The surprise move by the Fed to lower the Fed funds rate by more than 75 basis points to a record low and an unprecedented band between 0.25% and 0% led to sharp falls in the dollar (low of 1.4188 to the euro) and a spike in the gold price to over $859.40/oz.
The Federal Reserve has embraced ‘Helicopter Bernanke’s’ “inflate or die” massive reserve and money creation academic theories in an attempt to prevent deflation. Markets realise that this will lead to a lower dollar and higher gold prices in the medium and long term. Especially as Bernanke’s money printing looks set to be less of a helicopter style drop of money and more of a B52 bomber drop of humongous dollops of liquidity and cash into the US financial markets and economy.
The decrease to the lowest Fed funds rate ever in the US was greeted positively by stock markets but this will likely prove to be another instance of short term irrational exuberance.
With ZIRP (zero interest rate) policies, the US and global economy and monetary system is entering unchartered territory which is leading to continuing safe haven demand for gold. 2009 looks set to be another very uncertain and turbulent year and the largest financial crisis since the 1930s continues to impact the global economy and financial markets.
The financial markets and global economy remain in flux. Inflation won the early rounds prior to deflation clearly winning the middle rounds of the titanic “flation” battle. But the concern is that inflation and stagflation will come out swinging in the following rounds. The taboo ‘hyperinflation’ word may soon become more familiar to our lips as stagflation and deflation have recently.
Bernanke’s academic knowledge of the Great Depression and Japan’s ‘Lost decade’ while useful is quite obsessive and myopic . He would do well to also study Weimar Germany as there are parallels with America’s massive predicament that are increasing by the day.
Gold Is One of the Few Asset Classes to Have Increased in Value in 2008
While gold is some 15% lower than its record high above $1,000 an ounce, hit last March, it is important to state that gold is one of the few asset classes up for the year. Gold is up 7% in USD terms, over 10.5% in EUR terms and over 39% in sterling terms (see Performance tables), clearly showing it’s safe haven credentials.
Gold did fall in US dollar terms as the US dollar rallied strongly in recent months. But, while gold fell from a record nominal high of just over $1,000/oz, it is important to remember that it is only down some 15% after surging nearly 60% in the previous 7 months. In the seven months from the start of the credit crunch and the collapse of Bear Stearns, gold had surged by nearly 60% – from $640 in August 2007 to over $1,000 in March 2008.
Thus after a 60% surge in just 7 months, gold had become overvalued and was due a correction. This is exactly what has happened and despite carnage in equity, commodity and property markets internationally gold remains higher in 2008 in all major currencies including the strongest currency in the world – the US dollar.