|
Last week’s move by the dollar
price of gold into new high ground is an event of considerable importance; an
importance barely appreciated by the vast majority of market observers
– hardly even by gold bugs. They miss the point by slavishly following
the interpretation of markets by charts to produce their price forecasts.
This
myopic approach is little more than guess-work and is inadequate analysis,
because there are powerful forces at play. The two that are most relevant are
the economic background and the market dynamics for gold, both of which have
arrived at important inflection points, where everything seems about to take
on a new direction.
Economic
background
Around
the Keynesian world, economies are stalling as the inventory-led recovery of
the last eighteen months runs out of steam. What Keynesians never understood
is that you do not engender recovery by taking money from the productive
private sector to be spent or redistributed by the government, or
non-productive sector. It really is as simple as that. Fiscal deficits rob
the private sector of crucial savings, without which economic activity is
curtailed. Monetary inflation compounds the problem, being a further burden on
private sector savings, robbing them of value. The only winners in this
Keynesian redistribution are the government’s closest friends, and the
ephemeral benefits to them rapidly evaporate as well.
It
is wrong to attribute the economic recovery of the last eighteen months to
deficit spending and quantitative easing: the recovery was actually a
collective sigh of relief that the immediate crisis had passed without a
financial collapse. The effect of this relief was enough to obscure the
economic negatives of robbing Peter to pay Paul. Now that both confidence and
the ephemeral benefits of government reflation are ebbing, it should be no
surprise that the rocks of recession are becoming revealed again. The
consequence will be even larger budget deficits than currently expected and
an increasing desire in central banks to print yet more money to buy off
outright deflation.
This
is not a stunt that will work second time round, because the starting point
is entirely different. The economic negatives of a deteriorating budget
deficit and renewed quantitative easing will be there for all to see. In the
unlikely event that governments and their central banks find the required
room for manoeuvre, increased deficit spending and QE – collectively
the Keynesian stimulus - will perversely accelerate the downturn in the
private sector. This point must be repeated to drive it into impenetrable
Keynesian heads: the private sector cannot function when governments
monopolise savings. It is however almost certain that Western governments
will not even have the required room for manoeuvre, because the starting
point for the stimulus is a grossly overpriced bond market.
The financial world is
already awash with government debt, because there have been extraordinary
amounts issued. The reality is that governments themselves are insolvent, and
cannot repay their creditors; yet with a renewed downturn they are now faced
with a further round of accelerating welfare costs and falling tax revenues.
The politicians’ answer, which is to clobber the rich, is entirely
counterproductive, leading to less and not more tax revenue. These dynamics
are for the moment ignored in bond markets, because they are in a bubble
where all rational thinking is absent.
Like
all bubbles, this one will pop, making it impossible for governments to sell
meaningful quantities of debt. Governments in Europe as well as the US
have made the position even worse by shortening their debt maturity profiles,
so they will have to fund rapidly accelerating quantities of debt on rising
yields. For example, the US is faced with the maturity of $5.3 trillion of
its sovereign debt over the next three years, representing 60% of its current
outstanding total. Imagine for a moment the extra damage from rising bond
yields to US government finances while this is being rolled over; and
consider this for Italy, which is in a similar position.
So
Western governments are in a corner from which there is no apparent escape.
It is crunch-time for Keynesian and monetary economic policies. These
governments are not temperamentally suited to reducing the size of the state
at anything like the pace required. They will persist in their belief that
deflation is the greatest danger, and that only Keynesian stimuli can deal
with it. But with bond yields due to increase sharply, markets will not give
them the room to stimulate, so they will face the alarming prospect of
loosing all control over events.
Now
that an economic crunch from which there is no apparent escape is upon us, we
have arrived at an inflection point. The outlook for bond markets is
extremely grim, with the prospect of a global ramp-up in yields as prices
collapse. Equities will respond badly to such a development, as will property
prices. All of which brings us to gold.
