Gold Forecast: Commodity Slump Signals New Credit

As we write this, gold is experiencing a bounce from short-term oversold conditions. It is not unexpected as our forecast published every Sunday before the markets open has indicated the probability of this occurring for the last week. At this stage, our gold price forecast still remains bearish despite this short term bounce.

So what is the problem with cheap commodities? It’s a win for the consumer, it leaves them with extra cash in their pockets, which should see them rushing out to spend this unexpected surplus. This is the mainstream media view of the current downturn in commodities but of course it is an absurd and naive over simplification.

You may have noticed that one of the themes we write about the most is the huge amount of debt accumulated globally both before 2008 and since; we have tried to solve an unsustainable debt crisis by the addition of even more debt. A boom brought on by more debt will by the laws of nature eventually become unsustainable and will end when an increasing number of defaults force the issuers and the investors to re assess credit risk.

The global economy has been built upon a sea of debt; this has lead to the consumption of vast amounts of resources now that would not have been possible without the credit issuance.  Credit creates the ability to consume products and services now that would not have been consumed until some point further into the future. This bringing forward consumption to the present would not have been possible had society elected to consume only from savings and profitable production.

This unprecedented credit boom in consumption has created a huge misallocation of resources and oversupply in the production of goods and services from shale gas in the US to mega factories in China. This global oversupply of production coupled with a declining demand from over indebted consumers is beginning to have significant impact on global production and resource companies; it is also affecting the economies of countries from Australia to Brazil and across the oil rich countries of the Middle East.

The problem for the goods and services producers is that they too have continued to expand their businesses by either accumulating more debt or spending any surplus. Oil producers like Saudi Arabia have been using their surpluses to expand their social welfare systems this in turn has lead to an increase in the internal consumption of oil and this requires more production to maintain the same levels of revenue.

Shale gas producers in the US have taken on phenomenal levels of debt to increase production.  Even producers like Norway who have been able to save a surplus have a large welfare system that means it needs either a higher price level than previously to maintain welfare entitlements and its surplus or it needs to produce more.

Mining and extracting physical resources is an infrastructure and energy intensive business, much of these producers upfront costs have been sunk in to well heads, pipelines rail roads, refineries etc. This debt needs to be serviced so production needs to be in tandem with the value of the goods and services being produced, this leads to a need to continue or even increase supply as the price falls not because the demand is increasing but because of the financial structure of the producer itself.

So this misallocation of production brought about by a credit boom and overconsumption is at odds with the consumers of these goods and services themselves. Consumers in the developed world are saddled with the debt that created this production boom, when they reach saturation point they stop consuming.

The producers faced with falling demand and prices should rationally cut production but instead they need to do the opposite they need to maintain or increase output through their fixed cost infrastructure to service this debt mountain. Ironically the only way for a producer to compete during this boom was to increase volume by more debt and spending as margins fell. As hard commodities become more difficult and expensive to extract the producers need to produce more of it to maintain their business models they can’t pass on all the costs because the consumer demand is a function of debt and not of wealth or productivity.

However they are also entering a vicious battle to cut costs faster than their competitors this means highly skilled job losses, a dramatic decrease in capital expenditure a freeze on exploration or further infrastructure spending. This drop in spending is beginning to ripple through the global economy from Australia to the US it leads to layoffs within the producers themselves but also to a decline in activity for specialist engineering and infrastructure service industries.

Whilst 2008 was the credit squeeze for the consumer it is perfectly possible that the next credit crisis is well underway and it is a producer credit event. There couldn’t have been a global credit boom without the goods and services to spend them on. The production boom fed off the consumption boom but the production boom added to the consumption boom as billions in revenues and taxes were used for social welfare projects by commodity rich states and huge infrastructure spending leaked its way into the pay packets of employees and suppliers.

********

To view one of the most accurate and unique gold price forecasts available visit us at: http://www.kenticehurst.com