Bernanke lights the fuse on Gold and Silver

Ben Bernanke gave a speech last week promising to keep interest rates low through 2014, which is ultimately a promise to indulge in more money printing later down the line. This led to a drop in the dollar and a rise in both gold and silver.

By John Robert McDonald
Last Updated : 03 February 2012 at 19:30 IST
Commodity Online

Last week, Chairman of the US Federal Reserve, Ben Bernanke delivered another heartless blow to honest unsuspecting American savers - he pledged to keep interest rates near zero until at least late 2014. He made this controversial statement which is, in effect, a promise to indulge in yet more money printing further down the line, despite the fact that even the heavily manipulated CPI rate of inflation is already above 3% and shows no signs of dropping back.

Don't think that those of us in the UK are immune to this kind of financial repression either as Bank of England Governor, Sir Mervyn King, seems more than happy to follow where Bernanke leads.

What should really interest investors like us though is the reaction of the markets immediately after Bernanke's statement. There were two important developments: the US dollar tanked on the foreign exchanges (despite the problems in the Eurozone) and Gold and Silver shot up.

Now as far as the effect on the dollar is concerned I'm sure that Bernanke and others in the US government were very pleased to see the fall in the greenback. In fact, I'm sure that was exactly the intended effect as US policymakers seek to gain competitive advantage for their exports and stem rising domestic unemployment via a weaker currency.

However, I'd advise Bernanke and company to be careful what they wish for as it looks to me as though the US dollar, which has served as the world's reserve currency for over 60 years now, is close to a key tipping point.

Over the last couple of years, the widely followed dollar index, which measures the value of the dollar against a basket (or should I say a basket case) of other paper currencies like the euro, yen and pound, has attempted, and failed, to break through the 82 level on three separate occasions. After the latest failed attempt last week, the dollar has since sunk quickly to a level of 78.83 on the index, breaking key technical levels, as investors suddenly woke up in a cold sweat to the fact that their US dollar holdings are about to be rapidly devalued by an overspending and out of control government.

These investors could, at a pinch, turn a blind eye to CPI at 3% because (dollar-denominated) US treasury bonds have hitherto been regarded as the safest place on the planet to park your cash. This perceived safety offered a degree of compensation for the slightly negative real returns after inflation.

Once you get to CPI at 5%, 6% or even higher, however, and your 5 year US treasury bonds yield no more than 0.75%, things start to get a bit scary - very scary in fact, and that's why some investors (those with any sense at least) started to dump their dollar holdings in a mini-panic after Bernanke's speech.

India and China Get Wise

But the dominance of the US dollar isn't just under threat from home grown economic saboteurs in the US government - foreign governments who are getting fed up with America's increasing willingness to cheapen its currency at their expense are starting to knock chunks out of the world's reserve currency too.

Just recently, India signed an agreement with Iran to pay for its oil imports in a combination of rupees and gold - sidestepping use of the US dollar altogether.

Rather ominously, China has been massively increasing gold imports over the last few months. In November alone, the country imported 102 tons, whereas only 5 months ago imports ran at just 20 tons per month. Just to put that into context, worldwide gold production runs at no more than 200 tons per month. What could this mean? Could China be preparing to follow in India's footsteps and pay for its own oil imports from Iran (15% of its total requirements) with gold? Maybe China sees the day coming when its vast stash of US dollar holdings will no longer be acceptable payment for oil.

Moreover, we've been seeing a number of countries abandoning the dollar altogether over the past year and setting up bilateral trade agreements using their own local currencies. The more of these bilateral arrangements which spring up, the less demand there is for US dollars. The less demand there is for US dollars, the lower it falls on the foreign exchanges and the higher US price inflation goes. The higher US price inflation goes the less attractive a 0.75% yield on 5 year US treasuries becomes and the less demand there is for US dollars... The US government could try boosting demand for US dollars by increasing interest rates, but that would give investors in US treasuries (who fund all US government spending) an immediate capital loss, thus resulting in capital flight and, you've guessed it, less demand for the US dollar... Do you see where I'm going with this? US economic policy makers have now painted themselves into the tightest of corners - and there's no way out.

