Autumn in August?

“In a credit crunch, it’s often said, cash is king. In which case, gold’s just been crowned emperor.”

AT LEAST THE weather here in London suits the markets. More like October than August, the constant drizzle is broken only by chill gusts of wind, rattling the windows like a late autumn gale.

Unseasonable? Yes — even for a British summer! But it’s perfect weather for losing your shirt as yet another bubble turns to bust.

Just like the Bankers’ Panic of 1907, the Great Crash of 1929…Black Monday in 1987…and the “mini-crash” triggered 10 years later by the Asian Crisis…any trader bored of tanning his hide on the Cote d’Azur can now come home to find October in full swing. And if he’s seeking a snow-white pallor for autumn, he can turn white as a sheet within minutes in Mayfair, watching his funds under management shrink with each breath.

Wednesday, Aug.15 marked the deadline for hedge fund investors to withdraw what’s left of their money before the third quarter ends. Tuesday saw one fund, Sentinel Management Group, ask the U.S. Commodity Futures Trading Commission if it could “allow it to halt client redemptions until it can conduct them in an orderly fashion.” No dice, said the CFTC to the puny $1.6 billion fund. A disorderly fire sale might now be expected — which is just what the markets seem to be suffering.

Further north, in Canada, two trusts said that they’d failed to sell new securities needed to refinance loans that are due for repayment. A bank had also refused to provide liquidity, according to news reports, making August ’07 a real crunch for those trusts, if not yet for all of their peers.

“Everyone always waits until the last second to get out, and [Wednesday] is the last second,” said Mike Hennessy of Morgan Creek Capital to Reuters Tuesday. But in fact, redemption notices began “piling up weeks ago,” said the newswire. The proximate cause remains the collapse of Bear Stearns’ two highly geared mortgage bond hedge funds in June. Those wipeouts sparked the current turmoil in world financial markets.

“The longer this credit crunch goes on, the more likely that gold will attract safe haven buying,” reckons John Reade, head of metals trading at UBS in London. In the short term, “we do not expect institutional buying of gold to trigger any sharp move higher; we suspect that position closing and deleveraging will be the focus of these investors’ attention…

“[But] any move to gold will probably come from private investors, and as such, the listed exchange-traded funds in gold will signal this interest.”

Confirming the move into gold by a growing number of anxious private investors, the StreetTRACKS gold ETF reported a record holding of more than 510 tonnes on Tuesday. In London, the gold fund run by ETF Securities saw a trebling of holdings last week alone. According to AFX News, some 200,000 ounces of gold were bought in one day!

(Here at BullionVault — the world’s fastest-growing route to outright gold ownership between April and June — gold sales are also markedly higher. As ever, gold stored securely in Zurich, Switzerland is proving the most popular choice with new gold owners.)

But it’s not only private investors who are choosing solid gold bullion over paper promises right now. The last two weeks have seen a huge surge in gold leasing rates — the price charged by the major members of the London Bullion Market Association to lend out their gold. Put in plain English, the banks of ScotiaMocatta, Barclays, Deutsche, HSBC, J. Aron & Co, J.P. Morgan Chase, the Royal Bank of Canada, Société Générale, and UBS have become less likely to put their gold at risk by lending it out.

After all, in a credit crunch, cash is deemed to be king. In which case, gold owned outright has just been crowned emperor.

The move in gold lease rates, spiking inside two weeks from 0.15% to a 33-month high of 0.32% above dollar lending fees, would also contradict claims that the U.S. Fed and its fellow central bankers are dumping fresh gold loans onto the market. Such a forced increase in gold-for-hire would have pushed gold leasing rates down, not up. But whether or not you hold with the theory that central banks are wantonly quashing the gold price — despite it doubling since 2002 — it’s clear that the Fed and its friends have plenty to fret about besides bullion right now. The U.S. dollar, after all, is up versus the euro. It’s everything else that is down, besides gold, Treasury bonds, and the Japanese yen.

Last Friday’s open market operations by the Federal Reserve saw it accept mostly mortgage-backed bonds — precisely those unsellable “assets” undermining faith in the financial system today. That left the big houses free to trade their outstanding positions in both Treasury bonds and the more secure agency-backed notes, a gift from the Fed that points to how serious this credit crunch is beginning to prove.

To date, the quarter of a trillion in central bank cash lent to the world’s biggest investment houses has failed to prevent the asset-price bubble — way up there in the stratosphere of new or near all-time highs — from hitting a series of air pockets, bid free. The ECB’s money on Tuesday failed to save Europe’s 300 largest stocks from losing an average of 1.2% of their value. The S&P closed the day 1.8% lower, while the Nikkei dropped 2.2% by the close in Tokyo on Wednesday. Here in London, the FTSE 100 has now dropped nearly 650 points — bang on that 10% slump deemed to mark a “correction” — inside one month.

No wonder, then, that lower interest rates are now priced into bonds. Traders foresee an 88% chance the Fed will cut rates to 5.0% at its September meeting, says Bloomberg, followed by odds of 47% for a further cut by December.

There’s no risk of monetary policy allowing the bubble to burst, in short. Or at least, that’s what everyone thinks…even as the bubble bursts despite super-fast action in central bank policy. “My worry is the Fed will cut too little, too late,” said Nouriel Roubini, NYU professor and a former adviser to Bill Clinton, in an interview this week. And besides, if the money markets are freezing up with dollar rates at 5.25%, will anyone become more likely to lend money at just 5% or 4.75% this Christmas…?

Now that cash is once again king — and the dollar has seized the throne with its twisted sidekick the yen playing court jester — we think you might do well to keep an eye on the gold price. Even with spot prices ticking sideways amid the sell-off in paper, that’s still a sharp break from the strong correlation between stocks and gold bullion seen between 2003 and early ’07. Plainly put, the smart money looks keen to keep hold of its bullion.

Versus the resurgent dollar, the price of gold remains little changed right now from a week or even a month ago. Indeed, it’s risen against sterling and euros — a little-reported fact that U.S. investors wanting to take advantage of this spike in the greenback may like to note.


Adrian Ash
August 22, 2007

The Daily Reckoning