By Patrick A. Heller May 11, 2010

With all the financial turmoil in Europe over the past week, the U.S. dollar has risen in value against almost all other world currencies.  Even with the $1+ trillion rescue package (including significant assistance from the U.S. government – meaning U.S. taxpayers) set up to assist Greece and other European countries with their sovereign debt crises, currencies like the euro are shaky enough that investors are scurrying to get out of it.

Most mainstream investors think in terms of which currency into which they will park their investments. Generally, they don’t think of gold (or silver) as representing an alternative currency at all. Among all the paper currencies, the U.S. dollar looks to be the “least bad” right now.  Therefore, in the past few days, investors are flooding into U.S. Treasury debt and other dollar-denominated paper assets

All of this positive news for the value of the U.S. dollar is just temporary. In reality, the U.S. government has grown the size of its debt and budget deficits past the point of no return. According to David M. Walker, the former comptroller general (chief accounting officer) of the federal government, and others, the U.S. government’s actuarial liabilities and debt now exceeds $100 trillion. This is so large, more than six times the size of the U.S. economy, that it can never be paid off except through hyperinflation of the U.S. dollar into becoming worthless.

The size of the “official” federal government budget deficit for the 2010 fiscal year is forecast to be $1.4 trillion dollars.  This is the much smaller “cash-flow” figure rather than the correct “actuarial” deficit which would include all the commitments that the U.S. government is now incurring but postponing payment into the future. Even using the smaller number, the size of the deficit is so huge that, at current gold prices, the deficit could purchase more than 30 percent of all gold mined worldwide over the past 5,000 years.

Keep in mind that this is just the “smaller” deficit figure for just one nation for just one fiscal year. Future federal budget deficits are projected by President Obama and his staff to continue on this scale for at least the next several years (which I consider to be hopelessly optimistic).

As more investors realize that the U.S. dollar is no more stable in the long run than other currencies, the demand for physical precious metals will inevitably continue to rise. So, even though the dollar may look somewhat strong at the moment, it is destined to collapse in value. Unfortunately, as we saw with the Dow Jones Industrial Average last Thursday, the value of the dollar could suddenly plummet so quickly that the average investor has no opportunity to get out “just in time.” With such a high risk of being hit with a sudden loss for holding U.S. dollars and dollar-denominated paper assets like stocks and bonds, the sensible step is to get out of the dollar right now – at a time when it looks to be temporarily overvalued.

In years past, value of the U.S. dollar typically had an inverse relationship with the price of gold. If one was rising, the other was declining. That has not been true for the past week or two. It is entirely possible that the current temporary jump in the value of the dollar could lead into a much higher gold price in the coming weeks.

Other news notes:

1.  The investigation into JPMorgan Chase’s silver trading practices is expanding. Commodity Futures Trading Commission officials have unofficially announced they are conducting a civil investigation of JPMorgan Chase. The Anti-Trust Division of the Department of Justice has now sent e-mails stating that it has started a criminal investigation against the company. The investigations would include trading conducted on the London Bullion Market Association by the bank’s London office. JPMorgan Chase does not yet face any charges from either agency.

In the fourth quarter of 2009, JPMorgan Chase’s derivatives position in the silver market increased by 220 million ounces.  I am confident that most of this was unleashed to help hold down the price of silver.

As JPMorgan Chase is the lead trading partner executing the orders of the Federal Reserve, it is hard for me to think that the ultimate results of these investigations will severely cripple the bank. However, just the existence of the investigations could be enough for the price of silver (then gold) to shoot upwards.

2.  Most major international financial conferences are arranged a year or more in advance.  On May 11, the International Monetary Fund and the Swiss National Bank will be co-hosting a meeting of a number of the world’s major central banks, financial companies, and market analysts to discuss the current global currency crisis. That this meeting was only announced on April 23 is a sign of the urgency and depth of the crisis that is now affecting global markets. I’m not sure how it will be possible to come to any kind of agreement on such short notice that would reassure investors in stocks, bonds and currencies. If this meeting completely fails, you know, I suspect that there will be a lot of pressure for the media to not even report on it. In my judgment, the results of this meeting will give a good indication of where paper asset and precious metals markets are heading in the next couple of weeks.

