The New McKenna’s gold Rush

The glitter of gold, or rather its irrevocable sheen has been the universal theme stretching across market headlines and analyst reports in recent months. Talks of an increasing number of central banks –from the tiny island of Mauritius to the Indian tiger and the Asian Dragon – diversifying and upping the percentage of reserves held as gold brings to the forefront an important question -
Are we at the threshold of a crisis of confidence in the paper standard and if so, is the world headed back to the once-abandoned Gold standard?

Before we begin to logically reason out this spurt of interest in gold at $1000+ than at $750 at the beginning of the year, would like to throw some light on certain facts:

While the diversification to gold by central banks gets continually highlighted, is the financial world missing out an important truth ?– that, an international organization which oversees the global financial system with a particular eye on exchange rates and balance of payments of nations a.k.a. IMF should be doing just the opposite - selling its gold.

Nay-sayers may still debunk the above reasoning on the ground that the IMF continues to be one of the largest official holders of gold in the world and therefore its gold sales of 403 metric tones merely represents 13% of its total gold holdings. Even if they were true, isn’t it still a no-brainer that for every buyer, there ought to be a seller? .And since this is applicable even to commodities, if the whole world is suddenly evincing extraordinary interest in gold and buying it (and defacto selling dollar ), who exactly is selling that much to meet this voracious world demand.

The most often heard rationalization for the recent rise is that markets are sniffing a real threat of inflation or very simply a loss of purchasing power in the dollar. If this premise was true, then I believe that only a completely irrational being or very simply a fool would be out there selling his gold for the rest of the world to enjoy.

Fully convinced of the maxim that the primary job of the markets is to fool the maximum number of people the maximum possible number of times, I’m led to believe that this new rush for gold may infact fizzle out into a kind of bubble seen in oil just last year. $1300 is still reasonably probable, but should infact pave the way for a reversal in the fortunes of gold for atleast 1-1.5 years and to this end, a break below 1030 would serve as a key signal.

And why so?

The world at large, Asia in particular is known for its large holdings of US debt. While on one hand, talks are rife with them diversifying out of dollar, there is no denying of the fact that the appetite for US debt continues to grow, albeit at a slower pace

I often wonder if Asia is so blind so as to finance the US’s insatiable demand for credit, if it knew fully well that there could be a potential default? Or, is it so foolish to accumulate dollars, only to later diversify into something that is non dollar, fully taking on the cost of exchange risk.

Since the scenario of a sovereign default by the US is by no means inconceivable, in my opinion the dollar could actually rise in the face of a default before it falls.

Simply because before America defaults on its debt, it would first buy time in the form of a postponement of repayment commitments and this in itself could trigger a scramble for dollars amongst its creditors/world .This in turn should lead to a spectacular round strength in the dollar, for which creditor before deciding to write off a bad debt would not first demand it ? And since the debt is denominated in dollars, the dollar should rise and with it ideally bring down all commodities, gold in particular, and non dollar currencies, except the yen.



Finally let me leave you with one random wild thought: Namely, wouldn’t it actually be in the interests of the holders of dollar debt to see the dollar rise (and euro fall) to say, a level close to parity ( 1 Euro =1 $ ) as this would only facilitate their diversification efforts at virtually zero market risk, before allowing the dollar to fall freely?

May seem far-fetched at this point, that the euro should fall to a parity before being able to command 2 dollars in exchange. But given the enormity of the stakes involved, it may not be an impossibility either.

Surprising, that an age old classic blockbuster - McKenna’s Gold should be teaching a very valid lesson – that, the mad rush for gold could be killing. Eventually, only a few make it big in this game.


Think about it.