Gold News

New Strength in Gold

Gold will never be hauled around in wheel barrows to pay for loaves of bread...

MAYBE IT'S JUST the smell of spring in the Melbourne air, but the markets suddenly have a much more comic feel to them, writes Dan Denning in the Australian Daily Reckoning.

The tragedy lurks. But how can you get too moody when there is so much to laugh at? And besides, every wrong turn by a policy maker creates some unintended opportunity for investors.

The G-20 finance ministers wrapped up their meeting in London and agreed to attack the bonuses of bankers. This probably feels good. But it doesn't do much to address any of the problems that led to the whole Global Financial Crisis.

One meaningful result of the meeting was the agreement to boost bank capital "once recovery is assured." Specifically, the G-20 finance gurus say something needs to be done about the "quality, consistency, and transparency" of bank capital.

Can we get an Amen brother?

But what do the gurus say should be done? They want to introduce a "leverage ratio". That would limit the size of bank assets relative to equity capital. In other words, banks wouldn't be able to borrow up and inflate the asset side of the balance sheet to dangerous levels.

Dangerous levels are where losses on assets wipe out equity capital. That would be a welcome reform. But we think there's a flaw in the G-20 plan. The flaw is that they want to wait to introduce this reform until "recovery is assured". Yet the other big item of agreement from the meeting – that it's too soon to withdraw government stimulus spending – nearly assures that the recovery will be much delayed.

Government stimulus plans keep alive the illusion that everything is normal. The whole array of stimuli, loan guarantees, and credit facilities perpetuates the zombie credit economy. And this, of course, prevents further write downs in bank collateral that would threaten capital adequacy levels.

You's all a very cleverly worded way of trying to deny that there are any more bad investments to be written off. And in the meantime, spending other people's money is a lot of fun. It's no surprise there's government agreement to keeping borrowing and spending.

For investors, it means gold is going to have a good solid run at US$1,000 once again. It's in the neighborhood already. But in the lead up to the G-20 leader meeting in Pittsburgh later this month, we wouldn't be surprised to see the Gold Price start to factor in a lot more fiat money creation to come.

This is not quite straightforward for Aussie investors. The Aussie Dollar is at a one-year high versus the greenback. Normally, when the Aussie moves against the greenback, the Aussie Gold Price itself stagnates, even while the US-dollar price rises.

However, as we noted in an update last week to Diggers and Drillers readers, the Aussie Gold Price has actually moved up more in percentage terms than the US-dollar price in the last 30 days. That's unusual, given the relative strength of the Aussie currency.

So what does it tell you? And what should you do? It tells us that gold is gradually picking up speed against all paper currencies. Remember, gold is in this fight for the long haul. It will never be hauled around in wheel barrows to pay for loaves of bread. Whereas the strength of paper money lies in the confidence people have in it. And that only lasts as long as politicians manage to preserve that confidence with prudent policies.

There's not much prudence going around lately. We think that explains the recent strength of precious metals. Institutional investors are starting to hedge against both paper money and also the stock market indexes that have raced well ahead of realistic earnings for both 2009 and 2010.

This is good for gold. What's even better for Aussie gold investors is that Australia is set to become the world's second largest gold producer, according to Bloomberg. Aussie gold output rose 4% in the June quarter to 57 metric tons, according to Surbiton Associates here in Melbourne. The biggest producing mine was the Super Pit in Kalgoorlie, run by Newmont and Barrick. Newcrest's Telfer mine came in second.

Surbiton reckons that with Newmont's Boddington mine entering into production this quarter, the numbers will grow again. This'll put Australia second behind China in global gold production. For punters, however, we'd reckon here at the Daily Reckoning that aside from owning the big boys (or trading their chart patterns), the biggest stock market gains will come from the junior producers who can increase production in the next year without blowing out costs.

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Best-selling author of The Bull Hunter (Wiley & Sons) and formerly analyzing equities and publishing investment ideas from Baltimore, Paris, London and then Melbourne, Dan Denning is now co-author of The Bill Bonner Letter from Bonner & Partners.

See our full archive of Dan Denning articles

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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