3. With the nearly panicked reaction in European and other markets late last week, and the loss of trillions of dollars in the value of paper assets, it was almost certain there would be a major effort to prop up European currencies and all stock markets on Monday.  That is just what has happened, with European stock markets up 5-9 percent on May 10, and almost all other stock markets up by a lesser degree.  The market manipulation required to pull off this accomplishment almost looks like it cost more than $1 trillion dollars. These amounts are so large that the central banks simply cannot afford to commit to this level of resources very long. Even with stronger markets for paper assets, gold and silver are not retreating. I think that any sign of weakness in any paper assets could be sufficient impetus to start a flood of investor money into precious metals, accompanied by quickly rising prices.

4.  I constantly complain that the mainstream media is totally ignoring what has really gone on in the world financial markets in general, and in the precious metals markets in particular. That is changing.  “The New York Post” is the source of the inside information on the CFTC’s investigation of JPMorgan Chase. Last Friday, the “Los Angeles Times” included a glowing story on the prospects for owning gold. It even included the fresh information that European demand for physical gold is so strong that it is already almost impossible to find any to purchase (which I consider a sign of what is likely to occur in the U.S. within two weeks).Patrick A. Heller owns Liberty Coin Service in Lansing, Mich., and writes “Liberty’s Outlook,” the company’s monthly newsletter on rare coins and precious metals subjects. Past newsletter issues can be viewed at www.libertycoinservice.com.  Other commentaries are available at Coin Update (www.coinupdate.com) and Financial Sense University (www.financialsense.com).

Gold Volatility Whips Market

By Patrick A. Heller February 23, 2010

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The gold market suffered but overcame two major onslaughts last week.

After U.S. markets closed last Wednesday, the International Monetary Fund announced that it would offer the remaining 191.3 metric tons of gold from its planned gold sales onto “the market” rather than central banks. By making it appear that more than six million ounces of gold might be dumped onto retail channels over time, some investors panicked into selling, which pushed down the gold price.

Gold eventually fell more than two percent but then recovered all lost ground within 24 hours of the announcement.

The nature of the IMF announcement indicated that it was done to drive down the price of gold. Revealing such plans is a tactic that guarantees that the IMF sells the gold for the lowest possible price. If the IMF was really trying to raise the maximum funds for its own operations, it would not sell its gold by this process.

The quick recovery in gold prices meant that another tactic was needed. Late on Thursday afternoon, the Federal Reserve announced that it had increased the interest rate banks would have to pay the Fed for overnight borrowings. This was meant to be a signal that interest rates might rise in the near future, which again knocked down precious metals prices.

Still, gold came right back the next day. Over the weekend, Asian markets climbed as high at $1,130. When the U.S. markets opened Monday, the price was immediately taken down to the $1,110-$1,115 range.

There is a huge incentive to hold down gold prices this week. Gold options expire Tuesday, with more than 5,000 call contracts (over 500,000 ounces) that could be exercised at a price of $1,100. Should the COMEX close Tuesday above $1,100, these contracts for immediate delivery would be called. That would put a supply squeeze on the dwindling COMEX gold dealer inventories, which are down 25 percent in the past three months to only 1.65 million ounces.

Also this week, Fed chair Ben Bernanke will be testifying before the House Financial Services Committee and Senate Banking Committee. There is an effort under way to encourage a member of one of these committees to ask Bernanke the very same questions about admitted Federal Reserve gold swap arrangements that the Fed has refused to disclose in response to the Gold Anti Trust Action Committee’s Freedom of Information Act Request. If ever there was a week that Bernanke needed to appear competent, this is the week.

The U.S. government, the member nation with the largest voting power in the IMF, leaned on the IMF to make it appear that some of its gold might be sold to the public (which, if it occurs, I think will at most be only a token percentage of the total), then risked crashing stock and bond markets by raising one of the key interest rates. To me, these actions were obviously taken solely to try to suppress the price of gold.

Such extreme measures worry me that there are some horrendous financial developments about to break. There are so many potential crises waiting to collapse that I cannot discern just which ones they might be.

In the short term, I expect extremely volatile gold and silver markets. I expect to see more extreme efforts made to hold down prices at the same time that demand for physical metals soars. Daily swings of 5-10% are possible. I expect that the result of all this volatility will be significantly higher prices than we see today.

The safest way to participate in the continuing long-term bull markets for gold and silver is to buy physical metals, not paper contracts, and avoid trading on margin. As prices are whipsawed, those with margin accounts could actually lose money despite prices eventually reaching new highs.

