Gold

Gold was down $3.60 to $865.40 yesterday and silver was down 18 cents to $16.55. Gold traded flat in Asia and has risen marginally in early trading in Europe. While the dollar is down today, the dollar’s short term bounce may continue and this could put further pressure on gold and result in further consolidation at these levels (the $850 to $890 range). But oil is up more than 0.5% again this morning to over $125 a barrel again and this should result in gold being well supported at these levels.

While the CPI inflation data (more below) was tamer than expected yesterday, there are doubts as to the accuracy of the inflation data and concerns that government statisticians may be underestimating the data. The report said that gasoline prices dropped 2 percent in April despite the fact that gasoline prices actually rose some 10% at the wholesale level (from $2.58 to $2.83) in April. However, the data was greeted with glee by much of Wall Street and risk appetite was again very prevalent.

Today’s Data and Influences

There is a lot of US data scheduled today including the TICs, Empire and Philly Federal Reserve Indices, industrial production and the NAHB housing index and weekly jobless claims. The TICs will assume increasing importance in coming months as we see whether the U.S.’ many creditors are continuing to fund the U.S.’ massive debts even at near record low yields. Even a small decline in buying interest in dollar assets could have serious ramifications for U.S. bond markets, interest rates and the dollar.

A number of Federal Reserve speakers, including Ben Bernanke, are due to speak. Markets will be watching to see if Bernanke qualifies his recent comments regarding the current financial crisis when he said on Monday that "conditions in financial markets are still far from normal. This process is likely to take some time."

Former Chairman of the Federal Reserve Warns Again

In contrast to more speculative players with short term horizons and the stock market permabulls, Former Chairman of the Federal Reserve, Paul Volcker, warned yesterday that the United States could face a 1970s-style period of skyrocketing inflation if investors lose confidence in the buying power of the U.S. dollar. "We are back in the 70s or worse if confidence in the Federal Reserve is lost. . . . If there is a real loss of confidence in the dollar, then I think we are in trouble. That is something that has to be watched," Volcker told the congressional Joint Economic Committee.

Yesterday’s Inflation Figures and the Fundamentals

The consumer-price index rose 3.9 percent in the 12 months ended April 30, the Labor Department said yesterday. The inflation statistics were odd and some economists are rightly asking how gasoline prices were down 2% in April despite obviously soaring gasoline prices. The report also has energy prices unchanged. Conveniently and possibly a little simplistically seasonal adjustments were cited as the reason that gasoline and energy prices did not reflect their recent surge in prices. Some are suggesting that statisticians are manipulating figures in order to appease their political masters and this seems increasingly likely as inflation seems to be significantly underestimated in recent government data.

Even so with government inflation figures at an annual 3.9% and the Federal Reserve holding interest rates near record lows at 2%, there are still negative real interest rates and thus monetary policy remains extremely loose and accommodative which is very bullish for gold in the medium to long term.

Despite the big picture fundamentals remaining extremely favourable to gold it is finding it hard to get traction after this most recent sharp sell off. Many market players remain in some fantasy "la la land" and refuse to acknowledge the growing risks posed by stagflation and the markets appear to be in another one of their "irrational exuberant" phases where risk appetite is again the ‘force du jour’.

Having said that, periods of consolidation are common after such sharp sell offs and this type of sideways movement can often frustrate bulls and bears alike prior to the market reasserting its primary trend – which is likely to be up as none of the fundamental macroeconomic, geopolitical and geological issues driving the gold markets have been resolved.

Poor Analysis of Gold Market

Some of what purports to be ‘analysis’ of the gold market remains highly selective, uninformed and biased. A recent report said that gold would fall to $700. Interestingly it failed to say whether this was just another sharp correction and healthy consolidation or rather an end of the bull market.

The report purported to show that gold remains overvalued and said that the fact that gold is at near record low levels versus the price of oil ratio does not mean that gold is cheap relative to oil.

