Gold Plunges — What’s Going On (October 16, 2008)
Why was gold down so sharply today — in the face reportedly record demand from investors for bullion coins and small bars?
News that European central banks sold 7.6 tons of gold in the week ending October 10th has certainly been a heavy burden on the price and helps explain why the metal could not move higher last week and, if selling has continued, in the past few days.
But, it has been central bank gold loans — even more so than official gold sales — that has really pulled the rug out from under gold. Gold loans by central banks are an alternative — and invisible — means of injecting liquidity into the banking system.  These gold loans to banks and bullion dealers by the leading central banks are probably a significant multiple of outright official sales.
In simple terms, a central bank may lend or deposit gold with a banker or bullion dealer who simultaneously sells forward. Even with the recent substantial increase in gold-lending rates, at the end of the day the dealer receives cash in the transaction at a cost that may be advantageous to short-term money-market borrowing costs. Central banks have great freedom to lend gold outside their government-mandated rescue programs and these lending activities are typically hidden by their accounting practices.
Interestingly, just as some of the major central banks have stepped up lending, there have been reports of other central banks withdrawing deposits to avoid the counter-party risks.
At the same time, there have been reports of gold sales by hedge funds to cover losses in equity markets. In most cases, these sales are unwinding of long futures positions — and do not help offset the record physical demand for gold we have been seeing from virtually all four corners of the globe. Institutional trading of gold and now net sales have added to market volatility, making gains in the past few weeks difficult to sustain, but do not explain today’s sharp decline.
In contrast to today’s gold headline news, continuing strong physical demand for gold is a harbinger of gold’s ultimate ascent.
It’s no longer just “gold bugs” buying the yellow metal but regular investors and savers of all stripes. These are not traders looking for quick gains but scared people driven by fear seeking to protect their wealth.
This is why the demand for gold bullion coins — the American Eagle and Buffalo, the Canadian Maple Leaf, the Austrian Philharmonic, and the South African Krugerrand — is at levels not seen in three decades and why bar fabricators serving European, Middle Eastern and Asian markets are reporting increasingly long delivery times and rising premiums.
Gold-backed ETFs are also seeing a continuing, albeit erratic, inflow of funds resulting in a growing pile of bullion held on deposit. By this Wednesday of this week, the NYSE-traded SPDR Gold Shares, were backed by more than 770 tons of physical gold held on behalf of fund investors.
Recent data indicate that the major industrial economies are headed into a deep, prolonged, synchronized recession — or worse. Oil and industrial commodity markets are also confirming these same dire expectations. But a deeper downturn means that policy makers will need even more aggressive monetary ease and fiscal spending to breathe life back into the sick economy — and governments will be even deeper in the hole.
I’m bullish on gold because, in the end, as the global economic recession deepens, governments will find the only way out of this mess — the only way to pay for all the bank equity positions and private debt they are accumulating and to pay for the coming “New Deal” type programs and possible industrial bail-outs — is to print more money. In other words, to inflate.
