Paring Their Bets

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January 21st of 2015 stunned investors and economists as the Bank of Canada lowered their key interest rate by a quarter of a per cent. Prior to that, since September of 2010 policy interest rates in Canada had remained unchanged and the Bank of Canada was perceived to have a more hawkish bias. The surprise announcement last January from the more fluid and accommodating Bank of Canada governor, Stephen Poloz, has lent way to a loonie that continues to struggle to find any degree of stability. As focus remains on the Canadian dollar (in light of recently falling below the key psychological level of 70 cents), the question for Canadians, will the bank of Canada cut again next week?

To go out on a limb, the greatest probability heading into this January announcement is, not likely.

Numerous bank economists made headlines in the financial press this week for their calls for the bank of Canada to cut rates next Wednesday. Unfortunately, it seems the recent unpredictability of Canadian interest rate policy has led to greater uncertainty for the country’s top forecasters. A crucial point as well, made by CIBC’s Avery Shenfeld was where we have a dozen Fed Governors and Regional Presidents making speeches on current policy in the US, in Canada we aren’t afforded the same luxury of voting members utilizing speeches to offer guidance to the market. This makes predicting the bank of Canada a little more difficult.

There are a few simpler reasons, however, why it is unlikely for the Bank of Canada to take action next week. The first is that we are heading into the newly elected Federal Liberal’s first budget. With downgraded forecasts for Canadian economic growth, and some sluggish indicators from the final months of 2015, pressure is beginning to mount on Canada’s progressive new regime. With anticipated plans for short term infrastructure spending to boost economic activity, the Canadian central bank has reason to stand aside and let the new government officially unveil some of their plans. Then, should they anticipate a need for further measures to stimulate economic activity, a subsequent rate cut could come by the spring.

The second reason the bank of Canada can afford to hold off on a rate cut next week is attributable to the Canadian dollar. It is no secret Governor Poloz has been a cheerleader for a weaker dollar. With an approximate 20 percent decline in oil prices to begin 2016, the loonie is down nearly four per cent against the greenback. The continued deterioration of the Canadian dollar is the natural stabilizer the country needs to adjust from an economy over reliant on the energy sector to one of non-energy export led growth. Investment bank Macquarie Capital recently updated their forecast for a 59-cent loonie by the end of 2016. The reason for an even lower dollar is they see that as the level required to fully transition Canada from being an attractive market again for foreign investment.

Given the Bank of Canada Governor has come across as a bit of a wildcard to date, I don’t think any option is off the table for next Wednesday. But the continued weakness in the Canadian dollar has prompted large inflationary pressures on Canadian consumers from grocery bills to consumer electronics. Also, the quick pace of deceleration in the loonie will only be exacerbated by another rate cut, and no policy maker looks to shock markets. With the timeline for a federal budget and a focus of increased government spending from the newly elected Federal Liberals, there is their potential to surprise with a larger than anticipated deficit. Accounting for the aforementioned factors, my guess is like the span between September 2010 and January 2015, the bank remains on hold, and the loonie even sees a bit of a relief rally.

Precious Metals and Interest Rates

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Precious Metals and Interest Rates

Interest rates play a key role in today’s modern economy and monetary policy. The Federal Reserve can make changes to key interest rates and interest rate expectations and control the flow of capital into the economy. In other words, by maintaining low interest rates, capital is easier to acquire. This ease of acquiring capital can fuel economic growth as more money available translates into more potential spending. If too much capital becomes available, however, a situation may arise in which there is” too much money chasing too few goods.” This can lead to inflation due to the fact that as more capital looks to acquire fewer goods and services, those providers of goods and services can charge more money, hence rising prices.

 

Many central banks around the globe have held interest rates quite low for some time. The U.S., for example, has held rates at zero for several years now in order to spur economic growth. The U.S. is, however, getting ready to hike rates for the first time since June 2006. The topic of rising rates has been the subject of considerable discussion-and debate-and gold and precious metals have been mentioned considerably in those conversations.

 

Many investors seem to believe that the correlation between gold and interest rates, for example, is negative. While this does make some sense at first glance, the idea of this relationship can, in fact, be quite misleading. Looking back at gold over the last several years shows how low or negative real rates can drive the metal. Gold made its all time high back in 2011, as the Fed was engaged in a zero interest rate policy and was fighting the economic slowdown with massive amounts of bond purchases, or QE. Since that time, the metal has pulled back from this high, and currently sits around the $1200 level.

