The subprime crisis began to unfold last summer as lenders started to default on those mortgages given to people with poor credit histories. The assumption was home prices always go up.
In some cases, greedy salesmen sold unsophisticated borrowers loans theyâ€™d never be able to repay. In other cases, greedy borrowers took the money with no intention of repaying, and others took the money truly believing appreciation would allow them to painlessly refinance in the future.
Well, we now know home prices donâ€™t always go up, and billions of dollars of these bad loans remain repaid. Gee, it makes you wonder why they never saw it coming.
Many financial institutions gambled on high-yield securities and lost. We know about the recent problems at Countrywide Financial, Citigroup, Merrill Lynch and others. As a result, the common wisdom among many financial professionals recently has been to diversify out of the dollar. Buy euros, buy Japanese yen, buy British pounds; just make sure you get out of the dollar.
But wait a second, not so fast.
What many Americans donâ€™t realize is that although the subprime crisis started in the US, this isnâ€™t just a US phenomenon. Financial institutions around the world are announcing massive writeoffs just about daily.
A few weeks ago the Bank of England (BoE) announced plans to nationalize one of Britianâ€™s largest mortgage lenders, Northern Rock. This institution has a GBP25 billion (USD48 billion) subprime problem of its own. A taxpayer bailout certainly wonâ€™t help the value of the pound.
Just last week, Spiegel Online reported that the German government bailed out IKB Deutsche Industriebank to the tune of USD1.46 billion dollars (EUR1 billion). The bailout was blamed on the subprime crisis because the German government felt if it didnâ€™t act, the whole financial system would be in peril.
And this wasnâ€™t the only USD1 billion bailout of a German bank; there have been at least four others that required cash injections or government guarantees with dozens of smaller savings and loans requiring lesser bailouts.
And this problem wasnâ€™t only with the German banks. Last month Munichâ€™s Hypo Real Estate saw its market value drop by a third--EUR2 billion--in just one day, the largest drop ever recorded by a firm listed on the DAX (the German equivalent of the Dow Jones Industrial Average). Stuff like this isnâ€™t conducive to a strong euro.
Whatâ€™s my point? Perhaps diversifying out of the dollar into some other currency isnâ€™t the answer. Although the dollar is down nearly 10 percent from a year ago, itâ€™s been roughly flat since November. The euro (versus the dollar) has been roughly flat for the past four months as well, and so has the yen and the British pound.
On the other hand, gold is up 24 percent since November in dollar terms. Gold has rallied not only against the dollar, but against all major currencies: the euro, the pound, the Mexican peso and the yen.
Silver is up even more dramatically since November, an incredible 40 percent. Thinly traded platinum is up even more than silver, about 50 percent year-over-year due to its dual use as a precious as well as an industrial metal. Although I generally donâ€™t trade platinum (itâ€™s fairly thin), I just pulled out the weekly chart. Since August, platinum has only registered three weekly lower closes with 24 weekly higher closes. What a trend.
I donâ€™t believe the subprime mess is even close to being over. Therefore, although there will be ups and downs, the major trend for the precious metals should continue higher through 2008 and even beyond.
The moral to this story: Stop thinking about diversifying out of the US dollar into other currencies, and start thinking about diversifying out of the dollar into hard assets. I donâ€™t believe the general public has jumped aboard the gold and silver bandwagon yet. When they do, the bull market in precious metals will enter the final and most lucrative phase higher, but as of yet this hasnâ€™t been the case.
April Gold (Daily Chart)
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