The
market position for gold
The
prospect of a marked deterioration in government finances can be expected to
accelerate demand for gold, and indeed, as we approach the inflection point
for government finances, gold is making new dollar highs on cue. It may
have much catching up to do, since gold has barely reflected the monetary and
credit inflation of fiat currencies since Bretton Woods, and arguably longer.
But to simplistically link fiat-money inflation to the gold price is a side
issue, since the gold price has been manipulated by governments seemingly for
ever.
Modern
gold manipulation and currency intervention have had a simple purpose: to
facilitate the management of economies and their internal prices. Manipulation
of gold prices has become a way of life for the central banks of the US,
Europe and UK, together with the Bank of International Settlements and the
IMF, who we can refer to collectively as the Cartel.
Over
the years the Cartel has sold and leased large amounts of its gold. Some of
this has been declared through official sales, but the quantity of leased
gold can only be guessed at. There have been credible estimates of 5,000 to
10,000 tonnes of gold leased out by the Cartel since the 1980s, positions which
are presumably still being rolled over when they become due. Analysts usually
compare these figures to the 30,000 tonnes officially held by all central
banks, but it is more relevant to compare them with the 21,000 tonnes
declared by the Cartel, and the 2,500 tonnes mined annually.
However,
the quantum is not as important as the likelihood that the Cartel is now
ineffective. It is up against three basic factors: other powerful central
banks have emerged as buyers of gold, such as China, Russia and India; free
mine supply is contracting (especially when you take out Chinese and Russian
production which is not made available to capitalist markets); and hoarding
demand from virtually everywhere is accelerating, driven by pure fear. This
is another inflection point, and the Cartel is now virtually powerless to
stop it.
The
bullion banks have worked with the Cartel for the last thirty years to feed
leased gold into the markets in order to suppress prices. These actions have
led to the development and maintenance of huge short positions in London and
on the Comex futures market. In the past, the ready availability of leased
gold from the central banks, coupled with newly mined supply, much of which
was accelerated through forward sales, encouraged the bullion banks to run
these large short positions. Those easy days are now gone, though
market-makers and traders have not reduced their short positions to reflect
this reality.
New
leasing by the central banks, as opposed to roll-overs, can only be at
nominal levels. The miners have unwound most of their forward sales and China
and Russia are withholding their production from the markets. The short
position in London through unallocated accounts[i] can only be guessed at, but
judging by daily settlement volumes running at 530 tonnes per day, it could
easily be several thousand tonnes[ii]. The short position
on Comex has accumulated to about 900 tonnes. There is no possibility these
positions can be covered easily at current prices, which means they have to
be maintained.
This
is suddenly important, give the deteriorating economic outlook. The
inevitable and rapid deterioration in government finances will almost
certainly trigger a new wave of demand for gold. This demand is not yet
understood by those market professionals who assume that rising prices will
generate sufficient supply from profit-takers. This is usually true in other
markets, but the buyers of gold today are mostly hoarders, and hoarders tend
to buy more on rising prices as their earlier fears appear to be vindicated.
So the difficulty for those that want to put a lid on this market is that
rising prices will lead to accelerating demand. Since government finances are
close to an inflection point, so is the price of gold. As gold prices take
off, those short positions in London and on Comex will bankrupt the bullion
banks, and in the public mind at least, confirm the worthlessness of fiat
currencies and the bankrupt state of governments themselves.
So
gold’s move into new high ground is an extremely important event, and
we are about to discover how much power this weakened Cartel actually
possesses.
[i]
Bullion banks run unallocated accounts on a fractional basis. That is to say
they maintain physical stock sufficient to meet delivery demand. The ratio
between stock held and stock owed to account holders is never disclosed, but
analysts have suggested it could be below 5%.
[ii] This is end of day settlement,
including forwards. The LBMA states that inter-day dealings are typically
five times this level.
Alasdair McLeod
|
