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In the face of growing fears of a
renewed global plunge into economic depression and a climate of low apparent
price inflation, investors might expect commodities and precious metals to be
falling in price. Instead, gold continues to hover around a relatively high
$1,640 an ounce and silver at $29. At the same time, central banks -
including those of the ever more important China, Russia and India - continue
aggressively to buy gold.
At a time when very complex financial
instruments allow for the seemingly effective hedging of all manner of risks,
why should precious metals, which ostensibly involve considerable downside
risk, continue to be attractive? Simply, investors in precious metals see
traditional risk management instruments as too dependent upon the challenged
financial markets that they fail to represent true and ultimate insurance.
The 2008 financial crisis was rooted in
a property bubble, but was magnified when reckless risks were often passed on
to unknowing, conservative third-parties. This was accomplished by means of
increasingly sophisticated and deceptive financial instruments. When the
unthinkable happened and property prices turned down, the highly
interconnected Western financial world was awash with toxic assets and
so-called hedge instruments, including derivatives. At one stage, total
financial collapse threatened, so governments stepped in to absorb these
toxic assets or pass them off to more solvent banks.
To most observers, the threat was
averted. To others, it was merely hidden in banks, central banks, and
national treasuries. The result is that massive, latent deleveraging
continues to threaten Western economics and cast doubt on all categories of
paper assets. Among other consequences, this has raised the prospect of a
dismantling of the euro, the world's second currency. And yet another round
of political and central bank interventions have been taken to avert this
outcome.
Despite its posturing, Germany wants the
EU to survive as the domestic market for its exports. As long as Germany sees
the euro as vital to EU survival, she will support the continuation of the
status quo, even if it is necessary to support prostrate economies like
Greece. But even Germany's treasury could become overwhelmed attempting to
finance and support all the PIIGS (Portugal, Ireland, Italy, Greece and
Spain) in its pasture.
At each stage of the operation to paper
over the growing threat of national insolvency, the actions taken by
regulators, financial companies, central banks, and governments become not
only increasingly desperate, but also expose the systemically vulnerable
global financial system to unforeseen shocks. Sensing this, more players turn
to precious metals as an escape.
Looking at the current international
financial shoring up operations is like looking at an old, massive dam which
has suffered structural damage from earthquakes. Unwilling or unable to
rebuild the dam, politicians have been content to pour cement over the
cracks. Not only is this unsound engineering, but it also hides the real
cracks from plain sight. As such, no one knows from where or when the next
potentially fatal fissure will come.
Right now, all eyes remain trained on Europe.
If Germany were to overplay its hand within the eurozone,
the common currency could collapse. That would throw the $600 trillion
derivative market into panic, threatening the viability of most of the
Western world's prime banks, commercial enterprises, and even governments.
Judged by recent experience, it would
likely lead initially to a surge in the US dollar as investors sought
perceived 'safety.' Indeed, foreigners now own some $6 trillion, or almost 40
percent of the US Treasury's debt. However, with Treasury debt now at 102
percent of GDP, the United States has joined Portugal, Italy, Ireland,
Iceland, Greece, and Japan in the ignominious club of nations with debts
larger than their annual production. Should this fact start to worry overseas
holders (let alone domestic owners) of Treasury debt, a collapse of the US
dollar could follow. The undertow of a sinking dollar could drag down a
massive web of closely interrelated and sophisticated hedging securities and
vehicles. Indeed, a mass of financial assets previously perceived as
'uncorrelated' would appear suddenly to be correlated all too closely in
collapse. A sudden absence of bid prices, even for prime securities, would
devastate paper fortunes across the West.
However, those who hold precious metals
as a hedge should escape the worst of the fray. If the last decade is any
indication, keeping in mind that past performance is no guarantee of future
results, gold is still regarded as a true safe haven - its appeal growing as
other paper reserve options are exhausted. In the event of a Western
collapse, not only gold and silver, but all commodities will still be in
demand across the developing world - itself insulated from Western foibles by
its high domestic savings and tremendous productive capacity.
The current high prices of precious
metals, in the face of possibly deep economic recession, indicate that the
prospect of a sudden and catastrophic financial collapse is very real.
Indeed, as long as politicians continue to ignore the real implications of
the uncertainty they are creating, gold and silver should continue to set new
nominal highs.
John Browne is a Senior Economic Consultant to Euro Pacific Capital. Opinions
expressed are those of the writer, and may or may not reflect those held by
Euro Pacific Capital, or its CEO, Peter Schiff.
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