August 5, 2008
Many people as of late have been wondering what’s wrong with gold, fearing that gold will now re-test the $800 level. In fact, gold is down another $10 an ounce in London markets in a seemingly endless spiral as I write this. Given that the news about banking woes is devoid of the “Hank Paulson spin” in Asian countries, Russia and the Middle East, I doubt that these countries would continue to sit on the sidelines if gold indeed drifts even lower without pulling the trigger on significant buying. Everyone in the world that has been immune to the “Paulsonization” process seems to be cognizant that the most recent measures to bailout Fannie Mae and Freddie Mac and the American banking institutions will continue to exert downward pressure on the U.S. dollar. Thus there will be a scramble of foreign institutions, Sovereign Wealth Funds, and Central Banks to snap up gold as it drifts lower despite what Western Banks state through the vessel of the international media. In addition, the trashing of the U.S. Federal Reserve’s balance sheet to provide temporary liquidity to U.S. banks has also served to hugely dampen global confidence regarding U.S. treasuries and government backed securities.
In recent Congressional testimony, both Hank Paulson and Ben Bernanke stressed that market confidence was the key to holding things together now – remarkably they both have been tunnel-vision focused not on actual solutions that make any sense, but just the artificial manufacturing of public confidence. Most people most likely assumed that Bernanke and Paulson were referring to the confidence of the American public. However, I believe that they were speaking more specifically of foreign confidence in the American economy, and here’s why. Foreigners hold massive amounts of Fannie Mae and Freddie Mac securities, U.S. treasuries, U.S. dollars, U.S. stocks, and now, significant percentages of America’s largest Wall Street firms and banks.
I believe that most people completely missed one of the most important goals of the recent SEC law that made naked shorting of 19 of America’s biggest banks and investment firms illegal (at least until August 12). Although many people viewed this measure as a tactic taken to force the unwinding of massive short positions taken against the U.S. financial sector, more importantly, this measure was about maintaining foreign, not domestic, confidence in these institutions. As Paulson and Bernanke have repeatedly stated in the past during Congressional testimony, it’s not reality that counts, it’s what you can get people to believe. Paulson has tried this same tactic multiple times in the past, with his most famous botched attempt his very public declaration that the subprime problem in the U.S. was “largely contained” just months before the subprime markets turned illiquid.
Within the past year, foreigners, in an attempt to offload their rapidly devaluing dollars for tangible assets, engaged in an unprecedented buying spree, providing desperately needed capitalization to some of America’s largest banks and investment firms. With many foreign governments undoubtedly sitting on billions of paper losses in Fannie Mae and Freddie Mac debt right now, additional millions in paper losses in their recent purchases of these U.S. financial institutions that took place in July no doubt cast a serious blow to their confidence in the U.S. economy. And what would have been the most likely short-term beneficiary of their frustration and search for a safe haven for foreigners after experiencing massive loss after massive loss? Gold.
Gold is akin to being a weathervane for inflation and the North Star for the fate of the U.S. dollar. So with the confidence of the whole world at stake, it is no coincidence that some of the largest net short positions in gold futures contracts in the past 12 months were undertaken by the Commercials on July 15, and that this singular action consequently helped to trigger gold and silver’s usual July/August swoon.
Still, despite any back alleyway deals that may have already been cut, I just can’t foresee foreign governments and Sovereign Wealth Funds that possess hundreds of billions of surplus money not seizing the opportunity to convert significant portions of their fiat currency into tangible assets as gold drifts towards $880. Though some now believe that gold will retest last May’s lows of approximately $850 an ounce, I really can’t foresee gold drifting significantly lower than $880 before a quick snap back rally. Despite the fact that gold averaged about $30 an ounce less in price during the second quarter than the first quarter, the SPDR Gold (GLD) shares still reported a net inflow of five additional tonnes during the second quarter. It is very possible that Hank Paulson and the U.S. Treasury may have made a lot of promises to foreign nations during recent negotiations to stabilize the world economy, but based on history’s repeated pattern of having manufactured “market confidence” only successfully trump underlying reality for very short-time periods, I’m going to place my bet that by the end of the year, the question “What’s wrong with gold?” will have disappeared.
[tags]gold bull, gold correction, what’s wrong with gold, Hank Paulson, Ben Bernanke, US Federal Reserve[/tags]