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More Fuel for the Gold Rush of 2011

More Fuel for the Gold Rush of 2011

Summertime, history tells us, is wobble time for gold.  It weakens in value.  Not so this summer. 

Moreover, gold usually drops in value when the dollar rises. Not so now.  Since May 1, gold is up 2.58% percent even as the dollar has risen by 1.76% percent.

Why, to put it poetically, is gold so bold, not weak or wobbly in any sense, and, just the contrary, primed to keep busting through all-time record highs?

We’ve written a lot about our bullishness in past issues.  Another answer becoming more and more evident is the desperate rush by investors to shed Euros.

The financial muddle of the European Union, as we said last week, seems to produce one crisis after another. Bond markets and banks are in trouble. The present situation also appears to be generating a new wave of continental demand for gold, already now stronger than it has been in decades. This development, along with fundamental factors at play elsewhere in the world, provides additional fuel for gold continual rise.

You may see short-term technical resistance here and there as gold moves higher, still we see a confluence of factors that will create breakthrough momentum.  Thus, our outlook on gold, bullish since 2003, has become even more so than usual at this time of the year.


Stress Test in Name Only

The European Banking Authority last weekend delivered its “stress test” report card on 90 banks and declared essentially that things aren’t as bad as they seem. Only eight banks failed the test, meant to find weak spots in banking systems and help prevent banking collapses. The report was met largely with ridicule on the part of private-sector observers like us watching the farce play out. 

The conditions of the stress test were blatantly non-stressful and the results largely a joke. One major flaw (intentional, without a doubt) was setting a far greater value on Portuguese and Greek debt bonds than they currently trade for in the market. European banks hold significant quantities of such bonds and so the fictional pricing enabled the sickly assets of many vulnerable banks to masquerade as healthy. A real test would have identified many more than just eight troubled banks. Such a prospect, of course, would create ever larger waves of distrust and apprehension over the prevailing European bailout and spread-the-debt strategies. The lesson we take away from this test-that-really-wasn’t-a-test is that bank assets in Europe are largely, and probably egregiously, overstated. In a real crisis, the bank holders of sovereign debt bonds would have huge problems trying to sell these “assets” for anything near what they were valued at in the stress test.  The test was a sham but still informative. The financial hierarchy of Europe may be fooling some of the public but not the markets. 

The great majority of bond buyers are conservative. They look for a return with as little risk involved as possible. In the developed world today, the risks are high and the returns low. If you live in the U.S., or in most of Europe, the best case scenario is this: your bond is safe and will be repaid, but the currency in which the bond is denominated may fall in value. The euro, as an example, has fallen in value over the past few years. The European sovereign debt we have been concerned about trade in euros.

Banking systems in Europe, the U.S., and Japan remain stressed. They are shrinking, deleveraging, and less stable. But they are not the only unstable elements in the financial landscape. Instability is contagious.  Insurance companies, according to a recent article in the Financial Times, are also having problems.  Please click link http://www.ft.com/intl/cms/s/0/4f6eb26a-a65b-11e0-ae9c-00144feabdc0.html#axzz1Sl2aTi2P to read the article revealing how one in ten European insurance institutions failed to cope with a series of damaging financial market and economic shocks in stress tests carried out in recent weeks.

Newly-Rich Nations Stockpiling Hard Assets

When we look at developments in the developing world, we see a much different storyline. Demand for goods and services are very strong. Growth is rapid. Nations and citizens are becoming wealthier.

This turn-around is fueled by exportation of raw materials, goods, and services and increased domestic consumerism.  Countries in the fast growth lane include China, India, Brazil, Thailand, Indonesia, Malaysia, Chile, Columbia, Philippines, Peru, and even Mexico. Not everyone in these countries is getting wealthy, but the middle and upper classes are clearly reaping the benefits.

As nations and their citizens, grow in wealth, they tend to consume conspicuously, a la developed countries. They also tend to stockpile food, energy, and gold against lean times in the future. They do so for three reasons: 1) they can, 2) they acutely remember the recent lean times, and 3) they realize that holding consumable wealth may be more conservative and profitable than holding financial assets like bonds and stocks that are dependent upon unstable banking systems in Japan, Europe, and the U.S.

You may think this doesn’t make sense.  Wouldn’t the newly-rich deposit money in domestic banks? What do their banks have to do with banks in other parts of the world?  Unfortunately, banking systems throughout the world are connected to one degree or another. Banks and governments anywhere may own bonds and stocks of the deleveraging and shrinking nations. Herein lies the danger of contagion. The biggest banking systems — in the U.S., Europe, and Japan — are the most leveraged and the ones with the largest quantity of bonds distributed in the market place. Thus, a newly-rich investor and his/her newly-rich country will wisely look with suspicion and even distaste at many of the available investments on sale in the marketplace. They are less safe and in some cases potentially dangerous. If wisdom prevails, those state and individual investors will seek holding hard assets like gold, oil, and food.

