Monday, September 21, 2009

Why Everyone Is So Bullish on Gold

Cliff Wachtel at Seeking Alpha asked the question today, why are "speculators" buying so much gold while "professionals" are shorting?

It appears to us he fails to realize (or he's obfuscating his real understandings for some journalistic reason) the broader fundamental nature of where prices and value come from. By that we mean the fundamental nature as described by Ludwig von Mises' in Human Action.

In the fall of 2008, the Federal Reserve made it abundantly clear that they would stop at nothing to ensure they could control all financial markets and keep dollars flowing. Finally, after the success at keeping security markets open, they found themselves with functional markets but little or no demand for debt. As money piled up in accounts of all kinds, they then had to worry about the collapse of money velocity.

There is absolutely only one way to make money moving -- punish anyone who doesn't trade it (spend it) in exchange for non-money. Since they have no legislative power, the only tool is debasement and negative interest rates (charging savers for storing money instead of rewarding them with interest payments).

Debasement was easy -- in Dec '08 and Jan '09 they announced unprecedented (in the U.S.) money creation schemes in the purchase of agency debt and U.S. Treasurys. Negative interest rates seemed to manifest themselves by the nature of the credit crisis.

So we now find ourselves in an environment where holding cash carries a risk that has to be weighed against the risks of buying bonds, stocks, commodities, or anything else. Furthermore, add to the equation the necessity of businesses of all kinds to produce a ROI above single digits, and the natural inclination is to buy something that has potential for price appreciation or income. It's no surprise to us in this light, that equities and bonds are showing price strength in spite of so many macro-economic weaknesses and the fragility of all those green shoots.

Enjoy for now the fact that institutions are doing the buying of equities, bonds, and commodities. When the higher costs of the latter start squeezing business profits, they will either have to raise producer and consumer prices or suffer systemic business losses.

In the former case, PPI and CPI go up, which means the risk of "holding cash" now hits consumers with inflation -- they will start spending their cash before it's purchasing power disappears, empowering producers to raise prices (the ultimate feedback loop). In the case of the latter, shrinking profit margins will be bad for equities, which religiously motivates another round of policy changes to "stimulate" the economy, further devaluing (diluting) cash (i.e. dollars).

Very few choices today will provide price support for purchases in either scenario of inflation or economic stimulation (i.e. more currency debasement). One of them is precious metals and their centuries-old reliability as a store of value. It's not a coincidence that some sovereign nations are thinking of gold again as they did before the prevalence of fiat currencies and floating exchange rates. The only major institutions who seem to be bucking that trend are the biggest institutions in traditional western industrial regions who pin all their hopes on fiat currencies. They are the bankers and commercial traders Cliff refers to in his post.

Update Sept 22:
ColdCore now reports at SeekingAlpha some details about those other sovereign nations and their interest in acquiring the "real money" that the west shuns.

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