by Peter Schiff

The markets are going through another sell-off phase, yet the traditional notions of a ‘safe haven’ are changing. No longer is the US dollar the default shelter; instead, gold, the Swiss franc, and the Japanese yen are the preferred assets.

All three of these havens – gold, francs, and yen – have been surging upward this month. Two of them, however, are being actively devalued by central banks desperately (and foolishly) trying to curtail appreciation. The Swiss and Japanese are enlisting both policy measures and all the banker-speak they can muster to stem the tide of investment flows into their currencies.

The game is Last Haven Standing, and Spielberg has already acquired the movie rights.

SWITZERLAND: FROM NEUTRALITY TO INTERVENTION

Looking to Europe, the Financial Times now has the awkward task of reporting that mighty European Union’s currency is coming apart at the seams, while neighboring Switzerland has barely enough hotels to house the world’s waterlogged financial refugees. The franc is up 5.41% against the euro this year and almost 14% against the dollar. One wonders if the only way to prevent a collapse of the these major debtor currencies is to back them with Swiss-made wristwatches. At least then they’d have a partial gold standard and there’d be no excuse to be late for an austerity protest!

Unfortunately, the Swiss National Bank is so afraid of the franc’s rise that it has flooded the market with liquidity and cut interest rates to zero. The SNB even recently threatened to peg the franc to the euro. It’s as if survivors on one of the Titanic’s lifeboats were so confused and bewildered that they began tying their boat to the sinking behemoth out of a desire for a ‘stable relationship.’

NOTE TO JAPAN: IT’S NOT THE SPECULATORS

Japan, ironically, has been blessed that while its debt problems are severe, they’ve been severe for so long that markets are willing to take that as a sign of stability. And, aside from the public debt problem, Japan does have fairly impressive fundamentals. They are still a productive economy with high personal savings and exposure to booming China. So, it’s no wonder the Yen has risen 6.63% against the dollar so far this year.

Former Finance Minister, and now Prime Minister, Yoshihiko Noda stated recently that he would “take bold actions if necessary and won’t rule out any possible options” to restrain the yen’s appreciation. Yet, while Noda has said the ministry will study whether “speculation” is behind the yen’s rise, he doesn’t seem to understand that this is a permanent move away from dollars and euros and into anything which might be a better alternative. This is not driven by Wall Street gamblers, but rather by everyday investors seeking shelter.

CLEARLY SHIFTING SENTIMENTS

My readers know that I see these past years in the US markets as one ongoing crisis. We’re not “facing a double-dip recession” as the media suggests; instead, we’re really in the midst of a prolonged economic depression. The periodic market panics since 2007, both in the US and Europe, all stem from the same disease and, as such, ought to be properly understood as related symptoms, not as separate events.

And as one long, ugly narrative, these subsequent panics resemble a series of steps; sharp drops leading down either to a dismal “new normal” or – more likely – a collapse in both the fiat dollar and euro currencies and a widespread return to gold as money.

My brother, Andrew Schiff, wrote an article for my brokerage firm this month reviewing the market turmoil and how it compares to previous crises since ’07. He found a steady shift in what investors perceive as a safe haven.
During the depths of the credit crunch, from October 2008 to March 2009, the S&P lost over a quarter of its value, as investors flocked to the US dollar, driving it up 8%. Foreign stock markets sold off and most foreign currencies fell substantially. The Swiss franc fell over 3%. Gold rose some 6.5% and the yen rose 5.75%, but neither kept pace with the US dollar, which rose 13.5%.

Then, during the dip between April 23, 2010 and July 2, 2010, the S&P dropped again by almost 15%. The dollar rallied barely more than 3%. The Swiss franc gained slightly instead of falling. And this time, both the yen and gold beat the dollar, gaining 4% and 5.5% respectively.

Now here we are in August, and what’s happening?

In extreme volatility, the S&P fell over 13% before rebounding to its starting place. The dollar has remained essentially flat even with intensified fears in the euro zone. The yen is also flat, despite heavy intervention to push it down. The Swiss franc rose 8% before Switzerland’s central bank threatened to peg the currency to the euro, and gold has surged almost 12%!

See the pattern? On each step of this multi-year downward spiral, global investors are slowly but coherently altering their preferred safe haven. Alternatives are being desperately sought, though actions first by the Japanese central bank and more recently by the Swiss have prevented their currencies from fully realizing potential gains as dollar-alternatives.

Fortunately, gold doesn’t have a central bank, so it can rise as fast as the dollar falls.

THE FIAT DOWNGRADE

Whether it is in their interests or not – and I argue it is not – central bankers look set on continued competitive devaluation of their currencies so that their economies don’t have to do the hard work of retooling for the new reality.

That is why gold is doing so phenomenally well, and why it should continue to do so. New gold comes into the market at a rate of about 2% per year. This number has been fairly steady over time, and reflects the ability of mining companies to locate, finance, purchase, and develop new gold mines. I invest in these companies, and trust me, it’s not an easy job.

Contrast this with a paper currency – more dollars can be created by Bernanke simply printing extra zeros on his banknotes. See that $10 bill? Shazam, it’s a $100!

The reason currencies like the yen and Swiss franc are considered safe is simply a longstanding habit of their central banks not to print too much. But a habit is much less reliable than a physical constraint.

Think of a dog that has been trained not to eat steak. If you put it in a room with a juicy ribeye, would you be more confident the steak would be there when you came back if the dog was in a kennel or just sitting there? Just like a dog always craves steak, and will grab a bite when no one’s looking, central bankers always crave the printing press.

That’s why we need to hold an asset for which scarcity is dictated by nature itself – gold.

As this realization becomes more commonplace, and as this depression accelerates, I expect gold to be the Last Haven Standing. This will not be a “new normal,” but rather a return to thousands of years of economic tradition.

A NOTE ABOUT THE FUNDAMENTALS

Those who do not really understand the fundamentals, such as commodity trader Dennis Gartman, continue to look at gold’s rise as a bubble. In fact, Gartman just called the top in gold, again, claiming that one of the “great bubbles of our time” had finally popped.

