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By Don Miller
Contributing Writer
Money Morning
The currency markets reaction to the Federal Reserve’s recent interest rate cuts has ignited a rally in gold, as investors weigh the benefits of owning the yellow metal versus U.S. Treasuries and the dollar.
As a result, gold has started to shine again as a stable source of value at a time when the dollar and other commodities – like oil and copper – have fallen hard. The spot price of gold has climbed above $870 an ounce on the New York Mercantile Exchange, up about 20% from its October lows.
Gold has been on roller coaster ride in 2008, moving from its all time high of $1035 in March, to as low as $681 an ounce. Some of that decline occurred during the recent stock market plunge. Many investors were forced to liquidate profitable gold positions in order to raise money to cover their paper losses.
Its decline was then accelerated by the recent onslaught of financial bailouts, as many investors held a preference for liquidity and safety in the form of cash holdings guaranteed by the U.S. government. That was reflected in the skyrocketing prices of government bonds and investments in government-backed banks, which also lowered yields.
But with the Fed’s recent decision to cut its target interest rate to a range of 0% to 0.25%, the dollar has suffered a significant decline. Suddenly, foreign investors who were scooping up dollars have cut back on their flight to safety, knocking the dollar index (NYBOT: DX) down 10% in the last month. The index reflects the dollar’s value against the Euro, Japanese Yen, British Pound, Canadian Dollar, Swedish Krona, and Swiss Franc.
The Fed's interest rate cut may also have given gold a comparative boost in the eyes of investors. Gold, which never pays interest, suddenly doesn’t look so bad when compared to T-bills, which also are paying zero interest lately.
Volatility has risen this year compared to previous years, and the last few months have been the most volatile of all – an indication of investor ambivalence. But any uncertainty about the increasing price of gold may have been waylaid by the Fed’s recent rate cut and its dampening effect on the dollar and Treasuries.
Consequently, don’t expect this rally to be short-lived. As we pointed out in our 2009 Outlook Report on Gold, the fundamentals in the market hold the promise of more gains ahead.
It appears unlikely central bankers around the world will stop stimulating economies, printing money and doing whatever it takes until growth and confidence are restored – even if the cost is rampant inflation.
Consider these wild card inflation indicators that Money Morning Contributing Editor Martin Hutchinson believes will carry gold prices to $1,500 an ounce by the end of 2009:
- Over $7 trillion of freshly minted U.S. dollars are now in circulation with the aim of saving the global financial system.
- The incoming Obama administration has promised another $1 trillion or so stimulus package is on the way.
- It’s likely the Fed’s interest rate cuts will soon be followed by central banks around the world.
These economic stimuli are designed to do one thing – get the consumer spending again.
The bailout of the banks was the first step, but the banks are still keeping a tight rein on credit. Now the government is trying to get easily available, cheap money back into the hands of the consumer by running the printing presses around the clock.
“The government is pumping money in so many banks, and that money has to come out somewhere,” said Hutchinson.
Some of that money will “come out” into the economy in the form of higher stock prices. That will make consumers wealthier, and could give them more confidence in the economy. More confidence means more spending. As that happens, prices for goods should begin ticking upward, giving another booster shot to gold prices.
For instance some of that money is already going into gold bars and coins. In fact, the U.S. Mint was forced to suspend sales of the popular American Eagle and Buffalo gold coins for extended periods twice in the last year. The mint was unable to secure enough gold blanks from suppliers to match demand.
“I’ve never seen a case where demand was so high and supply was so short,” Chicago coin dealer Harlan Berk told the Associated Press.
With massive amounts of capital floating around, the time it takes to re-inflate the global economy will be far shorter than most analysts expect. Governments fear deflation more than anything. It appears they will only fight inflation when they are assured they have won the first battle, which is growth at any cost.
When inflation kicks in, the dollar’s buying power will suffer long-term. In fact, we expect a decline in all the world’s paper money, over time. Historically, investors in gold have prospered during periods of weakening fiat currencies.
That leaves gold as a bright light in the investment world, making it an odds-on favorite to open a new leg of a long-term uptrend
.
News and Related Story Links:
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Fortis Metals:
Fortis Metals Monthly – December 2008
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Associated Press:
Woes on Wall Street coincide with gold coin rush
-
Money Morning:
Five Ways to Play Gold’s Rebound to $1,500 an Ounce
When I studied economics 101, I was taught that Paper money and money represented as electronic digits have no intrinsic value.
Fiat money was a convenient medium of exchange and a store of value. In itself fiat money is essentially water marked paper, It cannot be used even for the most ignoble purpose that paper can be put to. It has efficacy only in as much as it is backed up by, the tillage and productivity of a nation.