CBOT Corn Future 1 (Year Chart)



ICE Brent Crude Oil Future (1 Year Chart)



Comex Gold 100 Troy Ounces Future (1 Year Chart)


Based on years of studying the history of world economy, we have an eye for current economic developments. Rising economies create stockpiles. They hoard gold and other valuable assets against future difficulties or to protect the buying power of their holdings. Today is no different. They maintain stockpiles to protect assets against the devaluation of the currencies or the bonds of debtor countries that sell them bonds. During the last couple of years major gold purchases have been made by China, India, Thailand, Sri Lanka, Russia and other developing nations. This is no surprise. Why would they not do so and instead buy more depreciating paper money or bonds of nations whose finances are poorly managed? It’s not rocket science.

 

Summary

Banks and government officials charged with overseeing banking systems try to answer these types of questions by performing stress tests—subjecting banks to “unlikely but plausible” scenarios designed to determine whether an institution has enough net wealth—capital—to weather the impact of such adverse developments.

Stress tests of banking systems in Europe in 2010 and the United States in 2009 have generated considerable interest given the impact of the global crisis on the health of the financial system as a whole.

Stress tests are meant to find weak spots in the banking system at an early stage, and to guide preventive actions by banks and those charged with their oversight.

Late Friday afternoon, the European Banking Authority released its report of the euro bank stress tests. The report suggested only 8 of the 90 banks failed the test, and these eight would pass the test with an investment of only €2.5B.

Analyst, having the weekend to pick at the numbers, concluded the stress testers from the Banking Authority were delusional. Take the treatment of the Greek debt, for example. The value of the Greek debt in the bank portfolios was written down a mere 15%, even though it is trading at 50% of face value, and most in the trade give the Greek’s a 90% default probability.

Consequently, the capital inflow needed by the euro banks is much higher. Goldman Sachs estimates 18 banks failing the test with a minimum of €26B needed, more, if there is any write down of Spanish or Italian debt. J.P. Morgan, using a higher percentage of capital requirement, 7%, said 20 banks would need an additional €80B

Are your finances strong enough to withstand another couple of years of this battering economy? Can you suffer additional losses and still pay your bills and, if not thrive; at least survive if the economy continues to deteriorate?

That’s what federal banking regulators are trying to determine with the country’s largest banking institutions. The stress tests you’ve heard about are “forward-looking economic assessments.” Do these organizations have enough capital to withstand another two years of an economy that may be worse than presently anticipated?

Nineteen banks and retail thrift banks, each with more than $100 billion in assets, are being put to the test. As a group, they hold an estimated two-thirds of the assets in the U.S. banking system. Most Americans do business with one or more of these institutions. Among those being tested are JPMorgan Chase, Bank of America, Citigroup, Wells Fargo and Goldman Sachs.


  Date Date Appreciation/Depreciation
Investment Recommended Closed in U.S. Dollars
Commodity Market

Recommendations

     
Corn 4/20/2011 Open -8.5%
Gold 6/25/2002 Open +391.4%
Oil 2/11/2009 Open +173.1%
Corn 12/31/2008 3/3/2011 +81.0%
Soybeans 12/31/2008 3/3/2011 +44.1%
Wheat 12/31/2008 3/3/2011 +35.0%
Currency

Recommendations

     
Short      
Japanese Yen 4/6/2011 Open -8.3%
Long      
Brazilian Real 9/13/2010 Open +9.3%
Long      
Canadian Dollar 9/13/2010 Open +8.5%
Long      
Chinese Yuan 9/13/2010 Open +4.5%
Long      
Singapore Dollar 9/13/2010 Open +10.2%
Long      
Swiss Franc 9/13/2010 Open +22.6%
Long      
Australian Dollar 9/13/2010 6/29/2011 +14.1%
Long      
Thai Baht 9/13/2010 6/22/2011 +6.5%
Short      
Japanese Yen 9/14/2010 10/20/2010 -3.3%
Equity Market

Recommendations

     
Malaysia 6/29/2011 Open +1.0%
U.S. 6/29/2011 Open +0.4%
India 4/6/2011 Open -6.3%
Japan 2/15/2011 Open -6.8%
Australia 2/15/2011 6/22/2011 -0.9%
Canada 3/24/2011 6/22/2011 -7.1%
Colombia 9/13/2010 6/22/2011 +2.6%
Malaysia 4/6/2011 6/22/2011 +0.8%
Canada 12/16/2010 3/11/2011 +7.9%
U.S. 9/9/2010 3/11/2011 +18.1%
South Korea 1/6/2011 3/3/2011 -2.9%
Colombia 9/13/2010 2/2/2011 +3.9%
China 9/13/2010 1/27/2011 +5.0%
India 9/13/2010 1/6/2011 +7.9%
Chile 9/13/2010 12/16/2010 +8.9%
Indonesia 9/13/2010 12/16/2010 +9.5%
Malaysia 9/13/2010 12/16/2010 +1.3%
Peru 9/13/2010 12/16/2010 +32.2%
Singapore 9/13/2010 12/16/2010 +4.8%
Thailand 9/13/2010 12/16/2010 +11.9%
       
Bond Market

Recommendations

     
       
30 YR Long Term      
U.S. Treasury Bond 8/27/2010 10/20/2010 0.0%