 

Some in the anti-gold crowd have suggested various reasons that the metal topped out when it did, such as improving economic conditions and the eventual end to the central bank’s QE program.

 

Many also suggest various arguments against holding gold, such as the fact that gold incurs storage costs and “does nothing” in terms of dividends or interest earnings. There is also the argument that gold will not perform well when interest rates do start to rise…

 

In Reality, however, gold can potentially perform well in both declining and increasing rate environments.

 

One of the major reasons for this possibility is the fact that as interest rates rise, there may potentially be an exodus from “risk assets” such as equities and bonds.  As investors move out of risk assets and into alternative asset classes, gold and precious metals may stand to benefit.

 

This scenario was seen back in the 1970s. Gold moved higher along with interest rates as stocks and bonds had a challenging time. From 1977 to 1980, interest rates skyrocketed from 4 percent to over 20 percent. Gold saw huge appreciation during this period, rising from less than $200 per ounce to over $800 per ounce.

 

Clearly, higher interest rates do not necessarily mean lower precious metals…

 

In the current global financial landscape, emerging markets such as China and India are responsible for a vast percentage of global gold demand. Because of this, rising interest rates in the U.S. will likely not have as much of an influence on the gold price as some anticipate.

 

Thus, Gold has shown that it can appreciate in value in both falling and rising rate environments.

 

As the global financial landscape changes, gold may potentially become more useful and important than ever. Stocks have been moving higher for years now, and could be showing signs of cracking.

 

China has been steadily taking steps to further cement its place among the world’s economic elite. These steps include buying large amounts of gold. The nation’s currency, the yuan, will likely be accepted as an alternative reserve currency, and could pose a serious challenge to the dollar as the global reserve currency of choice…

 

We believe that the notion of higher interest rates and correspondingly weaker gold is a fallacy. In fact, we feel that now is the opportune time to look at allocations in the precious metals complex, regardless of rising rates.

The Long-term Trend of Gold

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The Long-Term Trend of Gold

As a commodity, gold prices fluctuate. These fluctuations can be very minor and can at times appear to be more significant. Any financial news channel you may tune into, or any financial news website you may visit will likely have the current price of gold, silver and even other precious metals readily available.

 

The current price of gold can be affected by many different factors. Some of these factors include:

 

  • Central bank activity
  • Currency markets
  • Geopolitical events
  • Economic conditions

 

When looking at gold as an investment, we feel it is important to base such an investment on your objectives. For example, someone who wishes to invest in gold for a short-term move is “trading” gold rather than investing in gold.

 

It is very important to distinguish between “trading” and investing. Those who want to try to capitalize on short-term price fluctuations in gold-using technical analysis for example-are traders. Those who want to invest in gold for the long run are investors.

 

Gold investors are often not concerned with the day-to-day, week-to-week, or even year-to-year fluctuations in the gold price. They are often buying gold for the potential of an increase in value, but are also investing in gold for many other reasons. Some of these reasons may include:

 

  • To hedge potential inflation
  • To hedge currency risk
  • To provide peace of mind
  • To own a hard asset that is not tied to a central bank and carries no counterparty risk

 

Whatever the case may be, knowing where gold has come from and where it could potentially go may provide some peace of mind.

 

The long-term investor is likely only concerned with the “long-term” and therefore we felt it prudent to outline gold’s trend over a larger time period.

 

Mid Seventies: Gold traded for under $200 per ounce

 

Late Seventies: Gold prices began to climb, and climb rapidly. As inflation began to accelerate, gold prices accelerated along with it.

 

1980: The price of gold, already benefitting from high inflation, spiked to over $800 per ounce. Some believe that this parabolic move during this year was due to the Soviet invasion of Afghanistan.

 

1981: The price of gold settles down and prices move all the way back down to around $350 per ounce.

 

1982-2002: The next 20 year period saw gold essentially range bound. The metal fluctuated between about $500 per ounce on the high side and $250 per ounce on the low side.

 

2004/2005: Gold begins to find more buying interest, and prices eventually break above their highs of the last two decades. This could likely be attributed, at least partially, to the end of the tech boom, affectionately referred to as the “dot-com bubble” and corresponding bear market in equities.

 

2006-2011: Gold prices appreciate rapidly, moving almost straight up during this five year period until they hit their all time high of nearly $2000 per ounce. Gold’s rise may be attributed to massive central bank action including low interest rates and quantitative easing.

