Gold News

The Gold Price Meltdown

Survival is the limit of many investors' hopes for 2012...

GOLD PERFORMED outstandingly in the "quiet season" of July and August last year. A Gold Price of $2,000 an ounce looked a certainty before the end of the year, writes Julian Phillips of

But then unusual forces pummeled the Gold Price and all other global financial markets. Shades of the credit crunch hit the markets under the title of the Eurozone debt crisis. This had been going on for the last two years, but it entered a very dangerous stage in the final quarter of 2011.

Investors have been used to prices falling for fundamental or technical analysis reasons, but the phenomenon that we first saw in 2007/8 reared its ugly head again – what you might call Investor Meltdown.

This has nothing to do with investments, prices, or fundamentals; it has to do with investors themselves and their ability to hold onto their positions in the face of market volatility, shortage of liquidity, excessive leverage of investor's positions and the interaction of these factors.

Developed world markets have advanced to extremely sophisticated levels focused on maximizing returns for the smallest amount of money. Option costs can be below 5% of the value of the underlying investment value. Margins can be as low as 15% in the futures markets. Both these instruments allow 100% gains on moves of only 10%. Banks would lend up to 100% against selective investments for further purchases. These instruments inherently demanded price movements that warranted such gearing. If the investments moved in the opposite direction by those amounts then losses could be 100% too. Where a bank loaned money, the fall had to be 50% or so before the entire invested amount was lost. But that hasn't happened since 2007, until now.

So a system of protective stop losses was developed where broker's computers were programmed to trigger a sale (or purchase) of the investment if a certain price was reached. When prices went against the investment, investors 'walked away' from their options. When prices fell, exchanges demanded a topping up of investment money to keep the margin at 10%. Where prices fell 50% – or even before that—banks required the loan be called in. When this happened a forced sale often resulted.

When prices fell, a combination of these factors triggered price declines that did not reflect what happened to the investments. Where such actions forced investors to close positions, prices fell further. When this happened, investors often turned to investments such as gold where profits still sat and sold them to save themselves from predatory creditors. As each factor hit, one after the other, investors found themselves to be involuntary sellers as their financial capabilities shrank. 

As the Eurozone crisis got worse and the banks were threatened, liquidity dried up alongside shrinking asset values and rising interest rates (not central bank rates but interbank rates) – market falls were seen in most markets triggering Investor Meltdown. 

Where it goes is not a matter of market fundamentals or technical analysis but the vulnerability investors still have to falling markets. Have they de-leveraged to the point where forced selling is unlikely to damage markets further or have they succeeded in covering themselves? This is what will decide just how far future market falls will be. This will decide the future of all developed world financial markets in 2012.

In short, developed world assets, including its stock of money, shrank heavily and took the value of investments down too.

While we agree with Mr. Ben Bernanke and his colleagues that quantitative easing should repair this shrinkage of money, how much to inject and ensuring it goes into the right holes is beyond the capabilities of central banks. They need the full cooperation of the banking system to ensure that new money flows down to the right places to consumer and small businesses and the housing market. This has not happened – somewhat defeating the theory of QE. With the shrinkage hitting all but the emerging world, the exercise has to involve all the developed world's banks doing the same. Instead, they're contributing to the problem. 

The result is seen with a glance across most world markets. We see a potential for volatility that we've never seen before. From 1945 until 2010 the US, Britain and the rest of the developed world were the masters of markets, giving them a level of global financial control that defied basic common sense. It's the loss of control of the entire financial world that will create volatility and uncertainty in most markets going forward. The conflicting aims of the developed versus developing world are creating divisions that we cannot see being repaired in the future. There's now a battle for control of the world's wealth between West and East unfolding. It looks like the East will eventually win. 

The health of national economies will again dictate the value of its currencies. In the days of yesteryear, a county's Balance of Payments was the dictator of its currency's exchange rate. This changed when the US linked the oil price to the Dollar and issued its currency worldwide – all in the face of persistent trade deficits. With pressure to reinvest in the world's largest and most liquid markets, the States balanced the Balance of Payments of the US, which allowed the number of Dollars to grow to the point where it stood as the only completely liquid and sole, reserve currency (despite its issue being bloated well beyond the needs of the US financial system).

Today we're at a point where such over-issuance has led to debt levels that are completely excessive throughout the developed world. The shrinkage of asset values has not only hurt values, but it has also hurt confidence and trust. If there were to be an increase of interest rates in the developed world as a result of this loss of trust and confidence, not only banks but governments would see confidence in their currencies and creditworthiness collapse. More QE – whether it is through the back door in Dollar Euro swaps or QE3 — makes little difference except to postpone the fateful day.

