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Gold: Depression Safe Haven

As central banks turn to inflation to cure depression, gold emerges as the one safe haven...

"IF YOU WANT to continue to be the slaves of bankers, and pay the cost of your own slavery, then let bankers continue to create money and control credit," warned Sir Josiah Stamp, former chief of the Bank of England in 1927, says Gary Dorsch, editor of Global Money Trends.

Indeed, the world economy is now being held hostage by an elite banking cartel, a cartel whose reckless pursuit of speculation and bloated profits has precipitated a breakdown of the global financial system.

It's now plunging the world towards a "Great Depression". The global economy will grind to a halt this year, predicts the International Monetary Fund (IMF), after $30 trillion in market capitalization was erased from global stock markets by the financial crisis starting in summer 2007.

Gold vs. Depression: The Financial Crisis

The worst banking crisis since the Great Depression of the 1930s began with the bursting of the US house price bubble, but it has now – so far – resulted in $1.2 trillion of losses and write-downs from toxic assets held by banks worldwide. And "Unless stronger financial strains and uncertainties are forcefully addressed, the pernicious feedback loop between real activity and financial markets will intensify, leading to even more toxic effects on global growth," the IMF warns, predicting that bank losses could eventually peak at $2.2 trillion, hobbling the world economy in the year ahead.

"Downside risks continue to dominate, as the scale and scope of the current financial crisis has taken the global economy into uncharted waters, triggered by the collapse of bank credit and stock markets," the IMF said on January 28th.

Global trade collapsed by 45% in the fourth quarter from a year earlier, exposing the staggering depth of the global financial crisis. Speaking at Davos, Switzerland last week, Australian trade minister Simon Crean warned that falling global trade would compound the economic downturn. "If global trade is a multiplier in growth, it also has the potential to be a multiplier in reverse," he warned on Jan 31st.

The Baltic Cape-Size Index, which measures the cost of shipping coal, iron ore, and steel across the high seas, is still languishing 90% below its record high of 19,200 points, set back in May 2007.

Why? Because global bankers suspended issuing the "letters of credit" that importers and exporters rely upon to finance their overseas trade. Of the $14.5 trillion of cargo that is shipped across the oceans each year, roughly nine-tenths is financed with "letters of credit" issued by bankers, guaranteeing payment to the shipper once shipments are delivered to the buyer.

So with banks cutting off "letters of credit", the wheels of global shipping have ground to a halt. Now global growth this year will come to a "virtual standstill" warns Olivier Blanchard, the IMF's chief economist.

"We need stronger policy on the financial front," he said on January 28th. Leading the Group of Seven nations into contraction will be the UK economy, projected to slide 2.8%, with Japan's economy close behind with a 2.6% contraction.

The 330-million citizens of the 16-nation Eurozone will see their GDP shrink 2% overall, followed by the US economy with its own 1.6% contraction.

The reeling US economy has also translated into severe pain for overseas markets.

China's economy will slow to 6.7% growth this year, says the IMF, after peaking at 12.7% in the second quarter of 2007. But South Korea, the world's 13th largest economy, is among the most vulnerable to the global financial crisis – even though China is now Korea's largest trading partner.

Much of what China imports from Korea is re-exported to the global markets in the form of finished goods. And Korea's exports to China plunged to $4.75 billion in December, or 35.4% lower from a year before, despite a sharply weaker Korean Won on the currency market.

The last double-digit drop of exports was in 2002, amid the bursting of the Dot.Com bubble. So you can see that Korea's economy is a key bellwether of the global economy, because exports are equivalent to 52% of its gross domestic product.

Preliminary reports indicate that exports continued to plunge in January, with shipments to the US declining 21.5%, exports to Europe plunging 47%, and sales to Latin America 36% lower than a year ago. Not surprisingly, Korea's GDP shrank 5.6% in the fourth quarter from the previous three months, the biggest drop since 1998.