He cites as evidence the quick 200-point rise to over $1900/oz, which Gartman sees as a speculative blow-off top. He also cites the meaningless fact that one Gold ETF, GLD, has a larger market cap than one S&P 500 ETF. He absurdly compares this situation to the Japanese Emperor’s palace eclipsing the value of the entire state of California at the top of Japan’s real estate bubble. Those ETFs simply represent one way of owning assets, and do not, as Gartman contends, indicate that investors value gold higher than the entire US stock market. In fact, a true comparison of the two asset classes reveals gold’s value is historically low relative to the value of US stocks.

Rather than the bursting of a bubble, the recent technical action in gold is more indicative of a break-out. In fact, the positive divergence of gold stock from bullion in this recent correction is evidence that a more powerful leg in this bull market is about to begin. Up until now, the market for gold stocks has been characterized by fear. However, it now appears to me that gold stocks will make a new high before the metal itself. If the stocks finally begin to lead the metal, it means traders are finally starting to believe in this rally. Rather than evidencing the end of the trend, such a shift in sentiment likely indicates an acceleration in that trend. Maybe when the last skeptic finally throws in the towel, we may finally get the blow-off top Gartman thinks already occurred – but that day is likely many years into the future.

In fact, all the talk about a gold bubble seems to be based on the fact that so many investors are now talking about gold. However, the problem with this argument is that despite all the talking, very few investors are actually buying. Bubbles are not formed by talk, but by action. Before we get a gold bubble, all those investors talking about gold actually have to buy an ounce. In fact, before a bubble pops, its not just investors, but the average man in the street who will have to be buying. Thus far, he has not even joined the conversation.

by John Browne, Senior Market Strategist at Euro Pacific Capital

The basic unwillingness of politicians to face economic and financial realities has caused the United States and European Union to face currency collapse. The politicians are content literally to paper over the problem with massive amounts of newly printed currency. This means that savvy investors, facing major real losses, are turning increasingly to gold. In essence, even though currencies are no longer on a gold standard, they are increasingly being “redeemed” for gold in the marketplace.

For decades, fiscally irresponsible US Administrations have gradually reduced the world’s richest nation, with a currency perceived as ‘good as gold,’ to the position of the largest global debtor, with a debased currency. Furthermore, US stock markets have offered little real return. Indeed, the Dow stands just below 11K, down over 3K points from its all-time high on October 9, 2009. Discounting for inflation shows a loss close to 4K points, or a fall of over 25 percent from its all-time high. Meanwhile, equities in emerging markets have often shown handsome returns.

The recent political wrangling in Washington has damaged the financial credibility of the United States, prompting a long overdue debt downgrade by ratings house Standard & Poor’s. This removes a fundamental pillar supporting the dollar as the global reserve asset of choice.

In Europe, the unwillingness of politicians to face the fatal structural flaws within the euro is encouraging a fear-driven economic recession, sovereign debt defaults, a banking crisis, and, potentially, a currency collapse. This is hurting the euro’s formerly bright prospects of replacing the dollar as global reserve.

This week’s Merkel-Sarkozy summit meeting amounted to nothing constructive. The most popular topic was instituting a Tobin tax on forex transactions. This would, of course, drive financial markets out of the EU to more friendly environments. But more importantly, it leaves the major structural issues of a two-speed Europe unaddressed.

With nothing achieved by the EU’s ruling Franco-German axis, European banks are correctly seen as increasingly vulnerable to further EU sovereign debt defaults. Of course, former communist Merkel and her French ‘poodle,’ the socialist Sarkozy, will find no problem in transferring toxic bank assets to the public purse. But it will require more market anguish before they dare to do it. Once this happens, the euro will be locked on the same railway to devaluation as the dollar.

China’s yuan has strong fundamentals, but is not properly situated to vie for a place on the world stage. It is neither backed by hard assets nor freely floating. Though this policy is changing, it is not yet a true alternative to the dollar as it maintains a fixed exchange ‘band’ to restrain its true value.

Naturally, private investors and foreign central banks are turning to the very monetary instrument that they never should have abandoned: bullion gold. That is why the gold price is rising in $50 leaps per day, with only small corrections. Gold is being re-monetized. [Learn the difference between rare and bullion gold in Euro Pacific Precious Metals' new special report, free for download HERE. Please note: Euro Pacific Capital and John Browne are not affiliated with Euro Pacific Precious Metals.]

Still, despite our continued warnings, and perhaps motivated by yield or a misplaced sense of safety, some investors still are tempted into dollars and US Treasuries, driving them to negative real yields of up to three percent. This may prove to be one of the largest financial traps in history, potentially devastating the savings of many investors. It reflects a fundamental investment strategy flaw.

It has been held that most wise investors should look not at yield and capital appreciation, but at total return. The only need to differentiate between yield and capital growth is for tax purposes. Some investors avoid gold still, because of its lack of yield. This can be a costly mistake when gold’s meteoric capital gains are taken into account.

Some are skeptical because of the performance of silver during the spring. However, it must be remembered that silver is still up some 125% year-over-year. The drop from $50 to $35 was directly related to an unprecedented triple-margin hike by the Chicago Mercantile Exchange. The exchange made the same move against gold, but the yellow metal shrugged it off through buoyant demand.

Indeed, while silver is temporarily hobbled by worries of global depression and a corresponding drop in industrial demand, gold appears to have no such reservations. Silver may ultimately surge well past gold as the emerging markets prove themselves able to stand on their own despite an ailing West. But gold is a pure monetary trade, and its signal is indisputable.

As long as politicians continue to paper over their problems by issuing more fiat money, gold will regain its crown as the king of monetary instruments.

by John Browne, Senior Market Strategist at Euro Pacific Capital

Last week Fed Chairman Bernanke raised eyebrows and denied history when he asserted in front of Congress that gold doesn’t qualify as money. Yesterday he took the unprecedented step of announcing that the Federal Reserve would keep interest rates near zero for at least the next two years. In very short order thereafter it required much more of the money that he believes in (U.S. dollars) to buy the money that he doesn’t believe in (gold).

