Gold fever proves contagious

September 19, 2011 | 07:00
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"Wall Street could easily press the gold price back to $1,200-$1,500, draining China’s reserves, as it did to OPEC countries when the gold price fell from $850 to $200 after the energy crisis of 1979"

Local speculators have jumped on the bandwagon in step with climbing global gold prices

The time between gold prices passing the key psychological level of $1,000 an ounce and $1,500 at the end of April, 2011 was the shortest in the history of gold prices.

This new record not only reflects great fears about global inflation in the distant future as the prospect of a double-dip world recession still currently looms on the horizon, but also signals the return of the former gold-back currency system. This was abolished by the US and replaced with a fiat money system. It also shows a loss of confidence in the US dollar or any other currency as anchors of the modern financial system.

Furthermore, gold prices have continued to climb since 2010 after the 2008-2009 global recession, as countries around the world entered an easy monetary policy race.

Currency war since 2010

Since October 2010, business reports around the world have been full of news about central banks easing monetary policies.

Japan began this “war”, cutting interest rates to 0.0-0.1 per cent and implementing a quantitative easing (QE) package by buying an additional $62 billion worth of government bonds to pump money into its economy, in addition to adopting other stimulus policies.

In the US, attention was focused on the policy moves of the Fed, which announced QE2 in November 2010, buying $600 billion worth of Treasury securities. This move was actually the monetisation of government debts and the depreciation of the US dollar to curb a deepening trade imbalance and was expected to help reduce the unemployment rate, which stood at a record 9.6 per cent at that time.

The IMF and the World Bank immediately warned of a currency war that could jeopardise the global economy and slow down the global economic recovery. International commentators recalled the phenomenon of the 1930s, when every country pursued egoist trading policies, depreciating their own currency to stabilise their import - export balances and cut their unemployment rates.

Return of gold

In the first press conference in the Fed’s history, on April 27, 2011, to explain monetary policies and their impacts on the economy, Fed chairman Ben Bernanke announced the continuation of QE2 until the end of June because of the sluggish economic recovery.

The announcement immediately pushed up the gold price from its record $1,500 per ounce, reached in early April, to $1,565 in international markets and VND38 million/tael in Vietnam. Other factors that contributed to the fever in 2004 also reappeared in late April 2011. These include Brent crude prices hitting $120 per barrel, the soft US dollar  and new political turmoil in the Middle East and North Africa. All made gold a safe haven. The death of Bin Laden temporarily allayed anxiety over global terrorism. Gold retreated to under $1,500 an ounce for several weeks before bouncing back to $1,600.

Monetary easing and lower international interest rates stimulated global stock markets, especially in the US, from September 2010 to the end of July 2011, when the Dow Jones Average climbed back to 13,000 points. But, financial panic returned as a result of the bitter war between Republicans and Democrats over raising the government debt ceiling, which only reached a last-minute resolution on August 2.

Indications of a weakening US recovery added to the panic. The gross domestic product (GDP) in the US was 1.3 per cent in the second quarter, not the predicted 1.8-2 per cent and significantly slower than 3 per cent recorded in the fourth quarter of 2010. Easy monetary policy could not change as long as the Federal Funds Rate was at its present low of 0.5 per cent.

The US stock market lost 15 per cent of its value in just three weeks, amid fears of a public debt crisis and double-dip recession at home and abroad. Global stock markets followed suit.

At the same time, the European Central Bank (ECB) announced a programme to purchase Spanish and Italian government bonds, similar to QE. These events led to a second gold fever over this three-week period, resulting in a new record gold price of $1,918 in August 2011. The appearance of QE3 was all but confirmed in its main content at the time of writing this article. President Obama’s new job plan of $450 billion asserted the extreme weakness of the US economy which needs urgent help once again from the Fed.

Future price and big money trap?

The swift effects of the loosening monetary policy by the ECB and likely the Fed’s, increased the value of gold as a safe haven replacing fiat currencies. Although there exists a third alternative covering the Swiss franc, the Japanese yen and the Australian dollar, which are expected to keep their value better than the US dollar or the Euro. Therefore, I expect further peaks in the gold price despite its short-term zigzag trajectory.

The remaining question for international commentators and investors is whether gold could hit the next psychological barrier, of $2,000 per ounce. Some believe the question should instead be “when” it will hit it. Goldman Sachs has predicted that the price could even reach $2,500 by the end of the year.

The reasoning behind the $2,500 prediction is that the price is equivalent adjusted for inflation to the record $850 reached during the Iran-Contra crisis in 1980. Some of the bolder predictions put it at $2,600-$3,200 by the end of 2013. Answers are contingent upon oil prices, the Fed’s decision on QE3, the future value of the US dollar and the international political environment, among other concerns. One of the most significant elements is China’s decision to float its currency and also its foreign reserve policy. As the country is replacing US Treasuries with gold, how far will it go with its gigantic $3.2 trillion US dollar reserves? Importantly, other central banks are following China’s lead, such as the recent moves by the South Korean central bank. If China has bought as much as 8,000 tonnes of gold, as officials have announced, the aforementioned predictions will be on the conservative side.

The role of “Wall Street Grand Masters” with “Big Money” can also not be neglected. They could easily raise the price to $3,000 if China actually builds up its gold reserves. But with moves to affect US policies such as tightening fiscal and monetary policy to reduce public debt and increase interest rates to appreciate the dollar, Wall Street could easily press the gold price back to $1,200-$1,500, draining China’s reserves, as it did to OPEC countries when the gold price fell from $850 to $200 after the energy crisis of 1979, or to Japan in the 1980s after halving the value of US real estate held by the country, or to Thailand and South Korea, robbing them of the billions of US dollars they had in reserve after two decades of significant export performance.

In conclusion, investors, whether short or long term, must be vigilant in regard to international financial happenings.

Back to Vietnam, the gold price events are extremely important as the State Bank of Vietnam is considering more powerful control over the domestic gold market, making better connections with international markets to avoid pressure on the free market exchange rate, which at the time of writing was hovering around VND20,900 (while gold price around $1,850).

Dr. Pham Do Chi Independent economist

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