25/09/2012 - 09:20

Analysis: The gold canary sings a warning tune

25/09/2012 - 09:20


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If you thought the global financial crisis was a fading memory then you had better think again because last night the “gold canary” was singing loudly in Europe as the price of gold hit an all-time high.

The record was set when gold, as measured in euros, reached €1374 an ounce, €1 higher than the previous record set 12-months ago.

While most Australian investors will dismiss a euro gold price as irrelevant because gold is traditionally traded in U.S. dollars, the fact that Europeans are prepared to pay the highest price ever for a piece of metal is a powerful signal that faith in paper money, and the governments that print the paper, continues to fall.

It would be helpful to know precisely what message is contained in the current burst of interest in gold, and whether it is signalling a fresh outbreak of the GFC, but the truth is no-one really knows – and that’s the most alarming point.

All that can be said is that people with money are shifting it out of harm’s way and that means putting it in the universal currency which is gold.

Before making some suggestions as to what the revised interest in gold might mean it’s worth considering why it is happening, an easier job than trying to guess what comes next.

Factors behind the return of gold, which has also risen more than 10% in U.S. dollars since last month to its current level of $US1765/oz, include:

  • Near-zero interest rates in most of the world’s major economies, and as a bar of gold does not pay interest the metal becomes a safe alternative to a bank deposit.
  • Fear of inflation as money-printing speeds up with the U.S. proposing “quantitative easing” for several years, or “QE infinity” as it has been dubbed.
  • Avoidance of major currencies as governments indulge in a “race to the bottom” with a lower exchange rate seen as a way of helping create local employment. 

Australia, so far, has not been caught up in the currency debasement (or money printing game), but the chances of remaining in a cocoon of comfort as the world spirals downward is lessening by the day.

The end of the mining boom, which some people continue to deny, was the first warning shot for Australia with lower commodity prices only one factor at work. Soaring domestic costs and higher taxes played their part in killing the boom.

China’s slide to lower growth, and a possible internal political and social crisis, is a second warning for Australia because if our biggest trading partner catches a cold we risk getting the flu.

Budget blow-outs, of the sort confirmed yesterday when the Australian Government admitted that its deficit for last financial year totalled an uncomfortable $43.7 billion, and the collective budget deficit over the past four years had risen to $173 billion.

Deficits, at some stage, must be repaid, and there are only two ways to do that. Economic growth is the best option, but that has become a lot harder with the passing of the boom, and China’s slowdown. Reduced government spending, also known as austerity, is the second option, and that’s politically painful.

Australia is not Europe but a comparison of where we’ve been, economically, and where we’re going produces a very unpleasant parallel, especially when considering the accumulated deficit of $173 billion, much of it provided by borrowing in the international market, and then the question of how will it be paid back.

A reduced exchange rate would help local industry, as would lower interest rates, with both of those developments likely to occur over the next six months.

But, taking those steps will also force up the amount of money required by Australia to service its foreign debts, and there is no guarantee of success because everyone else is playing “race to the bottom”.

It’s at this point that the appeal of gold becomes more obvious. It is a metal which economists hate (“historic relic” as Lord Keynes said of gold) but it is also one of the few forms of investment unaffected by governments manipulating their currencies.

Last night’s record euro gold price, while barely noticed, was a pointer to what might soon happen to the U.S. gold price, and the Australian gold price.

Perhaps gold at $US2000/oz is not far away, and that could mean an even higher price in Australian dollars when our currency falls back through parity, which is looking highly likely to happen before Christmas.


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