In any event, it was beyond unusual for the Fed to make such an explicit time commitment on monetary policy. To underscore this fact, three voting members of the Federal Open Market Committee came out against the policy. Such dissent within the Fed’s ranks has not been seen in decades. But Bernanke’s shameless appeasement of market fears did interrupt, if only for a few hours, the free fall on Wall Street. Wiser investors, understanding how a more activist Federal Reserve will destroy the value of the dollar, moved to gold, pushing the metal up to north of $1,750 per ounce.

The economic forecast contained in the Fed statement was far gloomier than earlier pronouncements. Bernanke sees continued sluggish growth for the U.S. economy and subdued inflation. Normally under such conditions gold should be expected to fall. However, as we have said consistently, these times are far from normal.

Readers will know already that we believe that the U.S. Treasury market is a gigantic wealth trap. Even before the Fed’s statement, investors seeking safety from European debt fears and staggering losses and unnerving volatility in the equities markets had flooded into U.S. Treasury securities. Nevertheless, this week has thus far seen a stampede into Treasury securities, causing yields to plummet. One-month Treasuries now yield 0.02 percent, making them no better than cash; the 5-year yields 0.93 percent, 10-year 2.17 percent and the 30-year 3.56 percent. Assuming a Consumer Price Inflation rate of 3.2 percent, all new investors in U.S. Treasury securities with a maturity of less than 30 years are losing ‘real’ money. In addition, with little prospect of further interest rate reductions the possibility of capital gains through Treasury investments are essentially nil.

These negative returns will eventually act as a pressure for funds to drift away from the bloated bond market into the beaten down equity market. But the total size of the global bond market is more than twice the size of the global equities markets, so these fund flows, when they occur, may make an outsize impact on equity prices.

In addition, the Fed is debasing the U.S. dollar at an increasing rate. Despite the fact that other nations are following suit to protect their exports, the dollar is set to fall further. Indeed in criticizing the S&P downgrade last week, Former Fed Chairman Greenspan said that the Fed need not be concerned about debt service because it can just “print more money!”

Facing negative real yields, the prospect of further credit rating downgrades and a falling dollar, investors in U.S. Treasuries are setting themselves up to be plundered.

On the other hand, despite recession fears, the upward march of gold continues, with many mainstream investment firms now setting price targets north of $2,000 per ounce. But skepticism remains, with some analysts pointing out that the price of gold is in “record” territory and is therefore highly speculative. However today’s gold price of $1,760 is still about 30 percent below the inflation adjusted high set in 1980 when gold struck $850 per ounce. From my perspective, with a sovereign debt crisis threatening, a currency collapse looming, and a chronically persistent low interest rate regime, gold looks positively cheap.

by John Browne, Senior Market Strategist at Euro Pacific Capital

Although I believe gold still faces a very rosy future, an agreement in Washington that avoids default and growing concerns of a global economic slowdown could create significant near-term headwinds for gold investors.

While the dysfunction of the US government is on stark display over the debt ceiling negotiations, other areas of the world show similar policy confusion. In the European Union, great doubts exist as to how the leaders will be able to stem the tide of serious sovereign debt contagion without inviting recession and an uptick in inflation. In China, commentators seem to lack confidence that the economy can maintain its impressive growth rate if its major trading bloc partners fall back into recession. This uncertainty has created a level of financial fear that has contributed to gold’s run up to more than $1,600 per ounce. However, this also means that any weakening of these fears could lead to a pull back in gold. An agreement in Washington, however meaningless, may be such a trigger.

Evidence has grown that the United States government has no real intention of curbing its spendthrift ways. By next Tuesday, Congress will likely reach some sort of pallid agreement that will involve a short-term agreement to raise the debt ceiling just enough to postpone an imminent fiscal crisis until after the 2012 election. This will, of course, be another case of kicking the can down the road – and will only further compound the very problems that have helped send gold soaring. Still, any agreement that prevents an immediate default on Treasury debt will be greeted with great relief in the markets. The good feelings may spark a short-lived rally in stocks and sell-off in gold.

Another near-term hurdle for gold will be the dawning realization that recession may take hold once again in many regions around the globe, most notably in the US and eurozone. To the extent that these recessions are deflationary, they could drag on the gold price.

Despite the agitation of the freshman Tea Party members of the US House of Representatives, there appears little or no serious discussion about curbing the rise of runaway government spending that is acting as a crippling parasite on the US economy. Similarly, the punitive nature of the present so-called sovereign debt rescue packages in the eurozone likely will fan the flames of recession in Europe. To the extent that these downturns are not met with new money-printing, they could hypothetically hurt the gold price.

This is especially true if the implosions among Western economies impede the growth of China. For now, it appears China’s breakneck growth is indeed slowing, but it is neither clear what role their export markets play in this nor how quickly they will be able to shift to a domestic-consumption model.

In normal times, these deflationary forces could present long-term problems for the gold price; however, these are not normal times. Rather, we believe the stage is being set for the currency catastrophe we have long forecast. In our calculation, the sovereign debt problem likely will increase. Eventually, even suddenly perhaps, it will lead to a currency crisis. This may cause a temporary capital shift from the euro into the US dollar, temporarily correcting the current dollar slide. But very quickly, I expect investors would realize that the US dollar itself is most vulnerable. As it is the international reserve currency, this might very well threaten a currency collapse and a surge in the price of gold.

In summary, gold appears set on a very strong upward path. However, in the short term, if global recessionary forces re-emerge and/or investors become euphoric over the US dodging a debt default, gold could face a significant price correction. If governments inflate wildly in a futile attempt to avert a pending depression, leading to stagflation, as we expect, then gold should rebound in price.