 

2011-Present: Gold prices have pulled back since making their 2011 high, and currently sit around the $1200 per ounce level. While the U.S. has ended its bond buying program of the last several years, many other nations, including Europe and China, are still actively engaged in QE or other economy-boosting measures.

 

There are a couple key elements we feel are of importance here.

 

Gold’s trend is clearly up: When looking at the yearly gold chart, the price is undeniably trending higher. Does this guarantee gold will resume its uptrend? No. It does mean, however, that for the patient long-term investor, gold at current levels may represent an excellent long-term buying opportunity.

 

Gold may potentially rise during periods of uncertainty: Looking at the price of gold over the last several decades, you can clearly see how gold sometimes reacts to uncertainty-whether it is economic, geopolitical or otherwise.

 

Gold’s pullback has corresponded with a bull market in equities: As gold has retreated from its all time high in recent years, stocks have done the opposite, making new all time highs themselves.

 

What this tells us is that:

 

  1. If gold resumes its uptrend, it has the potential to move significantly higher. Think $5000 per ounce gold sounds silly? Think again.
  2. Gold may provide a hedge against falling stocks and a number of other economic calamities. Think the current bull market in stocks will last forever?
  3. Gold may continue to rise because it is a commodity of limited supply. As fiat currencies depreciate over time, demand for hard assets like gold may rise, and potentially drive prices significantly higher from current levels.

 

We believe that all of the pieces are in place for gold and other precious metals to rise sharply over time. While price trends can and do change, we believe that gold will in fact resume its uptrend to much loftier levels based on simple supply and demand, paper currency depreciation and economic/geopolitical factors.

 

Why is Gold held by the Central Banks?

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Why is Gold held by the Central Banks?

If one has looked into the gold market in recent years, one will likely have read that central banks are net buyers of gold. After years of selling the yellow metal these powerful financial institutions are now buying gold and holding it. Central banks are the largest players in the gold market, and if they are buying gold there is likely good reason.

 

Central banks have a great deal of responsibility. These mammoth institutions are responsible for monetary policy in their respective nations. Some central banks may be responsible for monetary policy in a group of different nations, such as the European Central Bank.

 

The scope of a central bank’s duties does not end with monetary policy. These banks are also expected to monitor and encourage employment, keep currency values stable and control inflation. In addition, central banks act as the primary bank of governments and oversee and manage the bank reserve and credit systems.

 

In Canada, the central bank is the Bank of Canada. In the United States, the central bank is the Federal Reserve.

 

The Bank of Canada’s responsibilities fall into a few categories. Its principle role is “to promote the economic and financial welfare of Canada.”  The categories for the Bank of Canada are as follows:

 

  • Monetary Policy-controlling the money supply
  • Financial System- promotion of safe and efficient financial systems
  • Currency- Issuance of Canada’s bank notes
  • Funds Management- The bank manages Canada’s foreign exchange reserves and public debt while acting as the fiscal agent of Canada

 

The United States Federal Reserve also has several categories outlined. These categories include:

 

  • Production of price stability and employment
  • Systemic risk control
  • Supervision and regulation of banks and financial institutions
  • Provide financial services to the U.S. Government

 

Although central banks have been net buyers of gold in recent years, some have a lot more gold than others. The Bank of Canada’s gold reserves, for example, pale in comparison to that of the United States. It should be noted, however, that the U.S. Federal Reserve does not own the gold but rather the U.S. Treasury does.

 

Whether through a central bank or a treasury department, many sovereigns own physical gold.  There are many different reasons that these large financial institutions may own physical gold. Some of these reasons may include:

 

  • Desire for credibility
  • Desire for stability
  • Reserve diversification
  • Hedging purposes

 

Gold is symbolic of power, value, economic credibility and prestige. The yellow metal has been recognized a reliable store of value for thousands of years, and can be exchanged anywhere in the world without counterparty risk.

 

China and its recent gold buying activities are a great example of what gold ownership may accomplish. China has been buying large amounts of gold in recent years, and although they have not publicly stated their gold holdings, some estimates put their reserves from 3000-8000 tons. This gold acquisition is likely an attempt by Beijing to boost the credibility of its currency, the yuan. The yuan is on the verge of being accepted as a global reserve currency and part of the IMF’s Special Drawing Rights.

 

The yuan could, in time, challenge the dollar as the preferred global reserve currency. The more gold that China has in reserves, the more likely such a scenario could become due to the fact that gold is viewed as a relatively stable asset.

 

Because of its history, inherent value and relative stability, gold may potentially provide central banks with a means of reserve diversification as well as global credibility.

