Monday, July 18, 2011


As readers know, I've expressed a fondness for gold and silver as an asset class for a couple of years now since August of 2009.  The reasons for this affinity is that our Federal Reserve has had little concern for preserving the value of the US dollar and therefore gold and silver have become a safe-haven as an inflation hedge.  Europeans also like the glittery stuff and have favored it because the sovereign debt issues in the Eurozone have forced them to use gold and silver as the un-currency of choice.  Individuals in emerging countries also have looked to gold as a store of value in an effort to fight inflation in their nations.  In other words, Americans, Europeans, Brazilians, Indians, and Chinese have all purchased gold because in a way it is a store of value for their assets.  The question remains though, why do central banks own gold? 

After the Greek debt crisis and the Italian sovereign credit rating issue, Europeans are not messing around with their assets and hoping for the best, they are planning for the worst.  While Ben Bernanke suggests that gold is not money, Germans certainly think it is valuable (whatever you call it).  Please see the following article; I've used Google Translate since the original source that is linked is in German. (WELT ONLINE -)

The buyers of gold are driven by worries about the future of the euro zone and the euro. After the doubts about the creditworthiness of Portugal and Ireland now also come to doubt on Italy's creditworthiness.  In the past five days Pro Aurum has sold gold worth more than € 21 million - three times as much as in "quiet times".

Gold is much more than a commodity," said Barbara Lambrecht at Commerzbank Rohstoffanalystin. The present development shows that gold is not only a hedge against inflation but an anti-anxiety indicator against the dollar. "Gold is a currency that is currently benefiting from the weakness of the two key currencies, the dollar and euro."

Well, maybe.  As you recall I made a confession that I've been trying to buy gold since $1475, but never got an entry that I had targeted (regret is dripping off of me).  Although I haven't added to positions I am still going through my normal process of wondering how this trade could blow up and I believe I've found one.  Margin calls.

Let's think through this cataclysmic scenario that all gold and silver buyers are essentially betting on (ok, not all, but the Mad Max types).  We wake up one fine morning to find out that the Irish or Greek citizens have had enough and they have essentially overthrown their governments and ousted them through a bloodless revolution of sorts.  Let's call it a Debtor's Spring.  The New People's government renounces all claims to debt by the ECB, IMF, and foreign banks and labels it "odious debt" meaning that it was debt that was corrupt and not for the benefit of the people (google odious debt).  The revolutionaries halt all principal and interest payments.  That declaration sets off a chain of events that tears the Eurozone apart and damns the Euro as a currency.

In response, global markets tank, the Euro is trashed, the USD goes higher, and oddly, gold and silver do moonshots in the wake of the carnage.  The tremors of the collapse are felt world wide and within days fear has a firm grasp on all developed economies.  As banks work through their exposure to the worthless debt of European countries, gold and silver begin to sell off strongly.  Why the fall?  Margin calls.  As investment banks, hedge funds, insurers, and commercial banks all attempt to sort through the tangled positions (many of which are levered) they get calls from worried counterparties demanding collateral payments.  As they attempt to cough up cash they will sell as much of the remaining valuable stuff as possible, meaning that gold and silver and commodity positions are liquidated at a furious pace.  

Note, the sale of these assets are timed right at the moment when folks that are holding gold and silver are all taking a collective sigh of relief.  Now some of my readers and friends suggest that this too is the time that the USD collapses in sympathy with the implosion of the Euro fiat currency.  I don't know, perhaps that is correct.  Perhaps it implodes on the weight of its own debt or a chain reaction to the collapse of the Euro, since the Fed has extended so much to Europe in the form of USD swaps.  But needless to say, it is ugly, and that translates into a free fall in gold and silver despite the notion that they are a safe haven. 

Now our friends at suggest that they have seen this coming in the post - FREEGOLD IN THE PROPER PERSPECTIVE.  Essentially, they suggest (as I have suggested but not for this reason) that this will be the moment when a rift takes place between the trading or paper value of gold and the value of the real hard stuff.  In other words, the value of gold for GLD may be $500 an ounce but if you asked your local coin shop or friend what they'd sell you a 1 oz American Eagle coin for, they would respond with something like "$3,500 for you buddy".  This amorphous pricing is hard for me to get my head around since I've been known to buy and sell physical gold and silver and attempt to play movements in these markets.  If this perspective is correct you almost need to retain a portion that never gets sold to protect you and your family.  In these collapse situations, this will be your only asset that has any value, unless of course you have some oil storage facilities on your homestead.   
I think the take away is that there will be extreme volatility as we near and cross the event horizon of the Euro fiat collapse.  Essentially as the collapse begins we'll endure a face ripping off acceleration in the price of gold and then a rapid drop as banks look to stop their bleeding.  As more worries surface about the health of institutions these gyrations will be repeated over and over.  
I'm not sure if there is a "best" game plan for enduring this ride, but it is clear that in the aftermath of a Euro collapse and possibly a knock-on fall of the USD I'd rather have some gold than some worthless Euros or USDs in a bank account.
Goatmug is an investor that cares about you and your family. Goatmug's Blog - Financial Perspectives From The Mountain Top is a collection of thoughts on our economy and how it impacts the lives of investors and average people. While several specific investments are named in many of his posts, these articles are simply invitations for you to do your own research and reference to these securities does not constitute financial advice. Your situation is complex and unique and you should seek professional assistance with your trading and investing. Please visit Goatmug and share your comments at