This should not be construed as an appeal for investors to sell their gold and try to time their way back into the market. Rather, I would suggest that there may be some discounted opportunities in the coming months. Hold on tight for turbulence ahead, and keep your bearings fixed on your intended destination.

by Peter Schiff

Imagine a day when you go to buy a quart of milk, ask the price, and the cashier says, “that’ll be a tenth ounce silver.” As the US dollar’s decline accelerates, several efforts around the country are trying to make this vision a reality.

Historically, paying for items in silver or gold was actually quite common. We happen to live in an unusual time and place where generations have grown up trading exclusively in paper. While my parents still used dimes made of silver, we have now gone several decades with no precious metals in any of our official coinage. But this system of money by government fiat is unsustainable.

While the practice of bartering precious metals directly for goods and services has continued on a small-scale over the last few decades, the 2000s saw the beginning of organized efforts to revive gold and silver as money.

THE LIBERTY DOLLAR

One such effort was spearheaded by an eccentric mintmaster from Hawaii named Bernard Von Nothaus. He called his project the Liberty Dollar, and it centered on privately minted gold and silver rounds as well as deposit certificates for precious metals held in his firm’s vaults.

I had many reservations about how the project was implemented – coins were minted with a fixed US dollar amount at which they were supposed to circulate, the dollar amount was well above the spot price of the metal, and authorized “distributors” were allowed to pocket the difference (which often resulted in buyers paying far higher prices for their gold than what they would have paid had they simply bought, say, Canadian Maple Leafs instead) – but I believe Nothaus’ idea was a good one, even if the product was over-priced. Tellingly, despite the obvious flaws, public participation grew steadily from 1998 until 2007, when federal agents raided the Liberty Dollar’s offices on trumped-up charges of counterfeiting.

Really, they were charging him with competing with the US dollar’s monopoly privileges by offering a better product. It’s important to note that the case against Nothaus was built around his coins looking similar to official US coinage (though no one actually mistook Liberty Dollars for US currency), and not around encouraging people to use precious metals as circulating money.

DIGITAL GOLD

Next came a crop of internet-based currencies backed by gold and silver. Most prominent among them are eGold and GoldMoney. Both were designed to allow customers to open online accounts that were valued in, and backed by, gold and silver bullion.

eGold was perhaps the better known of the two until it, too, was shut down by the US government on charges of money laundering. eGold was positioned more as an online payment system than a means of holding bullion. Due to the anonymous nature of the transactions – it was akin to spending cash – the authorities alleged that it was being used by criminal enterprises to funnel illegal funds. But mostly it was being used by regular people to begin saving and trading in money that holds its value. eGold had a transparent system of annual audits and live transaction screening by any user to keep the system honest. It, too, was growing robustly, and was putting up strong competition against PayPal until the authorities intervened.

GoldMoney, founded by my friend James Turk, has remained in operation by keeping its principal operations overseas and by cooperating fully with onerous US financial regulations. It offers similar services to eGold, but with an emphasis on long-term storage. GoldMoney improves upon traditional storage by locating offshore, offering real-time online account access, and providing extra liquidity. These services do come at a cost, however. Still, over the course of the last decade, GoldMoney has swelled to over $2 billion in assets. Clearly, many people want to trade gold and silver over US dollars.

Digital gold is a niche service, but I think the public’s rapid embrace of these projects – none older than ten years – shows that investors are viewing gold and silver as more than mere commodities, but once again seeing them as money. This could signal a paradigm shift back to tradition, which is good news for any precious metals holder.

STRAIGHT UP BARTER

While digital currencies are neat, in practical terms, nothing beats the resilience of traditional barter of bullion for goods and services. If you actually own the physical gold and silver that you intend to save or trade, then you can be sure it will be there until you’re ready to sell. You don’t have to trust anyone except yourself.

In that vein, several efforts have popped up around the country to simply get people trading gold and silver rather than dollars. Since the transactions involved are usually small, such as buying lunch at a local diner, silver is typically the metal of choice.

There are several hotspots for this sort of activity.

Philadelphia has one group, DelValley Silver, that has fostered a local barter market there by encouraging merchants to accept silver coins in addition to dollars. DelValley is also a silver dealer, but they sell privately minted rounds, which can be harder to liquidate than well-known coins like the American Gold Eagle and Canadian Maple Leaf.

Meanwhile, in New Hampshire, many merchants associated with the Free State Project have begun accepting gold and silver at their businesses. Innovation abounds here and the practice of encasing small amounts of silver in laminated cards seems to be the most successful.

Shire Silver encloses silver and gold wire in their cards and measures them in terms of grams. It’s much easier to trade a flat, plastic card containing a gram of silver than to carry around a 1 oz coin. However, even their website will admit that the premium on such a small amount of silver makes it less than ideal for investment purposes. Of course, when you’re ready to barter, they’ll be happy to take your 1 oz rounds in return for some Shire Silver. And that Shire Silver is being accepted by more and more merchants across New Hampshire and beyond.

Another variation, from a group based in Phoenix, Arizona, encloses a pre-1965 US dime inside the laminated card. Before ’65, every dime contained 90% silver, making them worth about $2.50 each in today’s debased dollars. That’s why you won’t find any pre-’65 dimes in your change from the grocery store. However, one fellow had the clever idea of putting them in these cards so they could trade at their silver value without getting mixed in with the worthless dimes we carry around today. The same group even created a free iPhone app that translates US dollar prices into various amounts of silver (more info here).

While I’ll still be selling regular old bullion coins and bars at Euro Pacific Precious Metals, because these are the best way to invest in physical precious metals, I am energized by these efforts. The great thing about holding and bartering physical precious metals is that there is no central company running the operations, like with the digital gold currencies, and therefore there’s no single person the government can go after.

(My new offshore bank, Euro Pacific Bank, Ltd., will soon be offering Visa-branded debit cards back by individual holdings of gold or silver. Euro Pacific Bank customers will be able to purchase gold from the bank, have it stored, and then access their holdings directly using their Visa cards to either make purchases though merchants or withdraw cash from banks and ATMs. Unfortunately, due to the reasons described above, I cannot offer this service to US customers. For more information about my offshore brokerage and banking companies, please visit www.europacintl.com.)

