Gold rates at crossroads, can touch $ 1000

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Gold rates at crossroads, can touch $ 1000

By John Lee
The story began in early 2007 with the blowout of Novastar and New Century, the multi-billion non-bank US intermediary mortgage brokers.

Then in summer last year, we witnessed the collapse of American Home Mortgage, America's largest subprime mortgage issuing bank. We then saw a series of subprime write-offs amounting to hundreds of billions by banks, funds, and institutions around the world.

The trouble moved up the chain of the mortgage complex, with Fannie Mae and Freddie Mac announcing surprising losses. And by 2008, the problem struck core as stock in Countywide, American largest mortgage issuing bank, plunged into the single digits on the rumors of impending bankruptcy.

The Countywide saga then ended last week with an orchestrated buyout by Bank of America.

In response to the damage already done, global central banks have lowered interest rates and willingly lent (printed) approximately $1 trillion to banks and institutions while taking questionable debt assets as collateral at face value.

Even with such drastic measures deployed, worry and uncertainty still linger. So where do we stand for 2008?

According to the ABX index at Markit.com, AAA mortgage-backed bonds are now selling at 70 cents on the dollar and look to go down further. This means that on every mortgage Freddie Mac and Fannie Mae guarantee, they are losing 30 cents on the dollar right away.

Given that the mortgage exposure of Fannie and Freddie sits in the hundreds of billions, we look for Freddie to announce insolvency unless bailed out by the government.

Subprime debts, meantime, are changing hands at less than 20 cents on the dollar. Thus the entire subprime market, a key driver of the US economy and money creation, is over.

Given there is upwards of $2 trillion of subprime debts, which are selling at 20 cents on the dollar, we will see a lot more subprime write downs to come not just from banks, but pension funds and endowments throughout 2008.

Indeed, Ben Bernanke lied when he assessed the damage of subprime at $200 billion as recently as Nov. '07. According to official data published by the Federal Reserve, asset-backed securities (the yellow line) have now dropped from $1.2 trillion in value to $750 billion.

And while the 40% loss officially reported is not as bad as the 30% to 80% loss estimated by Markit.com, the estimate nonetheless is stunning and shocking.

And this will create downward pressure for the Dollar.

Both the US economy and money supply growth will also slow. Dollars are created and supplied through borrowing, but if banks can't sell/flip those loans and mortgages they originated by selling them as asset-backed or securitized debt, they are likely to create a lot fewer loans and mortgages.

US consumers are tapped out, regardless of interest rate cuts. Frivolous lending on credits cards and home loans has come to an end through tightened lending practices. This will slow down consumer spending.

Interest rates will of course remain tame. The Fed can't raise them or it will trash trillions in already distressed debts. But it can't lower them much more with oil already near $100 per barrel.

To avoid an outright deflationary collapse, the Fed and US government have to keep money supply growing, albeit via creative monetary and fiscal policies:

Increase deficit spending and tax cuts;
Forgive credit card and mortgage loans;

Indiscriminately lend to banks at any rate to keep them from failing.
This is an extremely bullish scenario for Gold, not because the pace of money supply growth is increasing (in fact, quite the opposite is occurring), but because of the irreparable damage to integrity of, and confidence in the financial system that each bail-out creates.


Technically, the Gold Price has just overcome the all-time high of $850 set in 1980. We foresee a brief pause here before challenging $1,000 this year.