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Go for the Gold: Metal to Rise as Financial Tactics Fail

Commodities / Gold and Silver 2011 Nov 19, 2011 - 12:23 PM GMT

By: Barry_Elias


Best Financial Markets Analysis ArticleTwelve years ago, Goldman Sachs converted from a private partnership to a publicly traded company.

This enabled them to take more extreme risk at the expense of others (e.g., clients, taxpayers). Co-CEO Jon Corzine was instrumental in consummating this conversion, receiving roughly $400 million from the initial public offering (IPO).

Following his departure in 1999, he served as New Jersey Senator (2000-2005) and New Jersey Governor (2006-2010). Beginning in 2002, Goldman Sachs assisted Greece with cross-currency swap derivatives that camouflaged their true debt and deficit beyond that required by the Maastricht Treaty of 1992, the basis for the European Union. By using fictitious exchange rates, Goldman was able to secure an additional $1 billion credit line for Greece.

Less than a decade later, these real liabilities have become more visible and have metastasized globally.

In 2010, Jon Corzine became CEO of MF Global, a derivatives trading firm. Recently, he resigned as the firm declared bankruptcy with $6 billion of European sovereign debt exposure. In addition $600 million of client funds are not available for withdrawal. This failure points to the instability of fiat currencies, where undercapitalized derivatives are easily created and propagated with severe global repercussions.

This financial asset explosion and wealth destruction has further exacerbated geoeconomic and geopolitical uncertainties. The European sovereign debt dilemma has escalated into a global contagion. The ills that affected Greece now impact Australia and the United States. The values of sovereign fiat currencies, which can be readily manipulated, have declined, while the value of a more stable medium, such as gold reserves, has risen.

The destabilized global environment has enabled gold to become a favorable bastion of wealth preservation and diversification, a reliable collateral pledge, and a monetary exchange asset. It now represents economic sustainability, auspiciousness, and saving.

Moreover, its value is less dependent on other asset classes (more positive correlation). In the past, gold would typically rise as equity and bond prices fell during inflationary time periods (negative correlation).

Today, it appreciates based on dynamics less dependent on these asset classes.

The demand and supply of gold over the past four decades have changed significantly. Demand has shifted from west (North America and Europe) to East (India, China) as economic liberalization has increased.

Demand for gold has been exercised more readily due to a more stable environment: greater market access, more flexible products, enhanced transparency, forward hedging with a well-capitalized real asset, and the Central Bank Gold Agreement (CBGA) that limit annual sales of gold by global central banks. These stability measures have provided the gold market with increased liquidity and lower volatility.

According to the World Gold Council, total gold demand by the west decreased from 47 percent in 1970 to 27 percent in 2010. During this period, gold demand by the east increased from 35 percent to 58 percent. These figures exclude central bank purchases and OTC (Over-the-Counter) transactions.

A major component of demand is jewelry. From 1980 through 2010, demand for jewelry by the west, as a percentage of the total, fell from 56 percent to 14 percent. That for the east rose from 22 percent to 66 percent.

Central banks of the emerging eastern countries possess much lower gold reserves as a percentage of total foreign exchange reserves than the western countries: China: 1.7 percent; India: 8.1 percent; Russia: 6.7 percent; Brazil: 0.5 percent. By contrast, this figure for the United States is 74.7 percent. In addition, the eastern countries are actively attempting to increase their gold reserve percentage.

The dynamics surrounding the supply of gold have also resulted in a more stable (less volatile) environment. Supply is less dependent on fluctuations due to business cycles, external events, and idiosyncratic behavior.

The global supply has been more evenly dispersed where no single sovereignty possesses more than 14 percent of the total global supply.

China is the largest producer with 13 percent of the total. This is followed by: Australia: 10 percent; US: 9 percent; Russia: 8 percent; and South Africa: 8 percent.

Moreover, recycled gold, as a percentage of the total, has increased from 22 percent in 1970 to 38 percent in 2010. Bringing this supply to market is more cost effective and timely. This increases liquidity and reduces price volatility.

In 1944, the 44 Allied nations from WWII signed the Bretton Woods Agreement in New Hampshire, setting the price of gold at $35 per ounce. President Nixon removed this standard in 1971. Since then, the real rate of return (after inflation) for gold was positive, despite the widely held view that it functioned primarily as a hedge against inflation. The price rose every year during the first decade of this millennium, the first such run since the 1970s.

The Metal Economy Group (MEG) indicates that gold finds fell 90 percent (from 10 to 1) since 2003. During this time, the price doubled from $700 to $1,400 per ounce. This dynamic is atypical. When price is rising, exploration is usually strong, leading to greater finds. This data suggest supply may be limited it the near future, adding more upward pressure to price.

As financial derivatives inevitably decline and explode, gold will continue to rise.

By Barry Elias,

Barry Elias provides economic analysis to Dick Morris, a former political adviser to President Clinton.

He was cited and acknowledged in two recent best-sellers co-authored by Mr. Morris: “Catastrophe” and “2010: Take Back America - a Battle Plan.” Mr. Elias graduated Phi Beta Kappa from Binghamton University with a degree in economics.

He has consulted with various high-profile financial institutions in New York City.

© 2011 Copyright Barry Elias - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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