The Golden Game Changer

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— Earlier this week, the mainstream financial press reported dutifully on the 40th anniversary of Richard Milhous Nixon’s decision to end the US dollar’s convertibility to gold. It was a timely story. Not only for the anniversary. People are finally beginning to ‘get’ the fact that breaking the link to gold all those years ago has slowly but surely created the monetary mess we are in now.

— What’s perhaps less well known is that just prior to this, French warships arrived in New York seeking the return of French bullion, which had been stored there during WWII. The French, led by Charles De Gaulle and his economic advisor, Jacques Rueff, weren’t impressed with the advantages the Bretton Woods system bestowed on its creator, the US. They were losing faith, so they wanted to bring their money home.

— As history has shown, the following decade was an historic bull market for gold. Trust in paper currencies and the international system of finance plummeted and gold’s rise reflected that.

— The reason we’re taking a stroll down memory lane today is because something similar might be unfolding now. Venezuela recently asked the Bank of England – and others – for its gold back. While certainly no France, this request by Venezuela might be the first chink in the paper armour of the global central bank fraternity.

— According to a story in the Wall Street Journal, the South American country has a total of 211 tonnes of gold abroad. The Bank of England holds 99 tonnes while the Bank for International Settlements holds 11.2 tonnes.

— This Bloomberg article suggests the rest is held in institutions such as – wait for it – JP Morgan, Barclays, Standard Chartered and Bank of Nova Scotia. For a paranoid dictator, we’re not sure what Chavez is thinking by allowing these guys to store his gold.

— It is widely believed amongst those who watch the gold market closely that these ‘gold bullion banks’ and central banks like the Bank of England don’t hold the gold they say they do. When the economic seas were calmer, these players (it is alleged) sold or leased out the gold they were holding to others. They reinvested the proceeds in ‘safe and secure’ government paper, earning interest along the way. They could always buy the gold back later, they thought.

— Venezuela reckons the Bank of England has held its gold since 1980…(we hope they got bar receipts). Now they want it back.

— So just when gold looked technically overbought and ready to correct lower, it has spiked again to a new high. Could it be the request from Venezuela has forced these players into the gold market to buy back some of the gold they apparently had for safekeeping?

— It’s a plausible scenario. It was pointed out last year at a CFTC (Commodity Futures and Trading Commission) hearing that there is around 100 times more paper gold than physical gold. This paper gold trades via the futures market.

— If more and more investors, both national and individual, decide to ensure they hold physical gold – and not a claim to gold via a paper contract – that’s when you’ll see the gold bubble really get underway. Venezuela’s move this week might not seem a big deal, but it could be the start of a game changer in the gold market.

— Of course, we could be looking into things too deeply. Gold could just be rising because the one week recovery in global equity market’s has spluttered out…again. Gold, acting as a wealth preserver, is simply doing its job in times of turmoil.

— Equity markets are again in retreat as the weight of global debt crushes the world’s wealth. The US 10-year treasury bond yield hit an all-time low overnight at 1.99 per cent, meaning its price hit an all-time high. Is anyone in the mainstream talking about a bubble in bonds? Not many.

— This is a perfect recipe for Bernanke to start the engines running on QE3, in whatever form that may take. It’s almost a given the Fed will try to do something. Their masters over on Wall Street will be demanding it. There will be little concern that the Fed’s last two attempts have amounted to nothing.

— In the current environment, policy makers are faced with two choices – deflation or inflation. The Fed is scarred by the deflationary episode of the 1930s. Bernanke erroneously thinks the depression was the Fed’s fault. He won’t want deflation to happen on his watch.

— But if you go back and read his speech on deflation in 2002, you’ll see he is running out of ideas. Most of his solutions involve getting money into the economy via the banking system. But funnily enough, the banking system can’t find enough creditworthy borrowers to lend to. They have the cash but not the means.

— Of course, one’s thinking can develop over nine years. We’re sure Bernanke’s come up with some additions to his inflation making plans. And with global central banking heads about to bump into each other at Jackson Hole, Wyoming in a couple of weeks, it’s a prime stage for Bernanke to come up with more plans to halt the inevitable.

— What is the inevitable? The collapse of the global monetary system as we know it. That’s why you should be buying gold on the dips to protect yourself. Gold is not dipping now, but it will in the future.

— But Bernanke’s 2002 speech does give a hint at what might come next. Check this out:

‘…the Fed has the authority to buy foreign government debt, as well as domestic government debt. Potentially, this class of assets offers huge scope for Fed operations, as the quantity of foreign assets eligible for purchase by the Fed is several times the stock of U.S. government debt.’

— And in the past few days, some Fed officials have voiced concern over the European banking system, perhaps laying the foundation for some action there. Coincidence?

— Maybe. For the record we think the Fed buying foreign government debt or any foreign assets would be idiotic and cause absolute mayhem in the foreign exchange markets. It would also set off a major geo-political rumble.

— But since when have central bankers baulked at the idiotic before? It’s time to place your bets. What will Bernanke do? Suggestions welcome.

Regards,

Greg Canavan
Daily Reckoning Australia

Greg Canavan
Greg Canavan is a contributing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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6 Comments on "The Golden Game Changer"

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Bron Suchecki
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“Could it be the request from Venezuela has forced these players into the gold market to buy back some of the gold they apparently had for safekeeping?”

Not in my opinion, the amounts Venezuela hold with those banks is small compared to their overall physical holdings backing their fractional unallocated (which is not 100:1 – see here http://goldchat.blogspot.com/2011/07/turnover-and-fractional-memes.html).

It will only become a problem for the bullion banks if other central banks follow Venezuela’s lead and repatriate their gold. If that happens then it is a game changer.

hadenough
Guest

Greg i dont think the question should be what he will do, but it should be what he should do.maybe if he took one to many sleeping pills and a bottle of jack daniels….Could solve the problem!!!!

shortchanged
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Another timely and interesting article Greg, the French reclaiming their gold, with warships no less, i suspect not many people knew that.As for the banks holding Brazil’s gold, did Chavez just find that out, or is he trying to put the cat among the pigeons.Either way, can anyone be sure the Banks HAVE the gold, given the way accounting is done nowadays.For example,debts are counted as assets, but surely they are liabilities until that debt is paid.I really hope more countries repatriate their gold, to your readers, i suggest physical gold only. As for the rest i will paraphrase a… Read more »
hadenough
Guest

Shortchange, i wasn’t referring to chavez, he is much smarter than the clown i am referring too, that being federal chaiman BEN BERNAKE. Yo also said we live in interrestig times we sure will be if theese governments and BANKS haven’t got the goodies.

Ross
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First use of the fiat money always comes to mind. The suggestion of buying foreign government debt is intriguing because that essentially combines the two elements of exporting inflation and making first use of money as in Weimar. If they bough Europe the AUD along with others couldn’t cop it and the Japanese would go ape.

shortchanged
Guest

My apologies hadenough, must be my muddle day, had the wrong end the stick.I do agree with you about Benanke et al how do they and their familys sleep at night i’m damned if i could.As for the banks having the “goodies”,anyone in the know care to comment?.

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