Gold Climbs As Economic Catastrophe Looms

Last week, when Congress passed its $787 billion stimulus package, the size of the plan caused many observers to forget the water that has already passed under the bridge. Fewer still are wondering what havoc will erupt when all this liquidity eventually washes ashore.

The latest spending, signed into law yesterday by President Obama, came on top of $300 billion committed to Citigroup, $700 billion for TARP 1, $300 billion for the FHA, $200 billion for TAF and some $300 billion for Fannie and Freddy. Just over the last six months, which excludes the initial Bush stimulus and several massive, unfunded Federal guarantees, nearly $5 trillion has been committed by the government to the financial industry. Rational observers cannot be faulted for concluding, despite Administration claims to the contrary, that the government is merely throwing money at the problem.

Although the rhetoric has managed to convince many observers of the possibility of success, the gold market appears to clearly understand the implications of this unprecedented spending.

The feeling that the government has no idea how to proceed has created palpable panic. In response, pragmatic investors are seeking the ultimate store of wealth. In 2009, as has occurred countless times throughout history, that store will be stocked with gold. Thus, whether the Federal government’s interventions will succeed or fail will be anticipated by the price of gold. Right now, the market is screaming failure.

Prior to the latest round of Federal spending, the Federal government had committed $4 trillion to postpone bank collapses and to lay the groundwork for subsequent restructuring. But has any of this activity actually rescued the banking system? In light of the evidence of deepening recession, is it likely that the additional $787 billion in the latest stimulus will instill enough confidence to restore economic growth? If not, what damage will it do to the eventual recovery?

Congressional rescue packages rarely work. Nevertheless, Congress is turning up the heat with previously unimaginable increases of government debt to fund stimulus and rescue packages. Senator McCain rightly describes the scheme as “generational theft”. Each package of debt will encumber many future generations, halt restructuring and also threaten latent hyperinflation.

While Congress claims that the seriously over-leveraged economy is in desperate need of restructuring, it appears blind to the fact that deleveraging will encourage such restructuring. Instead, Congressional leaders actively seek to increase leverage and add debt. They warn of fire, while pouring petrol on the flames.

The seriousness of the situation is magnified by the rapidly increasing scale of the problem. Just today, the release of the latest minutes of the Federal Reserve confirmed that even that bastion of eternal optimism is sobering. The American economy, which shrank by 3.8 percent in the last quarter of 2008, is forecast to decline by some 5.5 percent in the first quarter of this year. In some pockets, the unemployment rate is already in double figures. Despite massive Government spending on rescue and stimulus, the American consumer clearly is becoming increasingly nervous, and the credit markets show few signs of recovery.

With bad news only getting worse, investment markets are turning into quagmires. The Dow Jones Average is testing new lows, and the commodities markets show few signs of life. In such times, the price of gold should fall along with the prices of other assets and commodities. But, the reverse has occurred. In the past two months, gold has staged a remarkable rally. This is despite the activity of price-depressants such as official gold sales by the IMF and official ‘approval’ for massive naked short positions to be opened by new ‘bullion’ banks.

Not only have gold spot prices risen in the face of such selling pressure, but the price of physical gold is now some $20 to $40 per ounce above spot. This would indicate that investors are now so nervous that they are insisting on taking physical delivery.

Make no mistake, the economy will not turn around soon. When the recovery fails to materialize, look for governments around the world, and especially in the U.S., to send another massive wave of liquidity downriver. When it does, the value of nearly everything, except for gold , will diminish. Don’t be intimidated by the recent spike in gold. Buy now while you still can.

8 Responses to "Gold Climbs As Economic Catastrophe Looms"

  1. Anonymous   February 19, 2009 at 11:39 am

    For the average person nearing retirment and trying to survive, what percentage of their savings should be in gold? and through what vehicle? (Although the GLD etf is the easiest to invest in, there seems to be many questions as to whether it is a good idea. Are we talking about physical gold? coins? specific company stocks?) Please advise – and thank you for any thoughts.

  2. NFrazier   February 19, 2009 at 9:56 pm

    A SCENARIOThe Fed has essentially lowered interest rates to zero. Credit spreads have effectively neutralized this stimulus.Fiscal stimulus has been watered down by putting it into the hands of those who are not willing to spend it. Even if this policy were to shift, it is clearly not sustainable.Core inflation was not above 0% for the last quarter of 2008.The combination of failing conventional stimulus and deflation suggests we are heading for a liquidity trap.Long bonds are likely to enter a bubble phase.The threat of a liquidity trap will probably create the political will to begin buying back corporate and government bonds with printed money. This will lower the real value of the dollar, reduce the real burden of debt, cause gold and other commodities to rebound, create inflation, and burst the bond market bubble. The dollar crisis will finally restore the US current account deficit to surplus while reducing the surplus of China and other US trading partners (who may then finally be forced to develop their domestic markets).With the equity, property, and bond market bubbles burst, and the risk of a liquidity trap firmly behind us, the Fed will begin fighting inflation in earnest a la Volker. The ensuing recession will burst the commodity bubble and restore real interest rates to above 2% for a few years. During this time the economy will restructure and finally free itself from its dependence on debt.Low debt, an easing of real interest rates, low inflation, the return of pricing power and a backlog of capital investment will then launch the building of the next asset bubble.The productivity gains of capital investment associated with this bubble will keep inflation low while supply builds. Recessions will again be managed by lowering interest rates (in accordance with inflation targeting…) and refinancing debt until we get back to where we are today.So in conclusion, the gold bugs are a little early – but they have it essentially right. Asset bubbles built on debt that cannot be repaid must burst in real terms. If a liquidity trap is to be avoided in the process, that means printing money.As an aside, it will be interesting to see if monetary policy ever begins to reflect an awareness of the supercycle described above.

  3. Anonymous   February 23, 2009 at 1:56 pm

    Thank you for this well thought out answer. I’m still at a loss for what to do now: As a retired individual, do I buy gold now or not! What % portfolio and in what form? Thank you.

    • Guest   February 24, 2009 at 1:05 pm

      i’m curious as to same question please let me know responses you get

      • Anonymous   March 10, 2009 at 11:25 am

        I did not get any responses! Did you?

    • Anonymous   March 30, 2009 at 12:15 pm

      I would invest in Gold Options as “Insurance”.Invest in FDIC insured CDs.Just live within my means and avoid all unnecessary expenses.Wait for Real Estate market to lose 15-20% more and then invest in a property and rent it out.Try to add a new skill so that a part time income can be another source of revenue.