By Julian D. W. Phillips
The gold and silver price has and will move in tandem with each other, with silver moving higher still when gold prices rise and falling further when gold prices fall. Despite different fundamentals behind the two and a different pattern of mining [silver is a by-product of base metal production usually] the two metals are reflecting their value as a means of saving value and wealth, their monetary value. This won’t change as we see the economic currents behind the world’s financial system continue to falter. After all, for several millennia, man has not trusted man’s promises, but has referred to the precious metals to determine true value. So why should the last forty plus years change that, particularly when the 40-year + experiment with a paper financial system has shown so many structural faults.
Looking at the state of the world’s monetary system what do we see today that will dictate the prices of gold and silver tomorrow?
Since 2007 the developed world has been caught firstly by surprise at the ‘credit crunch’ and secondly by it morphing into a Sovereign debt crisis while unable to resolve it. The attempts to date, firstly by central banks have succeeded in staving off a depression but not creating convincing growth. They should have worked in conjunction with their respective governments, but the state of government in the developed world has been one of political gridlock. The gridlock is likely to persist for at least another two years in the U.S. and the national diversities in the Eurozone are likely to continue to defeat economic integration in the future. We see a clash between politics and finance that seems intractable. The only way these structural shapes can be overcome is by changing political structures to ensure unity, but that’s not going to happen. In China it works, but the Chinese system of government will not be exported to the West. So we expect these structural pressures to dictate the economic and financial shape we live within to remain as they are now. Solutions, if there are any, must be found within this shape. The day-to-day news items that affect markets will rise out of these underlying influences.
Where do these underlying currents point to in the days ahead? We will not be tempted to state hopes and dreams that “it will all come right in the end”, because living happily-ever-after has rarely been a feature of global life. We have to take today’s realities and the objectives of the powers-that-be and see what they want to see and what they will do. And we can only judge on past and present performance to gauge that.
Looking at the U.S. we see two more years of political inaction and for ‘as-long-as-it-takes’ quantitative easing. Yes, there appears to be good signs that the economy is not falling back into recession but the signs are not large enough to convince us that growth is returning, yet. As the I.M.F. pointed out this last week, uncertainty has risen significantly. And this is not just a ‘mood’ it is in. This is now a well-entrenched uncertainty about the future at consumer and institutional level.
One contributing fundamental factor in the structure of capitalism is that you should target profits. If they are increased by moving manufacturing from the States to Asia then that’s what U.S. entrepreneurs will have to do. This will export jobs that will not come back until it is cost effective to do so [i.e. wages rise in China to U.S. levels or U.S. wages fall to Chinese levels]. Likewise, the extraordinary rise in efficiency and fall in employment triggered by information technology is a structural change that has permanently destroyed so many jobs. If employment is to rise to the point that the average consumer will spend again, we must see something as structurally constructive as information technology itself, happen in the labor world.
The main influence on precious metal prices in this area at the moment is the uncertain state of the financial world. Quantitative easing may have led to a vast improvement in the state of the banking industry but not in the state of the credit market. Business has not felt the benefits of healthier banks. The banking industry is to the economy as the main veins and arteries are to the body. The blood that has been transfused through Q.E. remains in those arteries and has not reached out to the muscles and flesh and to feed them. As we said in 2007, until the average consumer feels that his house is growing in value and that his employment is secure the U.S. economy [dependent for 70% of its activity on the consumer] uncertainty and fear of the future will remain. But let’s not mislead you, we are not saying that a growing U.S. economy will establish ‘certainty’, because the main rise in the gold price we have see [when it multiplied four-fold] took place from 2005 to 2007 when the U.S. economy appeared vibrant. The negative underlying current remains in the structure of the international financial system in the developed world. Growth may increase cash flow to the point that debt is serviceable, but it is the concept that continuous borrowing in a slow growing economy is acceptable that must change.
If interest rates began to rise from current levels savers would feel better [after all they put money on deposit for the income and believed they had a solid secure investment], but today these savers are the victims of the deposit system as inflation [even low inflation] eats away at their capital. Should interest rates rise the cost of servicing debt will jump rapidly, taxing an already tenuous cash flow to government and institutions and place them under renewed and possibly unsustainable pressure.
