A while back I wrote Something is Wrong… Possibly a crisis. In it, I stated that gold's rise then of 40$ in a couple weeks time was alarming. In the past several years gold's big moves were on the order of 15 to 20$ up or down. Now we are seeing twice that volatility. Next week should be interesting.
One of the major indicators of financial health is the volatility of gold. Whether it is political instability (very present today), or economic instability like massive US trade and Federal deficits, gold seems to telegraph the unease by weeks.
We are now well over a month into gold's latest spike. It has risen from about 460 Nov 1 to 530ish. That is 70 dollars in about 6 weeks. This is major volatility for recent years.
What is happening? I have seen reasons offered and some make sense. Central Banks are buying gold, Russia for instance intends to double its gold reserves, they will have to buy over 500 tonnes to do that. Other Central Banks are doing this too. The greatest player would be Japan, with one or two trillion$ of USD assets and cash. Recently Japan investors have been buying gold in part as an investment since yields are so ridiculously low there at 1.5% for a ten year JGB.
But is Central Bank buying and Japanese investor buying enough? I think this may be so. But, we have other players who have been buying too. The Oil sheiks and Russia, with large cash reserves from oil's rise. They are also going into this market. Then, we have Hedge Funds which always jump on any bandwagon, and add their buying using great leverage…(cowboys!)
So all these forces are pushing gold up strongly, and one wonders where the latest impulse up is going to level off. It ripped through 500 after a super brief 2 day drop to 493 after just touching 500 about a week ago. Then zoom.
Normally, one would think that gold bulls would take some time to launch increasingly higher volatility, but it appears that all the aforementioned bullish forces have now synchronized into a real bullish force in much less time than would have occurred in the recent years. One reason is that electronic trading is now so easy that the usual timelines for market activity are shortened greatly.
Now, either the confluence of these bullish market forces accounts for this 70$ rise, or there is something going on, like a budding financial crisis. Or more specifically, a US dollar crisis.
This potential crisis has a lot of reasons to happen. Even though the USD is rallying this year, from a low of 80 on the USD INDEX to about 91-92, there have always been huge problems from the twin US Trade and Federal Deficits. One day these two deficits will cause the demise of the USD and rabid inflation.
But there is more to this story. Take derivatives for example. They are leveraged financial contracts on practically everything in the world economy. And get this, they are creating derivatives on HOME PRICES in seven or so US metropolitan areas. So people can bet on the rise or fall of home prices and perhaps hedge this risk since, so many financial instruments are backed by home mortgages like asset based securities, GSE's like Fannie Mae and Freddie Mac mortgage bundles. Derivatives are massive and unregulated. They are a great threat to yours and my financial life and could cause a USD crisis all by themselves. To outline more about why would take pages, but they are new, unstable and super leveraged and risky and amount to over 5 times world GDP or 260 trillion $ ! That is something for a new market since about 1990, eh?
The hottest thing in finance is not only your housing boom. It is the finance back of it. Every kind of financial instrument has bundled together trillions of dollars these last years riding the wave of the world and US housing bubble. Since bond yields worldwide are so low, many financial institutions have put several trillions into the world mortgage frenzy. And this causes one very great risk. When the US housing bubble and the world housing bubbles let go, there are trillions of dollars of assets waiting to dump those asset backed securities, Fannie and Freddie stock, and a plethora of financial instruments behind all the booming home mortgage finance.
It is becoming clear that the US housing bubble is finally peaking, something I called several months ago. Then I said that the statistics would continue to be positive for 2005, but very soon these statistics would catch up with what I saw then as a peaked US real estate market. Those statistics are now evident. US home prices have dropped about 2% on average in the last couple of months. The number of homes on the market has increased from less than 2 months of inventory to 6 months. Lots of homes are waiting to be sold now, and people are getting the picture that the real estate gravy train is ending.
With speculators (who don't live in their homes) accounting for as much as 20 % of the homes purchased in recent years, we are sitting on a home time bomb that could deflate very rapidly in 2006. Then all that money back of all those home mortgages is going to start liquidating all those trillions of dollars of recent financial instruments.
A year ago, I said that the US housing boom is the key for 2005, and when the US ten year rates rise 1 percent from 4.25 to 5.25% then the housing boom would be finished. This was predicated on the fact that homeowners have stretched themselves thin and any increase in rates will stop the housing bubble. Now we see that adjustable rate mortgages have risen over 1 percent, and the 30 year fixed rate has risen well over 1 % and now the US housing bubble is peaking. Now the US ten year bond has not risen 1%, but that is because there is no decent sovereign bond yield to be had, so bond yields have been held way down. But the other key mortgage rates have risen now over 1% and we see the US housing bubble is peaking.
SO, could the massive recent move in gold be keyed on the imminent decline of the US housing bubble and the US consumer? I think so.
I think that if you were to add the normal gold bullish forces that I began this piece with, and include the imminent demise of the US housing bubble in 2006, you get very good reasons for gold's rises recently.
I wish to go a little further. Europe is having major strife with the Muslim immigrants. That is gold bullish because Europe is much more gold savvy than the US. Now add the Japanese interest in gold, the Oil sheiks, and Russia. New Chinese demand and Indian demand for gold Jewelry, increasing by several hundred tons more than usual. You basically get over 1000 tons of new demand this year. That is clearly enough for this gold impulse.
Then add the speculative wolves who pile on volatility….. We have one very strong gold bullish market out there.
Then add an imminent demise of the US housing bubble and the US consumer in 2006. And the flight to safety gold market kicks in.
All these bullish forces are now coinciding into a perfect gold storm.
There is one thing lacking. A clear publicly known financial crisis. Should that emerge, we will see gold rocket over 600 bucks within a couple of weeks. But I am not aware right now of an imminent USD financial crisis. But we have many reasons why one can ensue, starting tomorrow even….
Suppose the demand for US Treasury Bonds falls off or even turns into significant outright selling? That would do it. The recent rise in the USD would stop dead in its tracks and begin a swift decline. Now some people are saying that has already happened but, overall there are other players buying than the Central Banks who have said they want to underweight UST's. There are many other sources looking for yield and with US interest rates 2 to 3% or more higher than Europe and Japan, I expect this demand for UST's to continue.
But if there was any real hint of a USD crisis, then all bets on UST's are off and we could see panic selling develop…. Then the US stock market collapses, and US Bonds of all types collapse.
So we have a great many fundamental reasons for gold's recent spike. And there may be a hidden financial crisis looming out there that is waiting to manifest, and is only being telegraphed by gold price rises.
2006 is going to be a bad year. Be very protective. Be cautious of any stocks, even some reasonable care with gold stocks. If you want those buy the best like Newmont. But overall be super cautious going into 2006. We have lots of storm clouds on the US horizon.
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December 12, 2005
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