THE WRITING IS ON THE WALL

Besides these grassroots efforts at building barter communities, I’m seeing a cultural shift in favor of precious metals. Utah recently passed a law establishing gold and silver as legal tender and abolishing state capital gains taxes on their appreciation. I was interviewed for a new animated film called Silver Circle that features a rebel group in the near future which mints silver coins in defiance of an even more aggressive Federal Reserve. More and more people are starting to watch the gold price as often as they watch the Dow.

Peter Schiff is CEO of Euro Pacific Precious Metals, a gold and silver dealer selling reputable, well-known coins at competitive prices. To learn about our products and policies, please visit www.europacmetals.com or call us at (888) GOLD-160.

by John Browne, Senior Market Strategist at Euro Pacific Capital

This week, in the second in a series of less-than-impressive press conferences, Fed Chairman Ben Bernanke offered market observers little hope that any additional quantitative easing programs are on the horizon. The Chairman continues to cling to the position that the economy is improving (with the recent “soft patch” attributable to external forces) to the extent that additional Fed support will be unnecessary. Left unsaid was any guidance as to who the Chairman believes will buy the massive amounts of Treasury debt formerly swallowed up by the QE II program?

The logical conclusion is that Bernanke believes that there will be massive private sector demand for U.S. Treasury securities. If so, how long can it be expected to last? If the economy improves, as Bernanke expects, would it not be logical to assume that private investors would direct capital to more promising sectors than ultra low yielding U.S. sovereign debt? Clearly something does not add up. Judging by the Chairman’s halting delivery and sheepish demeanor, it appears as if he knows his position is untenable.

We have argued repeatedly that the inflation created by the unprecedented Fed monetary expansion remains hidden beneath the larger deflationary forces of a major recession. When banks inevitably start more aggressively pushing their Fed-supplied funds out to the broader economy through increased lending will the full inflationary impact of quantitative easing be felt.

If the Fed were true to its word, and could hold in abeyance any additional quantitative easing programs, inflationary concerns would justifiably drop and precious metal prices should be expected to dip. Given that many market participants are giving credence to these intentions, this very well may happen in the short term.

However, we do not believe that we have seen the last of QE. In fact we see the launching of the next monetary juggernaut as a nearly foregone conclusion. It is very likely that if the economy fails to improve as Bernanke anticipates he will reflexively reach again into his monetary bag of tricks. Nothing he has said has ruled out another round. If the door remains open, we should assume he will use it if the going once again gets rough.

For now however, the global winds may strengthen Bernanke’s hand. New and troubling developments in the long running Greek debt crisis have unleashed a knee jerk “flight to quality.” Investors have purchased U.S. dollars, giving it unexpected and to some extent unwarranted strength. More significant demand for U.S. Treasuries pushed yields down to fresh lows for the year.

Today, one-month bills earn only 0.01 percent. Five-year Treasuries yield only 1.48 percent, ten-year less than 2.9. These historically low yields are killing living standards of retired and middle-income investors who rely heavily on interest generated from bonds. Although the returns are minimal, these securities are nevertheless dangerous. They are backed by a government that has over $100 trillion of unfunded debt, whose published Treasury debt is forecast to reach 70 percent of GDP by year end, and which has embraced currency debasement as a national economic policy. When market perceptions focus more intently on these risks, and when the more meaningful returns offered by other asset classes become irresistible, private demand for Treasuries will evaporate.

But there is no logical scenario that will allow the status quo to persist. If the economy improves, inflation will flare and risk assets will become more attractive. This will reduce demand for Treasuries, and cause interest rates to rise, thereby impelling the Fed to launch more QE in a single handed effort to keep U.S. interest rates low. On the other hand, if the economy continues to deteriorate more, QE will be “needed” to keep the current recession from becoming a depression.

Either way, those betting that a Fed retreat from intervention will push up the dollar over the long term, or spell the end to surging inflation expectations, will likely be disappointed.

by John Browne, Senior Market Strategist at Euro Pacific Capital

This week saw the type of downside volatility in the precious metals market that will be remembered for years to come. For those of us who have been long gold, and silver in particular, the memories will not be pleasant. While many had been expecting a pullback in silver, when the violence did come it was nevertheless shocking. Silver shed one third of its value in less than one week. And while gold was pulled down by the general sell off in all commodities (oil, copper, coffee, etc.) the yellow metal shed only 6.5% during the carnage. Those mild losses should remind us that  gold is not just another commodity, but has monetary qualities that tend to smooth out volatility. But will silver survive the vicious downturn?

First, despite all the valid reasons that, in an era of perpetual quantitative easing, silver had become an attractive asset class, it had become clear in recent days that it was overbought. Leading up to April 28, the price of silver rose by more than 150 per cent in U.S. dollar terms over the prior year. On Wall Street momentum always attracts momentum, and as a result, the ascent accelerated in April, with silver rising 31 per cent from April 1 to April 28.

A “hot” commodity tends to attract leveraged speculators. As a result, the rise became more technical than fundamental. Its recent sell off should be viewed on the same terms.

After an exponential rise, supercharged by leveraged speculators, silver was bound to attract the attention of short sellers. In addition, silver speculation became more expensive as the Chicago Mercantile Exchange raised the margin requirement for buying silver futures five times in just one week! Factoring in all of these increases, the last of which becomes effective this coming Monday, the cost of owning silver futures contracts will have increased a staggering 84 per cent from the beginning of May. The rationale behind these moves requires serious inquiry…which I will leave to more informed columnists. But the results were predictably dramatic, as many leveraged players were forced to liquidate.

