Gold
Gold was down $19.90, or 2.3 percent, to $863.24 an ounce at the close in London (with NY closed for Martin Luther King Day) and silver was down 50 cents or some 3.5% to $15.59 per ounce. Both have sold off in trading in Asia and early European trading. Gold’s sell off is due to strength in the dollar which has rallied as high as 1.4360 against the euro (see FX below), the continuing fall in oil prices which are down another 1.5% today, margin calls due to the rout in equity markets and profit taking from all time record highs and what were overbought conditions.

Gold’s safe haven credentials were seen again yesterday and today. While major industrial and emerging equity markets crashed by some 4% to 8% yesterday (China and India are both down 12% in 2 days), gold only fell 2.3%. Unlike equity markets gold remains up by over 7% in the last 30 days. Most equity markets are off by over 10% in the last month (see Performance Table). Equity markets show some signs of recovery today with the FTSE flat on the day after experiencing significant early losses. The gold market has been far less volatile than stock markets and gold’s sell off has been orderly compared to the panic in equity markets.

Fears of financial contagion are growing and there is a realization that the “subprime crisis” may be degenerated into a property crash in the U.S. and in other markets. Thus the “wealth effect” is being replaced by the “poverty effect” and what was a subprime issue is now morphing into an unprecedented debt crisis affecting nearly all forms of debt - mortgages, credit cards, car loans, hire purchase and very seriously local government bonds. The root cause of all this is cheap money and a massive liquidity bubble which created the largest debt bubble the world has ever seen and a huge mispricing of risks in financial markets.

Risk aversion will be and should be the order of the day. Allocations to cash (particularly Swiss francs, CHF) and gold should be increased as we appear to be in the early stages of a sharp recession in the U.S. which may spread internationally. The great hope of “global decoupling” whereby the BRIC and other emerging market economies would decouple from the U.S. economy and not develop severe flu when the U.S. catches a cold is now to be severely tested.

Turmoil in international markets may in the short term lead to some speculative longs liquidating positions in gold but over the medium to long term this financial instability will create safe haven demand for gold. This is graphically illustrated in the last 30 days with gold up some 7% and most major stock markets down by 10% and more.

In recent months when there have been sharp sell offs in stock markets, gold has also sold off initially but by far less. So if major indices are off by 3% or 4% gold might only be down by some 1% to 2%. Subsequently, stocks have tended to drift sideways before recovering but gold has rallied more quickly and has outperformed stocks in the days following sharp sell offs. A similar pattern was repeated yesterday and will likely continue in the coming days.

The London AM Fix was at $862 (down from $874.25 on yesterday). Gold was down from near record highs in GBP and EUR and fixed at £442.50 (down from £448.47 yesterday) and €595.22 (down from €603.67 yesterday).

Support and Resistance
Gold briefly breached $850 and support is now at $840 to $845 which was previous resistance and interestingly $840 is very close to the 50 day moving average (DMA) and Fibonacci support.
Gold is likely to remain above $840 given the macroeconomic climate however should it close materially below $840 there is a possibility of a retracement to the psychological level of $800.

FX
The theme of risk aversion could be clearly seen in the Foreign Exchange markets yesterday. Most notably the carry trade unwinding that we feared over the past week continued unabated. The biggest benefiter of this was naturally the Japanese yen as all the major currencies fell sharply against it. The momentum in selling of high yielding currencies even took us by surprise and the market could be prone to a short term correction from oversold levels, however if the panic selling of the Dow continues expect further carry trade unwinding also to continue.

The euro came very close to completing a full retracement of the move against the dollar from 1.4315 to 1.4925 when it hit an overnight low of 1.4360. This can now pave the way for a resumption of the up-trend as a theme of dollar weakness returns.

Against sterling the euro would appear to have based as short term speculators have now exited this trade and again a return to the upward trend in the euro against sterling should begin.

As commodity prices fell yesterday on U.S./Global recession fears, so too did the commodity currencies as the Australian dollar, New Zealand dollar and the South African rand all lost ground against the Greenback. Again this will probably prove to be short lived as equities continue to falter, safe havens are sought and the global supply/demand imbalances continue commodities are set to continue what we feel will be a multi-year bull run, ultimately benefitting these currencies over the long run.

Silver
Silver is trading at $15.63/$15.65 at 1130 GMT.

PGMs
Platinum was trading at $1526/1532 as per above (1130 GMT).
Palladium was trading at $362/367 an ounce (1130 GMT).

Einstein: “The significant problems we have cannot be solved at the same level of thinking with which we created them”
Thus the problem will not be solved by more cheap money in the form of tax breaks and further interest rate cuts or by Ben ‘Helicopter’ Bernanke showering paper dollars on the U.S. citizenry. Further interest rate cuts may alleviate the problems in the short term but ultimately the U.S. and the world needs a period of gradually higher interest rates (as was administered by the excellent ex Federal Reserve Chairman Paul Volker in the 1970s) in order to gradually eliminate the huge and unprecedented levels of debt from the system, discourage the ‘casino capitalism’ of recent years with massive speculation and the creation of some $500 trillion in opaque and exotic financial derivatives, eradicate the significant inflationary pressures that have built up, rebalance the huge trade and current account deficits that have been developed between most western economies and their creditors in the Middle East and Asia. Thus, through administering the necessary short term pain the global economy will again be put on a more sustainable financial and economic path.

How to Survive a Recession - SMEs must learn to become flexible and scale down costs if they are to survive a recession
The backbone of most modern economies are Small to Medium Enterprises. Those enterprises that employ less than 500 people. Most commentators agree that we are facing recessions in many major economies, the key now is how will our economies deal with this threat. It is not inconceivable that left unchecked, a full recession could deteriorate into something more severe.

What to do? They key in our estimation is to acknowledge that a recession will have some positive upside as well as the obvious and painful downsides. It will clean house and leave behind the most robust enterprises allowing capital to be redirected towards worthwhile endeavours and reduce wasteful investment in poor performing companies and unproductive assets such as property. It may be true that in order to evolve to the next level of economic growth a recession is in fact necessary, the fact that we have not had one in so long means that our economic policy makers have become complacent and lethargic. The solution to the current problems lies in large part with the SME enterprises. By increasing their flexibility, such companies will gain scalability and if you can scale down with relative ease you can survive where competitors will fail. By scrutinising all their expenses and gaining maximum flexibility SMEs can quickly reduce their exposure to rapidly inflating costs and match their expenditure to their turnover. In addition such companies will be in a better position to capitalise on the inevitable round of government economic stimuli. Keeping an eye and reducing costs through use of technology (such as Skype and other VOIP providers) is also important. In a globalised economy SMEs should look to Asia and emerging markets internationally as while they may suffer recessions in the short term, long term China, India and other emerging markets offer huge opportunities to SMEs.