Our oil-rich friends in the Middle East are scared. How do I know? Because they are buying gold like crazy!
First, we got the news that Saudi investors spent $3.47 BILLION on gold in a recent two-week period. On a ratio-to-GDP basis, that's like investors in the U.S. spending $131 BILLION.
Why are they doing this? The only explanation I've heard is that the Saudis are turning to gold as a safe haven in the midst of the global financial crisis. And since the financial crisis kicked into high gear in August ... something must be scaring them quite a bit more right now.
Second, Reuters reports that Iran is converting some of its foreign currency reserves to gold. Iran has $120 billion in foreign currency reserves ... there's no details on just how much was shoveled into the yellow metal.
Third, gold dealers in Dubai reported running low on gold during the recent Indian holiday, the Festival of Lights, a traditional time for Indians to buy gold. More than 50% of the population of Dubai originally comes from India. And about 20% of the world's gold is traded in Dubai.
The world is in the grip of economic hard times — over 40 countries are officially in a recession. Japan just joined that unhappy club. And the euro-zone nations are already there. We also know that the forces moving the market now seem to be deflationary, not inflationary. That means the value of the U.S. dollar is going up, and the price of gold is trending lower.
But could our friends in the Middle East be thinking beyond the current deflationary spiral? Gold is traditionally a hedge against calamity. So I ask again, what are the oil sheiks afraid of?
While gold prices are going lower in the short-term as deflationary forces tighten their grip, there are also longer-term forces that are quite bullish for gold ...
Chinese investors' demand for gold is rising. Investment demand hit 38.4 metric tonnes in the first nine months of this year against 24 tonnes for the whole of 2007.
Demand for gold jewelry in China reached 241.6 tonnes in the first nine months of 2008, compared with 302 tonnes for all of 2007, when gold jewelry demand grew by 26%. China is the world's second-largest gold consumer.
Sources in the Indian market and preliminary data on Indian imports point to a strong revival in Indian jewelry demand during this year's third quarter.
In South Africa, gold mining output plunged 17.7% in September compared to a year earlier.
Global mine production of gold declined by 4% year-on-year in the second quarter to 590 tonnes, bringing output in the first half the year to 1,133 tonnes, 6% below the same period a year earlier.
Still, this long-term good news is cold comfort when prices are trending lower in the short-term. So it must be other things driving the Saudis and Iranians into gold.
There are plenty of good reasons people might want to buy gold. Sure, deflation is putting downward pressure on gold ... on paper. But just try buying physical gold anywhere near the paper price.
Pricing in a Government Default?
While gold is traditionally a haven of safety, that's not how it played out over the past couple months. Instead, we saw risk-adverse investors dump gold along with other asset classes and flee to the safety of cash.
Maybe the mighty dollar has more upside. But remember that the U.S. dollar is backed by "the full faith and credit of the U.S. government." Do you have a lot of faith in the U.S. government? I'd say the faith of the world has been shaken by recent events.
And apparently I'm not the only one who thinks that. Take a look at my next chart, which shows the 10-year credit default swap spread on U.S. Treasuries — a form of insurance contract against issuer default.
The cost of insuring against a U.S. government default is soaring. And similar trends exist in the bond markets of Germany and Britain.
I think this is because investors are pricing in the massive bailouts that central banks are throwing at their markets. For instance, the U.S. bailouts will add enormously to our country's already staggering national debt.
According to CNBC data, the cost of all the bailouts that have been going on for months has now hit a total of $4.2 TRILLION!
In fact, Morgan Stanley recently estimated that the 2009 fiscal deficit in the U.S. would reach 12.5%. That's more than twice the previous record of 6% set in 1983.
As a percentage of GDP, the U.S. national debt should pass 70% next year. That's lower than the 122% at the end of World War II. Yet we aren't fighting World War II, are we? That ended rather abruptly — this crisis won't. And the odds are our fiscal picture will get worse, not better.
Under the circumstances, maybe investors in Saudi Arabia and Dubai may just be ahead of the curve. Maybe having some gold — the ultimate safe haven against troubled times — is the right thing to do.
I'm not saying the U.S. government is going to default ... I'm saying the possibility of that happening could be priced in more ways than one. And that's the kind of environment where gold could really shine.
Consider Buying Gold on Dips ...And Hold for a Wild Ride
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