Gold Investments Market Update – US, UK Credit Ratings Look Set to Be Downgraded

Gold rose again yesterday, briefly rising above $950/oz and was up 0.6% on the day. Determined selling on the open in Asia saw gold fall and profit taking has seen gold fall in Asia and in early trading in London. This is to be expected as gold had risen by more than 15% in less than a month.

US, UK Credit Ratings Look Set to Be Downgraded

The credit rating agency Moody’s has said that the UK and US credit ratings were being “tested”. In a novel and somewhat bizarre departure, Moody’s has split various “AAA” sovereign countries into three categories based on their strength in weathering the economic storm, denoting Ireland and Spain as the weakest with the UK and US somewhere in the middle and Germany, France, Canada and the Scandinavian nations at the top. This will in time be seen as gimmickry. Standard and Poor’s have already downgraded Spain to AA+ and did not create sub grades within the credit rating system. Some have criticized Moody’s for being “unfair” to Ireland, Spain, the UK and US and have argued that these agencies previously gave almost everybody good ratings, and underestimated risks, but were now going to the other extreme. This is errant nonsense and the unfortunate fact is that Moody’s, the other credit rating agencies and the vested interests in the financial services industry continue to underestimate risks, as they have done for months and years. Given the massive deterioration in the public finances and economies of these nations, by right they should be downgraded and unfortunately in the coming months they will inevitably be downgraded. But Moody’s and all the rating agencies realize that this would compound an already disastrous financial and economic crisis. Many pension funds internationally have mandates or investment guidelines to only invest in "AAA" rated government bonds and if these countries bonds were downgraded, they would be forced to sell those bonds en masse. This would likely see a crash in the already very overvalued government bond markets and see long term interest rates rise quickly and sharply. The creditors of the US in Russia and China have rightly criticized the ratings agencies for their highly irresponsible practices in recent years and are increasingly nervous about their US denominated assets. Ratings agency Standard and Poor’s in January downgraded Spain’s sovereign debt rating to "AA+" from "AAA" in January, citing insufficient means to deal with weak growth and a ballooning budget deficit. As they did the sovereign rating of New Zealand. The fiscal position in the UK and US is arguably much worse than in these two countries (Martin Wolf of the Financial Times recently said that major US banks with their humongous Wall Street liabilities are insolvent) and thus it seems inevitable that the UK and US will be downgraded in the coming months. If the US is downgraded than in effect the reserve currency of the world is being downgraded and this has huge implications for the international monetary system. Not surprisingly there have been op-ed pieces in the Financial Times and the Wall Street Journal calling for a return to some form of gold standard. The governments of the world are nationalising and socializing the meltdown in the shadow banking system and the international system with potentially disastrous consequences for us all. Conditions are set to get markedly worse before they get better and the experience of Argentina and other previously wealthy South American countries may be instructive. The IMF is called in and there are structural adjustments, social services are affected or discontinued, banks nationalized, savings inaccessible, food and energy insecurity rise. This is a potential reality for large western economies especially if governments keep trying to inflate their way out of the current crisis. This is leading to massive currency debasement and will potentially lead to very significant stagflation and maybe even what could be called hyper stagflation. Now more than ever, it is essential that individual savers and investors, companies, pension funds and sovereign wealth funds have an allocation to and directly own actual physical gold bullion. Paper exchange traded funds with all the attendant counter party, custodian, sub custodian, auditing and indemnification risk are speculative trading vehicles and not physical gold. In these unprecedented economic times, it is irresponsible and extremely high risk not to have an allocation to gold bullion in an investment portfolio.

Mark O'Byrne
Executive Director