In addition to these technical catalysts, other factors contributed to the decline this week. Facing pressure from domestic exporters who complain about an overly strong euro, there are signs that the ECB is losing its commitment to vigilance against inflation. This has led to speculation that the U.S. dollar could strengthen for the remainder of the year. This could adversely affect the price of precious metals. In addition, with private sector unemployment rising in the United States, there is a risk that the U.S. economy could be entering a second, or double dip recession. This would lower the risks of overt inflation and dampen the industrial demand for silver.

But as far as long term fundamentals are concerned, the case for precious metals remains intact. First, as long as the Federal Reserve and other central banks around the world continue to treat fiat currencies as monopoly money, investors will be seeking alternative currencies as a hedge against inflation. But until bank lending to consumers and businesses increases dramatically, the dangers of hyperinflation will remain largely hidden from the broad swath of investors. As a result, silver’s upward price movements will be vulnerable to panic selling.

But from my perspective the biggest driver in purchases of silver and gold is likely a fear of a meltdown of the dollar and a collapse in the financial system. There are few signs that these fears have abated with the selloff in silver. The U.S. dollar is still standing close to a 3-year low against the dollar index. If more rumors spread that the dollar may lose its reserve status, the greenback could plummet. It is perhaps this perceived risk that has provided the majority of the force behind increases in precious metals over the past year. It is important to remember that the fundamental strength of metals attracted the speculators, but speculators did not create the bull market. It is my feeling that it will endure without them.

While a threatened recession and a stronger dollar should deflect inflation expectations in the short-term, the longer-term risk of a debt crisis spreading into a currency crisis remains. Indeed, the risks of a currency crisis are increasing. For investors who share this view, and who can tolerate the volatility, the reduced prices of silver may be attractive.

by Peter Schiff, CEO of Euro Pacific Precious Metals and author of the hit economic parable How an Economy Grows and Why It Crashes

I have worked on Wall Street my entire life, and one thing I’ve learned is that large institutional investors, like pension funds and endowments, rarely veer from the herd. They manage too much of other people’s money to stick their necks out alone – if their investments go bad, at least they can point to everyone else who fared just as poorly.

For this reason, these funds are often lagging in their perception of crucial market changes – changes such as a doomed currency. While many of us are buying precious metals to hedge against the collapse of the dollar, gold and silver have been taboo investments on Wall Street for years. Fund managers are taught that gold is a “barbarous relic” – much better to stick with government bonds and blue-chip stocks. That’s what everyone else is doing.

But there are early signs that the herd is changing direction.

THE CURRENCY THAT CAN’T BE PRINTED

In a remarkably under-reported story, the University of Texas’ endowment fund – the second largest in the country, after Harvard’s – added about half of a billion dollars worth of gold to its portfolio just this month, on top of the half-billion it purchased several months prior.

The university’s endowment now owns a staggering 6,643 bars of bullion (664,300 ounces), which have already appreciated by over $40 million since mid-April when the bars were delivered to a dedicated HSBC-owned vault in New York City. Not a bad start.

Kyle Bass, the well-known Hayman Capital hedge fund manager and UT endowment board member, advised the university on the purchase. He stated his reasoning plainly: “Central banks are printing more money than they ever have, so what’s the value of money in terms of purchases of goods and services? I look at gold as just another currency that they can’t print any more of.”

Apparently, the university agrees that sitting on a pile of fiat paper is an act of faith not befitting a prudent and enlightened institution.

AN INSTITUTIONAL AWAKENING

The purchase is certainly causing a few heads to turn.

Now that a major endowment has taken this step, other fund managers are going to be emboldened to follow through on their gut instincts. These are smart guys, after all; they are aware that although their funds may be posting nominal gains, they are losing much more in purchasing power. I’m sure many have privately bought precious metals, but now they have cover to do so professionally.

Perhaps the most interesting part of UT’s billion-dollar repudiation of Fed Chairman Bernanke and his printing press, however, is that the fund demanded physical delivery of the bullion. While more commonplace in Europe, this is truly unprecedented for a stateside institution.

The delivery of physical bullion has at least two important implications. The first is that UT perceives gold to be a long-term strategy for wealth preservation, as opposed to a short-term speculation. The second is that UT must be somewhat concerned about the stability of financial markets in general, so it wants to own physical gold safely stored in a vault, as opposed to owning paper claims, shares of gold funds, or other instruments with counterparty risk.

HUGE RAMIFICATIONS

I have long recommended that investors hold at least 5-10% of their portfolios in physical precious metals. UT’s $1 billion position represents roughly 5% of its $20 billion endowment, so they have reached my minimum recommendation – but likely have more buying to do.

As endowment after endowment decides to sell billions of Bernanke’s dollars and diversify into gold, what might this do to the gold price? If these colossal funds start getting the idea that holding 5% of their portfolio in gold is more conservative and intelligent than holding the current average of 1%, what will this mean for gold demand? The answer is obvious and the ramifications huge.

ONE SMALL STEP FOR INSTITUTIONS, ONE GIANT LEAP FOR GOLD

If US university endowments were to increase their gold positions from the current average of 1% to an average of 5% of their portfolios, it would equal $20 billion, or roughly 400 metric tons of gold at today’s spot price. This is significantly more than the entire yearly gold production of China, the world’s largest producer.

Beyond endowments, private foundations in the US, with 2010 assets totaling nearly $600b, would similarly require nearly 600 metric tons of gold if they sought to hold 5% of their assets in the metal – almost twice China’s yearly production.

And again, these are just US endowments and foundations; there’s a whole world of demand beyond the borders – and we can’t forget sovereign wealth funds (SFWs).

The largest SWF in the world, Abu Dhabi Investment Authority, has assets worth over $600b alone. The second and third largest funds, Norway and Saudi Arabia, together constitute roughly a trillion dollars in assets.

GETTING IN BEFORE THE HERD

The point here is simple: the total investable funds around the world are immense relative to the size of the gold market. It’s not hard to perceive what a simple move from 1% to 5% of the average institutional portfolio would do to the price of gold, and this why the University of Texas’ bullion delivery is so important – it’s a vivid indication that such a move is now taking place.

