Buy Gold Now? (source:goldseek)

Last week has to be one of the most stunning in the history of financial markets.

It started with the weekend sale of venerable Bear Stearns to JP Morgan for the laughably low price of $2 a share set the tone for what will be remembered as a prophetic event for the week that followed, and ultimately, for the months that will follow.

The Fed has essentially funded the sale of a distressed asset to avoid the collapse of Bear Stearns, which, if allowed to happen, would put so many other banks into a state of insolvency that the domino effect would ultimately cause more big banking names to fall. The term “capitulation” comes to mind.

So what has happened, is the Fed is exercising its right to print money with renewed abandon, comforted by the short term validation of its strategy afforded by the Dow’s responsive surge. Casual observers might be forgiven for interpreting the bear market rally, representative more of short covers and delusional optimists than of relative strength, for signs that the crisis is over, the market has bottomed, and business as usual is imminent.

But hold the phone. Is this the bottom of the well, or merely a ledge hit on the plummet to resume shortly?

Bet on number 2. Though both gold and oil have taken a near 10% hit during the last few sessions, and sure the Dow has piled on 400+ points in two sessions in the last two weeks, there is much, much more to come.

The confidence in the dollar and the Dow expressed in terms of gold, oil and commodities sell-offs is partially a reaction to the swift and decisive actions Ben Bernanke. The general feeling on Wall Street is one of suppressed awe for the utter absence of hesitation the Fed chairman has demonstrated in the face of the crisis. His creativity and resourcefulness during this time is admirable.

The turbulence ahead will no doubt be tempered by such deftness.

But, and this is the big “but”, the next 10 to 12 weeks are going to be no less chaotic then we’ve those we’ve been enjoying in 2008.

Next up on the Price is Wrong is commercial mortgages and their asset-backed derivatives.

There’s no doubt about the fact that the U.S. is suffering a downturn in economic vitality.

New Residential construction numbers announced Tuesday last week indicated a 36.5% drop in building permits issued since last February, and the numbers were down 7.8% for the quarter. Other key economic indicators confirm the slowdown in consumer spending across all areas of the economy. The result: business is slowing down in tandem.

So with business in a contraction mode, all those new office buildings in various degrees of completion add up to an oversupply of office and commercial space inventory, with the accompanying effect of falling prices. Add to that the inability of anywhere from 80% or higher of the commercial paper underwriting the financing of that construction to renew, and you’ve got a recipe for defaults on a scale that will make the residential mortgage problem tame in comparison.

According to a Wall Street Journal article dated March 22:

The spread on the CMBX Triple-A series 3 index has fallen to around 1.90 percentage points, its lowest level since late February.

That kind of a reading on the triple-A CMBX indexes implies cumulative default rates on the underlying loans of as high as 100%, players say, depending on the assumptions made for recoveries that would follow defaults.

The CMBX Triple A index tracks the cost of protection against default on a series of securities backed by commercial mortgages.

The major difference between commercial mortgage backed securities versus those backed by residential mortgages is exposure. Whereas most residential mortgage-backed securities are represented by hundreds of individual mortgages slices, its not uncommon for a single commercial mortgage to comprise up to 10% of any individual security. That means the quality of the entire issue can crash if just one mortgage defaults.

This is what Ben Bernanke is facing next, and the only real weapon left in the arsenal is more cash, which is okay for the short term, but the dollar is becoming more and more worthless with every billion dollar bailout.

It was exactly a year ago next week that China began to divest itself of US treasuries for the first time in seven years. With the value of all U.S. denominated foreign holdings free falling in value, other currencies are being sucked into the vortex.

All this means is that gold is going to grow in stature as a perceived store of value as long as the carnage continues.

During the first half of 2007, overall investment in gold was relatively weak; identifiable investment was 22% lower than one year earlier while statistically residual “inferred investment” was substantially negative. In Q3, while inferred investment was close to zero, identifiable investment soared as a result of record quarterly inflows into gold Exchange Traded Funds (ETF). In Q4 identifiable investment was more subdued, as retail investors took profits and ETF inflows steadied, but inferred investment became strongly positive. In dollar terms total net gold investment in Q4 reached just over $8bn – a quarterly record.

The $95 price drop in gold this past week is therefore nothing short of a gift. An unparalleled buying opportunity that will quickly be acted on, and one of a likely good number, as the volatility in the commodities, debt, and equities markets is going to stay high for the foreseeable future.

Next stop: $2,000 gold.

MCXARUN
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