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     Nov 25, 2010

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Gold shows its true metal
By Henry C K Liu

This is the second article in a series.
Part 1: Stagnant wages leading to overcapacity

The US Federal Reserve continues to engage in serial quantitative easing to release more fiat dollars into the US banking system, with the aim of enlarging the money supply to try in vain to revive a gravely impaired economy that is already weighted down with excess debt and misdirected liquidity.

The express purpose is to lower long-term interest rates. At the same time, gold keeps rising in price as other commodities fall because gold is a monetary metal, not just an industrial


commodity. Gold has not increased in value; only the dollar has declined in value as the price of gold rises.

The 28-year-long record high in gold price, at $850 per troy ounce, set at the pm fix on January 21, 1980, was broken several times in January and February 2009, hitting a then all-time high of $1,218.25 on December 3, 2009. It was broken again at $1,231.41 on August 19 this year, and again at $1,239.50 on August 25. This reflects the sustained decline in the value of the fiat dollar in gold of constant value.

The actual record high set in 1980 would be $2,387 in 2010 dollars, or 71% higher than it closed on November 9. Gold is a hedge against a weak dollar, not a hedge against inflation.

Gold futures on the COMEX Division of the New York Mercantile Exchange posted strong gains on Monday, August 16, 2010, as weak economic data from Japan exacerbated investor nervousness about the slow pace of global economic recovery despite central banks, led by the Federal Reserve, having lowered interest rates near zero, desperately resorted to quantitative easing to combat deflation without visible effect.

This sparked some safe-haven-driven demand for gold on fears of more central bank quantitative easing. The most active gold future contract for December 2010 delivery rose $9.60, or 0.8%, to finish at $1,226.2 per troy ounce. Gold reached $1,350 per troy ounce on October 5, 2010. December 2010 delivery reached $1,500 per troy ounce on the same day.

The smart money, having already been long on gold for decades in the context of fiat money released by panicky central banks, continues to view the price of gold as vulnerable to potential central bank upward market manipulation in the face of general deflation risk in commodity markets in the prolonged financial crisis. Investors are poised to push the price of gold towards $1,500 per troy ounce before 2010 ends.

Gold breached $1,280 per troy ounce for first time in history on Friday, September 17, 2010, and traded at $1,350 on October 5, at $1,372 on October 18, 2010, at $1,395.5 on November 5 and topped $1,400 for the first time in history on November 8 amid market uncertainty on the outcome of currency talks at the then upcoming Group of 20 summit in Seoul, Korea and renewed concerns over sovereignty debt in the eurozone.

On November 9, gold touched an all time high of $1,424 an ounce as the market reacted to the Fed's $600 billion quantitative easing (QE2) injection into the US banking system and to World Bank president Robert Zoellick's surprise call for including gold in a new currency based on a basket of dollars, euros, yen and yuan.

Still that record gold price after adjusting for inflation remained below the peak set in the early 1980s, which means the gold price still has some climbing to do, or the market expects the fiat dollar has more to fall, along with other fiat currencies that derive their exchange value with the dollar's value in gold.

In the week ending Thursday, October 7, 2010, gold notched what were then new records against the fiat dollar as bullion made a clean sweep of all other currencies. After its gains against the dollar, bullion's 2.2% advance versus sterling topped the list, followed by a 2.0% gain in yen and a 1.5% appreciation against the Swiss franc. Gold managed to climb 0.8% in euro.

For the same week, the dollar's performance was highlighted by the following:
  • Morning gold fixes in London averaged $1,332, wrapping up the week 3.7% higher at $1,360;
  • COMEX spot settlements averaged $1,330, but finished only 2.0% higher at $1,334;
  • Average daily gold futures volume fell 3.9% to 142,055 contracts; open interest rose from 4,753 contracts to 621,941;
  • COMEX gold warehouse stocks increased by 62,929 ounces (2.0 tonnes) to 10.960 million tonnes; inventories on that day covered only 17.6% of open interest;
  • One-year gold lease rates slipped to 0.26% or 26 basis points (1 bp = 0.01 percent) while three-month contract rates held steady at 0.3975%;
  • SPDR Gold Shares Trust (GLD) vault assets fell by 16.2 tonnes (521,935 ounces) to 1,288.5 tonnes.

    SPDR funds are shares of a family of exchange-traded funds (ETFs) traded in the US and Australian markets and managed by State Street Global Advisors (SSgA). Informally, they are also known as Spyders or Spiders. SPDR is a trademark of Standard & Poor's Financial Services, a subsidiary of McGraw-Hill Companies.

