Global background on the gold and silver markets

• The U.S. $ rose from $1.60 to $1.39 to the € in the recent rally against the €, and is currently standing at $1.47. Most of the fall of the $ was seen as an effect of the Wall Street investment banks implosion that occurred at the end of last week. The Treasury Secretary of the U.S.A., Hank Paulson, has put together a package that is likely to be passed by the U.S. Congress by the end of this week. Paulson hopes that by buying $700+ billion in 'toxic debt' from the Balance Sheets of the U.S. banking system and placing it on the shoulders of the U.S. Federal Reserve, they will remove the threat posed to the entire U.S. financial system. In the process, the Fed is exponentially increasing its own balance sheet to accommodate the move. Will this convince foreigners responsible for the exchange rate of the U.S. $?

• On the $ front, the broad expansion of the Fed's Balance sheet is raising questions among foreign $ surplus holders. To date we have seen Russia and Korea selling their $ holdings as fast as possible reflecting their own opinion of the U.S. $. There is no doubt that other surplus holders may also feel the same way but have found themselves trapped by the huge $ holdings they have at present time. However, in view of the catastrophic events in the U.S. financial system, it is decision time even for these nations.

• Within the U.S. there is hope that this will allow the banking system to renew the easy flow of liquidity to the system and allow it to 'get back to normal'. But will such hope in a rise in liquidity reassure foreigners of the soundness of the U.S. system and in turn safeguard the $?

• Part of the increased pressure on 'short sellers' has been increased margin calls in the gold and silver markets. This increased cost of 'shorting' is discouraging the continued holding of short positions as well as new short positioning. With the huge level of 'naked short' positions built up over the last few weeks, there is now speculative upward pressure on the gold price too. Now add to this the leap in investment demand for gold and silver in the last week, and you have them both looking towards higher prices still.

With gold moving in the opposite direction of the $ and all other paper currencies now, what effect will it have on gold and silver prices?

Global perspective

Attention of the U.S. financial problem is focused on internal solutions with little attention being paid to the position of the $ in the rescue formula. After all, it is against the $ and its global place that gold and silver have moved inversely for the last year and more. The decline in confidence, by foreign $ holders, in the U.S. financial system has been dramatic and irreversible with major consequences for the future of the $. The fall in the $ in the last few days has been faster and further than the market expected and reflects foreign sentiment on Paulson's Package. Foreigners are clearly underwhelmed by these hastily produced proposals. The problems faced by the U.S. financial system have been building up for some time and do require a fundamental reform of the principles underlying that system if confidence is to be recaptured. After all, every other nation on earth has to earn the dollars it has. The U.S. can simply print them and in vast quantities. Does this make a mockery of the underlying value of the currency?

Gold continues to be seen, even by central banks, as a "counter to the swings in the $". With the current lack of confidence in the currency and the system that backs it, gold is clearly more measurable, reliable and free from the adjustable promises of men. This has to count in these days where money rules the globe not military power, land or religion. This estate of printed money has dominated the globe since 1971, led by one superpower, the U.S.A. Bring this into question and the ramifications are excessive uncertainty and sapping confidence. With the East winning the battle for wealth on the Trade front, the days of the $ as the global reserve currency have been numbered by these recent U.S. financial events.

Other global currencies?

All other global currencies are based on, and reliant on, the U.S. $ and face the same maladies as U.S. relative to their dealing on the trade and capital front with the U.S.A. It is therefore clear that all other global currencies will feel the ripple of U.S. financial maladies to a greater or lesser extent. None can escape them.

We have discussed in earlier articles?, that the evolution of gold will be to move away from reflecting the relationship to the $ and will reflect the state of all the globe's currencies. Previously when the $:€ was the measuring line, it implied that gold moves with the €, which is a baseless comparison. Gold should rise in each currency that is weakening and in an environment where one currency after another falls, then gold demand in each nation should rise, once the investors realize the damage being done to the buying power of their currencies.

This will be reflected in rising demand for gold in each nation as the buying power of the local currency changes, say with the oil price?

Where foreign currencies are held in national reserves, particularly where there are weakening currencies [e.g. the Chinese Yuan], gold is looking more and more attractive. While the amount of U.S. dollars in Chinese reserves is so huge, gold does not yet appear a realistic addition to their reserves as their buying would propel the gold price to such a level that they would not be able to acquire sufficient quantities. It does make sense, however, to buy all local production for their reserves, a move that would not initially cause the gold price to rocket.

No doubt though, with European Central Banks moving rapidly to a cessation of their gold sales, central banks are realizing more and more the importance of gold as a reserve asset. Will they act on this conclusion? We wait in anticipation to see if they do.

What does the Paulson package say to us all?

The sight of Wall Street investment banks collapsing and the impact it has on U.S. citizens sends tremendous alarm signals to those outside the U.S. plans to protect themselves from these problems are in the process of being made, whether they be investments inside the U.S. or the $ itself. This is a conclusion that cannot be avoided. A large rescue package, larger than the one before, does not solve the problems as exemplified by the rescue packages of the past. Yes, the markets may be becalmed but the tide has changed. Prudence demanded a run for cover and still demands it because the risks inherent in the system remain. House prices are falling, consumer access to credit remains diminished and trust has largely disappeared with matters getting worse still. Bankers themselves remain in trauma and need to be convinced that they can accommodate consumer credit against assets that need to rise in value from now on. Will that happen? What is needed now is renewed confidence and that still seems far off.

A recession is here, and the possibility of yet another financial disaster remains a present danger, this time on a global scale. The ability of the global economy to absorb another crisis is growing thin. Each time a crisis occurs, gold looks to be a safer place. Each time investment managers are disappointed with the solutions to the problem of the U.S. its role as global economic leader wanes. Each time this happens, the $ looks more vulnerable. So what's next?

In the States there is only one currency choice for the U.S. citizens. Yet nations overseas have a choice. If you had that choice, would you hold the $ if you didn't have to? Seen from a global viewpoint, the recent disasters have made it important not to trust eventual outcomes but to stay away until one can be certain of the future of the $. Just this alone will undermine the $. And this will continue until the $ becomes a currency of choice. This means an exciting future for the U.S. financial system and the $. Should we expect that?

Conclusion: Gold and the $ going forward

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