Futures & Commodities

Some gold under the Christmas tree?

Bloomberg/Contributor | Bloomberg | Getty Images

Here is an argument in favor of gold as a long-term asset based on the following considerations: (a) the inflationary potential of an excessive monetary stimulation in one-half of the world economy, (b) major instabilities that will be caused by the withdrawal of unprecedented levels of global liquidity, and (c) dangerous geopolitical rivalries between new and established centers of economic, military and political power.

The present "sell gold" wave rests on an apparent conviction that the U.S. Federal Reserve will continue its expansionary open market operations for the foreseeable future. That, in turn, is expected to support continuing capital inflows into equity markets and liquidations of gold holdings.

As a well-known American investor would say, that is a "reflexive" (i.e., devoid of any thought) reaction to the Fed's policy announcements last week. And being "reflexive," it is no wonder that this market reaction pays no attention to two important issues of investment strategy: (a) the Fed's statement that it will continue to respond to activity and price indicators, and (b) the impact of the existing monetary stimulus on future economic developments.

NYMEX update: 'Bad times' for gold

"Cross the bridge when you come to it" is not investment strategy

Ignoring these investment strategy issues, "reflexive" gold sellers are saying "we'll cross that bridge when we come to it." But pushing aside the Fed's clear emphasis on its data-driven policy actions at a time when the economy appears to be at a cyclical turning point is a dangerous game.

Indeed, like any short-term forecaster, the Fed is estimating a range of probabilities about the bridges it will have to cross and the time horizon of the likely crossings. Beyond that, the Fed leaders can only keep their fingers crossed that it will all go well because, in the process, some bridges can – and regularly do – go up in flames.

Investors, however, should do better than pray with the Fed by reaching for defensive asset choices.

Market gurus you now hear screaming about selling equities and moving into cash may be exaggerating, but they are no crazy loons. They have a message founded on their long years of experience, and/or some recollection of what they may have learned in their basic courses of economics. Both educational exposures remind them of a simple empirical fact: the monetary policy is a very powerful instrument; it may take a while to work, but it does work always and everywhere, even in command economies.

(Read more: Has the Fed squashed gold bugs for good?)

And what do we see now? The Fed's monetary base (the liability side of its balance sheet) at $3.7 trillion is about five times what it was before the onset of the financial crisis; it is also 40 percent above its year-earlier level, having expanded at an average monthly rate of $87 billion since December of last year. Clearly, there are a lot of bridges to cross until this huge liquidity in the U.S financial system is brought down to levels compatible with sustainable and noninflationary growth of the economy.

The euro area, the world's second-largest economic system, is also awash in liquidity, as the European Central Bank (ECB) continues to provide funds to the banking sector at its record-low, 0.25 percent, interest rate.

The Bank of Japan pledged last Friday (December 20) to keep expanding its monetary base by 60-70 trillion yen per year until its inflation target of 2 percent is reached. They still have some distance to go because they are only half-way there.

The rest of East Asia – with the exception of China and South Korea – is a similar story: Real short-term interest rates are zero or negative, indicating, along with weak currencies, a large excess of money supply.

(Read more: Gold stumbles to 3-year low after Fed stimulus trim)

Can investors be confident that the central banks will be able to withdraw this huge monetary stimulus (a) before it creates rising inflation pressures, and (b) without causing major damage to their asset markets and to the integrity of their financial systems?

That is the fundamental question of investment strategy.

Gold demand has been 'phenomenal' from China: Pro

Bubbling geopolitical rivalries and a year of all dangers

Numbed by decades of serious wars and daily conflagrations in the Middle East, financial markets seem to be indifferent to dangers of broader military conflicts.

The ticking time bomb in East Asia is an example of that. China and Japan are now engaged in permanent military harassments around the group of islands they both claim in the South China Sea. And Japan is urgently building up its defense capabilities for the day the sparks may fly.

That would involve the U.S., too. In fact, it already did. On December 6 of this year the U.S. and China nearly came to blows in an "incendiary" (Pentagon's word) incident in the South China Sea as the Chinese warship hurtled toward the American guided missile cruiser USS Cowpens, coming within less that 500 yards (about half a kilometer) off its bow. The clash was avoided only because the U.S. vessel took an evasive action. The Chinese say that the USS Cowpens was spying and "harassing" its Liaoning aircraft carrier battle group.

The danger areas have now been widened because on November 23 of this year China introduced an air defense identification zone (ADIZ) that overlaps the South Korean and Japanese ADIZs put in place since the early 1950s, with their most recent extensions (by Japan) in 2010.

Due to competing territorial claims, China and Russia don't recognize the Japanese ADIZ. For the same reason, and probably more, Japan and the U.S., along with some South-East Asian nations are refusing to recognize the Chinese ADIZ.

(Read more: Here's what was behind gold's wacky jobs reaction)

All that is part of difficulties posed by China's rapidly growing economic and military clout.

It would be an extraordinary feat of wisdom and diplomacy if this epochal event were to pass off peacefully.

Europe is another security flashpoint, where events around Ukraine and the missile shield look like the Cold War never ended. The jostling between the EU and Russia about keeping Ukraine, Georgia and Moldova in their respective spheres of influence has thrown Europe into an acute phase of the old West vs. East confrontation – at the risk of disintegrating law and order in Ukraine.

While there is no danger of an immediate military conflict, the European missile shield and massive NATO and Russian military maneuvers at each other's borders strongly suggest that both are getting prepared for such an event. By contemplating large, nuclear capable, missile deployments close to its eastern neighbors, and announcing that it would immediately nuke whoever dares to attack the Mother Russia, Moscow very much sounds like a place ready to pounce.

Next year is the year of all dangers. The unwinding of the monetary stimulus in the U.S. will send tremors far and wide, with distinct dangers for EU and East Asian economies. The standoff in the South China Sea has all the markings of something about to become much more serious. And virtually no chance of any U.S.-Russia-China agreement on the global missile shield has already intensified the ongoing arms race.

How, under these conditions, can one expect any solutions to Iran's nuclear problems and the Syrian civil war?

I wish you all a very merry Christmas as I ask Santa to put some of that yellow stuff under my tree.