Wednesday, October 16, 2013

Gold, Government Debt, and the Last Time the Debt Ceiling Was Raised

Posted earlier at Zerohedge. Lends itself to the thesis that government debt and gold prices are linked. We will have to watch if the something similar plays out this time. More on this soon.

U.S. lawmakers are scrambling to come up with an agreement to increase the federal debt ceiling before tomorrow’s deadline. Gold has not priced in a U.S. default - which could result from failure to raise the borrowing limit - on expectations that Congress will reach a deal at the last minute.

A default remains unlikely but should it happen it would roil global markets, hamper economic recovery and lead to another wave of safe haven gold buying.

More likely, is that politicians once again raise the debt limit to over $17 trillion - thereby eliminating the short term crisis but increasing the likelihood of a far bigger crisis in the coming months and years.

Physical buying remains robust particularly in China and India where premiums are rising again as gold is snapped up by canny Asian value buyers.

Gold premiums in India, the world's biggest buyer of gold along with China, hit a record $100 an ounce due to a shortage of bullion to meet festival demand. In China, premiums in the Shanghai Gold Exchange climbed to over $20 an ounce from about $7 two weeks ago.

Gold has fallen about 4% since the government shutdown began on October 1, leading many to believe that if there is no debt deal, the price could shoot up, particularly should we get a significant bout of “risk off” in markets.

Gold In USD, 3 Days - (Bloomberg)
It is interesting to note that in 2011, gold rose in the months prior to the debt ceiling agreement. Then in the immediate aftermath of the debt ceiling extension agreement on August 2nd 2011, gold surged another 17% in 15 trading days after the agreement was reached. From August 1st to August 22nd, gold rose from $1,619/oz to over $1,900/oz.

The United States lost its important AAA credit rating from Standard & Poor's late on Friday August 5th, 2011, in a dramatic vote of no confidence for the world's largest economy and the U.S. dollar.
This was a catalyst for the surge to the record nominal high of $1,920/oz two weeks later.

Gold In USD, 10 Days - (Bloomberg)
How Fitch has not downgraded the U.S. already is a mystery to analysts looking at the U.S. fiscal position and the lack of political will to tackle it. It seems likely that significant political pressure is being put on credit ratings agencies regarding their credit rating of the U.S.

The very poor fiscal position of the U.S. will gradually erode confidence in the dollar which will see it continue to lose value against gold. The continuing depreciation of the dollar and the further downgrading of the U.S. credit rating from AAA will contribute to higher prices again.
The question is when, rather than if.

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