Time for gold to shine?

By Moyo Mamora, on February 3rd, 2009

 

With gold off its highs of 2008 by 10% in dollars, it still sits at a high against other world currencies, most especially the British pound. The past year has witnessed a great amount of market volatility that has sent investors and traders cashing out of the market to preserve their capital. Majority of Banks worldwide have had their balance sheets heavily attacked, and have heavily reduced lending, creating a credit crunch. The US is plagued with headlines of job losses and has since fallen into a recession with the lack of consumers having enough to spend so as to push up the economy.

 

In January 2008 gold peaked at a price a little over $1000 with intense recessionary fears, and by the final quarter of 2008 gold traded as low as $720. Though there was the speculation of heavy manipulation in the gold market, gold prices fell when investors began to realize that the US was fighting a battle of deflation with the threat of inflation not being an immediate threat. It is believed that the recession in the economy will slow down any debasing of the dollar.

 

The dollar which started 2008 by taking a major beating has since then turned to be a currency of strength amongst other world currencies. Investors worldwide are cashing out of various asset classes in this period of forced liquidation and are buying US dollars, hedge funds and other money managers have to buy US dollars to meet redemptions. The US dollar still remains the world reserve currency and is seen as a safe haven in this world economic crisis. This is not to be confused with the idea that the US economy is stable. World central banks have turned to the US to seek funds to increase liquidity in their economies.

 

This rise in the value of US dollar, being the world standard for purchase, has crashed the prices of commodities. Commodities have taken a beating of over 40% since their peak in the summer of 2008. Amidst this gold took a part of the hit in the fall of commodities, with crude oil taking the biggest hit. In spite of this, gold still came out profitable in 2008. Now what do we make of this? With the CRB index down over 40% in 2008, and gold coming out with a 5% gain in dollars, as well as being at a high against other currencies, what does that tell us?

 

Gold is commonly seen as a hedge against inflation, because of its fixed world supply, which causes the precious metal to rise in value with the increase of the circulation of paper money. However as stated earlier, the perception was sold to investors that inflation is not an immediate threat to the US economy. The US inflation in 2008 was put at 0.1%, but is the 5% rise in the price of gold a better indicator of the inflation in the US? Nevertheless, the US agrees to be fighting the battle of deflation and have decided to print money so as to spend the US out of this economic downturn. So far in the past year we have witnessed the Federal Reserve’s balance sheet increase by over $1.2 trillion, and there currently is no sign of this stopping because there seems not to be a clear bottom in sight.

 

With this increase in liquidity being turned into the market, the US dollar will slowly but surely begin to turn worthless (except you subscribe to the notion that the Fed will print just enough to stabilize the economy), when this happens, the value of gold will sky rocket.

 

(click chart to enlarge)

 

 

 

The gold chart above shows comex gold futures consolidating in a triangle pattern, last week witnessed a breakout to the upside, given the current price of gold, it remains extremely volatile, and with the rally is expected a dramatic pullback also. At this point two cases exist for continued upside in the gold market. A breakout above the upper downtrend line will likely send gold above $1000. However gold may retrace down to $834 (or the lower uptrend line) in which case it will be expected to continue its movement up.



Leave a comment   Financial Markets

The mystery of inflation, deflation and printing money

By Vipin Veetil, on February 2nd, 2009

The RBI weekly inflation figures are out, and inflation in India is pretty much around what it was last week. So prices continue to rise at a steady rate despite rapid decreases in interests which have pumped crores of Rupees into the economy.

How do we explain the puzzle. For one there is a time lag, this is a boring and well know explanation. A more interesting one is what may be called the “velocity of money”, though a term greatly misused by Keynesians, it did at some point have a simple meaning. The term is pretty old, Henry Thorton mentions it in his 1802 book on Paper Credit in Great Britain, and thats not the first instance I believe.

Velocity of money is the rate at which notes circulate, or change hands. So velocity can be something like a 10 Rupee note on the average changes hands every 10 minutes, for example.

Now say I get paid on a daily basis and usually exchange 50% of my notes for goods, so if I have 100, I spend 50. But when a recession breaks out people get a bit uncertain about their future income, they increase savings to be on the safer side of things. I like other good men reduce my spending to 25% of my holding. In other words the velocity of money is fallen, the same notes don’t circulate as much, they are hoarded as savings.

The Keynesian prescription then can take many forms. One of them is to send people checks, so if velocity of money is fallen, lets increase monetary incomes. I get a check of 100, my income is now 200, I spend 25%, which is 50. So monetary demand is maintained. Let me for the movement leave out the other diastorous consequences this kind of thinking can have, and just focus on inflation.

Now if the monetary fillip is less than decrease in velocity due to “fall in credit worthiness” and “fear”, then there maybe deflation or reduced inflation in the very short run. In otherwords, if the check is recieve is of 50 only, my income become 150, and I spend 25% which is 37.5 (less than the earlier 50). Monetary demand falls, so inflationary pressures fall.

But soon, as the economy gets itself rolling, people begin spending the money. Velocity of money goes back to earlier rates, plus now there is more money in the system, so you get rapid inflation, and more trouble! And if the government tires to pull the money out, say higher interests, then you get into all sorts of mess like some investment projects not being profitable anymore, etcetera.

So when does government printing of money lead to hyperinflation. Well typically the richer guys hedge themselves, in otherwords they don’t hold their wealth in government money. The poorer ones do, either directly in cash holding or in assets which are not marked to inflation. Usually, the middle class and poor find it too expensive to gather the knowledge or other resources necessary for hedging. But once the printing goes beyond a level during recession, almost everyone figures that though we must save to help tide over possible hardships, they cant save in government money since its becoming worthless. At this point the velocity of money shoots up exponentially, people want to get rid of government notes in minutes. And naturally high velocity combined with more money leads to hyperinflation.

So thats the story my friends, at least the way I see. Do let me know what you think. Also check out W H Hutt s Keynesianism: Retrospect and Prospect, a good read in these troubled times. I have just began.



Leave a comment   Monetary Policy   ,  
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