 

The Dollar as the Reserve Currency of the World

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The Dollar as the Reserve Currency of the World

The U.S. dollar has enjoyed its status as the global reserve currency of choice for some time now. Since the implementation of The Bretton Woods Agreement, the dollar has been considered the anchor of the global financial system. Under this agreement, the United States guaranteed other central banks that they could sell their dollar reserves for a fixed rate of gold.

 

In the 1960s and 1970s, some flaws were seen in this system, however. The Triffin Dilemma was first identified in the 60s by economist Robert Triffin who believed that a conflict of interests undermined the system. According to Triffin, this conflict arose out of differences in short-term domestic objectives and long-term international objectives.

 

Triffin also pointed out that the country who was supplying other countries with its currency for reserve purposes must be willing to supply enough of the currency to fulfill global demand, and this extra supply of currency leads to a trade deficit.

 

This dilemma is often cited as one of the most-if not the most-significant problems with the Bretton Woods Agreement.

 

This eventually led to a balance of payments dilemma as well. The U.S. had to run a balance of payments current account deficit to ensure enough liquidity for the conversion of gold into dollars. The influx of dollars led speculators to believe that perhaps the dollar had become overvalued.  As more dollars were converted for gold, it also meant that the country’s gold reserves were not as robust. Less gold in the country led to even more concern about the dollar’s value, and the country had to run a balance of payments current account surplus in order to boost the dollar. Needless to say, the country cannot run a balance of payments current account deficit and surplus simultaneously.

 

Clearly the system was flawed, and in 1971 then-President Richard Nixon initiated “Nixon shock” under which dollars could no longer be exchanged for gold. This was, in effect, the demise of the Bretton Woods System.

 

The Petrodollar

As confidence in the dollar was a concern, President Nixon negotiated a deal with Saudi Arabia for all future oil sales to be dollar denominated. In exchange, the U.S. would provide Saudi Arabia with protection for its vast oil fields. Other OPEC members also followed suit. These agreements ensured that demand for U.S. dollars would remain robust, and helped to support the dollar’s value.

 

While demand for dollars has been strong due to the fact that nations need dollars in order to transact oil, this agreement also likely boosted demand for U.S. debt in the form of treasuries. The dollar’s reserve currency status as well as demand for U.S. debt has been advantageous for the U.S., as it has kept interest rates down, although a stronger dollar can have negative effects on exporters.

 

The Dollar’s Future as the Global Reserve Currency of Choice

There has been much discussion over the years about the dollar’s status as the preferred reserve currency of the world. The currency markets appear to be currently undergoing some significant changes, and the dollar could potentially be challenged.

 

Several nations have already begun a move away from dollars. China, Russia, even France have all set up swap lines to facilitate transactions outside of U.S. dollars. Even some multinational corporations have also taken similar measures.

 

Some believe, in fact, that the only issue preventing a direct challenge to the dollar is the ongoing petrodollar system. If Saudi Arabia and other oil producers made a move away from dollars, it could potentially set the stage for massive dollar depreciation as capital could flow out of dollars and into other currencies, while demand for U.S. treasuries could also potentially see a dramatic decline. If many of these dollars found their way back home, the rapid increase in supply could severely undermine the value of the dollar and possibly lead to rapid inflation in the U.S. as well as rising interest rates.

 

The Yuan as the Next Preferred Reserve Currency

It’s no secret that China has taken steps in recent years to bolster its position both economically and politically. The country has also been reportedly buying massive amounts of gold, although the country’s exact holdings remain unknown. Some estimates put China’s gold reserves at 3000 tons while others believe the country could be holding 8000 tons.

 

Whatever the case may be, it is possible that China is looking to bolster its gold reserves in an attempt to gain more credibility for its currency, the yuan.

 

On October 20th of this year, the yuan is set to become a member of the International Monetary Fund’s (IMF) Special Drawing Rights. This would mean that the yuan is now accepted as a global reserve currency and could potentially be the first step in a direct challenge to the dollar.

 

While much of this may be pure speculation at this point, it would not be far-fetched to see even more countries moving away from dollars and into yuan.

 

China is the world’s second largest economy, and has been experiencing rapid growth in recent years. As China looks to further cement its place among the global elite, it will likely continue to push for additional acceptance of the yuan as a preferred global reserve currency.

 

While the dollar remains the global reserve currency of choice, the currency could potentially see outflows into a viable alternative such as the yuan.

