Saturday, July 10, 2010

Nature's Golden Standard Is Back (Whether The Macro-Managers Like It Or Not)

The news about gold swaps on the back pages of the Bank of International Settlements report made a few waves last week. Some immediately reacted in shock, claiming this is potential bad news for gold bugs because it augurs a future glut of gold supply on the market if and when the swaps fall through.

But this is not potential bad news for gold bugs, only for gold speculators. Because I am a gold bug, when I heard the news my immediate reaction was, "Hey, this is great. Some financial entity out there got so desperate that they had to use their gold as collateral. It's probably a large European bank or even a central bank, and this may not be the last time it happens. Gold is definitely coming back into style."

MomNature
[Thanks to BuyCostumes.com for the image of Mother Nature.]

A real gold bug like me believes that gold is Nature's monetary base, no matter how politico-academics try to manage their fiat (paper) money without it. The fact that central banks still store the yellow stuff is evidence in support of this, so when I learned that some important entity, perhaps even a central bank, was actually using gold as collateral in a borrowing transaction, I realized it was just more evidence in support.

Thus, in my e-mail update from Mineweb.com, I wasn't surprised to find a link to this article entitled "BIS gold swap--best news to hit gold in 30 years." Author Julian Phillips remarks:

"What is significant about this or these transactions is that gold is being used in international settlements after so many decades of being sidelined in the monetary system!"

This is surely what it looks like to me, too.

The poor speculators, however, unnerved by the slightest tidbit of information, are trying to figure out which way the gold price will move over the next few months. We gold bugs don't really care about the short run, because we know that in the long run there's too much paper money (or its equivalent) floating around, explaining gold's rise relative to a number of currencies. But contrary to us, the speculators don't see the joy here.

They think that gold is just a "hedge against future inflation." Therefore, their next question becomes: Will we get "inflation" (which to them means U.S. price increases) enough to spur the Fed to reign in the fiat dollars? The consumer and other figures suggest not. So should the gold speculators panic and sell it all?

I say that this double-dip will maintain prices, and therefore the Fed is not about to retire any fiat dollars for a while unless general prices start to rise. It would also surprise me if the Europeans manage to retire any euros, what with the PIIGS problem. So without a CPI increase does this mean we will not get "inflation" and the speculators should dump gold?

Well, that depends on how you define the word "inflation." I've been down this road before--it's one of my pet peeves--and I'll do it again by referring you to a modern web dictionary's definition of the word "inflation":

"A persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money, caused by an increase in available currency and credit beyond the proportion of available goods and services."

Interesting that they used the word "or." When can one have a "persistent decline in the purchasing power of money" without an "increase in the level of consumer prices"? Simple: when credit doesn't reach consumers through an increasing paycheck, or through home equity. Where is it, then? In the pockets of speculators, corporations who don't care to invest just now (and rightly so), Wall Street, Freddie and Fannie--in fact anywhere but in the wallets of consumers.

Therefore, general prices will not rise. BUT: the price of gold will rise, because gold is Nature's golden standard, the barometer of "inflation" as defined above in italics. And this italicized inflation situation exists now and has been growing, according to my theory, since consumer prices stabilized in 2008, and perhaps even since earlier than that.

More proof that one can have a decline in the purchasing power of money at the same time as stable prices: Gold compared to the CPI basket of goods has remained stable over time, e.g. about 2.5 ounces/ basket in 2004, the same as in 1942. (Source: www.northerntrust.com/library/econ_research/daily/us/dd052605.pdf.) With the recent increase in its price relative to a number of currencies, however, gold will buy more goods now than is customary. So we have a relative "decline in the purchasing power of money" without an "increase in the level of consumer prices."

Another perspective: Purchasing power in consumer hands is being syphoned off through higher taxes, higher corporate profits (they are not spending, but they are still pricing at the same level), a stagnation of average wages or loss of jobs, and decreasing home equity.

So who is bidding up the price of gold? Anyone with savings they want to protect from further erosion of purchasing power, including many small and large investors, huge hedge funds, enormous pension funds, sovereign funds--anyone who has money to save and who realizes that the dollar and some other currencies have been "over-printed," and that the central bankers are only watching the CPI.

So if the BIS report sent chills up your speculating spine, don't worry. The macro-managers are about to mess things up good, and Mother Nature has yet to sing her last song.

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