The Consequences of Manipulating Currencies (and Gold)

You may not even have noticed that overnight both gold and silver were smashed in the Asian markets. The bounce back resulted in an up market for both today in US markets. So in case you missed it, here's what it looked like:

 

While raids on the precious metals continue causing wild gyrations, there is clearly demand for the real thing as inventories are taken down. As I've shown in recent posts, the paper price is getting hit while physical demand soars.  In India, the Finance Minister is begging people to stop buying gold.

And from Goldmoney.com:

At least one bank was recently reported to be only prepared to settle bullion liabilities in cash. Therefore the price knock-down in April was a logical response by the bullion banks, which had to defuse customer demand for physical delivery. But given that the driving factor was not speculation but a reluctance to add to deposits in the banking system, the jump in demand for bullion at lower prices was inevitable.

Where does this leave things? The crisis in bullion markets is worse than it was before. A good example of how little physical stock there is can be gained by tracking bullion deliveries on the Shanghai Gold Exchange. In the last few weeks they have dwindled to virtually nothing, having been a truncated 190 tonnes in April and 297 tonnes in March. Yet we know from reports that retail demand in China has taken off; so it is only a matter of time before prices are bid up on the Shanghai Gold Exchange enough to replace lost inventory.

It will be interesting to see how many more bullion banks are forced to admit the fiction behind their customer accounts in the coming weeks. For the moment the temporary solution amounts to rationing bullion supplies to the public.

Of course, the problem with price fixing is that it has unintended consequences:

In August of 2011, Argentina’s government slowly began to implement a series of actions destined to curtail the right of citizens to access US dollars (foreign exchange in general). The goal was and is to force savings into pesos, as pesos are after the taxable asset in a country that cannot access capital markets and fully monetizes its deficits.

From that moment onward  physical US dollars started to trade at a premium. Last week, with the paper US dollar value at 5.11 pesos, that premium was over 100%. Physical US dollars, i.e. dollars outside the system, reached a bid/ask of 10.30/10.45 pesos. The chart below should help visualize this dynamic (source: Reuters/La Nación)

 What can we learn from Argentina? Well, the government is trying to push their people into holding the "official currency" but are failing because the people don't believe its value is equal to the official exchange rate. Here in the US we might view the USD/ Gold exchange rate the same way. With the paper price having been pushed below the natural market price, the demand for physical (but not paper) has exploded. In the same way the dollar trades at a premium of 100% to the Peso from the official exchange rate, I believe we will see a physical gold premium continue to increase as I recently posted .

When the price is artificially low demand is high and shortages loom. The average Soviet knew this well in their time. The price of bread was always fixed  low to keep it "affordable". The only problem was that there were always shortages.