Gold News

Gold Price's "Default" Model Broken

Why? Because this is not the debt default gold prices were looking for...
 
NO DENYING it, writes Adrian Ash at BullionVault. The threat of US debt default has been a non-event for gold prices so far.
 
In fact, the mere hint of a short-term fix knocked gold prices below $1300 on Thursday, with a further plunge as the week ended.
 
For long-time investors, the irony looks so thick you could butter your toast with it.
 
The US Dollar is the world's most important currency. The United States is also the world's largest debtor. So-called gold "bugs" who began buying gold in the early 2000s thought they saw what was coming. Then from 2007, Washington only added to its historic debt pile, backing the nation's entire finance sector with yet more taxpayer promises.
 
The endgame looked clear. And here it is, with less than one week to go. We now have the very real risk of an outright default, a failure by the United States government to pay its debts or bills as they come due.
 
US Treasury bonds underpin the world's financial system, setting interest rates and acting as collateral for pretty much the entire planet. The panic about to take hold should mean silver and gold prices are soaring. Yet here we sit, back below $1300 and $22 per ounce.
"You would think," offers John Waggoner in USA Today, "that the threat of a government default would send gold soaring. In default, after all, those who normally buy government debt would flee, driving down the value of US currency on foreign markets. But gold is doing little to aid your portfolio."
The gold price just isn't working as it should, in short, as US default draws near. "Honestly, it doesn't make sense," adds Dan Denbow – a guy who understands gold more than most, as manager of the $1bn USAA Precious Metals fund (USAGX). "The current situation is a bit perplexing."
 
But step back for a second. The world doesn't fit your model. So the world must be wrong?
 
Back in 2009, "the recent [gold] price surge looks suspiciously like a bubble," wrote Nouriel Roubini. Because in the absence of severe inflation, or a catastrophic economic collapse, the NYU Stern School professor couldn't imagine gold prices rising. Yet they were. So gold must be wrong. Because of course, Roubini could only be right.
 
Now in late 2013, the opposite problem is confusing pundits and traders alike. Gold is falling when it "should" be soaring. Maybe gravity's failed, the earth is flat, or somebody's rigging the market?
 
But this US "default" isn't for real. It's a sham, a fraud and scamola. Political posturing is all that is happening, and the financial markets know it. America faces default on a technicality, not on a refusal by creditors to finance any more of its spending. Even if no deal is done by Oct. 17th, equity and bond investors know the US can borrow and spend all it wants at the moment. Only the arbitrary and very moveable debt ceiling is stopping it. And the US of course remains the world's biggest economy, and the source of its hottest must-have investments, regardless of value.
 
Take communications, for instance. The UK has Royal Mail, floated this week for the equivalent of $5.25 billion, and then jumped 38% on first trading today. The US in contrast has Twitter, priced at twice as much by its IPO. Never mind the business models (Royal Mail made $700m operating profit in full-year 2012. Twitter lost $68m in the first-half of 2013). One of these stocks is a sell. But the faller will most likely be different short term from long.
 
Meantime, there's little surprise that gold and silver aren't jumping. Because the US default isn't happening, whether it does next Thursday or not. And together with America's rediscovered bounce, the sense of crisis peaking in 2011 continues to ebb. The real panic, the financial "end times" which Tea Party Republicans are winking at, is still pending. It isn't here today. And when it does show up, precious metals – most especially gold – will offer a stand-out antidote. 
 
Physically rare and indestructible, gold is the very opposite of debt investments. Owning it puts you a million miles from being a creditor. If this US default were for real, gold would say so. For now, this is not the debt default gold owners were looking for.

Adrian Ash is director of research at BullionVault, the physical gold and silver market for private investors online. Formerly head of editorial at London's top publisher of private-investment advice, he was City correspondent for The Daily Reckoning from 2003 to 2008, and is now a regular contributor to many leading analysis sites including Forbes and a regular guest on BBC national and international radio and television news. Adrian's views on the gold market have been sought by the Financial Times and Economist magazine in London; CNBC, Bloomberg and TheStreet.com in New York; Germany's Der Stern; Italy's Il Sole 24 Ore, and many other respected finance publications.

See the full archive of Adrian Ash articles on GoldNews.

Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.

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