Quick Take On Gold’s Drop, Oil’s Collapse And Worries About An Oil-Driven Credit Collapse

We all know that the major central banks around the world are on the same page when it comes to inflation:  They want it higher.  One member of the European Central Bank’s executive board, Yves Mensch, went so far as to suggest that Europe’s central bank might buy gold in an effort to ratchet up the inflation rate.

Today OPEC decided to take no action to stem the glut of oil depressing the price in global markets.  The oil price is the chief driver of price inflation, thus with OPEC showing little interest in propping up the price, deflation starts to dominate market thinking.  Thus the drop in various currencies – a miserable day for the British pound (the BoE is trying desperately to create inflation in the UK) – and the drop in gold.

CNBC ran a headline asking Could the oil collapse cause the next credit crisis? “It’s not just the Saudis who could get much poorer from the oil price free fall,” says CNBC. “Everyone could suffer if the collapse triggers a wave of defaults through the high-yield debt market, and in turn, hits stocks. The first to fall: the banks that were last hit by the housing crisis. Why could that happen? Well, energy companies make up anywhere from 15 to 20 percent of all U.S. junk debt, according to various sources.”

Gold is always the canary in the coal mine when it comes to these sudden shocks in the financial marketplace.  Its reaction is quick and visceral, but the first market reaction is not always the real reaction.  That will come later.  Those who are driving gold down today on the commodities exchanges forget that gold’s rise over the last several years (despite its interim downside correction) has been in response to disinflation, not inflation — and demand remains strong due to concerns about the stability of the financial system itself.  Gold rose like a phoenix from the ashes of the last financial crisis because it is a store of value and a portfolio insurance policy, not because prices were about to bolt higher.  The gold as an inflation hedge bias is group think minus the advantage of objective analysis and the correct reading of recent history.

If the latest oil shock – this time in a southerly direction – creates knock on effects, we will hear a great deal about systemic risks in the days and weeks ahead.  Recall that gold at first went south in the crisis of 2007 and 2008 and then headed sharply higher as investors moved to shore up their portfolio’s against the possibility of a showdown on Wall Street and within the banking system.

We are in a much different situation today than we were back then and the system as a whole still suffers from the damage done by the last crisis.  If a crisis were to hit today, it would start with a much weaker line-up on the playing field than the last time around.  Keep in mind too that all of this has occurred because quantitative easing on a global basis simply has not worked.

We suspect that gold and silver demand will grow stronger even if the price weakens, or perhaps because the price weakens.  Those who understand the virtues of gold ownership are not going to suddenly go to their national currencies, or the banking system, as a defense.  They will go to gold and silver.