Gold remains widely neglected among the big-money players, but it’s clear that they’re beginning to come to terms with the US dollar’s terrible prospects. After all, while fund managers don’t want to veer from the herd, they also don’t want to follow the herd off a cliff.

The University of Texas, with its billion-dollar stash of physical gold, is one institution that has finally seen the cliff. The physical delivery of this purchase exemplifies the severity of the threat that UT’s endowment board perceives.

The average investor should recognize that there is little time left to purchase precious metals before substantial new demand drives the price of gold higher. A very small percentage change in large institutional investment is all that’s required for massive gold price increases.

I believe we are on the cusp of a smart-money gold rush. It will drive gold to a record in real terms, even before retail investors join in. Though you may have missed the last decade of gains, there is still a chance to buy in before the stampede.

Despite loud huzzahs from a variety of boosters who proclaimed that Chairman Bernanke spoke with gravitas and wisdom at the first ever Federal Reserve press conference, the wider investing public clearly saw the performance as unconvincing. During and immediately after the proceedings the prices of gold and silver rose strongly to new highs as the U.S. dollar plummeted. The affair seemed to solidify the understanding that Bernanke and his cohorts have no intention whatsoever to reverse the current trend of inflation and a weakening dollar.

With all the preliminaries swept away, it appears that the great dollar slide that we have long feared will not be interrupted. In the last year alone, the dollar has fallen 25 per cent against the Swiss Franc, (the gold standard of fiat currencies) – with one quarter of that decline coming since the beginning of April alone. Against gold itself (the gold standard of all forms of money), the decline has been even worse, 31 per cent so far this year, and 8 per cent this month.

Ominously, the dollar index (the broadest measure of dollar strength) is just a percentage point or two above the all time lows that it set before the financial panic of 2008 sent spooked investors into the apparent safety of America’s deep and liquid Treasury market. It appears that spell has now been fully broken.

Bernanke’s press conference was heralded as a chance for the press to ask penetrating and unscripted questions to the Chairman. However, only a handful of reporters were selected and they were limited to single questions. As any lawyer will tell you, usually it is not a single question, but a line of questioning that tends to tease out the truth.

In addition, it is no accident that Bernanke called upon reporters who were likely to tread lightly upon him, including the reliably supportive Steve Liesman of CNBC. One intrepid Financial Times reporter even asked the Chairman how the investing public can be persuaded to give up their irrational fear of inflation!  Given the supportive environment it was easy for Bernanke to appear commanding and reassuring while skirting the key issue of latent inflation.

Clearly however, Chairman Bernanke still was worried about the slow pace of the U.S. recovery. Claiming substantial success for his QE1 and 2, he left the door at least partially open for a QE3. Perhaps this, more than anything, tipped his hand to the anti-inflation hawks. Most probably, they continue to believe that the Fed will assist the Administration in its bid to inflate out of recession by means of political life support rather than genuine consumer demand. Many investors now accept that the government’s plan involved debasing the U.S. dollar to erode the massive and profligate debts of the U.S. Treasury.

Key to the reasoning of Bernanke and his FOMC are balancing the rates of inflation and unemployment in pursuit of the Fed’s dual mandate of securing sound money and employment. Somewhere along the way, although never proclaimed officially, the Fed decided that its “mandate” compels them to maintain inflation at a minimum of 2 per cent annually.  With Bernanke citing the official inflation rate at 1.3 percent, the conclusion is easily made that the Fed sees no reasons to step on the brakes.

At the same time he expressed sympathy for those American householders who are experiencing inflation at least in double digits for oil and food. This means that, in terms of real money, all investors in bank deposits are being robbed of some 8 per cent each year. This hidden transfer of wealth from the private to the public sector and their banks is just part of the massive general and stealthy transfer of wealth from the private sector.

In 1994, in response to political pressure the formula used to calculate unemployment figures was changed. It is my belief that the current methodology understates the true number of unemployed. Most notably this was achieved by excluding those unemployed over the long-term. Although knowing this better than anyone, Bernanke expressed concern about the level of long-term unemployment. However, in claiming to show the efficacy of his recent policies he continued to quote the 8.8 per cent unemployment figures that exclude such workers. If he had included them the real level would be some 16.2 percent.

While the stock markets welcomed the fact that Bernanke intends to continue his covert inflationary policies, the currency, gold and silver markets were not fooled and gave Bernanke a resounding thumbs down.

by John Browne, Senior Market Strategist at Euro Pacific Capital

As a result of active “demonetization” efforts by the IMF and its member central banks, gold and silver have experienced the type of volatility that has given conservative investors reasons not to perceive the metals as dependable cash alternatives. Instead gold and silver have become known as the asset class to hold as a hedge against inflation.

However, during the 1990′s, when inflation was in general much higher than it has been since the turn of the millennium, gold and silver prices drifted lower and stagnated. However, since 2000, gold and silver have risen by over 400 and 700 percent respectively. Remarkably, this has occurred over a time frame during which, by most accounts, low inflation has prevailed.  How can this be explained?

In 1944 when the U.S. dollar was considered ‘as good as gold,’ it was made the international reserve currency. This unique status is the reason that Fed Chairman Ben Bernanke was recently able to say that, “The U.S. Government has a technology, called the printing press that allows it to produce as many dollars at it wishes at essentially no cost.”

Today, with the Federal Reserve treating the greenback as a never ending lottery ticket for deficit spending politicians, many investors feel the U.S. dollar is good for nothing. As a result there is an increasing international pressure to remove the U.S. dollar’s reserve status. Given that there is no widely accepted alternative to the dollar (the euro has many problems of its own), this is creating fears of an international currency crisis, which has fueled interest in precious metals. So metal prices have risen even with low inflation expectations.