 

Clearly, China believes that owning gold is important. Gold is symbolic of power and prestige, as well as financial stability. As uncertainty over the dollar’s future as the world’s reserve currency mounts, gold may see additional demand from other nations as well as smaller investors looking to hedge against currency risk.

 

What Drives the Price of Silver?

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What Drives the Price of Silver?

Silver is a commodity, and like any other commodity, its price is a reflection of current supply and demand. Silver is somewhat unique in the precious metals space, however, as its value may be driven not only by investment demand but also industrial demand. This allows silver to potentially experience the best of both worlds. In a strong economy, industrial demand for silver may heat up and potentially drive prices higher. In a slow economy, or during times of risk aversion, silver may potentially benefit from investment demand as investors look for perceived safe havens to put capital to work in.

 

Silver Market Fundamentals: It is important to understand that while only a small portion of gold is used in industry, a very large portion of silver is used in modern day industry. Silver is used in jewelry, but is also utilized in an ever-increasing variety of industrial applications.

 

According to The Silver Institute, 95 percent of annual silver demand falls into just three categories. These categories are:

 

  1. Industry
  2. Investment
  3. Jewelry and Décor

 

Silver in Modern Industry: Recent years have seen more and more uses for this incredible metal becoming main stream. Silver is used in many products as well as sub-components of products, and we are now surrounded by this white metal. Here we will examine just a few of the thousands of potential uses for silver to demonstrate why demand for this metal may continue to rise:

 

Your car-tens of millions of ounces of silver are now used in cars every year. Electrical connections in your car are facilitated by silver contacts. Silver switches are used to perform such mundane tasks as starting your car’s engine, opening or closing your power windows and adjusting your seat. In fact, silver even makes it possible to see out your back window. Silver-ceramic lines are present in the rear windshield. These lines can be heated in order to melt snow or ice from the glass and maintain visibility. Even your car’s anti-freeze contains ethylene oxide, a compound made from silver.

 

Batteries- Modern technology has provided millions with the ability to do more. Many common everyday gadgets, like an iPhone or a watch, are powered by small batteries. Silver oxide batteries have been replacing the older lithium batteries. Silver oxide batteries are now widely used in watches, hearing aids, cameras and other small electronics. Silver oxide batteries provide a greater power-to-weight ratio, thus delivering more bang for the buck. Silver oxide batteries are also being used to phase out lithium ion batteries commonly used in laptop computers and cell phones. The silver oxide battery provides a superior power source with a favorable environmental footprint over other alternatives.

 

Switches- Silver is widely used in electrical switches. Silver is an excellent conductor of electricity and makes a great choice for television and light switches as well as circuit boards and plasma screen displays. Silver is very reliable, and may be used for millions of on/off cycles.

 

The world is growing, and as more developing nations such as China begin to utilize better technology, demand for physical silver in industry may continue to expand at a very rapid pace.

 

Silver in Jewelry: According to The Silver Institute, approximately 275 million ounces of silver was used last year in jewelry and silverware. Silver is highly sought after in these arenas for several reasons. Silver is a precious metal, and is more affordable than other types of metals. This provides jewelry makers and buyers with a cost-effective metal to use that is very durable and will stand up to the test of time and wear. Silver can be worn with almost anything, and all types of stones may be used in conjunction with the white metal. Silver may even have some health benefits, and is reportedly hypoallergenic and may have other healing properties. The metal is durable, easy to clean and looks beautiful.

 

Investment Demand: Silver is widely regarded for its investment value. Nearly 200 million ounces was reportedly used last year in coins and bars, and we would expect this number to continue to grow. Silver, like gold, has been recognized as a reliable store of value for thousands of years. Silver is not only recognized the world over, but is also traded and exchanged all over the globe. Physical silver as an investment may potentially offer numerous benefits. Some of the potential benefits include:

 

  • Lack of counterparty risk
  • Ease of acquisition
  • Liquidity
  • May potentially hedge against currency, economic or geopolitical turmoil

 

Silver has never been easier to acquire than it is today. Even those on a very limited budget can begin to build a precious portfolio. Silver is not only available everywhere, but it is also available in many forms. Silver can be bought for investment purposes in coin, bar or round form.

 

The world is an ever-changing place. As such, we would expect investment demand for silver to continue to grow along with industrial demand. Emerging markets, along with a potential shift in global currency markets may be some of the primary drivers of silver in the future.

 

Possibility of Retun to the Golden Standard

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Could There Be a Return to the Gold Standard?

