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Sunday, April 21, 2013


Our financial system, based as it is on high and rising leverage, low and falling rates, borrowing short to lend long, and financial engineering, has become very brittle.

Inflation, understood in this light, can pump up asset prices for a while, and then cause a violent crash. Inflation directly undermines the stability of the system.  It has nothing to do with consumer prices.  Though, at times, consumer prices can rise as a result of inflation.

There is a much more important dynamic than consumer inflation that we should consider for its role in the formation of the gold price.

Let’s use Cyprus as a microcosm. Prior to March 15, the average Cypriot thought of gold as an inflation hedge. He may have felt that since prices weren’t rising that much, despite unconventional monetary policy, it was not worth holding. Today, he is regretting not having bought gold. Why? Because Cypriot banks defaulted, and gold is as good as ever.

Again: I emphasize that the reason to own gold has nothing to do with consumer prices. The problem with the system is that every financial asset, except gold, is the liability of another party. Every one of them is leveraging up in a desperate attempt to chase yield and keep mismatching the duration of their funding to their assets, and their assets consist increasingly of counterfeit credit. The probability of default is rising. Gold is the only way to avoid risking default and total losses.

So who is pushing down the price of gold?

 You are!

Everyone who thinks of his wealth in dollars, whose balance sheet uses the dollar as numeraire, and especially, everyone who borrows dollars to fund gold purchases is contributing to the unsustainable spikes up and vicious crashes down that characterize the current market for gold. And I have one other unpleasant thing to tell you:

Volatility will rise, as the financial system gets closer to the terminal phase!
If you think that $250 down in a week is painful, you can look forward to $250 up or down in a day. Not necessarily this year, but it’s coming.

Once most of the speculators are flushed, then other buyers can begin to push up the price with their more steady—and unleveraged—accumulation. Patient, and relentless, these people think of their wealth in terms of gold.  (THINK CHINA, INDIA, SOUTHEAST ASIA)  They are the driver towards permanent backwardation, as they are not motivated to sell by higher prices.

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