August 12, 2011 by Brien Lundin
Gold’s explosive move to new nominal heights reflects more than an expansion of the European sovereign debt crisis and Standard & Poor’s downgrade of the U.S. sovereign credit rating. It also reflects the expectation of massive liquidity injections — in the U.S., in Europe and around the world — to pay off the massive debts that have been accumulated.
“The United States can pay any debt it has because we can always print money to do that,” former Federal Reserve Chairman Alan Greenspan recently noted on Meet the Press.
It was one of the most succinct statements ever uttered by this master of obfuscation. But Greenspan knows better than most people that the thing being questioned today is not whether the U.S. can pay its debts with dollars, but what those dollars will be worth.
Consider that the greenback has been rapidly losing value against gold, its true barometer of value, since the moment S&P announced its downgrade of the U.S. sovereign credit rating.
When the world learned late Friday that S&P was, indeed, going to downgrade the U.S., it was obvious that the next Monday was going to be a wild trading session. It was that, and more.
The U.S. stock market began a nosedive at the opening bell that steepened as the day wore on. At one point, while President Barack Obama was addressing the nation, the Dow slipped more than 600 points. A late rally regained some lost ground after Obama had stopped talking and the market had begun to calm down a bit. This ended up looking like a failed intervention effort, however, as the market resumed its slide going into the close.
Equity sell-offs such as this, and those we endured last week, have the smell of the type of margin-call-driven liquidity vacuum seen during the credit crisis of late 2008 and early 2009, except for one thing. Unlike the liquidity crunch back then, there has been plenty of money left to buy gold.
In fact, gold has been rocketing higher, setting new record highs in nominal terms on a daily basis and blowing away even silver in terms of performance.
In times like these, it’s important to look beyond the blaring headlines and mind-numbing stats to search for the real meaning of these events.
As far as the precipitating events behind the current market turmoil, most analysts are placing equal weight on the S&P downgrade and the European sovereign debt crisis, which saw the European Central Bank moving into the market for Italian and Spanish debt in a last-ditch effort to stem their crises.
Many are drawing parallels between the current situation and 2008, when we also saw the effects of a massive credit crunch. But there are important differences this time around — and these differences harken back not as much to 2008 as to 1978.
For example, in 2008 we saw the dangerous potential for cascading bank failures leading to a failure of the global financial system and a slip into a depression. In the view of the Treasury and the Fed, the banks simply had to be bailed out by a massive injection of liquidity into the monetary system.
Today, we see the potential for a more frightening scenario: the cascading failures of nations.
In 2008, the banks were bailed out. Today, nations are being bailed out. The difference is not only of kind, but also of degree. It will take much, much greater liquidity to bail out Italy, Spain, Portugal… and the U.S.
This is why the spikes higher in gold during the 2008 crisis were also accompanied by sharp drops, as margin calls in other assets forced speculators to sell their gold for the cash needed to settle up with the margin clerks.
Today, no one is desperate enough to sell gold. Instead, they’re buying the metal hand over fist. Because, as uncertain as today’s turmoil may be, there is one long-term certainty: It’s going to take a lot more money to bail out nations today than it took to bail out banks in 2008.
Thus, the current situation is more analogous to 1978. Two years into the Jimmy Carter Presidency, it was patently obvious that the guy had no clue as to how the real world worked, and his Administration’s Keynesian schemes to juice economic growth through money-pumping were being exposed as futile and ineffective.
While it’s obvious that the current Administration is equally ignorant of free-market operations and that its Keynesian experiments have also failed, there are differences between today and 1978.
Of course, we have yet to see the double-digit interest and inflation rates that typified the 1970s. At least not yet.
In addition, the current bull run in precious metals has already lasted longer than that of the 1970s and, depending on where you mark the starting points, today’s run has been arguably greater in percentage terms.
But I believe these differences are a function of the maturation of the gold market and investors’ assimilation of the 1970s experience.
We haven’t seen the price-inflation results of this period’s monetary inflation, but smart investors know the effects are coming. (They also know that inflation is being measured by a longer yardstick today.)
Thanks to Carter, investors today also know the financial damage that can be done over two years of an incompetent Presidency is nothing compared to what can be done in four years.
So, today’s flight to the safety of gold is due not so much to what is happening now, as to fears of what will happen over the months to come.
As readers of Gold Newsletter know, my view has been that we have at least 18 months left in this gold bull market, or until about the time of the 2012 elections. If, however, Obama regains the Presidency and Democrats retain control of the Senate, then all bets are off: The next four years would be very bad for the fiscal health of our nation, but very good for gold prices.
Instead of Carter’s 1970s, the analogy would shift to Franklin D. Roosevelt’s 1930s.
In view of either scenario, I continue to recommend the steady accumulation of gold and silver. I advise you to do it on a dollar-cost-averaging basis, buying the same dollar amount each month, with an effort to concentrate your purchases during any price dips during the month.
As prudent investors, we must consider the dangers of the latter scenario, wherein the Obama Administration retains the White House and, in its last term, unleashes its collectivist tendencies free from the restraints of an impending election.
Frankly, I don’t see this scenario and the worst dangers it would entail as being very likely at this point. But it is still something that smart investors will insure against by buying gold and silver in small denominations, purchasing from a number of dealers and keeping quiet about it.
I don’t think that gold confiscation is a very likely danger in this day and age. But I’m sure that citizens in 1933 didn’t consider it very likely in their day and age either.
For this reason, I’m also recommending that investors stay abreast of rapidly changing events in our geopolitical and economic situation. A great way to do this is by attending this year’s New Orleans Investment Conference, which features Glenn Beck, Dr. Charles Krauthammer, Peter Schiff, Dr. Mark Faber, Dennis Gartman and dozens of top experts in precious metals and mining stocks.
Of course, gold and silver mining/exploration stocks have not benefited from the current rally in the metals. Investors are buying for safety and not betting on returns. Thus, the summertime “buying season” that seemed to be ending has not only been extended, but the sales have gone to the clearance rack.
Granted, it takes courage to buy when blood is in the streets, and there will likely be more bloodshed in the days to come. But this is when the big profits are made. My Gold Newsletter readers will remember that I recommended Millrock Resources at 6 cents a share in November 2008; it subsequently traded well over $1 a share.
I expect similar profits to be created from the current crisis. However, I caution you against rushing into the market in pell-mell fashion; these are very volatile times, and there has been a tremendous flow of speculative money into gold in recent days. At some point, I expect this flow to reverse, resulting in a significant short-term correction in prices.
So pick up the best bargains in the junior resource sector, but do so prudently. (I am releasing some of the most irresistible bargains that I see in the market right now to my Gold Newsletter readers; if you’re a subscriber, pay close attention to these opportunities.)