Gold Update - September 13, 2011

By David Levenstein Sep 13 2011 10:17AM www.lakeshoretrading.co.za

As Currency Wars Intensify, Eurozone and US Debt Problems Deepen, Gold is Setting Up for its Next Move to the Upside.

Greece didn't default over the weekend, but it is quickly running out of cash with officials from the International Monetary Fund, European Union and European Central Bank returning to the country Wednesday to determine if Greece will qualify for its next bailout tranche after failing to meet deficit reduction targets.

The probability of a Greek default in the next five years has soared to 98% as Prime Minister George Papandreou fails to reassure international investors that his country can survive the Eurozone debt crisis. The nation’s government now expects the economy to shrink more than 5% this year, which is considerably more than the 3.8% forecast by the European Commission.

The risk of contagion beyond Greece pushed sovereign credit-default swap prices to record highs across the Eurozone. European bank debt risk also rose to the highest ever amid speculation French lenders will be downgraded because of their holdings of Greek bonds.

The contagion impact of a default will be severe and Italy, Spain and Portugal will become the next victims of this crisis. And, that will impact negatively on the entire European banking sector. No wonder credit-default swaps on Portugal, Italy and France surged to records.

In the meantime, in the latest move in the global currency war, last week, The Swiss National Bank shocked global markets on Tuesday by saying it would buy unlimited quantities of foreign currencies to prevent the franc from rising above 1.20 Swiss francs to the euro, as it fights to contain the meteoric rise of its currency that threatens its exports and economy. In a statement made on Tuesday, September 06, 2011 the Swiss National Bank (SNB) said the following:

With immediate effect, we [the SNB] will no longer tolerate a EUR/CHF exchange rate below the minimum rate of 1.20. The SNB will enforce this minimum rate with the utmost determination and is prepared to buy foreign currency in unlimited quantities."

Immediately after the announcement, the Swiss Franc dropped by around 10% to the Euro and while this action may deter investors from ploughing additional money into the Swiss currency in the short-term ultimately, the SNB cannot control what happens to the economies in the rest of the world. And, unless there is an improvement in the economies of Eurozone and the US – which I can’t see happening anytime soon - it will be very difficult for the SNB to keep the Swiss franc from rising once again. While the Swiss franc is globally well-respected as a safe haven currency, the SNB do not have unlimited resources to continually intervene in the currency market and the currency cannot compare with the US dollar, euro or Japanese Yen, in terms of size and circulation. Thus, further interventions by SNB are rather limited.

Even if the SNB had not intervened in the currency market, the deterioration in the Eurozone debt crisis and the U.S. economy's inability to create a single job last month will only increase investors’ concerns about global economic growth while at the same time decrease their confidence in paper assets in particular the world’s fiat currencies.

After the SNB intervened in the forex market and as the debt crisis in the Eurozone deteriorated, the euro dropped more than 400 pips in two days against the greenback. Yet the price of gold remained relatively soft and very volatile. In light of the Euro debt crisis and a potential default by Greece, one would expect the price of the yellow metal to be much higher. As the fundamentals have not changed, and by looking at the price action of gold it is clear to see that the US bullion banks are once again attempting to drive prices lower by using the futures markets. In their all too familiar strategy of selling on the open of Comex yesterday’s price action seemed to follow this pattern perfectly. Additional downside action could also be attributed to the stronger US dollar; the possibility of margin calls as well as the liquidation of gold positions in order to cover losses in global stocks. Nevertheless, any market manipulation in gold will be short-lived and the lower prices will only attract prudent buyers of the physical metal as well as bargain hunters.

As much as the usual gold critics would like to see gold prices collapse, I think they are going to be in for another big surprise, not that this is will surprising, after all they have been consistently wrong for the last ten years or so; an achievement worth some acknowledgement as far as I am concerned.

With a potential Greek default looming resulting in massive losses for European banks, and, since the U.S. Treasuries lost their triple-A status in August by Standard & Poor's, and as German Bunds waver as investors ponder the cost to Germany for bailing out its neighbours, and the Swiss franc with limited upside, I find it surprising that the price of gold is not already trading back above $1900 an ounce.

Since gold was less than $500 an ounce I have been continually urging individuals to own some physical gold. Gold has always been a safe-haven asset so named for the reassurance it offers investors when markets become unstable. In today’s global economic climate, it is more important to preserve your wealth than try to locate some high yielding low risk bond or equity. That is why it is essential to own precious metals in particular gold and silver.

TECHNICAL ANALYSIS

During the last week, the price action of gold was very volatile. It seems that gold is stuck between $1800 and $1900 an ounce. Long-term investors should buy on the dips as I see a break above $1900 level in the short-term.

By David Levenstein