Another Factor Begins Impacting Gold

Feb 23, 2007 – A subtle change is taking place in the gold market. In addition to all of the reasons people already have to buy physical metal, gold now has a new driver. Banks are starting to report significant loan write-offs.

To understand the importance of this new development, one only has to look back to the mid-1980s and the then brewing ‘savings & loan’ crisis. Years of imprudent lending began adversely impacting the earnings of S&Ls as they were forced to write-off loans that had defaulted and had therefore become uncollectible.

These write-offs soon snowballed as the depth of the problem became recognized, with the result that the S&Ls began reporting huge losses that eroded their capital. Some readers may recall the collapse of EPIC, Equity Programs Investment Corporation, which at that time was one of the country’s leading mortgage insurers. Imprudent mortgage lending killed it, while also severely hobbling its S&L parent.

This deterioration in the financial condition of the loss-making S&Ls in turn spooked depositors, which began withdrawing money. S&Ls in Ohio and Maryland were closed in a forced ‘banking holiday’ that prevented remaining depositors from getting access to their money. The parallels to FDR’s ‘banking holiday’ in 1933 were too obvious to ignore, so by then the crisis was in full swing. The chronology of major events is precisely laid out by the FDIC at the following link: www.fdic.gov

Missing from the above chronology is gold’s response to the crisis, but it is predictable. Gold rose $50 in three days at the time of the banking holiday which marked the beginning of a 2-year bull run that eventually almost doubled the gold price. Can history repeat? We’ll find out over time, but the developing parallels to today are obvious and ominous.

So far the write-offs by banks have been limited, but that is no reason for complacency. If the mid-1980s history is any guide, the problems now being reported by sub-prime mortgage lenders are only the tip of the iceberg, meaning that there are more loan write-offs to come. If so, will the problems of the 1980s repeat? Is a financial crisis brewing?

For now there are more questions then answers. But maybe gold’s strength over the past several weeks is giving us some guidance. The demand for physical metal has been strong, so maybe some people are not waiting for more bad news. They are seeking the safety and security of gold just in case history of the 1980s is going to repeat.