Lehman Five Years On: Gold Still Safe Haven As Financial System 'Insane'

Today’s AM fix was USD 1,308.25, EUR 984.46 and GBP 827.12 per ounce.
Yesterday’s AM fix was USD 1,340.25, EUR 1,008.54 and GBP 847.46 per ounce.   

Gold fell $41.60 or 3.05% yesterday, closing at $1,323/oz. Silver slid $1.31 or 5.66%, closing at $21.83. At 3:01 EDT, Platinum fell $28.60 or 2% to $1,437/oz, while palladium fell $2.03 or .3% to $688.47/oz.

Gold in USD, GBP and EUR Before and After Lehman Brothers Crisis

Gold has fallen 5.4% this week and is headed to its lowest in five weeks (see chart below). A heavy burst of selling led to another sharp fall in gold from $1,323/oz to $1,312/oz, again in less liquid Asian markets overnight and gold broke through support at $1,320/oz and may now test support at the $1,275/oz level.

The losses appear to be primarily due to speculative paper selling of futures contracts leading to further technical selling as stop loss orders are triggered. There has been no marked decrease in global physical bullion demand or significant physical selling of any note in recent days.

Speculation that the U.S. Federal Reserve will decrease its stimulus next week and the lessening of the threat of U.S. military strikes on Syria may have contributed to the price falls as nervous speculators take profits or go short.

Lehman Brothers filed for bankruptcy at 0145 EST late Monday night, September 15, 2008, and the five year anniversary is this Sunday. 

Little has changed in the financial world and on Wall Street since the collapse and vital lessons have not been learnt.  The financial system remains vulnerable to excessive risk taking, unforeseen shocks and systemic risk.

It is important to note how the Lehman bankruptcy and subsequent systemic, financial and economic crises showed gold’s importance as a safe haven asset and as financial insurance in a portfolio.

Gold in dollar terms has risen 73% and silver by exactly 100% since the Lehman bankruptcy and collapse. Both have risen by similar amounts in other major currencies.

Gold rose in the years preceding the crisis when more prudent observers were warning about risks emanating from cheap money policies, overheating stock and property markets, an out of control derivatives market and the shadow banking system. A Lehman Brothers style crisis was obvious to many analysts who warned of systemic risk.

In the immediate aftermath of Lehman, gold prices fell for a few days leading to loud pronunciations that this proves gold is not a safe haven. However, by year end gold had risen again and it continued its gains as the crisis rumbled on into 2009 and morphed into a sovereign debt crisis subsequently.

MSCI World Stock Index Before and After Lehman Brothers Crisis

Commentators have suggested that risk assets such as equities have fared well since Lehman Brothers and this shows the importance of passive investing. This is true to an extent. However, equities had fallen substantially prior to the Lehman Crisis and there is a strong argument to be made that stocks were pricing in the coming crisis in the months prior to September 2008.

This crisis showed how equities are risk assets and far more risky than accepted by Wall Street and some hedge fund managers. It rightly called into question the ‘cult of the equity’ and the tendency for many investment and pension fund managers to be very overweight equities.

Many of these same fund managers completely ignore and or disparage gold. Yet a 5%, 10% or even a 20% allocation to gold would have greatly protected investors as gold’s long term inverse correlation with equities was seen once again.

This is an important lesson from the Lehman debacle. It is a lesson that if learned will protect investors from the coming financial, economic and likely currency crises.  

Gold in US Dollars, Year to Date - Boomberg

The respected Gillian Tett has written an important op-ed piece in the Financial Times where she argues that the financial system is arguably more insane now than it was prior to the Lehman Crisis.

Tett is an award-winning journalist and author, and is a markets and finance columnist and an assistant editor at the Financial Times. 

Her 2009 book ‘Fool's Gold: How Unrestrained Greed Corrupted a Dream, Shattered Global Markets and Unleashed a Catastrophe’ was widely reviewed throughout the English-speaking world and won the Spear's Book Award for the financial book of 2009.

Gillian Tett

She has been positive regarding gold as an asset and diversification for some time due to the degree of financial and economic uncertainty in the world.

In the Financial Times  today, she writes:

But the bad news is that the system is just as insane – perhaps more so. There are a host of developments that are at best counterintuitive, and at worst dangerously bizarre. Investors may no longer face six new banking shocks before breakfast, but there are at least six peculiar features of the post-Lehman world that might make Alice blink.

? The big banks are bigger – not smaller. When Lehman collapsed, there was outrage over the fact that many western banks had become so enormous they were “too big to fail”, creating concentrations of risk. Reformers called for banks to be broken up, to make them smaller and create badly needed diversity. Some financial officials, such as Richard Fisher of the Dallas Fed, continue to demand this sensible step. But, as the investor Henry Kaufman points out, the banking world, especially in the US, has become more concentrated than ever. That is unnerving, particularly since no one knows how regulators would ever shut down a really big bank.

? The shadow banking world is taking over more activity, not less. When Lehman failed, regulators suddenly realised they had been ignoring the non-bank sphere, enabling egregious behaviour to flourish. Given that, you might have expected those shadows to shrink. But think again: it has expanded since 2008 from $59tn in size to $67tn, according to the Financial Stability Board. And it is likely to swell further, because tighter bank regulations are pushing more and more activity into the non-bank world. The FSB insists it has become better at monitoring these shadows; we had all better hope it is right.

? The system depends more than ever on investor faith in central banks. One issue that caused the last credit bubble was excessive investor trust in the abilities of central bankers, both to keep inflation low and understand how financial innovation worked. Logic might suggest this blind faith should have wilted after Lehman Brothers failed. Not so; these days all manner of asset prices are now being propped up by a sunny investor belief that central bankers know what they are doing with quantitative easing; even though nobody has tried it on this scale before, or knows how to exit.

? The rich have become richer. The Lehman Brothers crisis triggered a surge of popular anger against wealthy elites; hence the rise of the Tea Party, Occupy Wall Street, and other protest groups. But that has not caused elites to lose wealth. On the contrary, one (largely unacknowledged) consequence of QE is that this has raised asset prices and thus benefited the asset-rich wealthy elite, widening inequalities. The Bank of England, for example, calculates that 40 per cent of the QE benefit has gone to the top 5 per cent, including those bankers.

? Financiers have been prosecuted – but not for the credit bubble. After the Lehman collapse, politicians demanded banker prosecutions, and initially this seemed likely to occur. After all, almost 2,000 financial professionals were convicted following the 1990s savings and loans crisis in the US. But while senior financiers have been hauled off in handcuffs since 2008, this has generally not been due to credit bubble issues (think, for example, about Bernie Madoff, Alan Stanford, Raj Rajaratnam, Rajat Gupta and so on).

? Fannie and Freddie are alive and well. Back in 2008, it seemed self-evident that the rotten entities of Fannie Mae and Freddie Mac were overdue for reform; indeed, it was a crisis in those state-backed housing finance agencies in August 2008 that started the chain of events leading to the Lehman shock. But five years later, Fannie and Freddie are more entrenched than ever, accounting for more than 90 per cent of the US mortgage market, up from 60% before.

" ...  these issues are ...  a powerful reminder of the vast amount of work still to be done before we have a financial world that looks both sane and safe."

GoldCore Conclusion
The collapse of Lehman Brothers, the risk of other large important banks failing in the coming months and the still significant systemic, macroeconomic, monetary and geopolitical risk of today shows the vital importance of real diversification and an allocation to physical gold.

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