Korea's industrial output plunged 9.6% in December, slipping for a sixth consecutive month, as Hyundai Motor, Hynix Semiconductor, and steelmaker Posco reduced output in January to cope with sagging demand. Samsung Electronics, the world's largest maker of memory chips, liquid-crystal displays and televisions, reported its first ever quarterly loss.

Exports of semiconductors plunged 47% in January from a year earlier, and automobiles declined 55-percent.

China's vast manufacturing sector, which employs tens of millions of workers and has functioned as the cheap labor workshop of the globe, also slowed dramatically as demand for its exports collapses in its major North American and European markets.

About 20 million migrant workers, moving from villages to cities and factories, have returned to the countryside after losing their jobs because of the economic downturn. Beijing is warning that rising unemployment could fuel social unrest after the economy grew by more than 10% per year for a full half-decade.

Still, China has internal resources – roughly $2 trillion in foreign currency reserves – to prevent a hard-landing for its economy. It has also vowed to spend 4 trillion Chinese Yuan (CNY) on various infrastructure and social programs over the next two years. That's equal to 15% of its total economic output.

Chinese premier, Wen Jiabao, said his goal of 8% growth this year is "an attainable target through hard work. The harsh winter will be gone and spring is around the corner," he said.

When searching for a glimmer of optimism for the global economy these days, there is a small sign of relief in China's Purchasing Managers' Index (PMI) rising to a reading of 42.2 in January from 41.2 in December, inching further away from the record low of 40.9 plumbed in November.

The PMI is a snapshot of overall conditions in manufacturing industry, and still signals a sub-par growth rate that could ultimately lead to higher Chinese unemployment. However, the index for new export orders from overseas jumped to 36.3 in January, up 28% from a low of 28.2 in November and thus a possible sign that the worst is behind China's export industry.

If China is going to be the savior that pulls the global economy out of its death spiral, one early signal could be a sustained rally in the Shanghai stock index, not least if it rises above the December high at the 2,100-level. Copper traders in Shanghai are also tracking factory activity and stock market trends.

Gold vs. Depression: Davos Debates the Crisis

Last week, meantime, the world's most influential business executives and politicians converged in Davos, Switzerland.

The most dangerous economic and financial crisis since the 1930s dominated the discussions. One of the main attractions at the World Economic Forum was Russian kingpin Vladimir Putin, whose political strength rests on the Kremlin's authoritarian control over the media, secret police, banks, and natural resource oligarchs – a combination that has stifled any meaningful political opposition.

Putin scolded Western capitalists for dragging the global economy into a death spiral. "A year ago, American delegates emphasized the US economy's fundamental stability and its cloudless prospects," he said. "Today, investment banks, the pride of Wall Street, have virtually ceased to exist. The entire economic growth system, where one regional center prints money without respite and consumes material wealth, while another regional center manufactures inexpensive goods and saves money printed by other governments, has suffered a major setback."

World leaders in Davos were also told of street riots and spreading discontent across Europe, and they vowed to prevent the financial crisis from inflicting deeper damage and making global poverty worse.

Last week, more than a million people took to the streets of French cities to protest, "Buy American" initiatives have sprung-up in the US Congress, and thousands of British employees staged walkouts against the use of foreign contract workers.

So far, however, the biggest casualties of the global financial crisis have been the Russian economy, currency, stock market, and the Kremlin's rapidly shrinking stash of foreign currency reserves.

The Russian Trading System Index, once the world's biggest stock market bubble, has collapsed, with a staggering 80% slide from its record high set in July of last year. Little wonder then, that with thousands marching to protest at the global depression in Moscow, Putin called the Western banking crisis a "perfect storm whose destructive powers were multiplied worldwide."

In humbler tones, he also called upon his economic rivals to work together to find an exit route from the financial crisis. Because global bankers are retreating en-masse from the emerging world, not least Russia. Private capital flows to emerging markets are expected to plunge to $165 billion this year, down from almost $1 trillion two years ago.

