Lending money to a European Investment Banks who form a Special Purpose Vehicle who issues bonds guaranteed by broke countries to use as collateral to borrow more money to buy more bad debt? That's their plan? No thank you; I'm still buying gold.
The financial markets are not their usual jovial selves, aggravated by the inconsiderate nature of fiat currency. Gold, long touted as the antibody to central banks and political brinkmanship, has failed to hold up its end of the bargain. (Track Gold & All the Metals Here)
Everybody likes a winner, unless they consistently picked them to lose badly. As the price of gold dropped from a high of over $1,900 an ounce to sub $1,600 territory, the run seemed beleaguered, if not altogether dated. But unlike most things that involve money and emotion, this isn’t all that complicated.
Last quarter’s fixation with the obvious, that developed nations have underwhelming economies and mature obligations, has awakened the bears from hibernation. The European debt crisis, known for being easy to look at and hard to watch, motivated the US money market funds to reduce their exposure to Europe by $700 billion.
The European banks, however, must not only repay previous short term financing received from American institutions, but account for 25 percentof all commercial and industrial loans in the United States. Starved for dollar denominated assets intended to fulfill transactions, they likely pawned the precious metal to manufacture liquidity the way once wealthy families part with remnants of a more prosperous time.
It seems that roller coaster rides to nowhere impact sophisticated investors as well. Given the recent volatility, margin callswhere triggered, prompting traders to sell assets with double digit year to date returns as liquidity needs trumped long-term concerns about the health of sovereign debt. The exchange operator CME also raised the margin requirements on gold by21 percent, forcing speculators to put more skin in the game.
Despite the rotation of balance sheets and bandwagons, Greece still teeters precariously on the brink of default, and with it, the prospects that Italy and Spain will soon find themselves on the coattails of excess. A bailout of Italy alone would cost€2 trillionand Apple is worth more than the top 32 European bankscombined. Gold may have dropped from its peak, but Europe is still broke.
One of the proposed solutions is to increase the European Stabilization Fund and create a European Investment Bank that in turn forms a Special Purpose Vehicle to issue bonds and purchase suspect debt, which would of course be guaranteed by nations who may need a bailout themselves.
Investors must wonder when shell games replaced affluence and gimmicks became the kissing cousin of opulence. It should be obvious that fiat currency is the silhouette of a free market economy that hasn’t existed for some time, the body long ravaged by thirty years of debt.
As one reviews the reasons why gold recently dropped, the case for owning the hard asset becomes stronger than originally thought. Greece’s economy will contract by over five percentthis year, which causes tax revenue to drop by 10 percent. Austerity measures originally meant to solve the problem are now the hoe that digs a deeper hole.
Gold has seen price declines like this before, although the global economy has little experience unwinding this much debt. The need for liquidity may have been temporarily solved, but paper money still isn’t backed by anything of value. It should strike as ominous that when a real asset was in demand, gold was held in the highest regard.
Ivory Johnson, CFP, ChFC, is the director of financial planning at Scarborough Capital Management, Inc. and has over 20 years of investment experience. Mr. Johnson attended Penn State University, where he received a Bachelor of Science degree in finance. He can be followed on www.IvoryJohnson.com.