What's Holding Gold Back?

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Recently by Peter Schiff: Flying Blind

Gold first broke $1,200 on December 2, 2009; nine months later, instead of witnessing the birth of the full-on gold boom I have long anticipated, the yellow metal has gained a modest 4%. Fortunately, it has spent the summer solidly above $1,150, which should put to rest the claim that we are seeing an exponential gold bubble like we saw in 1980. And those waiting for the "big pullback" to $8-900 might be seeing the futility in their cause. But I never doubted the strength of this secular bull market. In fact, I still maintain that gold is grossly undervalued. So, what’s holding gold back?

First, it’s important to account for the season. While everyone is at the beach, on their boats, or switching apartments, very few are out buying gold. June and July have always been low-volume months in the gold market. August tends to pick up a bit, and then by September, we’re off to the races. The fact that gold hasn’t had a major pullback this summer is very bullish for the fall.

But the bigger factor affecting gold’s price is the US bond bubble. Spooked by global market volatility, and deceived by the Fed’s continued intervention to keep bond yields farcically low, private investors seem to have made a ‘flight to safety’ into Treasuries. In the past, this may have been a prudent move; but today, the government bond market is about as safe as walking alone at night in downtown Detroit.

Despite massive capital inflows, the US dollar is losing ground to the yen, Swiss franc, Aussie dollar, loonie, yuan — and gold. The state of our public finances is extremely weak. In the FY2010 budget, the federal government is spending 49% more than it is taking in revenue per year, adding to a national debt that is now 98.5% of GDP. Compare this to Greece, which is spending 33.5% more than revenue and has a debt of 113% of GDP. And the political climate here is just as hostile to even the mention of austerity. Unlike the EU, the US has guaranteed the ongoing viability of mortgage holders, major corporations, the states, and its own bloated social programs. Unlike Japan, the citizens can’t be persuaded to shoulder these burdens because they are broke too.

If the ratings agencies were honest, they’d rate US debt as ‘junk.’ Of course, the first characteristic of a bubble is that the vast majority can’t recognize that it is one. Bubbles depend on confidence to grow, and quickly pop when that confidence disappears. The People’s Bank of China, the #1 holder of US debt, has spent the summer quietly selling Treasuries. Japanese holders of US bonds (#2 in the world) are getting clobbered as the yen surges. This could be the beginning of the end of the US bond bubble. When it collapses, private investors, institutions, and central banks will be trampling on each other trying to reach the exit.

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Peter Schiff is president of Euro Pacific Capital and author of The Little Book of Bull Moves in Bear Markets and Crash Proof: How to Profit from the Coming Economic Collapse. His latest book is How an Economy Grows and Why It Crashes.

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