Gold hits new highs and falls back as Eurozone dominoes line up

There should be plenty of life yet in gold as Eurozone financial systems remain under huge pressure and perhaps U.S. States not far behind.

Author: Lawrence Williams
Posted:  Wednesday , 08 Dec 2010 

LONDON - 
Gold rises to new peaks, falls back - and is then almost immediately written off by the bubble proponents, only to rise from the "dead" and move yet higher again and again.  That seems to have been the pattern of gold's progress over the past months and years.  Yet still there seems to be plenty of life in the yellow metal as western financial systems remain under huge pressure and the big money is nervous about collapses, confiscations and collaborative dealings to try and control the mess in which the Western World finds itself.  Yesterday it hit a new high yet again, but profit taking brought it back down sharply in U.S. trading.  It remains to be seen where it goes from here, but one suspects global economic uncertainty will continue to keep it moving higher overall.

In the Western economies bailouts and restructurings are the order of the day - defaults by any other name - and the Eurozone in particular is feeling the crunch at the moment ,but the U.S. federation can't be far behind, and even some Canadian provinces appear to have some pretty shaky finances.


But take the Eurozone first. The Euro is a huge trap for the weaker states.  Before the Euro any country that got itself into the kind of difficulties that so far have virtually brought Greece and Ireland to their knees could grit their teeth, devalue and probably receive IMF money to tide them through a transition period as their economies became more competitive and capital inflows started to come back in.  True imported goods and foods would become more expensive and domestic inflation would become a problem, but the process might be gradual and by and large the population would live with it as did the U.K. populace during the Wilson government devaluation and subsequent inflation from 1967.  Floating currencies too add much more flexibility, but again this is not possible within the single currency area.

So, nowadays European economics are different.  The bailouts are reluctantly given supported by, mainly, the one major exporting nation in Europe which is hugely benefiting from the Euro because its currency cannot rise independent of the Euro (Germany), and these are coupled with potentially draconian austerity measures which may well lead to blood on the streets.  According to the pundits, Portugal is likely to be the next nation to suffer this ignominy and then, perhaps, horror of horrors, Spain with a vastly bigger economy which may need bailing out, and this is a nation with a pretty volatile populace.  Italy isn't in great shape and now some are suggesting that France's economic position is far weaker than its official figures show and it could also be close to financial collapse.  The U.K. is, of course, also in serious trouble having been led there by a Chancellor and then Prime Minister, Gordon Brown, whose reputation for financial prudence has been shown to be a tissue of hype and hot air.  But as the UK is not in the Eurozone proper, having kept out of the single currency, it has a little more flexibility available, although the new Cameron government is already having a hard time pushing its own austerity measures through.

But back to the Eurozone proper.  Each domino which totters and needs bailing out has to bring the potential demise of the Euro itself nearer and nearer.  Germany may feel the Euro project is valuable enough to be worth saving as long as it is only the smaller countries which need its, and the European Bank (and IMF), assistance, but if any, or all, of Spain France and Italy succumb then it will probably become politically unacceptable to the German people to keep on paying to bail out its profligate neighbours.
If the Euro does collapse - and maybe the odds at the moment are that it won't, but that it will remain under major strain, - then that would throw a huge hunk of the global economy into a financial tangle which could last for years before it all gets sorted out.  And in such circumstances gold thrives!  More and more money would move into anything which offers stability against currency fluctuations and turmoil and a flood of European devaluations.

The U.S. however, even though there are perhaps some small signs of recovery, cannot be immune to the Eurozone travails.  Indeed it can also not be too long before the populace, and the financial system, starts to accept that what is being seen in Europe can be mirrored in potential defaults and bailouts of the majority of U.S. states running similar levels of deficits to those faced by the Europeans.  Indeed some of the bigger states have the most severe problems.  The Fed is unlikely to let them default, but the only real way it would have of avoiding such defaults is to print, and make available, yet more money - maybe QE3, 4 or 5 are on the horizon - and ultimately the volume flow of dollars into the economy has to lead maybe straight from stagflation as at present to high inflation and even hyper-inflation if the panic sets in.  Again we are here looking at a scenario which we earnestly hope and pray will not arise, but with current policies we are seeming to be heading in that direction and perhaps we are already too far down the road to come up with a serious alternative.

It would seem that the Fed's policy is to inflate its way out of its financial problems, but that is really taking the dragon by the tail and it will need cool nerves and a lot of luck for such inflation not to get out of hand.

But in this case the clouds have a golden lining.  The yellow metal still looks to many as potentially the best way of doing the best one can to protect one's wealth which is why investment continues to flow into the metal.  It still only accounts for a tiny proportion of total investment so there remains plenty of room for further intake, and while QE continues and interest rates effectively remain negative, then there would seem to be few barriers to further growth.  Supply is, in effect, limited and demand is also growing rapidly in China in particular, which has the potential for soaking up more and more of global production, while at the same time absorbing all of its own output as the world's biggest gold producer.  With a recent estimate suggesting that 80% of China's enormous population will have achieved ‘middle class' status by 2025, and individual purchase of gold is seemingly built into the national psyche, then the potential strength of gold, and other commodity, demand could be phenomenal.

Thus gold's fundamentals are truly changing.  Central Banks are becoming net purchasers instead of net sellers, gold mining growth is severely limited as grades fall and costs rise and replacement of declining reserves becomes more and more difficult to achieve, scrap sales appear to have peaked and investment demand continues.  The only way does appear to be up until, and unless, sentiment towards the global economy changes and a serious proportion of investment gold starts to trickle, and then perhaps flood, back onto the market - but this day could still be years ahead.