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Gold Reacting to Central Bank Money Attempting to Prevent Collapsing Credit Bubble

Commodities / Credit Crisis 2008 Feb 21, 2008 - 01:45 PM GMT

By: Christopher_Laird


Best Financial Markets Analysis ArticleBottomless financial pits - With gold again having a try at $1000, speculators aside, one wonders how far that has to go?

Well, for one thing, Central Banks have posted about only $2trillion worth of financial injections and bailouts since only August 07 to combat the credit collapse. 

In recent weeks, the German banking crisis had its latest manifestation . German banks are again in crisis mode, and needing more bailouts. When the credit crisis exploded last year, German bankers stated that it was the worst crisis since the 1930's, when German banks collapsed headlong and caused a European banking crisis amidst the Great Depression.

German State Owned banks on verge of collapse
By Wolfgang Reuter

The German government has had to bail out state-owned banks with taxpayers' money after their managements recklessly gambled away billions on subprime investments. But if a state-owned bank were to go under, the consequences could be disastrous for the whole economy.

… As the head of KfW, Matthäus-Maier is a major shareholder in IKB, the Düsseldorf-based bank that is on the brink of bankruptcy and is only being kept afloat by a series of government bailouts running into the billions (more...). Last week was marked by one crisis meeting after the next - Feb 20 08

And England just stated they will have to nationalize Northern Rock because there are no buyers interested in a big stake. That costs English taxpayers something like $100 billion.

Then, we hear that the ever present US bond insurers MBIA and AMBAC are at risk of being broken up by NY regulators who gave them 3 to 5 business days last week to get organized (money) or face a possible break up. Time runs out.

And, we haven't even touched on the $200 billion in losses to US investment banks and financial institutions to date, with ever expanding losses popping up, as with UBS this week. They thought they had that dragon slain, but it was not dead. More losses appear.

Now Asian banks next?

Then, we hear that the Asian banks might be hiding some big losses as well related to mortgage derivatives, and you ask why? Because the losing mortgage derivatives such as CDOs, MBS, etc are something like $3 trillion, and since these are being discounted so far by various credit indexes by about 10% or more, we are looking at about $400 billion in losses out there, at least… and where are the other $200 or so that no one has reported? Asia likely. They have been heavy buyers of these mortgage derivatives. As like last time (90's), they may be hiding the losses from view. In about a month, we are going to see some shoes dropping in that arena, as they have to report financials in March.

CB cuts not doing much

Even as the US Fed has cut about 2.25% on its target rates, 30 yr mortgages were not declining significantly. Some credit spreads in Libor have narrowed, but overall the credit mess is spreading.

We have not gotten to other collapsing credit sectors and the losses that will engender, such as consumer credit, auto loans, etc. 

Corporate finance/bonds are in trouble. Municipal bonds are in trouble. Those markets have been infected by expected losses that mortgage derivatives are inflicting on municipalities and corporations who have invested in various derivatives. So their bonds are going up in yield/cost.

But, in any case, the overall problem is a collapsing world credit bubble. US mortgage derivatives were only the detonator. As central banks frantically try to stem the losses accumulating on the books – in banks, corporations, municipalities, and households, practically every sector of the economy is in financial contraction as credit contracts drastically.

It's a big bottomless credit loss pit that yawns before the big world central banks. Their $2 trillion plus efforts to stem the collapse of credit are barely affecting credit markets. In fact, contracting credit markets are far outrunning CB efforts to combat it.

Gold started its latest rise to threaten $1000 in August. If you look at a chart of gold prices since then, the big rally to these $900 plus levels started when the credit crisis started to explode in Aug/Sept.

Basically, gold is reacting to all the CB money as they try to control a collapsing world credit bubble.

Of course, speculators as well are all over gold, oil and some other commodities. Inflation is a problem in the US and EU, and is going to restrict the needed interest rate cuts by their central banks. Stagflation forces emerge. Gold loves that.

Gold could correct, but frankly, the overriding macroeconomic forces are stagflation and the black hole credit bubble collapse. This very restrictive on CB options. If they don't cut rates (the only hope for this collapsing credit collapse is further big interest rate cuts before it's too late) we get real deep recession and massive credit losses. If they do cut rates, we get more inflation and gold will love that. This is a win win situation for gold.

Of course, one thing we all need to realize, as a caution, is that we might see a big world stock collapse. That would hit gold rather hard at first. But, ultimately, we see gold going well over $1000 and staying there, and people will remember when they could have bought gold at under $1000.

Gold can indeed correct from these $900 plus levels technically, but the overriding macro trends are stagflationary and very gold bullish into 08.

By Christopher Laird

Copyright © 2008 Christopher Laird

Chris Laird has been an Oracle systems engineer, database administrator, and math teacher. He has a BS in mathematics from UCLA and is a certified Oracle database administrator. He has been an avid follower of financial news since childhood. His father is Jere Laird, former business editor of KNX news AM 1070, Los Angeles (ret). He has grown up immersed in financial news. His Grandmother was Alice Widener, publisher of USA magazine in the 60's to 80's, a newsletter that covered many of the topics you find today at the preeminent gold sites. Chris is the publisher of the Prudent Squirrel newsletter, an economic and gold commentary.

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