In order to paper over the effects of the financial collapse, central banks around the world are printing as fast as their presses can manage. But unlike prior periods of monetary inflation (like the 1970′s), some major powers (China) are withdrawing liquidity. In addition, emerging market manufacturers are holding down prices even as currencies lose value. This may explain the strong performance of metals despite seemingly manageable inflation. But if higher prices emerge into the light of day (as they already have in commodities), currency uncertainty combined with high inflation should intensify the market for precious metals. The question then becomes how to play the market.

Gold has always been the reserve asset of choice for central banks and major private investors. But now, as smaller investors become aware that paper dollars are under threat, many are looking towards silver. Taken in aggregate, these smaller investors have enormous buying power. Through ETF’s and mining stocks they are not bound by government restrictions on holding precious metals in retirement funds. In contrast to gold, central banks do not hold much silver. They are therefore less able to push down the price of silver by dumping inventory when rising metal prices undermine currency confidence.

Indeed, so far this year, silver is up nearly 50% while gold is up only about 6%. Given these figures, investors may be forgiven if they feel that the big move in silver may be over. Technical analysis may provide comfort.

According to the U.S. geological survey silver is about 17.5 times more abundant than gold in the earth’s crust. This ratio has long been appreciated by civilizations throughout history. Thus, in 1792 the newly formed U.S. Congress passed the First Coinage Act, which legally set the valuation ratio of gold/silver at 15 (it was raised to 16 in 1834). In the early 1990′s, with silver out of favor with investors, the ratio approached 100. At the beginning of this century gold stood at some $250 an ounce and silver at $4, putting the ratio at about 62. Today, with gold at around $1,500 an ounce and silver at $45, the ratio has closed to around 33. But this is still far higher than the ratio seen in the late 1980′s (silver’s last mega spike), and if far higher than the natural proportions of gold and silver would suggest.

The demand for physical silver also remains strong, which supports the market for spot silver. Smaller investors may find gold too expensive at $1,461 an ounce, but may be nevertheless prepared to buy several ounces of silver for much less. Potentially, this ‘poor man’s gold’  market may help drive silver prices far faster than gold.

by John Browne, Senior Market Strategist at Euro Pacific Capital

It is rare in recent history for precious metals to appreciate in parallel with the broader stock market. Yet, this has been the case in the two years since the stock market began crawling out of the wreckage of the 2008 financial crisis. Although metals have vastly outperformed US equities over that time frame, it is noteworthy that stocks have gone up at all. Since January 2, 2009, the S&P 500 stock index is up just about 50%. Over the same time, gold is up 68% and silver is up a staggering 267%. With rising interest rates, oil at over $100 a barrel, and the recovery running out of steam, many investors are wisely asking if the markets are set for a sharp pullback. Given the correlation that we have seen across asset classes, some are making the seemingly logical conclusion that metal prices are vulnerable.

The results of 2008 loom large in many calculations. In the second half of that year, when the extent of the financial catastrophe emerged into the light of day, the S&P 500 dropped some 31%. At the same time, gold dropped by more than 7% and silver almost 39%. Recent volatility in the shares of gold and silver mining stocks reveal that the fear of such reversals may be a growing concern among investors.

But one example does not a rule make, especially the example of a panic rush into dollars and US Treasuries. Wise long-term investors make decisions based upon fundamentals, and those for precious metals remain strong.

Throughout history, precious metals, especially gold, have been seen as a store of wealth and a hedge against inflation. But the assumption that gold is always negatively correlated with the stock market is incorrect. Rather, gold is negatively correlated with stability. For all intents and purposes, gold is equivalent to cash in a portfolio. In that role, it competes with the major fiat currencies.

Gold’s rise has thus been driven by cash demand on two fronts.

First, while US savers have been pushed into the stock market in search of yield for a couple decades, the underlying value of the US dollar has deteriorated. This has driven more investors to allocate the cash portion of their portfolios to precious metals, even while the S&P rises. Both of these dynamics are motivated by the Fed’s low interest rate policies since the early 1980s.

But a policy that causes precious metals and the stock market to correlate on the upside will cause them to diverge on the downside. As the Fed is forced to tighten interest rates, stocks will take the brunt of slowing economic activity. Still, we don’t expect the Fed to be able to tighten to the level that real interest rates rise, i.e. bank interest pays more than the rate of inflation, because this could cause the federal government to default on its debts and further harm the teetering housing market. In an environment of negative real interest rates, gold should continue to rise.

The second front driving cash demand is the explosive growth of Asian markets. Traditionally, certain cultures, such as in India and China, have favored gold and silver as both a display and as a store of wealth. As wealth has been accumulated fast in these countries, their demand for gold has increased greatly. In addition, their central banks and those of other nations, such as Russia, also have been massive buyers of gold in recent months. This trend is a continued bullish indicator for precious metals regardless of how the US markets perform.

How might these two factors ultimately benefit gold and silver?

There is a growing realization that recent economic growth has been financed by huge Federal Reserve subsidies. This has built up bullish momentum in the metals market that should continue until real interest rates turn positive. And even if interest rates do rise (which could be a negative for metals) prices of existing Treasuries will fall. Investors selling at a loss may turn to precious metals as an alternate safe haven.

Meanwhile, important international interest rates are already rising, including in such key economies as China, Australia and in the EU. These moves should channel the inflationary impact of QE and artificially low U.S. interest rates back into the dollar, thereby exerting upward pressure on the dollar prices of precious metals.

However, what may be the single greatest upward price pressure is the increasing fear of a debt crisis leading to a currency collapse. It is important to recognize that, at $1,470 an ounce, gold stands at only some 61 percent of the present value of its 1980 all-time high of $850, which, adjusted for inflation, is some $2,400 an ounce. Given the frail state of the US economy today, the chance of a local collapse is much higher than in 1980, when America was the world’s largest creditor – instead of its largest debtor.

Therefore, it appears that, despite some volatility, the price of precious metals could be set for a continued rise, and the stock market for a steep fall. Indeed, if inflation materializes at rates equal to those of 1980, a gold price above $2,400 looks feasible. Should it be accompanied by increased fears of a debt crisis and a threat of collapse in the US dollar, far higher prices could be in store.