Gold Surges on Inauguration Day; Concerns Regarding Derivatives, ETFs

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January 21, 2009

Yesterday was an historic day for the world with the inauguration of the 44th President of the United States of America.

Gold rallied by more than 2% despite continuing dollar strength and oil’s collapsing 7% to just over $34 per barrel (Light Sweet Crude Oil Future – Combined – FEB09: -7.6%) . While the dollar is up on hopes that President Obama can turn around the ailing US and indeed the global economy, stock markets internationally are under pressure again with increasing concerns regarding the international banking and financial system.

Obama has been left an unholy mess by his predecessors in both the Clinton White House and more especially by the irresponsible foreign policy, fiscal and economic policies of the Bush administration. We wrote about these challenges upon his election and unfortunately the situation has worsened considerably even since then.

The great hope is that Obama’s stimulus packages will lessen the effect of the deflationary slump. But unfortunately, the job creating elements of the stimulus packages will take months to come to fruition and the crisis is far more immediate than that.

As we have continually warned, the multi billion pound, euro and dollar bailouts (CNBC compiled statistics saying government bailouts have risen to $8.5 trillion and rising in the US alone) are proving ineffective and large parts of the western banking system look like they may be nationalized. This will transfer the much of the risk from the banks and the banking system onto sovereign governments, the bond market and tax payers. It is an extremely high risk strategy with the potential to backfire in the form of severe stagflation in the coming months, and ultimately the need for higher interest rates.

Monetary debasement has never been a sustainable way of creating real and lasting economic growth.

Concerns Regarding Asset Backed Derivatives and ETFs

There are increasing concerns regarding a collapse of the derivatives market and about asset backed derivatives and some exchange traded funds (ETFs). Clive Hyman of Hyman Capital Services told CNBC said that there is no liquidity in some of the commodity traded items and some of the commodity backed derivatives “may well have reached the end of the line”.

He said that gold was doing well and would likely continue to do so and that private investors were trying to access the market but difficult to do as type of sums that investors are trying to shift are very large. Hyman said that he had never come across this in his 47 years in the business. The gold market remains tiny vis-à-vis the stock, bond, currency and derivative markets.

This is a reminder that physical gold should be owned and not derivatives such as ETFs, which are subject to considerable counter party risk (and with annual charges are also less cost effective than safer ways of owning gold).