September 16, 2013 Update

DJIA:15,376 S&P 500:1,688 NASDAQ:3,722 Gold:$1,316 Oil:$106.79 EURO:$1.33 YEN:98.89

How Chavez Changed the Gold Market Forever

The complexities of the financial system are largely unknown to the majority of the world’s population. Even some politicians do not fully understand how financiers have been able to make multiple somethings out of nothings for centuries. Gold and its historical value may very well be one of those complex financial instruments that have lost is gleam to investors internationally. From 1792 to 1971, the United States was on the Gold Standard; which meant that the US dollar could be exchanged for gold since the currency was backed by the precious metal. Up until that point, gold is what gave the fiat paper system value. In fact, during the Great Depression gold was so valuable that President Roosevelt outlawed private ownership in order to restore the value of the dollar. The Gold Standard even kept central bankers honest. Quantitative easing never would have happened before 1971, since the manipulation of interest rates was impossible when gold was considered money. Despite the move away from guaranteeing currencies with commodities in all major economies, central banks have continued to hold gold reserves internationally. Instead of trading gold for dollars, central banks have leased it out to bullion banks who then use it to trade while paying interest to central banks (the lender). Bullion banks that trade gold do so in a fractional reserve way, and central banks that lend the gold have the right to call it back from the bullion banks that borrowed it. In August of 2011, Hugo Chavez repatriated $11B worth of Venezuela's gold from central banks throughout Europe and in the US. After Venezuela repatriated, so did Libya and Iran. In January of this year, Germany announced that it was going to repatriate gold reserves held at the Fed and in the Banque de France (showing a major lack of confidence in the system). Since then, Poland and Texas have asked the Fed for their gold back, too. Critics have claimed the request as unnecessary and expensive, but the move is clearly symbolic of the state of fragility that exists in the global financial world. The fact that Germany has asked for their gold back is indicative of the loss of faith in the fiat paper system. And because fractional reserve lending is so complex and has allowed gold to be rehypothecated multiple times, it will take until 2020 to unwind the books and return Germany’s gold back to the Bundesbank reserves. If more countries repatriate and the trend continues, it will cause a complete meltdown in the financial system and a crisis of similar scope of the one in 2008. Ironic that Bernanke told congress that he “(doesn’t) really understand gold,” yet undoubtably knows the significance of the repatriation of it from the Fed’s reserves, and the loss of revenue the lack of faith will result in. I think he’s trying to play down the dilemma. If more gold is repatriated, the market could suffer a huge squeeze and gold prices have the potential to dramatically increase. The rehypothecation of gold is indicative of how delicate this system created on multiple layers of leverage really is, and the precedent Chavez set has the power to change the market forever. Many investors consider gold to be a fashionable hedge against inflation and interest rates, but if centrals banks take the commodity seriously than it’s clearly more valuable than a shiny metal that can be used as a “hedge.” With fear building of the rise of interest rates and the Syrian Shivers going around, it could be the perfect time for investors to add what was once considered the “silver lining” in portfolios and invest in gold... and make multiple somethings out of shiny nothings while they still can. 

Domestic News

• Market Update Futures are ripping on news that Summers dropped out of race to be the next head of the Federal Reserve. 

International Updates

Asia

• Market Update Markets are mixed as technical indicators signal that equities are overbought. 
• India’s wholesale price index climbed to a six month high of 6.1% in August vs 5.8% in July.

Europe

• Market Update  Markets reacted in gains to news that Summers dropped out.  
• Eurozone CPI edged up in August 0.1% , as expected, vs July -0.5%. 1.3% inflation YoY is in line with expectations. Lowest rates were in Greece (+1.1%) & Bulgaria (-0.7%).