In recent years, there has been seemingly more and more debate about the feasibility of returning to the gold standard. As concerns over the U.S. dollar mount, there may be further talk of such ideas, although whether or not they make sense and could be actually implemented is highly debatable.

 

To understand the implications of such a move, one must have an understanding of how the gold standard works. We will briefly outline the gold standard monetary system, and then discuss some of the potential pros and cons of such a system in today’s world, as well as some of the potential challenges that could be faced trying to implement such a system.

 

The Gold Standard in a nutshell…

 

The gold standard is a financial system in which each unit of currency is directly tied to an asset-in this case that asset is gold. Use of gold as money began thousands of years ago, and even to this day the commodity is recognized as money.

 

Under a gold standard monetary system, every single unit of currency would be backed by a specified amount of gold bullion. This accomplishes several things. Here are a few of the potential advantages of a gold standard system:

 

  • Under a gold standard system, price stability can be achieved and maintained. Because the government can only increase the money supply with a corresponding increase in gold holdings, any significant inflationary pressures are not likely to be seen, and any hyperinflation is essentially impossible. The overall lack of currency manipulation can keep prices stable while maintaining stable currency values.
  • The gold standard can help promote international trade. This monetary system can encourage international trade because participating countries operate on fixed exchange rates.
  • The gold standard can help prevent financial repression. This term refers to the transfer of wealth from creditors to debtors. This can be used to reduce debt, and is also considered to be a form of taxation. Having a gold-backed currency can prevent deficit spending and thus keep wealth with the people rather than with the government. Gold acts as a barrier to such practices, and given this fact it’s no wonder that many proponents of big government are opposed to such a system.
  • A gold standard keeps the government, its people and its leaders accountable.

 

While a return to the gold standard could have many potential benefits, it could also have some serious drawbacks. Some of the potential arguments against such a system include:

 

  • The gold standard can act as a barrier to economic growth. Once an economy has reached its productive capacity, it cannot grow further without a corresponding increase in its money supply. If a nation’s currency is directly tied to the amount of gold held by that nation, then limits on the gold supply could limit economic growth potential and severely hamper a country’s ability for economic expansion.
  • The gold standard can bring a degree of volatility to prices in the short-term.
  • Countries that produce gold may have a distinct advantage over non-producing countries.
  • Central banks would not have the ability to manipulate the money supply in order to fight economic contraction.
  • Because the money supply is based on gold production, inflation could be caused if gold production outpaces economic expansion. On the other hand, if economic growth outpaces the production of gold, then growth is constrained and could lead to deflation.
  • The devaluation of fiat currencies under a gold standard could be sharp and severe.
  • The gold standard limits a central bank’s capabilities when it comes to regulating inflation and deflation as well as dealing with economic crises.

 

While these pros and cons are only based on some of the arguments for and against a gold standard system, they provide a great degree of color on what implementation of such a system could entail.

 

Implementation of such a system in the modern era could prove to be extremely difficult. In order to move to such a system, the U.S., for example, would have to acquire enough gold bullion to back every single dollar currently in circulation. At the present time, that’s nearly $3 trillion dollars’ worth of gold.

 

The current gold reserves of the U.S. stand at approximately 260 million ounces, worth about $431 billion. The country would, therefore, have to go out to the open market and buy enough old to cover its liabilities; unfortunately, buying that much gold would only serve to further inflate the price of gold, making the transition even more expensive.

 

The other option would be to inflate the price of gold in dollars high enough to cover the current monetary base. If the gold price were to be inflated from current levels to $10,000 per ounce, it could have a significant negative impact on the economy, an impact that may be severe enough to fully wipe out the potential benefits of such a system.

 

While the arguments for a return to the gold standard will likely be ongoing, and anything is possible, given the difficulties associated with implementing such a system it is unlikely that a return to the gold standard will be seen any time in the near future.

The Chinese Demand for Gold

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Chinese Demand for Gold

China is the world’s second largest economy, and has taken steps to cement its place among the economic elite of the world. One of those steps has been the acquiring of gold. The country appears to have an insatiable appetite for the yellow metal, and has been building its gold reserves in recent years.

 

China has not published its actual gold holdings since 2009. At that time, the country reported that it held 1054 tons of gold. The country reportedly doubled its reserves during the 2008/2009 buying cycle. Recent estimates have ranged considerably, with some analysts believing the country holds over 3000 tons of gold, while other analysts believe that number may now exceed 8000 tons.

