Below is a table containing eight representative markets - three "commodities", one currency, and four major stock markets. They are arranged in order of the size of their percentage falls to date from their 2006 highs. The table also shows their performance to date in percentage terms from the level at which they began 2006.
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There are many interesting things to note in this table. Silver has had the biggest fall since its 2006 high while still having the biggest rise since the start of the year. Gold has the second biggest fall since the its 2006 high but is in third place for its rise since the start of the year, behind Silver and oil.
Of the eight items, four stand out as still being in the black this year. These are, in descending order, Silver, Oil, Gold, and the Aussie stock exchange. As is well known, the Aussie stock exchange is HIGHLY susceptible to commodity prices. The Dow, while being in the black for the year, has had its rise more than offset on an international basis by the much bigger fall of the $US index (USDX).
With the exception of the USDX, all of these items were well in the black at their 2006 highs. But over the past month, a gigantic global "liquidation" led by US investors has cut a swathe through all markets everywhere. Now, due to a gigantic overhang of "cash" in the coffers of most fund managers worldwide, the tide has turned, however temporarily, thanks in part to some "soothing" comments from Fed Chief Bernanke.
The fear which has arisen over the past month is not of (price) inflation or indeed of inflation itself, nor is it directly a fear of higher interest rates. It is a fear of debt, the most deadly fear which can ever arise in a world of fiat currencies and economic "growth" based on credit creation.
Underlying all this is an even greater fear. Before there can be a flight out of (paper) cash, there must be a flight into cash. This is especially true in a situation where it is becoming increasingly difficult to use "assets" of any description as collateral with which to borrow money. While the prices of commodities are still well up on the year despite the savagery of the month-old correction, the prices of most paper assets (and the price of real estate) is not. In most global cases, it is down. What is curtailing the ability and/or willingness of most people to borrow is not higher interest rates - in most cases global interest rates are still absurdly low by historical standards. What is curtailing that ability is the simple fact that future valuations of almost all "assets" of all descriptions are falling.
For almost the entire period since the great US stock market bull topped out in early 2000, there have been warnings about the unsustainability of the US twin (budget and trade/current account) deficits and about the "global imbalances" caused by the borrowing requirements to fund same. These warnings have reached fever pitch over the past three months or so. But since mid May, they have started to be taken seriously.
That has what has led to the global sell-off
The "best of all possible" worlds for modern inflating and credit-creating Central Bankers is a situation in which assets denominated in the currencies they create are rising. This is the so called (paper) "asset inflation" which fuelled both the stock market and the more recent real estate booms. A markedly inferior situation is where the new "liquidity" changes direction and moves into real goods and commodities, including precious metals of course. But even this is manageable, so long as most of the "liquidity" employed in this investment is still being borrowed into existence.
A still worse scenario is one in which people begin to shun borrowing to invest in assets of any kind and start to accumulate cash. Don't forget, the precious metals sell-off has been in paper claims to Gold and Silver. The demand for the physical metals has not eased at all. The same is true to a greater or lesser extent for other commodities and raw resources. The problem here is that cash doesn't pay any income, and in our debt-saturated age, that is a situation in which few can afford to remain for long.
If this retreat into cash continues much longer, a point will inevitably be reached where the ability to service present debt levels will not be able to be met. This is especially true in nations like the US where savings are NEGATIVE. At that point, the debt will begin to be reneged upon. And at that point, the cash itself, which rests on no more robust a foundation than all the debt paper which is held as "reserves", will become suspect.
If that situation is allowed to fester, the end result would be inevitable. There would be a stampede out of cash and into REAL economic goods of all descriptions. Of course, as all of economic and monetary history shows, Gold and Silver would be the most in demand REAL economic goods of all, having a proven facility as providing the indispensable medium of exchange needed to keep a modern economy functioning at all.
The high wire act without the net which Central Bankers and Treasurers will now perform is an attempt to reassure paper asset holders that it is "safe" to get out of cash and back into the paper markets. They must also reassure consumers that it is "safe" to borrow and bankers that it is "safe" to lend. But after this past month and the panic flight into cash, this is going to be VERY difficult to pull off.
Since Mr Bernanke's comments about the "long-term" affects of higher prices, notably higher energy prices, being "manageable", there has been a lull in the storm and the markets have snapped back to a minor extent. Of course, Mr Bernanke has no choice but to make these soothing noises because he has no concrete means to genuinely address the situation. With American financial institutions already stampeding into cash, should he stop raising rates, he risks a renewed and accelerating dive in the US Dollar at the same time as Americans hold vastly more of them. Should he actually panic and start lowering rates, he risks a US Dollar obliteration.
And if he continues to raise rates beyond the next (June 28-29) FOMC meeting, he turns a growing reluctance to borrow and lend into a situation where US consumers can't afford to borrow and US bankers do not dare to lend. That, in turn, pulls the foundation out from under his entire system.
What would be left then would be the stark choice between a deflationary collapse and a runaway paper-snowstorm inflation.
The flight into cash over the past month is a mini-deflation. For those who wondered how precious metals would do in such a scenario, please refer to the table above. Yes, the prices of precious metals have dived substantially, but these are the prices of paper claims to the metals. There is no more globally liquid class of asset than the precious metals, and this basic fact has been fully taken advantage of as the fear of debt rises
But on a year to date basis, precious metals still retain substantially more purchasing power than any purely paper class of asset, including most currencies themselves. They have lost "value" faster recently but still retain more value over the longer-term.
While the bull market in Gold and Silver is still perfectly intact, the depth and rapidity of the correction is such that it is not likely to be made up as quickly as the corrections of the past year or so have been. But none of the previous corrections happened in a situation in which a fear of debt was rising. In such a situation, the CARDINAL virtue of the precious metals is that they are all but alone amongst all assets in that, in physical form, they are the liability of NO ONE. Paper money is based and "underpinned" by debt. The precious metals are underpinned by the fact that they are economic goods in their own right and they are historically supreme as the globally preferred medium of exchange. That is an unbeatable combination.
In a credit-based world where the medium of exchange is underpinned by debt and nothing but debt, a flight into "cash" such as the one over the past month is a giant step forward towards the mistrust of the paper currency itself. That will take a while (it is impossible to say how long) to dawn on most people, but dawn it will inevitably. We are one giant step closer to a currency revolution, and the currency in the firing line is the US Dollar itself.