Gold News

UK Gold, UK Banks

The UK's No.1 bank is now a penny stock. Gold Bullion is trading above £600 an ounce...

THE SPREAD of the financial crisis to the broader global economy has boomeranged onto the suddenly tight-fisted banks, writes Gary Dorsch of Global Money Trends.

It's undermining their investments far beyond sub-prime mortgages, on to credit-card debt, auto loans, commercial real estate and other assets, as unemployment surges and consumers and businesses default on their debt.

This, in turn, is rapidly eroding confidence in the solvency of major financial institutions, and fueling a collapse of their share prices.

In London, and despite £500 billion pledged for a bank rescue package in October, the UK banking cartel is still not lending at normal levels, deepening the worst recession since World War II. Seeking to break the stranglehold of the big-four British banks, the government of prime minister Gordon Brown says it will only insure banks against default on their toxic loans in exchange for legally binding commitments to make credit more freely available to British businesses and home buyers.

Thus Brown has moved towards the quasi-nationalization of the Royal Bank of Scotland, by converting the government's preference shares into ordinary shares, and increasing the stake in RBS to nearly 70%. The government takeover became necessar after RBS estimated its full-year losses near £28 billion ($41.3bn), the biggest by far of any British corporation in history. The loss includes a £20bn write-down following its purchase of Dutch bank ABN Amro and US bank Capital One.

Now, after RBS's shares crashed to 13 pence in London trading this week – down 95% since Jan. 2008 and more than 98% since Jan. '07 – it's become an all-but-worthless penny-stock. The incompetent bunglers who drove the bank to ruin have been ousted and future lending will now be subject to new government guidelines.

RBS's preferred share (series-T, traded in New York) lost half of its value on Jan. 20th, plunging to $6.60 to yield only a little less than 30%, as traders braced for a reduction in dividend payouts.

The credit default swap rate on RBS bonds – effectively the cost of insuring against bond default – rose 30-basis points wider at around 150-basis points, which means investors are paying $150,000 a year to insure against default on $10-million worth of RBS bonds. And while there is a strong moral argument against using taxpayer money to rescue bond holders of troubled banks, the alternative – a default by mammoth global banks – risks a replay of the Lehman Brothers meltdown, but with ten times the firepower.

It would threaten to ignite the nuclear $32-trillion credit default swap market, and in a chain reaction, risk another stock market rout of horrific proportions.

Despite the meltdown in the bank's common and preferred shares, however, bondholders are confident that RBS won't be forced to default on its debt, and that the UK's bailout package will fall short of full nationalization, although with lots of strings attached. 

As part of the second rescue package, to prevent the UK economy from spiraling into a depression, PM Gordon Brown has instructed the Bank of England to begin purchasing £50 billion of corporate bonds and other assets, starting on Feb. 2nd.

The aim is to combat deflation and unblock frozen credit markets. Because the top-350 UK companies are scheduled to refinance £210 billion of loans over the next five years, threatening economic collapse if they can't reload their debt.

Initially, the Bank of England's purchases will be "sterilized" by a matching and equal sale of British government gilts soaking up the excess cash pumped into the financial system by the corporate bond purchases. But the latest banking bailout scheme is expected to dig Britain deeper into debt, which could make taxpayers liable for up to an extra £350 billion. So when necessary, the BoE has been authorized by the Treasury to begin monetizing the debt – otherwise known as simply printing money in order to buy the new supply of gilts.

The Pound Sterling, meantime, plunged deeper into a black hole on the foreign exchange markets this week, as traders anticipated a further reduction in the Bank of England's base rate – already at record lows in its 300-year history – possibly down to near zero-percent. There's also been an explosive surge in the UK's broad M4 money supply, which is now expanding at a 16.4% annualized clip.

The BoE has slashed it base rate by 350-basis points since October to a record low of 1.50%, pulling out all the stops to stop the slide in the UK-housing and stock markets. Yet the BoE's rapid-fire rate cuts have back-fired on the central bank, by crushing the value of the British Pound to ¥124, an all-time low, which in turn, has fueled the unwinding of "yen-carry" trades and thus fresh dumping of UK-listed shares by powerful Japanese speculators.

There is a real danger of this devaluation in Sterling becoming a full-blown crisis, and a serious headache for gilt holders both foreign and domestic.

Roughly £484 billion was wiped off the value of Britain's top-100 companies in 2008, and UK home prices fell an average 18.9%, the largest in a calendar year, reducing the average home value to £159,896.

Furthermore, the big-four British banks have a combined loan book of more than £6 trillion, more than four times Britain's annual GDP – and a collapse of this sector can deal a punishing blow to the broader economy.

Combined with a sharp slide in global commodities, a consensus view of a looming deflationary depression has emerged in the UK. So the speculator's first instinct was to jump into British gilts, guaranteed by the Bank of England's printing press for redemption, as a "safe-haven" from the global financial crisis.

Mirroring the sharp slide in base metals, crude oil and grain markets, yields on the UK's 10-year gilt plummeted from as high as 5.20% in July to a record low of 3.00% in December. Yet counter-intuitively, the best performing asset in these times of a deflationary depression has remained the ultimate hard currency – Gold Investment bullion – more commonly perceived as a hedge against inflation.

The Gold Price in British Pounds has surged to all-time highs as Sterling lost its purchasing power against the Euro, Japanese Yen and US Dollar. Prior to the second rescue package for UK banks, new issuance of government debt this year – in the form of gilts – was expected at £146.4 billion ($222bnb). But now, there is no ceiling on government borrowing, with Sterling under heavy speculative attack, dealing the gilt market its first significant set-back in four months and lifting 10-year yields as high as 3.60% this week.

The price of gold for British investors is now perched above £600 per ounce, while UK banking shares have been bludgeoned amidst a mass flight from the sector. The fear is that RBS and other banks, such as Barclays, could find themselves controlled by the state. But if the Bank of England is successful at some point, using its new Quantitative Easing framework to revive inflation in the UK economy, gilts would continue to lose purchasing power to the yellow metal.

GARY DORSCH is editor of the Global Money Trends newsletter. He worked as chief financial futures analyst for three clearing firms on the trading floor of the Chicago Mercantile Exchange before moving to the US and foreign equities trading desk of Charles Schwab and Co.

There he traded across 45 different exchanges, including Australia, Canada, Japan, Hong Kong, the Eurozone, London, Toronto, South Africa, Mexico and New Zealand. With extensive experience of forex, US high grade and corporate junk bonds, foreign government bonds, gold stocks, ADRs, a wide range of US equities and options as well as Canadian oil trusts, he wrote from 2000 to Sept. '05 a weekly newsletter, Foreign Currency Trends, for Charles Schwab's Global Investment department.

See the full archive of Gary Dorsch.


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