In wake of currency wars, gold wins every time

March 13, 2015 12:08 PM

Priced in euros, gold opened the year at €980.52. It quickly spiked to €1,154.94 before what appears to be a 50% retrenchment. It then picked up again and at the time of writing, it is priced around the €1,092 mark. So in euro terms gold is actually up around 11% this year.

In GBP gold followed roughly the same pattern but did not rebound so well due to recent sterling strength and is currently trading slightly above its price at the start of the year.

We expect gold to be supported in the near term and to rise in the longer term as the European Central Bank (ECB) lurches into its quantitative easing (QE) program. The expectation that the ECB will inject massive liquidity into the financial system by buying up bonds en masse has been met with unquestioning enthusiasm.

We do not share this enthusiasm. The anticipation of this monetary experiment has already caused the euro to plunge. This should aid exporters in the coming months. But in the longer term it will lead to inflation as importers have to pay more for their raw materials and the public have to pay higher prices for imported goods.

Also of vital importance is that most central banks are involved in competitive currency devaluations.

Therefore, in the medium and long term, currency devaluations will be of little benefit to exporters as most central banks are engaged in the same ‘beggar thy neighbour’ trade andcurrency wars. So far this year twenty four central banks globally have lowered interest rates in a bid to weaken their currencies to aid their export sectors and create jobs and economic growth.

The haphazard manner in which this QE experiment is being executed in the eurozone is also concerning. In the absence of a truly centralised central bank it has fallen to national central banks to purchase the bonds that will create a sustainable recovery. The lack of oversight is ripe for abuse of the system.

The experiment has only been in operation for four days and already there are serious questions over whether it can be actually implemented as planned. Due to arcane accountancy rules governing the quality of bonds which may be purchased it appears that there simply may not be enough bonds to meet demand.

Given that the ECB flagged its intention to engage in QE long in advance, the bond markets have already factored in anticipated massive central bank purchases. If it turns out that the central banks cannot buy their expected allocation of bonds it will likely cause chaos in the bond markets.

The uncertainty now hanging over the European bond markets cannot have been alleviated by reports that Greek Finance Minister Varoufakis said on Tuesday that “Greece would never pay back its debts,” which was followed by Prime Minister Tsipras confirming that “Greece cannot pretend its debt burden is sustainable.”

Greece’s future in the eurozone is still questionable. The BBC is now warning that Greece may be pivoting towards Russia. They report that a “drove of Greek cabinet members will be heading to Moscow” in May, a month before the current bail-out arrangement expires.

Anticipation of ECB QE has also caused European stock markets to rise considerably. These price rises have not been matched by a rise in earnings or dividends indicating a liquidity driven bubble in some European and other indices.

By some measures, US stock markets are more overvalued than they were in 2008.

The subprime bubble and meltdown of 2007 has now been surpassed by large bubbles in auto loans, student loans, many tech and biotech stocks, junk bonds and other sections of the bond market.

Compounding the risks is the fact that there is now $8 trillion more in public and private debt in just the United States alone.

The imbalances, distortions and malinvestment that caused the 2008 meltdown are much worse today than they were in 2008. As is the complacency and hubris.

And many of the same people who got us into this mess remain at the helm and are pursuing the same ultra loose monetary policies that got us into the debacle.

Given the risks of today – the euro and other currency QE experiments, competitive currency devaluations, currency wars, bail-ins, stock and bond market bubbles – gold will continue to protect and grow wealth over the long term.

 

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About the Author

Mark O'Byrne is executive director of Ireland-based GoldCore.