(03/21/13) Cyprus Bailout a Boon for Gold

The Cypriot banking confiscation will drive many investors to gold, both on and off the island, says Tom Luongo of LiveCharts.co.uk.

The gold bears have been pressing their case very hard now for a few months. In the face of soaring monetary statistics, the current meme is that moneyprinting does not lift gold prices, even though the correlation between the US dollar monetary base and the price of gold is unmistakable.

The news released after the markets closed on Friday that the EU/IMF bailout of Cyprus will carry with it a confiscation of up to 10% of Cypriot bank deposits is simply a moment akin to Caesar crossing the Rubicon. By doing this, the most basic trust between banker and depositor has been breached, and much of the money pulled out of any bank in response to this will likely never be put in another bank anytime soon.

The instability created by this will have ripple effects well beyond Cyprus. In the US during the Great Depression, loss of faith in the banking system had become so complete that nothing short of deposit guarantees would bring money out from underneath the mattresses.

I agree with those that cite the creation of the FDIC as the watershed moment in the era of monetary history. Only after that could there be the building of a positive credit growth cycle. Not that I advocate this being the right course of action, but rather that it was a precursor to being able to achieve that specific goal.

Fast forward to today, and we see the exact opposite scenario playing out in Cyprus. I guess for Cypriots, the current version of the plan to steal their bank deposits is far more benign than, apparently, what the Germans were asking for originally—40%.

And even though the EU is reaching new levels of incompetency by constantly shifting the terms of the theft to see which trial balloon will float the longest, the main point is that like food scares, once trust in one's money or bank is gone, it’s not coming back anytime soon.

This is what brings me to gold. Sure, the US dollar and Treasury bonds will see a bid from this. Gold is not a big enough market to soak up the money that will flow out of European banks...but at the same time, this fear trade will not result in a simultaneous hammering of the gold price.

Last year’s Eurozone breakup fear trade was happening against a backdrop of the Federal Reserve actively tightening the monetary base. This year, we are in the exact opposite environment. Bond yields are far lower across the board than where they started this year, and gold hasn’t been rallying. Quite the opposite has been occurring.

Therefore, a great deal of the money flowing out of European banks will find its way into the gold market. If you couple that with the inevitable backlash from both the Russian and Italian interests who were the target here, then I would be very surprised not to see a major attempt put in by gold to move back toward $1,700 in the near term.

If there is a loss of confidence and trust in the banking system, money will flow down the pyramid. Gold will benefit from this, as will the US dollar, simply due to the sheer size of the problem.

Gold rising into this, however, is important for the euro as well as all other countries which mark their central bank gold to the market, like the ECB and those of the BRICS.