Gold, Silver, Metal Prices: Commentary – 2/22/2010

Ah, The Good Old Days…

Good Morning,

Easing apprehensions about an imminent hike in the fed funds rate helped gold climb to a one-month high overnight in overseas trading. On the other hand, the speculation that the withdrawal of various government spending programs will reignite the erosion in the value of the US dollar was seen as once again augmenting the quest for precious metal exposure. That speculation however, is running up against the hard fact that the greenback has managed a better than 5% gain against the euro thus far in 2010, and it is still trading at 1.36 against the common currency — having had pushed the latter to just under 1.35 last week.

"Although the slightly softer U.S. dollar has contributed to the strength seen today, it seems secondary to the bullish charts and technical plays overnight," said Carl Johansson, Senior precious metals analyst with Goldessential.com. There was some rumored hedge fund interest manifest at the market’s opening late on Sunday, and the yellow metal was also seen as being assisted by continuing speculative interest (and related strength) in oil, which is now trading at above the $80 a barrel mark.

On a technical basis, it is thought that so long as bullion manages a break to above $1,130 an ounce, it is then fairly likely to target the $1,143 an ounce resistance area. Support currently is presumably found between the $1,105 and $1,097 an ounce levels. Gold Essential’s analysis of metals ETF movements for Friday shows that gold-oriented funds shed 66,890 ounces or about 2.08 tonnes, and that silver ETFs added 350,175 ounces or 10.89 tonnes on the day. Platinum-oriented metals ETFs gained 19,908 ounces (0.62 tonnes) while palladium-flavored exchange-traded funds also rose by 19,997 ounces (0.62 tonnes).

The market’s speculative gaze shifts this week over to Ben Bernanke’s upcoming testimony before the HFSC on Wednesday, but especially to Friday’s quarterly GDP data. A robust showing in the US GDP figure could once again revive fears that the Fed will drain the liquidity tub sooner, rather than later — a question that remains wide open in terms of timing. Also in limbo, is that fate of the nearly 200 tonnes of IMF gold, slated to start hitting the open market. The ‘when’ and ‘how much at a time’ parameters of said sale remain guesses that are as good as anyone’s for the moment.

New York spot bullion dealings started the last week of February with gains across the price boards, as the dollar was only marginally ahead on the trade-weighted index (last seen at 80.56, up only 0.02) while black gold continued to hold up well, quoted at $80.20 per barrel. Spot gold gained $5.80 per ounce to open at $1122.90, while spot silver rose by 16 cents to start the session at $16.45 the ounce. Tuesday marks the last trading day for COMEX March gold options, while Wednesday will be the last trading day for COMEX February gold futures. Spot platinum gained $12 to open at $1543.00 and palladium climbed $7 to the $445 mark per ounce. Rhodium continued unchanged at $2350 the troy ounce.

From the COT angle, GoldEssential.com market analysts opined this morning that the "strong decline in open interest and equally declining speculative long positioning that was seen in recent weeks" implied that the opportunity was there last week for the accumulation of fresh long positions. "That said, we remain careful at the present time, given that much of the strength in the period between February 9th and February the 16th seems to have been caused by short-covering rather than significant fresh longs being initiated." GoldEssential’s analysts also added.

The next two months will continue to present challenges to the gold price as some of the world’s central banks continue to tilt towards tightening rather than continuing to inject monetary adrenaline into the system. The progression in the EU credit situation will also come to impact bullion values (the euro’s). Finally, the disposal (orderly as it is hoped to be) of the IMF gold tonnage will…weigh on player’s minds.

Something else weighing on people’s minds (at least those of a libertarian and conservative ilk) is the pre-Presidential election flavored campaign being waged by Rep. Ron Paul in the USA, especially in the light of his CPAC straw-poll victory last week. There are many resonant themes being offered by Mr. Paul as he tries to connect with various factions in the American political spectrum. But, as CNN.com’s David Frum observes, "Of all those themes, the one that has achieved the widest audience is Paul‘s call for a return to money based on precious metals such as gold and silver."

A closer look at such a seemingly attractive proposal raises questions that one is not so sure Mr. Paul’s ardent supporters are quite ready to answer just yet. Not unless they are also prepared to have their gun collection at the ready, and their supplies of Spam neatly tucked away in well-stocked bunkers. Why? Because the return to a gold standard –such as was in place in the "Good Old Days"- would all but ensure total chaos at a time when America can least afford it. Agree as one might with the basic principles of sound money and responsible government, the reality is that the G.O.D. never really existed.