    The name SPDR is an acronym for the first member of the family, the Standard & Poor's Depositary Receipts (NYSE: SPY), the biggest ETF in the US, which is designed to track the S&P 500 stock market index.

    The risk trade resumed in the week ending October 7, 2010, as investors favored junior gold mining shares over established producers; the Market Vectors Junior Gold Miners ETF (GDXJ) gained 2.8% versus a 1.2% rise in the Market Vectors Gold Miners ETF (GDX); the Gold Miners (GDX/GDXJ) Ratio fell from an average 1.66 the week before to 1.65; the S&P 500 Composite Index's correlation to gold producers rose 5 points to 14%; the blue-chip benchmark's correlation to bullion climbed 16 points to -3%.

    WTI (West Texas Intermediate) crude oil prices rose 2.1% to close out the same week at $81.67 per barrel; the gold/oil multiple continued to fall, dropping from 16.8x to 16.2x.

    TED is an acronym formed from T-Bill and ED (eurodollars), the ticker symbol for the eurodollar futures contract. The TED spread is the difference between the interest rates on London interbank loans and short-term US government debt (T-Bills). Initially, the TED spread was the difference between the interest rates for three-month US Treasuries contracts and the three-month eurodollars contract as represented by the London Interbank Offered Rate (Libor). However, since the Chicago Mercantile Exchange dropped T-Bill futures after the 1987 crash, the TED spread is now calculated as the difference between the three-month T-Bill interest rate and three-month Libor.

    Futures contracts in general, and Treasury bill futures in particular, are taxed in the US in a manner that provides individual investors with an opportunity to reduce taxes on gains and to take full tax deduction of losses. The Internal Revenue Service (IRS) considers all futures contracts to be capital assets. Unlike other capital assets, however, the holding period for long-term gain is six months for futures contracts but only long positions qualify. All gains and losses on short positions are short-term regardless of the holding period. This asymmetrical treatment of long and short positions gives individual investors an opportunity to profit at the expense of the government by taking all gains as long-term capital gain at lower tax rates and all losses as short-term with full tax deductions.

    One-year TED spreads ending December 31, 2010, (an indicator of banks' willingness to lend to each other) averaged 53 bps (basis points) - a point higher than the previous week - on lower Treasury yields; three-month spreads also rose a basis point.

    Although three-month Treasury Bill rates and three-month eurodollar deposit rates generally move together - rising in times of monetary tightness and business cycle expansion and declining with monetary ease and cyclical weakness - the co-movement typically is not exactly equal. The TED spread, which reflects the difference between these two interest rates, can offer some attractive trading opportunities to investors/speculators who can correctly anticipate such differential movement between the two rates.

    Finance rates embedded in COMEX gold futures traded at a 23 bps discount to one-year Treasuries; the discount started to narrow with the late-week decline in yields; the one-year gold contango averaged $10.70 an ounce, but finished the week at only $9.70.

    Contango depicts a pricing situation in which futures prices get progressively higher as maturities get progressively longer, creating negative spreads as contracts go further out in time. The increases reflect carrying costs, including storage, financing and insurance. It is a term used in the futures market to describe an upward sloping forward curve (as in the normal yield curve).

    Such a forward curve is said to be "in contango" (or sometimes "contangoed"). Formally, it is the situation where, and the amount by which, the price of a commodity for future delivery is higher than the spot price, or a far future delivery price higher than a nearer future delivery. This is a normal situation for equity markets. The opposite market condition to contango is known as backwardation.

    A contango is normal for a non-perishable commodity which has a cost of carry. Such costs include warehousing fees and interest forgone on money tied up, insurance cost, less revenue from leasing out the commodity, as in gold.

    For perishable commodities, price differences between near and far delivery are not a contango. Different delivery dates are in effect entirely different commodities in the case of perishables, since fresh eggs today will not still be fresh in six months' time, 90-day treasury bills will have matured, and so on.

    Continued 1 2

  • The Complete Henry C K Liu

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    2. Hu lets cash do the talking

    3. India key to Syria's tilt to the East

    4. Young general has got what it takes

    5. Intel on Iran has telling flaw

    6. NATO, Karzai and the relics of Kabul

    7. China gets smart

    8. Ideological and hostile

    9. Welcome to NATOstan

    10. Crime and punishment in China

    (24 hours to 11:59pm ET, Nov 22, 2010)



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