This week:

Are We There Yet Poppa Smurf Systemic Risk Remains Very Real Speaking of Interest Rates  Now versus the 70’s

Another week, another tumble. This commentary is getting all too repetitive now with the sharp fall for gold and silver continuing last Thursday and Friday before a very sharp bounce higher on Saturday in US trading.

NZD gold is today back above the NZ$1600 level at $1606 versus $1649 a week ago. So we did briefly see local gold prices below the April low.

While NZD Silver is at $25.07 only down slightly versus $25.34 when we wrote last week.

So the question is still are we there yet Poppa Smurf?

We’ve read quite a lot of solid commentary from various big names in the precious metals sector this week arguing that it seems likely a low may well be in for gold and silver. Some calling for a V shaped bounce higher on the back of the lack of short positions in the futures markets from the bullion banks. Others like Frank Holmes saying :

As of the end of April 15, the gold price on a year-over-year percentage change basis registered a -2.6 standard deviation. While minor corrections in the gold price happen frequently, a move this severe has never occurred before over the previous 2,610 trading days.

With gold’s standard deviation drastically below the “buy signal” blue band, we consider the yellow metal to be in an extremely oversold position on a 12-month basis. The probability that gold will move higher over the next several months is high.

It makes good sense to us that there will undoubtedly be a short squeeze at some point, where all the speculators who have had the bullion banks short positions off loaded to them will be forced to cover sending the price higher.

Gold and silver have both fallen very far and very fast so it makes sense that there was a bounce and so this could run on for a bit yet too.

Backing this up is the fact that, over the past few days we have read reports that some institutional analysts and brokers at Goldman Sachs and Scotia Mocatta (both bullion banks too) have indicated that the fall in precious metals is near the end, or at the end, at least for this year.

Then on top of this JP Morgan has just issued a report telling their institutional clients to buy commodities.

Recall that the banks were the ones who just prior to the sell off in April issued alerts to short gold. Given they seemed to know what was coming then, perhaps they know what to expect in the future too? They took short positions themselves then urged clients to follow in April. Result? Profits to the banks. Now the Commitment of traders reports show the bullion banks have gone long in gold and reduced their shorts in silver massively. And now they are getting clients to go long commodities. Possible result? Profits ahead for the banks on the rise too?

However we still have a nagging suspicion that there could be a bit more pain to come yet. Rather than the V shaped bounce of 2008 we could be in for a more protracted bottoming. The trouble is that “nagging suspicions” are difficult to quantify and take action on. It’s why we say picking the bottom is nigh on impossible and it can spell emotional trouble when you try to take a large position at what you think is the bottom.

Psychologically it can be beneficial to follow the averaging in approach and whether that ends up with you averaging up or averaging down overall you have a better chance of getting a decent price with less anguish.

We did a large part of our buying during the sell off in 2008 and no, were sorry to say, we didn’t pick the bottom. In fact we think if we recall correctly it was $100 to $150 from the bottom in gold where our average price ended up. We were a bit closer in silver. However in the long run and even now after this massive fall our overall position is still looking pretty good.

So remember financial insurance in physical gold and silver is for the long haul, but buying in tranches can be a way to alleviate some of the emotional impact of buying in one hit and seeing a position underwater. We’ve said this many times so hopefully you might have been one of those that listened along the way and have some cash in reserve to put into play now or in the near future.

Systemic Risk Remains Very Real

The derivative tower is really off the radar altogether at the moment. (Want the basics on derivatives heres an old article from last year: Derivatives – a Beginner’s Guide to “Financial Weapons of Mass Destruction” ) But in Alastair Macleods weekly wrap up for Goldmoney he outlined that the risk of rising interest rates isn’t just that it threatens “the recovery”. Rising rates could have a profound effect on the massive pile of derivatives. He also outlined as we’ve said recently that Bernanke is damned if he does and damned if he doesn’t:

Systemic risk should not be treated lightly. There are two worries for Mr Bernanke that explain his indecisiveness: firstly, falling equity prices undermine consumer and business confidence (at least in the central bankers’ playbook); and secondly rising interest rates along the yield curve are bad for bank solvency.