Gold vs. Depression: Crude Oil Whacks the Kremlin

Since August, foreign investors and Russian citizens have withdrawn at least $278 billion from Russian banks deposits, exchange traded bonds and stocks, knocking more than $1 trillion from the RTS Index.

Given that energy and metals make up 80% of Russia's exports, deputy prime minister and finance chief Alexei Kudrin said on Jan 30th that Russia's export revenue could plunge by $200 billion in 2009, down to roughly $269 billion.

"It is the first time since 1982-1983 that the global economy will see demand for crude oil and energy products decline for two years running," Kudrin said. However, unlike in the Eurozone and the US economy, Russia doesn't face a debilitating deflation risk, since "falling demand in Russia will be counteracted by rising prices on imported goods due to the devaluation of the Russian rouble," Kudrin said.

The demise of Putin's empire is largely linked to the stunning collapse of crude oil, with Russia's Urals blend tumbling from as high as $140 per barrel in July as low as $32 a barrel in December.

Surprisingly, the Kremlin has refused to join the Opec oil cartel in cutting its oil output to support prices, or even siphoning off some of its oil supply into strategic tankers, to help reverse the bear market slide.

The sharp slide in crude oil prices has left Russia's Ruble vulnerable to speculative attack by currency traders. The 40% drop in budget revenues has also laid bare Russia's poorly diversified economy. Putin relied upon oil profits to steer Russia out of the 1998 currency crisis, a strategy which wiped-out the country's foreign debt, amassed nearly $600-billion in foreign currency reserves, and doubled average worker's incomes in six years during oil's boom years.

Russia's economy quickly became the world's seventh-largest, and one year ago – on Valentine's Day 2008, Putin boasted of Russia's economic transformation in his eight-years in power.

"It will be quite easy for Russian banks to get through the liquidity crisis. We have restored the fundamental principles of Russian economy on an absolutely new market base, and we are surely changing into one of the economic leaders of the world. The stock index rose 20% in 2007," Putin declared.

But without a competitive manufacturing base as a balance to Russia's dependence on energy, base metals and other natural resources, Russia's economy is highly vulnerable to commodity price fluctuations. Russia has lost 6 million jobs since the global credit crunch began to bite, as industrial output went into free-fall.

Foreign inflows – which hit $100 billion in 2007 and were responsible for 25% of the investments in Russia's capital markets – went into reverse after Putin's accusation in July that the coal and steel company Mechel MTL.n had engaged in price-fixing, knocking its shares 40% lower in a single-day.

The continuing battle between Putin and the embattled Anglo-Russian oil producer TNK-BP also continues, reminiscent of a Yukos-style asset grab. Plus there was the August invasion of Georgia.

Urals crude oil, Russia's chief export blend, has slumped far below the $70 average required to balance Russia's government budget this year.

Declining oil prices and a deteriorating economy has invited speculators to short-sell the Russian Ruble, and ordinary Russian citizens – mindful of the previous Ruble devaluation in 1998, when the currency lost 70% of its purchasing power – are rushing to convert their cash savings into US Dollars, Swiss Francs, and Gold Bullion.

Russia holds the world's largest natural-gas reserves, the second largest coal reserves, and the eighth largest oil reserves. And twelve months ago – after the crowning achievement of Russian Petro-power, when Putin ordered the Russian Ruble to be freely convertible into other foreign currencies – new puppet president Dmitry Medvedev declared that he would push for Russian oil and gas to be traded in Rubles.

"We need to stimulate the switch to Ruble payment for our commodities," Medvedev said, pointing to how a decline in the US Dollar's value had eroded purchasing power for oil exporters.

But one year later, it's the Russian Ruble which has fallen to an all-time low against the US Dollar, sinking despite the central bank trying o stem capital flight by hiking its repo rate to 13% and selling $200 billion from its foreign-currency stash for Rubles on the open market.

