A Milestone Week for Gold
China seizes the reins for physical pricing
As we sat here writing this update this past Sunday morning just a few hours before watching the World Cup final, we were making no predictions as to which team would win, Spain or Argentina. But there was one thing we were and are willing to bet on: This week—and Friday, July 24, specifically—will be notable for some major milestones for gold that ultimately will bear on the major geopolitical shifts now underway.
Why are we singling out July 24? As we’ve noted previously (see the article, “Mantra for Today’s World: Safety First”), the date marks the official launch of Hong Kong’s government-backed gold clearing and settlement system. The Hong Kong system will have its own vaults in which gold is stored, but more important, it will be seamlessly connected to China’s Shanghai Gold Exchange, with access to that exchange’s huge reserves of gold—somewhere in the many tens of thousands of tonnes and more than enough to satisfy the requirements of any massive clearing operation.
And there’s more. What’s also special about this Friday is that it marks the end of speculative gold trading within China. Effective July 24, major Chinese banks no longer will allow retail clients to carry out leveraged precious metals trading on the Shanghai Gold Exchange. Clients who have been speculating on gold are required to close their positions, liquidate, or take physical delivery by the deadline.
With these actions, China is taking a giant step forward in implementing its long-desired goal of establishing a gold market in which prices reflect actual trades of physical gold, as opposed to the speculative futures trading that characterizes trading on the Comex and London Bullion Market Association. Those two exchanges have long been the ones that set gold’s price. But now Hong Kong’s system will act as a counterweight. Over the longer term, that will be an overwhelming positive for gold’s price.
Hong Kong’s status as a special administrative region of China is what makes its debut as a trading hub so significant. That’s because while Hong Kong is part of China, it is free of the capital controls that China has imposed in the mainland, which have made the Shanghai Gold Exchange less attractive to international investors. Hong Kong will be able to attract a far broader base of investors, making it a weightier factor in gold trading and pricing.
When pricing is based on physical trades—on what investors are actually paying for the metal—one welcome effect is that it makes prices harder to manipulate, i.e., to suppress. Gold prices have a long history of being manipulated by Western financial institutions desperate to ward off any threat to the primacy of the dollar. Gold with its long history as a monetary metal, is the main threat to the dollar maintaining its role as the world’s primary reserve currency, a status that is becoming increasingly dodgy as the U.S. economy becomes weighted down by debt that isn’t supported by any tangible asset.
One telling change can be seen in the composition of reserves held by central banks. The bulk of these reserves consists of dollar-related assets and gold. Dollars overall still make up the biggest proportion. But those dollar assets consist of cash, which countries need to have on hand in order to engage in international trade, plus U.S. debt in the form of Treasury securities. Significantly, central banks’ gold holdings have overtaken their holdings of U.S. debt, which is becoming increasingly unattractive to foreign buyers as the country’s huge existing debt forces us to issue even more debt simply to service that previously issued debt.
Lowering the Odds of Deflation
Last week, in his appearance before a Senate committee, Fed Chair Warsh made a striking comment that hasn’t gotten much attention but that we think is very significant. Warsh stated that he would be willing to use the Fed’s balance sheet aggressively should the U.S. find itself in an economic crisis. In other words, he was saying yes to quantitative easing—money printing—the very policy he is known for being so opposed to.
It suggests that Warsh recognizes that facing two unappealing alternatives, the Fed would choose inflation over the risk of deflation and a devastating economic downturn. We noted recently that we wouldn’t have been shocked to see gold go as low as $3,500 but that if it did drop to that level, we would see it as indicating the U.S. was headed toward deflation. But that now seems less likely. Gold would still be a top investment under deflation, holding its value, but during times of inflation, it soars.
Iran, Ukraine, and Fading U.S. Hegemony
The war in Iran continues to be a disaster for the U.S. that is further sealing the deal on the decline of our hegemony, including in our military technology. Most of the current focus has been on re-opening the Strait of Hormuz to something resembling where it was before we started the war. But in a way, while that would be nice for the world’s economy, it’s almost irrelevant in terms of Iran’s new, stronger position in the world. Even if Iran decided to completely yield control over the strait, which it almost certainly isn’t going to do, the country still would maintain the hypersonic missiles that transcend anything that we have. For our allies in the Mideast, we’ve gone from their protector to a liability. The war in Ukraine sends a similar message about U.S. relative capabilities, with reports indicating that Russia is now producing on the order of 25 Oreshnik missiles a month.
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