Black Swans, and global currency decline: for gold the only way is up

It is not unforeseen disasters and events which necessarily move the price of gold, but the general decline in value of global currencies against the yellow metal. Everything is relative

Author: Lawrence Williams
Posted: Friday , 18 Mar 2011


Black Swan events are obviously a bit like London buses. None appear for ages and then a whole succession occur one after the other. Australian floods, cyclones, bush fires, New Zealand earthquake, North African and Middle Eastern states erupting into civil disorder leading, in some cases, to government overthrows and now the Japanese mega-earthquake, tsunami and possible nuclear disaster. It's a bit like the term Black Swan itself. Hardly anyone used the expression (which describes a completely unforeseen circumstance or event) up until a few years ago, now everyone's talking about them! Obviously a currently over-utilised expression so I'll try not to mention Black Swans again.

In some scenarios this succession of critical events would have gold escalating through the roof, followed, and probably being overtaken by, silver and why this has not happened, at least not yet, might bear some examination.

As Julian Phillips pointed out in a recent article on this website some factors which might be thought to move the price typically do not. Disasters on the Japanese scale have mixed effects with some seeing gold as a protection against such horrendous calamities, while others will need to sell to survive and rebuild. The net effect is that sales may serve to cancel out purchases just leading to a steady-state equilibrium which is what seems to be happening to the gold price at the moment. The main driver at the moment does seem to be the U.S. dollar - when the dollar falls gold picks up and vice versa and at times of immense disasters the dollar may be being seen as the more readily tradable safe haven in the short term.

One interesting fact which seems to have emerged from the Japan situation is that in the West of the country - virtually untouched by the quake and far from the tsunami is that gold bars and coins are attracting premiums which were not there only a week or so ago, suggesting there is a demand for the yellow metal to help protect against, and alleviate, such horrific disasters.

Almost certainly the biggest recent driver in gold demand has been China, but with the authorities there tightening economic controls we could see some of this demand fall away - but then the biggest sellers have been the Americans of late, or so it would seem, and there are also indications that lower gold prices - and perhaps the realisation by almost anyone living on the West Coast of the U.S.A. or Canada that they could be subject to an earthquake of similar magnitude and possible tsunamis - are bringing high-wealth individuals back into the gold market again.

It does seem to this observer though that any gold price hiatus of the moment may be shortlived. This rapid succession of events, hopefully not a precursor of Armageddon, is having a serious financial impact on an already shaky global economy. The real long term instability lies initially with the profligacy of the commercial banks and then with the even greater profligacy of Governments and Central Banks pumping out more and more fiat money in an attempt to restore even a smidgeon of growth to their domestic economies.

The gold price thus is being raised by the resultant devaluation of ALL the major global currencies in concert - notably the dollar, the Euro, the Pound and the Japanese yen - due to the release of huge unbacked volumes of new money into the global economy - a position which is now being exacerbated by the Japanese Central Bank having to release billions more yen into its own tsunami-stricken economy to try and shore it up. And not only is this Central Bank profligacy effectively devaluing these key currencies, but it is also stoking the fires of related inflation all around the world.

Gold remains, in many people's minds, the key protector against declining wealth caused by inflation. In many views, if not necessarily those of academic economists, gold is the constant in this process. It's not that gold is actually rising in value, it is that everything else is falling against gold and the more these unpredictable events occur, the more the pressures on so-called global reserve currencies will escalate. The downwards spiral is hard to control once it starts to move in earnest - hence recent talk of hyperinflation, even if the actual point at which plain inflation becomes seen as hyperinflation remains obscure in the proponents' prognostications.

Lessons can always be learned from history. It is an oft-spoken truism that history repeats itself - even though it would seem that economic drivers nowadays are seemingly totally different from those which may have affected our forefathers. But analysis of the patterns of the past shows that they do recur over and over through time and it would seem likely that gold will similarly continue to retain its position in people's hearts and minds as the best form of wealth protection.

Thus as the major global currencies continue on their downwards value spiral, in terms of these currencies gold will continue to move upwards. The recent price correction should thus be seen as an opportunity rather than the beginning of a burst bubble. One thus sees the future path of the gold price as upwards - but not necessarily in any kind of smooth pattern. It will likely remain volatile in its continuing rise which has to carry on as long as currencies continue to be devalued by enormous increases in money supply, or until some new reserve currency system (which could even include gold as an important element of it) emerges from the current global economic mire.

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