This is the backdrop against which precious metals will perform in the future.
Systemic impact – “No man is an island…”
The sharpest point of impact that the above currents will strike will be the banking system and financial markets. So intertwined is the banking system and financial markets that the shock waves from the point of impact of systemic fracture will flow through to the entire financial world.
Wise money is looking for a place where the shock waves will inflict the least damage and where wealth and value can be retained during and after the following storms. Throughout history gold and silver have proved their ability to do that. We’re not just talking about individual investors but investors at the heart of the financial system, the banks. Only one other respected commentator that we know of has emphasized the danger of currency failures and the moves by banks to re-define gold to a Tier 1 asset on the bank’s balance sheets and the impact this will have on the gold and [by extension] the silver price.
Apart from there not being enough gold available in the international gold market to meet this potential new demand, the very fact that banks are discussing the issue and are about to enact the re-definition [we are led to believe that this could happen at the beginning of next year] demonstrates that bankers realize that gold may do a great deal of good in shoring up faith in their institutions in times of crisis. And crisis is where we have been since August 2007!
It was the banking system that rejected gold in 1971 [with the backing of government] and it is the banking system that will bring it back. Don’t be misled this is not a return to a gold standard. It is the harnessing of a confidence factor that will allow the current financial system to continue, as is. It will, as always, be an academically impure re-integration of gold into the system and only be used to keep the present banking system seemingly healthy.
But if there is not enough gold in the markets now, where will the needed gold come from?
In 1933 the U.S. government confiscated citizen’s gold with the intention of rapidly increasing the money supply through its revaluation. In the process the U.S. money supply and the banking system itself was made healthy. The revaluation in 1935 was just long enough for the dust to settle over the confiscation matter.
Could those reasons be the ones gold is confiscated today? We think not, because it purpose then was to increase the money supply. Today, increasing the money supply is done effectively through quantitative easing. So why on earth would the government see fit to confiscate gold today?
We return to the fundamental need in any monetary system for gold to function at all, confidence building! The ability to breed confidence in the financial system has never been as important as it is now. Today while the Eurozone debt crisis festers on from bad to worse, the dollar is falling against the euro. Neither currencies are inspiring confidence, but they are the only acceptable ‘means of exchange’ around. We have to use them, even while their value falls.
But in the last few years through the Bank of International Settlements, international banks including, we believe, central banks have been using gold as collateral for their own interbank loans and possibly swap arrangements. The presence of gold brought qualities that were rapidly being lost in the monetary system, trust and liquidity. The use of gold was successful in these instances.
As the system continued to decay since then the need for gold to add those qualities to banks dealing has grown considerably. This is more than aptly demonstrated by the continuous large buying of gold by the emerging world’s central banks since 2009 when European central banks stopped buying.
As possibly the main factor we see today that will affect gold and silver prices tomorrow central and commercial bank demand for gold, provided it is re-defined as a Tier 1 asset, could exert a dominant force over the gold price. How?
There are three [progressive ways that will follow one after the other] that central and commercial banks can push for the acquisition of gold:
By forcing local producers of gold to sell the gold produced direct to the central bank at market related prices.
Forcing the price of gold up! This can be done by offering a dramatically higher price per ounce [forcing out gold from investor’s hands] to the market.
Through the confiscation of their citizen’s gold!
Currently, Russia and China [we believe] are buying the local gold production into reserves. Emerging nation central banks are buying gold in the market, but at present [in the absence of commercial banks] feel it unnecessary to chase gold prices up. They are content to wait for the offer of decent quantities of gold from the bullion banks. Once the number of banks in the market place rises, this will not be easy. At that point they will change tactics to trigger greater supplies to the market from current holders.
While confiscation of citizen’s gold will be a last ditch measure, we are of the opinion that central banks and governments will not wait for desperate times but will act ahead of them to avoid the desperation. It may even be that when they see free market supplies dry up that they will feel that they have no option but to confiscate their citizen’s gold.
That time is closer than you think!
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