This is not the first time that gold has played a role in U.S. Presidential politics. One only needs to recall the Republican platform on which Ronald Reagan ran in 1980; it called for a return to a watered-down gold standard for the dollar. In a nutshell, the position of many advocates of a gold standard is that the Federal Reserve System ought to be abolished, that the U.S. government should allow private banks to issue currency as they see fit, and that the U.S. government should extract itself from the control of money supply in the United States.

Reality check: In the 65 years between the U.S. Civil War and World War One there were 16 recessions in the United States. Several of them were particularly nasty and devastating depressions that made the Great Depression pale in comparison. The average duration of these recessions in this period was 22 months. Economic conditions were much more volatile and much worse during the era of free banking than they have been since World War Two.

In contrast to these "glory" days, in the 62 years since World War Two ended there have been 10 recessions, 37% fewer than in the earlier era. The average duration of these recessions has been 10 months, less than half the length of the recessions during the "good old" days. The last recession, in the year 2000, was the first recession on record that did not see any actual contraction in U.S. real GDP. Real GDP bottomed out at 0.2% in the third quarter of 2001, but never actually contracted.

How did the US government handle the problem? Mr. Frum finds that it: "did exactly the opposite of what economists would otherwise advise: It cut spending and raised taxes — capsizing the economy even deeper into depression" adding that: "It’s very strange to hear gold standard advocates criticize President Hoover for imposing steep tax increases in 1932, the Depression’s worst year. Yet the gold standard they champion was the reason for the tax increases they deplore."

Between 1929 and 1932, the U.S. money supply collapsed, as banks failed and bank deposits and commercial credit vanished. In their classic “Monetary History of the United States” (1966), Milton Friedman and Anna Schwartz identified this contraction of the money supply as the proximate cause of the Great Depression. Why didn’t the Federal Reserve act to prevent the contraction? Again: the gold standard.

In a modern recession, the Fed will buy Treasury securities in the open market. After the purchase and sale, the Federal Reserve has more securities — and the former owners of the securities have new cash. Those new cash owners then spend or lend their cash, spurring economic activity. But in 1930, the new cash owners didn’t spend or lend. They swapped their cash for gold. The “open market” operations that were supposed to accelerate economic activity instead accelerated the country’s gold drain.

So the Fed ceased — and instead passively allowed the economy to collapse in order to save the nation’s currency. Every other gold-standard country faced similar challenges in the 1930s. Those countries that quit gold first, like Britain, suffered least. Those that hung onto gold longest — the United States and France — suffered most.

Imagine now if the gold standard were in operation today. The federal government would be scrambling to balance its budget in the midst of recession, cutting spending and raising taxes. Instead of pumping money into the economy, the Federal Reserve would be sucking money out. Priority 1 would not be creating and saving jobs, but preserving the nation’s gold hoard. Instead of living through the nastiest recession since the war, we’d be deep into a second Great Depression.

But in a way, this counterfactual is impossible. No government ever can return to the gold standard. Back in the 1930s, governments accepted horrific suffering because they were terrified of the consequences of going off gold. When President Franklin Roosevelt told his budget director, Lewis Douglas, of his decision to quit gold, Douglas replied: “This is the end of Western civilization.” He wasn’t kidding either.

In fact, the decision was the turning point of the Depression, the beginning of recovery. And every monetary economist knows it, which means, that the first thing any future gold-standard government would do in the event of recession would be to jettison gold. And every market trader knows that too.

So … as soon as the first sign of recession materializes on the horizon, the traders would dump the currency of the gold standard country. The gold standard country would then have to decide whether to self-impose draconian 1932-style budget-balancing or forgo the whole painful experience and surrender right away to what is inevitable sooner or later. Since everybody knows that a gold standard country would quit gold as soon as times got tough, nobody will ever believe the decision to restore the gold standard in the first place.

It’s as dead as monocles and walking sticks (deader, really). The punch line to one of my favorite anecdotes goes, “Son, your answers are so old, I have forgotten the questions.” Has the Depression receded so far into history that the answers that once plunged the nation into misery can possibly look credible again?"

Mr. Frum also finds that "G.K. Chesterton observed that you should never pull down a fence until you understand why it was put up."

In so many words, not only be careful what you wish for, but examine the very factual nature of that wish. It is not always what it appears to be. Certainly not if the historical record is any indication. Of course, no pain may equal hardly any gain. However, the pain’s intensity is not something one can realistically believe that the world’s largest economy is ready, willing, and- most importantly- able to endure at the present time. Or, ever.

Happy reading of the dusty pages.

Jon Nadler
Senior Analyst

Kitco Metals Inc.
North America 

Check out other site market resources at Bullion Prices, US Silver Coins Values and the US Inflation Calculator which easily finds how the buying power of the dollar has changed from 1913-2010.