it in the more dubious members of the Eurozone.
4. Rising interest rates undermine equity markets, house prices and in turn the overall economy. With such low growth rates in the States already we would expect deflation to take hold.
5. With energy and food inflation already high, add deflation to the formula and unemployment rates will rise alongside the weakening economy.
6. Asset values will fall.
7. The only assets that will rise inside theU.S. are those that act both as cash and assets, internationally, namely precious metals. With emerging nation’s demand for precious metals already rising unstoppably, the addition of developed world safe-haven demand will keep precious metals rising to new levels as the world adjusts to an economic climate that is destructive to the developed world and at the same time will favor the developing world.

We are describing a global economic climate that the world has not seen before. In the past when such pressures have arisen they have led to wars. Today’s pressures cannot be fought over. Where battles can occur is in the financial and economic areas of life. Such battles are called “Protectionism”, “Currency Wars” and there are few winners in such wars. These wars lead to global fragmentation and distrust.

Internationally, precious metals will become the preferred reserve assets, not just an important one. Their prices will then relate more closely to the total volumes of each international currency in the world. As you can imagine, the prices of precious metals will then have to be higher than most people even thought possible.   With the gold market being such a small one in volume terms, silver will then become a monetary metal too, at considerably higher prices.

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