Market Sees Bright Future for Gold Price as Credit Crunch Worsens

Gold futures closed up almost 9% yesterday. December gold closed at US$721. The spot gold price is ten dollars lower. The market, then, reckons gold has shinier days ahead. What will Ben Bernanke have to say about that?

Bernanke is sticking to his theory that there’s a “global savings glut”. This “glut” has kept interest rates down in America as foreign money flowed into US bonds. Was the Chairman indirectly telling the market there’s no need to cut interest rates when the Fed meets next week? Or was he just being obtuse?

Rate cut or no, stocks are bound to be disappointed. They’ve rallied as if a cut was a certainty. Even if it is forthcoming, we don’t see how it fundamentally improves the prospects for stocks. Still, that the Fed would choose to cut rates instead of supporting the dollar is not that surprising.

The Fed fears a Japan-style deflationary recession. The bear market in credit is one key aspect of that recession. A bear market in credit not only dries up the money for private equity deals and the commercial paper market, in restricts consumer borrowing too through higher interest rates on revolving credit card debt.

You can kiss goodbye to home equity lines of credit as well, in a real credit crunch. Cutting rates is one way of trying to avoid the adjustment that inevitably comes to an economy when credit tightens. That wasn’t always the case.

“Under a gold standard,” one of our colleagues in Australia wrote to us earlier this week “the domestic economy bears the brunt of any adjustment needed. But under a floating currency environment, the currency takes the hit to minimise the impact on the economy.”

“Floating exchange rates and democracies evolved (loosely) together. Factored into the above probability is that in a democratic system, politicians will sacrifice the integrity of a currency to minimise the damage to the economy…and of course gold will be the winner.”

That is the first time in recent memory we’ve seen the words “politicians” and “integrity” in the same sentence.

The point is spot on, though. The rising gold price may as well be a lack-of-integrity meter, giving us readings on central bankers. There is not much an investor can do about monetary policy.

On the other hand, with the rising oil and gold price, the market seems to be on to the Fed’s game. Tangible assets-things priced in dollars are going up as the US dollar goes down. Australia’s dollar…and its numerous tangible assets…are going up too.

Dan Denning
Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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