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Tuesday, July 24, 2012
The Calm before the Storm

The Calm before the Storm

Monday July 23, 2012 12:47

Late last week when reading the World Gold Council’s Gold Investment Statistic’s commentary, we were reminded of when Doug Casey said ‘“inevitable” is not the same thing as “imminent.”’

As we keep mentioning on these pages the financial situation, which has been snowballing for over 40 years, will continue to do so and in the process those who decided to invest in gold bullion will benefit.

However, since the beginning of the year, action in the gold price has been victim to much criticism as it seems that despite the negative headlines in regard to the state of the world economic situation, gold has not been acting its part.

The WGC’s report addresses some of the key arguments against gold and reminds us that in the long term, gold does what it is supposed to do – hold its value and has zero counter-party risk.  But we must be patient and watch as the farce continues to be acted out for us by the central banks, safe in the knowledge that whilst the rush to gold is inevitable, it is by no means imminent.

Deflation paves the way for inflationary policies

As argued by Ronald Stoerferle, in his latest ‘In gold we trust’ report, the risks of deflation in the world economy are, in fact, increasing. Whether we are heading for further inflation or in fact deflation seems to be the multi-million dollar question at present. But policy makers are so paranoid as to the effects of deflation that they are almost predestined to implement further stimulus packages.

Whilst many believe that deflation spells the end of gold’s bull-run, the WGC explains that ‘this simplification does not capture the full depth of the situation…gold is useful to investors in various economic scenarios.’

A study, ‘The impact of inflation and deflation in the case for gold’ finds that whilst deflation may be good for the US dollar, and therefore create negative turbulence for gold, the destructive impact the strong dollar would have on traditional assets was likely to provide a boost for gold, and outweigh the effects from the dollar. The WGC report drives this point home, arguing that we must not be alarmed by the purported low inflation levels as gold will benefit from either scenario.

Currency debasement set to continue

For each stimulus package implemented by policy makers, in fear of deflation and slowing growth, the currency is devalued further.

Despite the rush to currencies outside of the Eurozone, namely the US dollar, British pound and Swiss franc, the WGC calls on these ‘safe-haven currency’ investors to remember that the value of these assets continues to deplete the more the supply and debt of these currencies is increased; thereby creating an attractive prospect for gold.

Gold has particularly lost out to the US dollar in the last half of this year. But, we should remember the challenges which the Federal Reserve must face in the coming months. Bernanke is yet to make a decision on QE3, but most of us believe the outcome of his decision is a given. The upcoming elections are no doubt likely to cause turbulence regardless of the outcome, particularly considering the trillion dollar budget cuts required towards the end of the year (if the US is to remain within the current debt ceiling… which it probably won’t).

In the long term, the WGC expect gold to continue to act as a hedge against currency debasement in the international monetary system.

Imaginary strength for world’s economies

The WGC are also quick to warn us of seemingly strong economies and the increasing pressures upon which they may find themselves. They ask investors to pay particular attention to Germany which will find itself in the eye of the contagion zone of the euro crisis, despite strong industry figures being released recently.

They state that this ‘on-going saga will be painful not just for the peripheral countries but also for the core-economies – particularly Germany…whate ver the outcome over the euro area saga, Germany’s liabilities are large and likely to increase as a result of greater burden sharing.’ This increasing pressure mainly weighs on the image of the Bunds as the ‘asset of the last resort’.

Whilst US Treasuries and German Bunds may have provided shelter from the economic storm in recent months, they still both carry liabilities, as do the US dollar, Japanese Yen and Swiss franc which have also benefitted. These are dissimilar to gold, which carries no liability ‘thus a rise in its value can have no detrimental effect on other parties.’

‘…while gold has been negatively impacted by a stronger US dollar this year, it remains an important alternative to investors seeking to preserve capital over the longer time horizon.’

Conclusion leads to gold

The WGC make no reference to recent speculation of the manipulation in the gold market. This can only mean one thing – they do not see it having affected the gold investment landscape in the last quarter and nor do they foresee any future effect. As we argued some weeks ago, manipulation in the gold market does not destroy the fundamental reasons for investing in gold, if anything it should strengthen them.

For many gold investors this must feel like an anxious and long wait. Repeatedly we hear tales of how the global collapse is imminent and gold is going through the roof. Then a central policy maker pulls yet another rabbit out of the bag and we have to remind ourselves that it is just another trick and illusion.

There are only so many rabbits that can be pulled out of the hat, and lots of rabbits creates plenty of chaos which is most certainly inevitable, but most likely not imminent. We remind those who have decided to invest in gold or who are looking at the gold price quizzically, that to own the precious metal is to play the long game. But the long game will one day be won…

By Jan Skoyles

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