Gold and Silver - the Fuse is Lit

The reaction of Gold and silver to Bernanke's statement was electric: he'd barely had time to finish speaking before gold was up 3.85% and silver by 4.3%. Both metals have now clearly broken out of their recent downtrends and look ready for a significant run-up in price over the next few months.

Why should the precious metals react in this way? What's so special about them? Aren't they just a "barbarous relic" like some well-known economists would have you believe? Or aren't they just another asset bubble about to burst as some other misguided investors have been telling you for the last 10 years (while they've been missing out on the profits)? My answer to those doubters is that gold and silver aren't just another asset class and they're not useless lumps of metal - they're money plain and simple, the only true money out there in fact. Their rise this past week simply signifies a response by investors to Bernanke's latest act of US dollar debasement.

To illustrate the point further, a colleague of mine who's a little sceptical about the investment story on precious metals put this argument to me: he explained that all the gold in the world would buy me 6 Exxon Mobils and all the agricultural land in the United States, so which would I rather have, the gold or the land and oil?

My response was to ask him what he'd rather have - a lump of gold or a Zimbabwean trillion dollar note. My point here is that you buy gold as protection against government abuse of paper money as gold has always performed this role perfectly through 5000 years of human civilisation (plus you can't put oil and land in your pocket when you need to do the weekly shop).

Maybe you're thinking that Zimbabwe isn't the US or the UK and "it couldn't happen here." I believe that Ben Bernanke's actions last week and the responses of India, China and US dollar investors gave us a strong hint that it just might.

If I'm right, and the starting gun on the 2012 collapse of the US dollar has just been fired, then where can hapless investors go to find a safe haven for their wealth? After all, the US Treasury market has been the biggest, most liquid investment market on the planet - and up to now has also been perceived as the safest. If that safe haven status is now open to question, where else can investors look for wealth protection?

To answer this question, I feel we can do no better than defer to one of the world's foremost gold and silver investors, Mr. Doug Casey, of Casey Research. He believes that when the panic out of the US dollar begins in earnest, the only safe haven left will be gold.

The trouble is, the gold market is minuscule compared to the size of the US bond market. According to the Securities Industry and Financial Markets Association, as of the 2nd Quarter of 2011 the amount of money held in the US bond market amounted to the unimaginable sum of $32.3 trillion. Remember, we're only talking about US government paper here and haven't even considered the further trillions of debt issued by other governments.

Compare that to the current value of all the gold ever mined in human history, which at a current price of $1739 per oz equals only $8 trillion dollars. The vast bulk of that 8 trillion is already in strong hands and not available for sale at anywhere near current prices (I know my share certainly isn't) - which only leaves a tiny fraction available to new investors, maybe as little as 5%. Doug Casey addresses this problem with the following observation: he believes that when the panic out of the US dollar begins and tries to flood into the tiny gold market, it will be like trying to get "Niagara Falls through a hosepipe".

The evidence of the last few days suggests that Ben Bernanke's statement last week brought us a lot closer to that "Niagara" moment - the moment when the dollar dies and precious metals are re-established in the world financial system, regaining their role as money - and money, as we all know, isn't an optional asset like a share, a bond or even a property investment - it's something you can't live without.

When that tipping point arrives, the demand for gold and silver will be such that you won't be able to buy them at any price. So the point is to protect yourself by getting in early and buying it while you still can. It's still not too late and you can find out how to get your share quickly and safely by checking out your local coin dealer or by doing a Google search for one of the various low-cost bullion vaulting services. But don't leave it too long - after all, you don't want to be one of those left standing under Niagara Falls holding a limp hosepipe, do you? Perish the thought.

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