This latter point needs more explanation. During the Libor scandal, it became apparent that a small interest rate fall boosted derivative values significantly. Citigroup helped us quantify the effect when in 2009 it reported that a 1% fall in interest rates would enhance its derivative values by nearly $2bn a quarter. Citigroup is one of the smaller players in the derivatives market, with only $14.2 trillion of interest rate swaps at the time. This explains why zero interest rates were a necessary component of the rescue package at the time of the Lehman failure.

According to the Bank for International Settlements, last December there were $370 trillion of interest rate swaps. Using the Citigroup numbers as a guide, a 1% rise in interest rates would cost the banking system over $200bn in a year. Bear in mind that this cost is concentrated in a few too-bid (sic)-to-fail banks, and this is only part of the total derivative market, which amounted to $633 trillion. The reality of tapering is that the Fed is going to have to tell Congress that their interest bill is going to rise, so they better cut their spending, and that he is going to have to find an extra one or two trillion to give to the banks.

Instead, the reality is there is no going back from QE, and current instability in financial markets is probably only the beginning of an acknowledgement of this dilemma. The trade-off is between escalating systemic risk and being locked into further monetary inflation, either of which justifies protection by owning precious metals.

As we said, damned if he does and damned if he doesn’t.

Speaking of Interest Rates 

It seems the RBNZ doesn’t think its time to raise them yet. Last week in the herald was this piece.

“While the bubbling property market is leading to increased consumer spending, it isnt yet threatening overall inflation, which is sitting at an annual pace of 0.9 per cent, and any hike in the record-low official cash rate may put unwanted pressure on the currency.

For these reasons, higher interest rates are not the right policy response at this time, Spencer said.

The bank favours imposing restrictions on the high loan-to-value ratio home lending, which offers the greatest potential for moderating the current excesses in the housing market, Spencer said.

LVR restrictions have the most potential to reduce risk both by making bank balance sheets less risky and by dampening housing market pressures through reduced credit supply, he said.”

So it looks more and more like the RBNZ will be trying to put a lid on house prices by the use of lending restrictions and not raising interest rates as the bank economists have been predicting.

As it happens the Bernanks “tapertalk” might have bought them some time also.

How’s that?

Well with the market spooked and selling bonds and driving up interest rates in the US (mortgage rates are up a full percentage point since May), our central bank may well be able to sit on its hands for a bit longer and not raise or lower rates. As a lesser interest rate differential between us and the likes of the US may see money continue to leave our shores for elsewhere. Result? A lower currency without the RBNZ doing anything. Exporters are happier but not so good for the man in the street where the cost of fuel etc would rise.

Anyway that’s just a theory that sprang to mind our crystal ball is no less murky than any others out there.

This Weeks Articles:

We’ve written a number of times about how gold fell 50% in the 1970’s in the middle of that bull market and how we needed to prepare ourselves for such an eventuality.  We’ve posted this great article from Peter Schiff where he lays out just how similar the current correction is to the mid 1970’s, but along with what is different today as well.   The Golden Cycle

The shares of large gold producers have really taken a shellacking and the following article shows just how undervalued they now are.

A Rare Anomaly in the Gold Market

While we have low inflation in most western countries currently (well according to government CPI measures anyway), the following article is a reminder of how fast the prices of everyday goods can rise when inflation hits.

Of course the time to buy your insurance is not when your house is burning but rather when everything is sunny and bright. And if you listen to the mainstream we are out of the woods and everything will turn out fine so perhaps that makes now a good time to purchase some financial insurance against the likes of inflation and financial system shock. So if you want to take a position in the only “things” that fulfil this requirement (Gold and silver are the only financial assets you can own that are not at the same time someone elses liability) you know where to find us.

2. Phone: 0800 888 GOLD ( 0800 888 465 ) (or +64 9 2813898)

3. or Online order form with indicative pricing