The price of Gold leapt at the US opening on Wednesday, surging more than 7% on what the newswires could only call "short covering" and a "technical break-out".
Gold jumped to a two-month high vs. all major currencies as Western stock markets sank after the nationalization of AIG – the world's largest insurer.
The Dow Jones dropped 350 points and London's FTSE100 lost almost 2.3%.
Currency markets held flat, meantime, but on massive volume. The "safe haven" bid for US Treasury bonds pushed 3-month yields down to a record all-time low of 0.03%.
Confirming the dangers now apparent in "counterparty risk" across the financial markets, the London Metal Exchange today asked traders using Lehman Bros. – the failed US bank – to declare their unsettled base-metal deals by Dec. 17th.
The crucial DJ-AIG commodity index – which offers to mimic hard-asset ownership by tracking some $30bn in commodity futures, swaps and options – had earlier slid 4.2% in Frankfurt.
London banks and brokers ceased making a market in AIG-backed notes on Tuesday, fearing a collapse of their ultimate counterparty.
"Investors in commodity indices were increasingly aware that they did not own hard assets but a swap on an index of commodity futures with counterparty risk," said John Reade, metals analyst at UBS, to the Financial Times.
"AIG commodity bankers declined to comment," the paper reports.
According to ETF Securities – the London-based trust group behind such "securitized" commodity products as the Gold Exchange Traded Funds – American Insurance Group stands as counterparty in some $2 billion-worth of DJ-AIG contracts.
AIG – now 80% owned by the US Federal Reserve – also insures more than $300bn worth of finance company bonds. Hank Calenti at RBC Capital Markets put the potential market impact of AIG failing at more than $180 billion.
"They pretended they were drawing a line in the sand with Lehman Brothers but now two days later they're doing another bailout," said Nouriel Roubini, economics professor at NYU's Stern School of Business, overnight.
Add the $85 billion rescue of AIG to the aid given J.P.Morgan when it bought Bear Stearns – plus the $200bn rescue of Fannie Mae and Freddie Mac and another $300bn for the Federal Housing Authority – and the US government has now pledged $900bn of tax-payers' money to support the finance industry since March.
"We're essentially continuing a system where profits are privatized and...losses socialized," says Roubini.
Put another way, "from financialization of the economy to the socialization of finance [it's] a small step for lawyers, a huge step for mankind," as former Bank of England member Willem Buiter puts it for the Financial Times.