 

Whatever the case may be, it appears that China has been buying gold and doing so quietly. The question then becomes: Why is China buying so much gold and why are they not making it public?

 

For starters, gold has long been considered a way to project power. Desire for gold jewelry has also always been a consistent source of demand.

 

There does, however, appear to be something much larger at work here. Something that could potentially change the global financial system as we know it today…

 

China has likely been positioning itself, and its currency, the yuan, for a more prominent role in global finance and trade. In fact, the yuan is about to join other key global currencies, such as the dollar, yen and euro, as a member of the IMF’s Special Drawing Rights. Becoming a recognized global reserve currency could significantly bolster the yuan’s status, and in the process ensure that China is a key figure at the global bargaining table. The introduction of the yuan as a global reserve currency could potentially draw capital out of dollars and into the Chinese currency. As money flows out of dollars and into yuan, the dollar could potentially see a significant decline.

 

Although the dollar has been strengthening in recent months on the notion of higher rates and as other countries continue with quantitative easing programs, the introduction of a viable alternative reserve currency could have a significant and lasting effect on the U.S. currency. It’s no secret that a move away from the dollar is already under way. Several nations, such as China, Russia, even France, have already set up swap lines that facilitate transactions outside of dollars. Several global companies have also begun such moves.

 

There has been talk by many nations for some time to move away from the dollar, and it looks like that idea is finally gaining some real traction.

 

As China directly or indirectly challenges the U.S. dollar as the global reserve currency of choice, the more gold the country has in its possession, the more credibility its currency will have. China may even be going a step further – as the world’s largest consumer of gold and the world’s largest producer of gold, China may be seeing a way to control global currency markets through gold.

 

China has recently announced that it is seeking to establish a yuan-based gold fix. Such a gold fix can potentially have enormous implications on global markets.

 

The Shanghai Gold Exchange, or SGE, would operate much like the exchanges of the West, with one key difference, however. Unlike London, for example, the SGE will be sponsored by banks with direct Chinese Government support. Unlike the private banking structure that is used in London, the banks sponsoring the SGE are largely state-owned and are used as tools for central planning. While the SGE may appear to be operating a “free market” structure, the influence of the Chinese Government will likely play a major role in the gold price. What this means is that the Chinese Government will be able to increase or decrease the yuan-based gold price at their discretion. This further means that the dollar-yuan relationship would also have to change, since gold would be denominated in both currencies.

 

The power of the Chinese Government to influence global currencies and exchange rates would represent a significant shift in the balance of power from West to East. China is pushing its agenda, and gold plays a key role in that agenda. The nation will likely continue to buy and hoard gold as it looks to gain further power and global economic influence.

 

This ongoing saga is a clear demonstration of the power of gold. Gold ownership brings credibility and power to the global financial stage. Nations realize and understand the inherent value of gold, and therefore look to acquire and hold it…

 

Shouldn’t you?

What a Week

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What a week. It’s a new year for the world’s financial markets, but it sure didn’t take long for investors to realize that the themes of 2015 are still very much prevalent. The week and the year began with Chinese regulators attempting to maintain control of their currency as the offshore market continues to discount the official rate has seen investors sell Chinese stock markets and prompt fear of further weakness in the world’s second biggest economy. The immediate and pertinent questions as fear of contagion spreads around the globe is, are the events over the previous week indicating some sort of paradigm shift in the global economy like a crisis or is this simply volatility that is to be expected in 2016?

At this point, it seems the latter scenario of increased volatility is more likely. Furthermore, ending the week Friday with strong US job numbers only added credence to this point. As the US labour market created 292 thousand net jobs in December, the year of 2015 topped out as the second best year for job creation since 1999. The US economy continues to moderately advance as the least dirty shirt in an obstacle-ridden world.

The US Federal Reserve remains in their challenged position as the world’s central bank. As the IMF points out, global growth in 2016 will be muted and uneven, but domestically US businesses continue to have a positive outlook and hire. Hence, there is an environment to continue to support a strong dollar. Shifting overseas, part of the fear of the rapid currency depreciation in China, and other emerging markets is linked to local firms holding US dollar debt that inflates with currency weakness. This currency weakness is being prompted by diverging central bank policy between the US and the rest of the world. This has certainly been the dark cloud that has reappeared over financial markets, not unlike August and September of last year.

