Gold and silver have risen in Asian and early trading in Europe today. Last week saw gold fall some 1.4% while silver rose 4.9%. The performance of the precious metal mining shares may be an indication that we are at or near a low in this sell off as the HUI and XAU mining indices were up sharply last week – up 14.4% and 14.95% respectively. They tend to be a leading indicator of a trend reversal in the precious metals.

Similarly the reversal in the dollar’s recent strength and stabilisation of oil in the mid to high $60s could also signify that we are close to lows. Not to mention massive physical demand, delays, shortages and surging premiums in the bullion markets.

October – Brutal Month for Investors

The international financial system resembles a slow motion train wreck and October saw unprecedented volatility in all markets.

October was a particularly brutal month for equity markets with the US suffering the worst monthly losses in 21 years – the S&P 500 was down some 17%. Japan’s Nikkei had its weakest ever monthly performance – down 24% in the month. Other equity markets internationally also suffered sharp falls. While Asian markets were largely up overnight, the Nikkei fell a further sharp 5% fall.

Gold in dollar terms fell nearly 17%, its worst monthly performance since 1983, however it is worth remembering that the dollar was the strongest currency in the world in the month and major currencies such as the pound and the euro fell sharply against the dollar. The euro lost some 10% in October alone – its worst monthly performance since its 1999 launch. The dollar posted its biggest annual monthly gains against a basket of currencies in more than 17 years. Thus, gold’s fall in other currencies was shallow.

Significant Reappraisal of Sovereign Risk (Including Euro Sovereign Risk) to Benefit Gold

The huge volatility and sharp falls seen in many financial markets and recent economic data showing the likelihood of sharp and protracted recessions internationally will lead to a significant reappraisal of risk in the coming months. In October the only safe havens were short dated government bonds (which we have advocated for some months) and some forms of dollar denominated cash. The coming months will see gold’s role as a safe haven asset reaffirmed and those who write gold off prematurely are not aware of the fundamentals driving the gold market which are as strong as ever.

While money market rates have eased somewhat in recent days it is premature to say that the worst is over. This week’s 49bp fall in 3 month dollar Libor rates lagged the fall of 90 bps the previous week and the overall level of interbank rates remains stubbornly high.

With the focus shifting from the solvency of banks, financial institutions and large corporates such as AIG to the solvency of nation states, we are entering a new and potentially more dangerous phase of the financial crisis. The sovereign debt of emerging economies and large industrial economies will soon be scrutinised with the potential of massive selling of national currencies and government bonds leading to far higher interest rates.

Many currencies internationally will come under pressure including the euro. It is important to note that the spread between the 10 year bonds of Germany and those of Italy and Greece have risen to 125 and 155 basis points respectively – the highest since the launch of the single currency in 1999.

A brutal global deflation is upon us and central bankers and politicians look set to try and inflate are way out of the deflationary spiral. It is worth noting that gold outperforms other asset classes in deflationary depressions as it did in the 1930s when the dollar (which was backed by gold unlike today in our modern floating fiat currency monetary system) was sharply devalued overnight by Roosevelt from $22/oz to $35/oz.

With the likelihood of an Obama victory and promises of a new “New Deal”, gold is set to again confound the critics and show itself as an essential component in a properly diversified portfolio.

Indeed increasing speculation regarding a new Bretton Woods deal and a new monetary system may foretell a new monetary system with the creditor nations of the world (China, India, OPEC, Russia etc) having a larger say and role in the international monetary institutions such as the World Bank, the IMF and the BIS.

The role of gold itself as an important, finite safe haven currency within international currency reserves and within the monetary system itself may also be looked at. Indeed it is not beyond the realms of possibility that we may see gold be sharply revalued in the coming months (as was done by Roosevelt in the 1930s) in order to stave off a crippling deflationary depression and provide stability and sound backing to the international monetary system.