Bizarrely, the report selectively chose the 1982 to 2008 as their time frame of choosing. ‘Lies, damn lies and statistics’ comes to mind. How convenient to ignore the 1970s which is the last decade that gold and oil were in bull markets. Stagflation is already present in western economies and to completely ignore the last time period when western economies had high inflation and low growth – the 1970s – is shoddy at best and extremely biased at worst (see Former Chairman of the Federal Reserve, Paul Volcker, warning above). And seems like an attempt to use data in order to establish a pre ordained set of opinions. Rather than allowing the facts to help guide and establish opinions.

Financial and economic history pre-1980 and the reality of stagflation remains taboo which is incredible given the current macroeconomic conditions. From a research point of view this is very much a case of "garbage in – garbage out".

The same report said that gold was primarily a play on dollar weakness. This is nonsense – dollar weakness is a factor in gold’s strength but gold has been surging in all currencies internationally (as seen in the gold charts here – http://www.research.gold.org/prices/monthly/). We have a global financial and economic crisis and gold has surged in all major currencies particularly since the start of the crisis last summer. To suggest that gold’s strength is primarily due to dollar weakness is very misinformed and blinkered. How bizarre for any analysis to ignore unprecedented systemic risk as seen in the run on Northern Rock and the bankruptcy of Bear Stearns. A few of our clients who had their life savings in Northern Rock would have something to say about such analysis. Most of them are not concerned in the least regarding the dollar’s weakness.

The IMF has warned that if another major bank fails (a la Bear Stearns) it could take down four or five of the world’s largest 15 banks with it. Obviously this has serious ramifications for the stability of the global financial system and the global economy. The macroeconomic climate is the most uncertain since the Great Depression and much of the western world faces the toxic combination of a virulent housing crash and credit and debt crisis and the spectre of stagflation.

To attempt to analyse the gold market while completely ignoring geopolitical risk is highly unprofessional as well. Geopolitically, the world remains beset by many serious risks any of which could seriously impact western economies. Pakistan, North Korea, Lebanon and Israel are some of the hotspots posing risks in this regard. This was graphically illustrated when Benazir Bhutto was tragically assassinated in Pakistan and gold surged some $25 on safe haven buying due to fears regarding a nuclear bomb falling into the hands of Islamic militants in Pakistan.

The crux of the matter is that the western world, and particularly the U.S., is massively dependent on oil and gas exports from countries who are at best lukewarm and at worst outright hostile to them. Russia, Venezuela and Iran are some of the more obvious glaring examples of this.

The economics 101 of supply and demand might have something to do with gold’s rising price as well. Gold production is stagnating and gold output in the leading gold producing countries continues to fall year on year despite higher gold prices leading geologists to wonder whether we may have or may soon reache the point of ‘peak gold’ production. The world’s biggest producer South Africa produced nearly a 1000 tonnes of gold in 1980. This was down to 264 tonnes last year, the lowest since 1932.

Best not to let the facts get in the way of a good argument though. Gold remains one of the most poorly covered and analysed markets in the world and this creates amazing opportunities for investors as the mass of the public remains blissfully ignorant of gold’s fundamentals due to this extremely poor analysis of the gold market.

Gold and silver will very likely at least reach their inflation adjusted highs of 1980 in the coming years at $2,300 per ounce and $150 per ounce. They will also likely reach inflation adjusted record highs in all major currencies. And those who have been wrong regarding the precious metals markets in recent years will continue to be wrong. This is unfortunate as it will cost many investors a lot of money through further misallocations of capital. Even if their bearish pronunciations on precious metals were right, it would be more responsible of them to admit that nobody knows the future direction of any market or asset class and thus proper diversification is merited and risk aversion should be a prime consideration for investors. Thus, a 5% to 10% allocation to precious metals should be advised in order to hedge against increasing macroeconomic and systemic risk.

Silver

Silver is trading at $16.63/16.68 per ounce at 1200 GMT.

PGMs

Platinum is trading at $2017/2027 per ounce (1200 GMT).
Palladium is trading at $429/434 per ounce (1200 GMT).