By remaining committed to Ruble convertibility, the Kremlin was forced to spend a third of its treasure chest to defend its currency. But the Russian currency still lost a third of its value against the US Dollar since the invasion of Georgia last August.

Unable to restore confidence in the Ruble, and amid weak base metal and crude oil prices, Moscow has adopted a so-called "dirty float" that will allow the currency to gyrate within a wide range of 26 to 41 to the Dollar. The forex market is still allowed to determine the value of the Ruble, but the central bank could intervene to enforce the trading band, rather than trying to influence it on a day-to-day basis.

By widening the trading band for the Ruble, the Kremlin aims to conserve more of its badly depleted forex stash. Sergei Shvetsov, Russia's currency chief, said on Jan. 27th that the central bank had spent $35 billion trying to support the Ruble last month.

But there were no interventions in the last week of the month, as the Ruble found its own level of equilibrium and Urals crude gyrated around $42 per barrel.

Should Urals crude tumble towards $30 amid a synchronized global depression, however, the Ruble could tumble further towards 41 per Dollar, down from around 36 today.

Shvetsov also expressed his backing for a freely floating currency in order to have more leverage over inflation through adjusting interest rates. The switch would also attract foreign capital should commodity prices stabilize and begin to rebound. But the global capital and money markets operate in a vast web of interconnections that are sometimes difficult for traders to uncover. And one of the outgrowths of the Russian Ruble devaluation – and the collapse of the crude oil and Russian stock markets – was a flight into safe-haven Swiss Francs and Gold Investment.

Gold vs. Depression: Switzerland Warns the Speculators

The Swiss Franc has gained 35% against the Russian Ruble over the past three months, while the yellow metal has soared 65% to an all-time high of R33,000 per ounce.

Gold also hit all-time highs against most other major non-US currencies in January, confounding conventional wisdom amid the current depression. The background of plunging industrial commodities, and a global economy that is lurching towards a deflationary spiral, gold's role as a hedge against excessive money printing by central bankers – and major currency devaluations – has attracted legions of investors worldwide.

"Nations are not ruined by one act of violence, but quite often, gradually, and almost imperceptibly, by the depreciation of their currency, through excessive quantity," said the Prussian astronomer Nicolas Copernicus in 1525. But even the Swiss National Bank (SNB), with its reputation as a monetary hawk, has now declared war against deflation and turned to inflation as the answer – not the problem – for its economy.

The Swiss National Bank is ready utilize all the weapons in its arsenal to prevent further appreciation of the Swiss franc against other currencies, especially against the Euro, said SNB deputy Philipp Hildebrand on Jan 21st.

The SNB slashed its 3-month Libor target by 50-basis to 0.50% on Dec 11th, yet the Swiss Franc has climbed 7% higher against the Euro since then, threatening to undermine Switzerland's export oriented economy.

"The SNB could also buy government or corporate bonds to ease monetary conditions further," Hildebrand warned if rates reach zero. Currency traders who are bidding up the Swiss Franc as a safe-haven against other depreciating paper currencies – such as the Russian Ruble and weak central European currencies – be warned.

"We have all options open and have no limits when intervening in financial markets should it become necessary," SNB member Thomas Jordan agreed on Dec 11th. "In general, a central bank can always increase the absolute amount of its own currency in circulation," Hildebrand added.

"The SNB could sell Swiss Francs against other currencies without limits. In an extreme case, it could commit itself to buying foreign currencies at a fixed rate."

What to do? In a world of currency devaluations and instability, zero-percent money market rates, and soon, massive central bank monetization of government bonds, gold has emerged as the safe-haven for preserving wealth.

"The things that will destroy us are politics without principle, pleasure without conscience, wealth without work, knowledge without character, business without morality, science without humanity, and worship without sacrifice."
   - Mahatma Gandhi

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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