Chinese equities perhaps tell part of this story as they represent investors fleeing their domestic market, but don’t share a link to their economy that financial markets in more advanced economies may have. This is why they only an incomplete story. Proof of this is in the issues over the past week where circuit breakers and trading halts that failed to restore investor confidence and minimize what was an incomplete emotion-filled rush for the exits. As their equity markets require reform, it will be important for investors to keep this in mind in the year ahead and anticipate further violent moves. Chinese equities, while making headlines surrounding trading halts and selling bans, are only a small part of the story for global markets.

In retrospect, the outlook for the markets circles back to the US Fed and their interest rate policy. Despite the fact that we are now past the point of quantitative easing and emergency level interest rates, it is still the pace at which the US Fed continues to raise rates that will be the focus of investors. The unconventional measures of the past allowed the fed to maintain a liquidity backstop for global markets. This game is now changing as their ultra-accommodative measures are tapered back. Less liquidity prompts more volatility, and that is why in 2016 it is most important investors are tempered and have a plan for when the market sells off, instead of being caught in shock.

How Can I Diversify my Precious Metals Holdings?

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How Can I Diversify My Precious Metals Holdings?

 

What is Diversification?

Diversification is the careful consideration and combination of a wide range of investments within a portfolio in an attempt to smooth overall volatility.  Diversification is a broad term, however, and can be accomplished in different ways.

 

A retirement portfolio, for example, may contain a mix of stocks and bonds. The idea here being that if stocks are rising bonds may be falling and vice versa. In fact, many portfolios in the past have been constructed of just these two asset classes.

 

As investors have become more sophisticated and economic conditions have changed over the years, more and more investors began looking for other ways to diversify.

 

A stock portfolio, for example, could be further diversified by owning stocks from various areas of the economy such as oil and gas, healthcare, utilities and more. The idea here being that during times of economic prosperity and higher markets, stocks that benefit from consumer discretionary spending may outperform while companies involved in “staples” such as utilities, healthcare and food companies may underperform.

 

In a similar fashion, bonds and fixed income investments could be further diversified by owning bonds from different issuers with different rates and maturities.

 

Over the years, investors sought out even more ways to diversify. Some alternative asset classes that have been utilized in recent years include precious metals, real-estate and futures.

 

Precious metals are recognized today as an excellent vehicle for additional portfolio diversification. Just as it may be beneficial to have different stocks and bonds in a portfolio, it may also be wise to own a diversified basket of physical precious metals.

 

How this applies to Precious Metals

Diversifying a precious metals portfolio is simple and convenient. In order to best diversify your holdings, it is necessary to consider a few questions first:

 

  • What are my investment objectives?
  • Is liquidity important to me?
  • What is my time horizon?
  • Where will my metals be stored?

 

Once you have answered these questions, you can begin the process. Here we will discuss some ways to diversify a standard precious metals portfolio that one intends to own as a long-term investment.

 

Buy different types of metal: This would seem logical, yet many people get focused on just gold or silver when it comes to owning precious metals. Platinum and palladium may also serve a purpose within a portfolio. One can consider a mix of several types of metal for various reasons. Gold, for example, is used primarily in jewelry and for investment purposes. Silver, on the other hand, is used in jewelry, for investment purposes and in literally thousands of various industrial applications. It stands to reason, therefore, that during economic boom silver could potentially outperform gold while during times of risk aversion gold could potentially outperform silver. A portfolio consisting of different metals may potentially lower volatility within the portfolio.

 

Buy different forms of precious metals: Precious metals may be purchased in various forms including coins, bars and rounds. Coins from major mints are well-recognized, are legal tender and very liquid. Bars and rounds, on the other hand, may offer lower premiums and carry no face value. Coins and rounds may be more easily exchanged and transacted than larger bullion bars. If you hold large bullion bars in a depository, for example, you could also consider holding smaller quantities of coins and rounds at home or in an accessible and secure storage location.

 

Consider some graded coins or numismatics: Graded coins carry higher premiums than standard bullion coins. This is because they have gone through the grading process by a major grading company and are certified for authenticity and fineness. Graded coins may increase or decrease in value at different rates than non-graded coins.

 

Numismatic, or collectable coins, are typically bought for their scarcity and not just their precious metals content. These collectable coins may carry vastly higher premiums than standard bullion or graded coins. Their value, however, is based more on their scarcity and condition than bullion coins. These coins may retain or even increase in value in spite of lower gold or silver prices. Because their value is not based solely on the spot price of gold or silver, they may provide a means of diversification.

 

With a little research, time, and openness to other products, diversifying a precious metals portfolio has never been easier. Just as with any other type of investment, one should not put all of their eggs in one basket.