In the 1979-1980 bullion boom, I worked as a certified public accountant. One client was a commodity broker who personally bought several thousands of ounces of silver on margin. The day before the price of silver rose almost consecutively until it reached the January 1980 peak, it dipped about five percent. This client was unable to cover the margin call and saw his silver position closed out. If you don’t buy on margin, you won’t have this risk. At that time, I owned significant positions in gold and silver coins, almost all of which I sold in early 1980 for sizable profits.

The idea of purchasing precious metals on margin is to multiply the hoped-for profits. However, in volatile markets, the strategy could backfire. Buy physical gold and silver with your own funds, then relax and sit back to watch the coming fireworks.

Patrick A. Heller owns Liberty Coin Service in Lansing, Mich., and writes “Liberty’s Outlook,” the company’s monthly newsletter on rare coins and precious metals subjects. Past newsletter issues can be viewed at http://www.libertycoinservice.com. Other commentaries are available at Coin Update (www.coinupdate.com) and Financial Sense University (www.financialsense.com). His periodic radio interviews can be heard on the Korelin Economic Report at http://www.kereport.com.

Gold Ready for New Highs?

By Patrick A. Heller February 16, 2010

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As I write this mid-day on Monday, gold has addded more than five percent to recover from of its intraday lows 10 days ago. It is about $1,100 at the moment.

It looks like the $1,108 level is one that would signal to technical traders to again jump in to buy. If gold can get and hold that level, and there is a good possibility it will occur this week, then it’s highly likely that gold will generally rise in the short term to pass the early December 2009 all-time high of about $1,212. It won’t go in a straight line, but it could rise so quickly that it will amaze people.

Once gold reaches a new record high, the odds are that it would pause for some profit-taking before again rising up to even higher levels.

There continues to be so much demand for physical gold (versus paper gold contracts) relative to the available supply, that many would-be buyers seeking immediate delivery in the London market are having their orders rejected by every trading house on that exchange.

London is the world’s largest gold trading center, so larger buyers frequently try to place their orders there. The London Bullion Market Exchange trades contracts for physical delivery of gold. In theory, the trading houses on the exchange have the physical gold to deliver on maturing contracts. It does not make sense for these firms to reject orders on which they would make a profit. With multiple reports of great difficulty experienced by buyers seeking delivery of London contracts, a great suspicion is raised that the physical gold may not all be there.

I would not be surprised if, within a month, a two-tier market develops between the physical and the paper gold spot prices. If this happens, the price for physical is almost certain to be significantly higher. The lower price for paper gold contracts reflects the risk that the seller of the contracts would default. Obviously, a buyer who takes custody of physical gold has no risk of seller default.

The recent major snowstorms in the eastern part of the United States have disrupted U.S. Mint production and delivery of gold and silver American Eagles. The U.S. Mint headquarters in Washington, D.C., was closed Feb. 8-11. Both the Philadelphia and West Point, N.Y., mints, the manufacturers of most Eagle products, closed on Feb. 10. The receipt of planchets to make the coins, the production of the coins, and the shipment of finished product were all interrupted. This has made existing supply shortages even more of a problem.

Even better than the positive outlook for gold, silver seems hugely undervalued at today’s levels. Silver fell more than 20 percent from its early December peak, with the result that the gold/silver ratio is now above 70. The long-term forecasts I have seen for this ratio range from about 10 to 50, so all of the analysts behind these projections like silver’s prospects better than gold.

My own long-term expectation is for a gold/silver ratio of about 35 to 40. If our analyses are correct, silver’s price should appreciate far more than that of gold.

It should be no surprise that most of the action in physical metals in the past two weeks has been in the silver market. It is almost unanimously one-way traffic, with buyers eager to buy but almost no liquidation by owners. As a result, premiums are rising and delivery times are stretching out into the future, with some products already having expected delivery of more than one month. Supplies are not yet as tight as they were in late 2008, but they are going in that direction.

Physical gold products are relatively available, though U.S. Buffaloes are up in premium and not that easy to find. Once the price of gold starts to rise to new heights, I anticipate that supplies will dry up, just as we are now experiencing with silver. Between now and the end of March, the precious metals markets could get very exciting.

Patrick A. Heller owns Liberty Coin Service in Lansing, Mich., and writes “Liberty’s Outlook,” the company’s monthly newsletter on rare coins and precious metals subjects. Past newsletter issues can be viewed at http://www.libertycoinservice.com. Other commentaries are available at Financial Sense University (www.financialsense.com). His periodic radio interviews on WILS-1320 AM can be heard at http://www.amlansing.com and on the Korelin Economic Report at http://www.kereport.com.