HOW GOLD & SILVER MAY COLLAPSE IN A SOVEREIGN CREDIT APOCALYPSE

TRADITION
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? 

DESPITE HEIR BERNANKE'S ASSERTION THAT GOLD IS NOT MONEY, EUROPEANS THINK IT IS -

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."

NO BRAINER BUY GOLD HUH? 

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.

HOW MARGIN CALLS UNDO A GREAT TRADE

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 http://www.fofoa.blogspot.com/ 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.   

 

RIDING THE BRONCO

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   

 

 

 

 

 

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 http://www.goatmug.blogspot.com/

CFO SURVEY - JUNE UPDATE

Duke and CFO Magazine have again released their CFO Survey.  As I always state, the CEO is the sales man and the CFO is the guy we need to pay attention to.  (Yes, I'm biased I worked in Corporate Finance for years).

http://www.cfosurvey.org/10q3/PressRelease.pdf

HIGHLIGHTS -

CFO SURVEY--Chief financial officers in the U.S. say they have limited plans to hire over the next 12 months, although nearly 60 percent won’t return their staffing to pre-recession levels until 2012 or later. Benefits and wages also remain at reduced levels at many firms, and credit is still tight for small firms, which is hindering hiring plans and constraining growth.

GOATMUG INTERPRETATION- Ok, get this.  The recovery is not going to include hiring.  Only 40% of CFOs are projecting getting back to pre-recession levels (if everything goes well) by 2012!  Oh yes, and if you still have a job or will be one of the lucky ones getting rehired, you might expect lower pay or reduced benefits.


CFO SURVEY--The recovery is not completely stalled, however, as CFOs predict strong business spending and earnings growth.
 
GOATMUG INTERPRETATION - Businesses are hoping and praying for a rebound although they are not confident enough to bet on it (hire).  As I've mentioned, my belief is that during the peak crisis months company's quit reordering to replace inventory.  Ultimately we had a situation where firms HAD to reorder and begin acquiring materials for their products just to replenish them.  We've done that, now let's hope we have someone to buy all of this new inventory.
 
CFO SURVEY--Borrowing conditions remain tight, with roughly an equal split between firms reporting that credit conditions have tightened and those saying credit has eased. One-third of micro-firms (100 or fewer employees) say credit conditions have worsened in the past six months.


GOATMUG INTERPRETATION - Lending is still a problem?  Either banks aren't lending or the loan officers are suddenly looking a realistic levels for debt and requiring firms and borrowers to actually be credit worthy.  I think this is got to be a very accurate piece of data in that I'm sure 50% of the firms are actually decent credit risks while I'm sure another 50% are scary and probably don't deserve the lines of credit they previously consumed.  I guess this is why we see that credit is actually worse than 2009 in many cases.  I'm sure there will be a rollout of a new Federal loan program that loses billions of your tax dollars to bail out credit starved firms that "deserve" all the credit they can handle.


CFO SURVEY-- Earnings are expected to rise 12 percent and capital spending 9 percent in the next 12 months. Research and development and tech spending will increase 4 to 6 percent. 
 
GOATMUG INTERPRETATION -  They better!
 
 

TOP CONCERNS

 


CFO SURVEY - The top two concerns for U.S. CFOs are weak consumer demand and the federal government’s agenda. U.S. CFOs, who expect to raise the prices of their products by 1.5 percent, are also worried about price pressure from intense competition. Maintaining employee morale is among the top company-specific concerns.

GOATMUG INTERPRETATION - Wait a minute, we have growth forecasts and profit expansion predictions, but our top concern is the anemic consumer demand and the not so invisible hand of the government?  On top of that, CFO's say that management can't raise prices because price competition, these guys are trying to spin this.  I'm not buying it and I don't think they even believe it!
CFO SURVEY - Health care costs also have reappeared among the top four concerns for U.S. companies, with corporate health care payments expected to rise 8 percent in the next year.
 
GOATMUG INTERPRETATION - Healthcare costs an issue?  Just wait for 2011, 2012, 2013, and 2014.   That is 4 and 1/2 years for the insurance companies to prepare (increase prices) for the national healthcare system.  Employers with 50 or more employees will suffer most in the business community right along with the tax payer.
 
 
All in, I don't think this is a very positive report.  This should be a report that suggests that CFO's are seeing increased momentum and better long term visibility about revenue growth and margin expansion.  We should not hear that CFO's are concerned about weak demand and a lack of pricing power.  In addition, boards and executive teams are worried about our government's plans for business.  It is incredibly hard to predict and create strategic plans when you don't know where big government will decide to regulate or takeover within the business world. 
 
A closing word on credit.  We are really hearing two stories when it comes to credit.  Strong firms are being lavished with amazing opportunities to borrow at ridiculously low prices (interest rates).  In fact this will be a monster year for highly rated corporate bond issuance (at least so far year to date).  This is driven by the fact that overall the FED and central banks have lowered the alternative lower risk yield so much that investors are DRIVEN to take more risk just to outpace inflation.   On the other hand, smaller firms or high yield firms are facing tremendous problems funding their operations and rolling debt.  Europeans are also having a terrible credit funding year.  The market has dissected the risk and is punishing poor creditors (forcing them to pay much higher rates) and rewarding good creditors (giving away cheap money).  At least the system is starting to appropriately price some risks! 
 
I think the CFO's are hedging their bets and remain totally cautious because they know that demand is falling and they may have one more quarter of upside and then down we go.  June's update shows that the rate of change on many metrics is absolutely falling and the actual real levels have also dropped from their peaks.  No amount of government stimulus is working and the economic disaster in the Gulf will only increase the speed of the double dip.  We had all better be praying a hurricane or tropical storm does not form in the Gulf. 
 
Having said that beware, our government is still involved in the house bubble it is trying to reflate.  Hence we see a tremendous mispricing of residential home mortgages where we can obtain a 30 year $400,000 loan today for at 4.8% in Baton Rouge, LA with zero points!  They will attempt to roll out any plan to keep the plates spinning.  I fully expect the Fed and Treasury to execute Quantitative Easing Part Deaux within one or two more months.   They will blame it on the crisis in the Gulf as we remember that they never waste a good crisis.
 
TRADING UPDATE
This market is and has been really hard to trade.  If you are a short term trader, you are being ground up as moves of plus or minus two to four percent a day will ravage you.  If you are a longer term investor you are either back to where you were in August of 2009 or have been crushed if you bought after that period. 
We could still see a rally here to the 1140 area, but I ultimately believe that we'll end lower for the year.  I've made it a point to highlight those posts that are simply suggesting that you get out of the market because you need to see these.  If you don't get out, you need to have some protection in investments that will get you out if possible or at least earn you interest or dividends despite things going down (dividend paying stocks or bonds).  Several indicators I watch are beginning to confirm a rollover in the market and if we end June under 10,000 in the Dow, we'll have a confirmation.  These are traditionally very long term signals too, so I'm sitting up in my chair and waiting for them to trigger.  If they don't trigger, I'll still be sitting up watching.  Be very careful.  The Dow was up today almost 80 points and then ended down  20 - just another 1% reversal - nothing to see here!
 
 
GOATMUG