The law of supply and demand cannot be conned and where subject to vigilance and strict rules of engagement Fiat money serves well as a medium of exchange but human nature being what it is, the tendency has always been toward duplicity.
The attempt to con the consumer into paying for the excesses and reckless spending of government, business and labor leads at length to inflation of the money supply where
productivity, the real wealth of the nation, is misrepresented by too many dollars chasing too few goods. History has proven time and time again, this has been the case and the propensity to avoid discipline and discomfort in the short run leads ultimately to painful recession and depression in the long run and capitalism is permitted to turn on itself with reckless abandonment.
The hesitancy exhibited and the reservations influencing the publics decision to shun the $U.S. in exchange for gold is a mystery that had me thinking because it up til now it has confounded even some of the most experinced Financial observers and seemed to challenge sound economics 101 precidents.
The anxiety of the ignorant masses is evident by their placing so much trust in their government, clinging to the dollar in the desparate hope that somehow the same government that ruined the money supply could somehow restore its vitality and true value.The last life boats are leaving and Gold is beginning its resurge. Elvis has left the building!
One mitigating factor in the hesitancy of American citizens warming up to gold could be the memory of what happened
during the FDR administration New Deal. Gold bars and coins
held by US citizens were confiscated (to my knowledge jewelry was excepted) and reimbursed at the rate of $37.50
per ounce. I don't know what the gold exchange rate was at that time, but I would be amazed if that number represented anything near the going rate…that's not the way governments
operate. To be on the safe side, I'm sticking with inderect ownership through the miners.
[…] Gold Bugs Have Fed to Thank for Recent Rally […]
[…] Inflation is almost certain to return in 2009, because of all the fiscal and monetary stimulus. That has to be bullish for gold, other precious metals, and mining […]
yep i am with you,the consumers are spent up, only the investors are on the side lines,but gold will only have a limited run as it is expensive to store and as soon as interest rates rise with inflation then gold will loose its appeal,well run profitable companies win either way,let us hope we return to the free market economy sooner rather then later as government medalling only delays the inevitable and obscures the reality. cheers
[…] Inflation is almost certain to return in 2009, because of all the fiscal and monetary stimulus. That has to be bullish for gold, other precious metals, and mining […]
You underestimate the deflationary forces that will keep inflation at bay for much longer than you are forcasting. Rising unemployment will continue to dampen credit demand and eligibilty. Forclosures, credit card and auto loan defaults continue to rise.
The banks cannot lend because the bailout money is really reimbursement for the losses on mortgages and the alphabet soup of derivitives. Debt is being tranferred from the institutions and individuals to the taxpayers. The funny money created by the Fed is just canceling some of the debits. However, the debits are larger than the bailouts and will continue to grow as the economy continues to tank.
The consumer is broke, so inflation cannot gain too much traction if people with no access to credit and no savings are forced to make do and do without anything but the basics.
Longterm, inflation is possible as the economy recovers-if it does recover. The government fixes are certainly going to delay the inevitible correction in the economy.
Regards,
Darrell Wyse
Regarding gold confiscation: Citizens did not have their gold confiscated. FDR called it in and citizens complied, likely a majority. Americans at the time believed the propaganda spun by Government webs that it was patriotic to return your gold, and if you didn't give up your gold you could be prosecuted, blah blah blah.
Today? No one believes or trusts anyone in government, and I seriously doubt most citizens would comply with confiscation orders. It is easy to hide and smuggle, Homeland Security, the military, and border guards notwithstanding. They can't stop insurgents from crossing borders with weapons on horseback, they can't stop the illegal cigarette smuggling trade between Canada and the US, they can't stop drugs from coming in, how the hell are they going to stop someone from smuggling anything else? It is the oldest most respectable tradition in history.
Following FDR's decree, the gold smuggling trade was enormous, and gold could still be purchased by Americans outside the country, mainly Canada, and held in accounts there. I've heard many old timer anecdotes about this.
WW2 displaced Europeans who had converted their wealth into gold or diamonds arriving in the US smuggled it into the country. IRS? No problem there either, gold can be sold in small amounts or traded for food or goods and services. Always.
Of course the Fed will use propaganda and will make examples of people. Smart careful people can always outwit them. Keywords are smart and careful. Holding metals is the only way you can truly be protected.
Who the heck actually HAS any gold, I mean PHYSICALLY? Most people just have pieces of paper stating they have gold held in trust somewhere, so "confiscating" it won't be that problematic for whoever wants it (whether that be the government or some other entity). Not that I believe that even those pieces of paper are actually worth more than… well… the ink on them. Where are the credible PUBLICLY ACCESSIBLE audits on the gold inventories? People are being duped into buying blips on a screen again, thinking they're buying a rock-solid investment.
Fool me once, shame on you; fool me twice, shame on me.