With interest rates close to zero, we should be seeing financial markets in the developed world roaring ahead. Instead they're marking time and have done for the last two years. The potential for equity bull markets is there, but few believe in it. The focus is now on staving off more deflation and hoping the banking system holds together. The Fed has reassured markets that there'll be no interest rate hikes until 2013, at the earliest. Many feel that markets will be safe until then, but then what? 

The feeling is not one of future, growth or even hope, but can we survive without a major bank/government crisis? For instance, it's more and more likely that Greece will leave the Eurozone in 2012/13 because it will remain a deadweight in the Eurozone, for the foreseeable future. 

Market hopes are limited to survival hopes...

A major change in the developed world has been caused by the emergence of Asia; as in the last few years the power and control held tightly in the developed world has begun to shift to the east. Asia has undercut the developed world in a host of manufactured products, intellectual costs, and generally drawing off a great deal of wealth and growth that is undermining the developed world. They are outgrowing, out-developing and outnumbering the developed world and can survive on a tenth of the income of what the developed world is used to. This is unlikely to change even with a revaluation of 20, 30, or 50% of the Chinese Yuan.

So developed is the West that it has become excessively dependent on whatever confidence its markets, banks, and currencies can muster. In 2007 – 2011, that confidence was badly dented. Because the reasons are so fundamental, don't expect to see this confidence grow again unless there's a resurgence of growth in the developed world – such as their finances are repaired, asset values recovered completely. Unfortunately, this would mean demise in the emerging world, and an ebb-and-tide of power, wealth, and control flowing back into the developed world. 

We've searched everywhere but cannot find any sign of such change. We must adjust our view to a pragmatic one and look forward through the factors that are going to define the future world.

As Europe (and soon the US) has to face the harsh realities of unsustainable debt levels and a decline in economic power, the developed world needs accept that there'll be a shift to Asian currencies. The developed world will have to accept declining standards of living and shrinkage of markets –unless they incorporate Asian markets. The process will continue to be painful, but unavoidable, as China in particular grows in global, economic dominance. Such changes will mean that the developed world structures and financial instruments will also lose power, influence, and value.

The strains these changes will engender can only succeed, without market collapses, if the world uses non-national internationally trusted assets to maintain values as the changes occur. Precious metals will be part of that story. It's unavoidable. Without the dominance of the developed world central banks, the ability to manipulate values and prices will be gone. 

China for sure will not allow its fortunes to be controlled by the US or Europe. And it likes gold and wants it citizens to own it.

Right now, we're seeing precious metal and other financial markets churning much as one would expect at the changing of the tides. The churning is a mixture of asset value shrinkage and steady emerging world and central banks turmoil that is not price driven. However, when the new tide takes over, expect gold and silver to flow with it. Despite the possibility of further falls, we feel that the further downside risks do not warrant exiting from the precious metal markets as the upside potential is so potentially remarkable. 

Its osmotic drift back into the global monetary system we feel validates our hopes, promising a golden future. We feel that the current setback is not a selling opportunity. With present and future changes in process, we also see a more-than-likely scene where gold continues to outperform other markets. 

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JULIAN PHILLIPS – one half of the highly respected team at – began his career in the financial markets back in 1970, when he left the British Army after serving as an Officer in the Light Infantry in Malaya, Mauritius, and Belfast.

First he worked in Timber Management and then joined the London Stock Exchange, qualifying as a member and specializing from the beginning in currencies, gold and the "Dollar Premium". On moving to South Africa, Julian was appointed a macro-economist for the Electricity Supply Commission – guiding currency decisions on the multi-billion foreign Loan Portfolio – before joining Chase Manhattan and the UK Merchant Bank, Hill Samuel, in Johannesburg.

There he specialized in gold, before moving to Capetown, where he established the Fund Management department of the Board of Executors. Julian returned to the "Gold World" over two years ago, contributing his exceptional experience and insights to Global Watch: The Gold Forecaster.

Legal Notice/Disclaimer: This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment. Gold Forecaster/Julian D.W. Phillips have based this document on information obtained from sources they believe to be reliable but which it has not independently verified; they make no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of Gold Forecaster/Julian D.W. Phillips only and are subject to change without notice. They assume no warranty, liability or guarantee for the current relevance, correctness or completeness of any information provided within this report and will not be held liable for the consequence of reliance upon any opinion or statement contained herein or any omission. Furthermore, they assume no liability for any direct or indirect loss or damage or, in particular, for lost profit, which you may incur as a result of the use and existence of the information, provided within this report.

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