Thursday, December 1, 2011

Gold and Silver Shoot Upwards

Or do they?

Again, it's all about scarcity and value. The amount of physical gold and silver didn't decrease in supply overnight, so what happened to give the price a fright?

Firstly, the risk trade is back on. Those dollars once parked are now let lose as fund managers feel the glow of excitement once again. They bought everything they could lay their hands on in the commodity sector.

This is a reaction to the big news overnight of the concerted effort made by six of the worlds largest central banks for the Federal Reserve to provide dollar swap lines to banks in Europe. Apparently what this does is halt the liquidity crisis that banks are in at present. It allows them to 'swap' US dollars for their local currencies and begin lending out again. The banks are in a solvency crisis, that is they don't any money or don't want to lend it out as they don't trust the prospective counter-parties. This line of credit from the central banks allows money to begin flowing for a wee while to keep economies moving.

Swap lines work like this. A foreign central bank draws down on its swap line from the Federal Reserve Bank. It sells a specified quantity of its own currency (say euros) to the Fed in exchange for dollars at the prevailing market exchange rate.

At the same time, the Fed and the foreign central bank enter into an agreement that obligates the foreign central bank to buy back its currency at a future date at the same exchange rate. Because the exchange rate for the second transaction was set at the time of the first, there is no exchange rate risk associated with the swaps.The foreign central bank then lends the borrowed dollars to banks etc in its jurisdiction through a variety of methods.

At the conclusion of the swap, the foreign central bank pays the Fed an amount of interest on the dollars borrowed that was equal to the amount the central bank earned on its dollar lending operations (edited from source

But it hasn't solved anything long term. The structural issues of sovereign debt are still there and still need to be dealt with. Perhaps this new lifeline will get us through Christmas.

So who benefits? Obviously the people who hold commodities and especially precious metals have preserved their wealth. In New Zealand dollars, for example, the value of gold has virtually remained the same as yesterday, even though the spot price of gold has gone up US$50 per ounce. So the effect here isn't that marked, especially as the NZ dollar is seen as a 'commodity' sector beast anyway.

This is a short term solution and one that simply cannot be continued. Markets cannot continue to function sensibly with this form of massive intervention. Risk on, risk off.

Own precious metals and turn off the news and rest happily.

Finally I urge you to watch this recent seminar by Chris Martenson. Show it to your children as well.

Gold in New Zealand dollars: $2237.96 per oz
Previous all-time high: $2311.02 per oz (15 Nov, 2011)

Silver in New Zealand dollars: $42.11 per oz
Previous all-time high: $59.19
per oz (30 Apr, 2011)

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