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Gold Volatility Jumps as Deflationary Depression Battles with Inflationary Bail-Outs

Commodities / Credit Crisis 2008 Sep 09, 2008 - 07:47 AM GMT

By: Adrian_Ash

Commodities

Best Financial Markets Analysis ArticleSPOT GOLD PRICES slipped back from an early 1.2% gain in London trade Tuesday, holding in a $10 range below $804 an ounce as Western stock markets added to their "Fannie & Freddie" surge.

Asian stock markets closed markedly lower, however, while Treasury bond prices recovered from yesterday's sharp sell-off.


Crude oil fell after the Saudi oil minister, Ali al-Naimi, told reporters that the Opec cartel will maintain its current output quotas despite this summer's 25% drop in prices.

The US Dollar slipped on the forex markets, but stayed within the sharp uptrend it began in mid-July.

The Euro fell to a fresh 11-month low beneath $1.4100 – almost 12% off its record top of July 13th – as Germany reported a one-third drop in its trade surplus for July.

UK manufacturing output fell 1.4% year-on-year, but the British Pound bounced one cent from Monday's 3% loss.

"The Dollar is stronger and crude oil is declining," noted Alexander Zumpfe, metals trader at the Heraeus refining group in Germany, to Bloomberg earlier.

"As long as these two sectors are under pressure, I don't see how Gold will recover."

Over the last five weeks the Gold Price has moved inside a range between $775 and $845 an ounce.

That range has tightened to $790-820 in the last week.

Monthly volatility in the daily Gold Price has averaged almost 23% so far in 2008, up from an average in 2007 of less than 15%. Average volatility in Gold during the 1990s was barely 10%.

Hedge Fund Research in Chicago says funds trading volatility have far-outperformed more traditional strategies in 2008 to date, returning more than 7% gains by end-August.

Stock market funds lost their clients' almost 8.4%. Corporate bond funds fell 4% on average.

"Nobody knows the direction of the markets or economy at the moment, and we're profiting from that uncertainty," says one investment officer in Miami. But following the US Treasury's decision to put the $1.6 trillion obligations of home-loan insurers Fannie Mae and Freddie Mac onto its balance-sheet, however, "a US economic recovery is now assured," believes Anatole Kaletsky, writing in the London Times .

US Senate Banking Committee chairman Christopher Dodd, in contrast, thinks the only certainty is that "a President Obama or a President McCain is going to have a mess dumped in their lap in the next 60 days."

Welcomed by the governments of both China and Japan – the first and second-largest owners of Fannie & Freddie debt respectively – the Treasury's nationalization may now cause the central bank of Russia to reduce its holding of their home-loan bonds further still.

First deputy chairman Alexei Ulyukayev told reporters on Monday that the Bank of Russia has already cut its exposure by 40% since January to less than $60 billion.

The nationalization will also trigger bond-insurance payments on the failed agencies' debt, notes today's Financial Times , since it constitutes a "technical default" by the formerly private-sector agencies.

"There is likely to be a considerable amount of [credit default swap] protection outstanding," according to analysts at Lehman Bros. "This is a big deal," agrees Sarah Percy-Dove, head of credit analysis at Colonial First State Global Asset Management in Sydney, Australia.

"The CDS market is not experienced at settling a credit event for a name of this size, so it is a bit of an unknown."

Put another way, "Back office procedures for [credit default swaps] are surprisingly primitive," says the Naked Capitalism blog. "Confirms are sent via fax rather than electronically...Language in contracts has not been tested.

"Some have claimed it is often poorly drafted and subject to challenge."

Law-suits aside, "recovery could be close to 100%", according to a note from CreditSights, if Fannie and Freddie bonds continue Monday's steep rally "and trade close to par value, with protection sellers having little to pay out despite a technical default."

But if the sellers of CDS don't actually own the bonds? Simply grazing on insurance premiums – much in the fashion of Lloyds of London names, who were wiped out in the late '80s – could suddenly prove to have been a high-risk strategy in the $62 trillion credit derivatives market. ( Get the full story on such Investment Landfill here... )

Meantime in equities, Asian stock markets reversed yesterday's jump on Tuesday, with the Nikkei in Tokyo losing 1.8% of its value and sliding back its down-trend of the last three months.

Platinum dropped more than 4% at the Tocom metals exchange. The price of palladium – also used in auto-catalysts and so also suffering on reports of a one-tenth drop in new Chinese car sales last month – fell more than 6%.

Nickel prices at the London Metals Exchange fell 1.5% – taking the total loss for 2008 to more than one-quarter – after Asia's largest stainless steel manufacturer, Posco, announced plans cut its output for the third month running.

Orange juice futures went "limit down" this morning, losing almost 9% of their value, after Hurricane Ike was forecast to miss Florida's groves.

E-Financial News reports that the Dutch pension fund run on behalf of French oil giant Total has now sold its entire portfolio of commodity investments, cashing in the strong gains it's made over the last 18 months after the sector turned markedly lower this summer.

The CRB-Reuters index of the world's 19 most heavily-traded commodities – including Gold Bullion – has fallen by one-fifth since the end of June.

It had more than doubled over the previous five years.

"We shouldn't dismiss entirely the possibility that all the bailouts fail to revive credit growth and that a deflationary secondary depression is now under way," writes Dr.Marc Faber in the latest edition of his highly respected Gloom, Boom & Doom Report .

"The sharp deceleration in credit growth, with rising default rates across the board, could suggest that debt liquidation is now occurring...[but] Ben [Bernanke of the US Fed] and Hank [Paulson of the Treasury] may replace private debt with government debt in order to bail out the system.

"That such a bailout will diminish the purchasing power of the Dollar even more (it should be highly inflationary) is clear...

"Under this scenario, renewed US Dollar weakness and strength in commodities – in particular, in Gold – should reappear."

By Adrian Ash
BullionVault.com

Gold price chart, no delay | Free Report: 5 Myths of the Gold Market
City correspondent for The Daily Reckoning in London and a regular contributor to MoneyWeek magazine, Adrian Ash is the editor of Gold News and head of research at www.BullionVault.com , giving you direct access to investment gold, vaulted in Zurich , on $3 spreads and 0.8% dealing fees.

(c) BullionVault 2008

Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it.

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