Systemic Financial Crisis and Its Implications for Gold
The cyclical bear market in equities, which is around 6 months old, is still far from being over. Problems caused by the real estate bubble, which are now permeating throughout the entire US economy, cannot be solved quickly.
The fact that the real estate contagion has caused a severe infection of the entire US financial system is now finally being widely admitted by Wall Street. This realization is well reflected by how the labeling of the crisis by the media evolved over the past year: from a "Subprime Crisis" in early 2007 to a "Liquidity / Credit Crisis" in summer 2007 to a more recent "Solvency Crisis" and now finally to a "Systemic Crisis."
A Systemic Financial Crisis requires a solution that will not take months but rather several years. At present, the Federal Reserve and the federal government are being forced to address two main issues:
- How to prevent a collapse of the ailing financial system; and
- How to convince the entire world that the US financial system will be rebuilt based upon a new, strong and healthy foundation.
The first problem is highly relevant and to solve it, two methods are being implemented:
- Inflationary Legislation and Easing Fed Policy. Congress pushed through a fiscal stimulus bill for $150 billion, and more legislation is unquestionably on its way. The Fed is providing monetary stimulus by slashing interest rates and attempting to increase money supply;
- A Masked Bailout of the financial institutions by the way of fixing their awful state of affairs through damaging the Federal Reserve's balance sheet. This is being accomplished by swapping Asset Backed Securities with unknown market values for the highly liquid treasuries. The model for a swap of non-liquid bank assets in exchange for government treasuries was first implemented in the Fed's deal with JP Morgan in March and has since been used in the $200 billion Term Securities Lending Facility.
Ultimately, these ways of addressing system problems will only be viewed as the first steps toward a massive nationalization of mortgages which are under a threat of foreclosure.
Further deterioration of the Fed's balance sheet will cause continued weakness in the US dollar and contribute to the already super bullish fundamentals on gold.
A continuing crisis in the financial system which caused a dramatic risk aversion on behalf of investors has led to a temporary distaste for the junior mining sector. When combined with exceptionally robust prices for precious metals, this has led to extraordinary values in many small cap gold and silver juniors; such are the opportunities which we continue to seek out.