Articles

Gold and Silver Are Your Hedges Against Centrally-Planned Economies
by Eric McWhinnie - Wall Street Cheat Sheet

June 13, 2012

     

Spain recently became the fourth member of the euro to request a bailout since the beginning of the region’s insolvency crisis. The country stands to receive as much as 100 billion euros ($125 billion) in order to prolong the life of its current banking system. It is debt trying to fix more debt. “The loan amount must cover estimated capital requirements with an additional safety margin, estimated as summing up to 100 billion euros in total,” a Eurogroup statement said. With rescues drafted for Greece, Ireland, Portugal and now Spain, the European Union and the International Monetary Fund have committed nearly half a trillion euros to finance European bailouts.

The Spain bailout is just the latest example of governments and central banks trying to solve an insolvency crisis with more debt. The markets quickly figured this out though, as Spanish and Italian bond yields reached new highs on the year just two days after the announcement. On Tuesday, the yield on Spain’s 10-year benchmark hit 6.8 percent, while Italian yields reached nearly 6.3 percent. “It is quite likely that Spain needs a full bailout in the near future although policy makers will try all possible options to avoid this outcome, including a revival of bond purchases by the ECB as well as another three-year liquidity operation,” said Pavan Wadhwa, global head of interest rate strategy at J.P. Morgan Chase.

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While sovereign yields signal that nothing has truly been fixed, precious metals are signaling that central banks are likely to rely on money printing to prolong the status quo. Over the past two days, the price of gold has climbed $22 per ounce to recapture the $1,600 level. However, when governments and central banks turn to monetary easing for temporary relief, the consequences are felt by many.

According to a new Federal Reserve report, American’s median family net worth plunged almost 40 percent between 2007 and 2010. It fell to $77,300 in 2010, compared to $126,400 in 2007. It was the lowest level seen since 1992 and the biggest drop since 1989, when the data started to be collected. In other words, the Fed-induced credit and housing bubble was able to wipe out enough net worth to send American’s wealth back to a level not seen in 18 years. Americans placed too much faith in the central bank’s ability to manage interest rates and incorrectly relied heavily on their house as an asset, a textbook case showing the misallocation of capital that comes from centrally-planned economies. Interestingly, gold and silver preserved wealth quite well during the same time period.

From 2007 to 2010, gold prices increased from $640 to almost $1,100 per ounce. Meanwhile, silver prices climbed from $13 to $17 per ounce. The ride was not a straight line to the top to say the least, but certainly maintained wealth more effectively than most assets. The price of the two precious metals today make these prior prices look like the bargain of the decade. With the global solvency crisis far from being over, gold and silver still have huge potential as more central bank intervening is sure to come.

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Disclosure: Long EXK, AG, HL, PHYS