## Using Standard Deviation & Probability to Trade Options

I recently discussed the ability to use implied volatility to calculate the probability of a successful outcome for any given option trade. To review briefly, the essential concepts a trader must understand in order to make use of this helpful metric include:

1. The prices of any given underlying can be considered to be distributed in a Gaussian distribution- the classic bell shaped curve.
2. The width of the spread of these prices is reflected in the standard deviation of the individual underlying’s distribution curve.
3. Plus / minus one standard deviation from the mean will include 68% of the individual price points, two standard deviations will include 95%, and three standard deviations will include 99.7%
4. A specific numerical value for the annual standard deviation can be calculated using the implied volatility of the options  using the formula: underlying price X implied volatility
5. This standard deviation can be adjusted for the specific time period under consideration by multiplying the value derived above by the square root of the number of days divided by 365

These derived values are immensely important for the options trader because they give definitive metrics against which the probability of a successful trade can be gauged. An essential point of understanding is that the derived standard deviation gives no information whatsoeveron the direction of a potential move.  It merely determines the probability of the occurrence of a move of a specific magnitude.

It is important to note that no trade can be established with 100% probability of success; even boundaries of profitability allowing for a three standard deviation move have a small but finite probability of moving outside the predicted range. A corollary of this observation is that the trader must NEVER “bet the farm” on any single trade regardless of the calculated probability of success. Black swans do exist and have a nasty habit of appearing at the most inopportune times.

Let us consider a specific example of a “bread and butter” high probability option trade in order to see how these relationships can be applied in a practical manner.

The example I want to use is that of an Iron Condor position on AAPL. For those not familiar with this strategy, it is constructed by selling both a call and put credit spread. The short strikes of the individual credit spreads are typically selected far out of the money to reduce the chance they will be in-the-money as expiration approaches.

I want to build an iron condor on AAPL in order to illustrate the thought process.  As I type, AAPL is trading at \$575.60.  August expiration is 52 days from today; this is within the optimal 30-55 day window to establish this position. Consider the high probability call credit spread illustrated below:

This trade has an 88% probability of profit at expiration with a yield of around 16% on cash encumbered in a regulation T margin account.

Now let us consider the other leg of our trade structure, the put credit spread.  Illustrated below is the other leg of our iron condor, the put spread:

This trade has a 90% probability of profit at expiration with a yield of around 16% on cash encumbered in a regulation T margin account. As the astute reader can readily see, this put credit spread is essentially the mirror image of the call credit spread.

When considered together, we have given birth to an Iron Condor Spread:

The resulting trade consists of four individual option positions. It has a probability of success of 79% and a return on capital of 38% based on regulation T margin requirements. It has an absolute defined maximum risk.

Note that the probability of success, 79%, is the multiplication product of the individual probabilities of success for each of the individual legs.

This trade is readily adjustable to be reflective of an individual trader’s viewpoint on future price direction; it can be skewed to give more room on either the downside or the upside.

Another characteristic and reproducible feature of this trade structure is the inverse relation of probability of success and maximum percentage return. As in virtually all trades, more risk equals more profit.

I think this discussion illustrates clearly the immense value of understanding and using defined probabilities of price move magnitude for option traders. Understanding these principles allows experienced option traders to structure option trades with a maximum level of defined risk with a relatively high probability of success.

If So Join www.OptionsTradingSignals.com today with our 14 Day Trial

Jw Jones

This material should not be considered investment advice. J.W. Jones is not a registered investment advisor. Under no circumstances should any content from this article or the OptionsTradingSignals.com website be used or interpreted as a recommendation to buy or sell any type of security or commodity contract. This material is not a solicitation for a trading approach to financial markets. Any investment decisions must in all cases be made by the reader or by his or her registered investment advisor. This information is for educational purposes only.

## Dollar Tumbles as Easing Speculation Emerges

Tradervox.com (Dublin) –The greenback dropped against most of its major counterparts as speculation Federal Reserve will embark on a third round of quantitative easing rose in the market. Investors are wary of the disappointing data coming from the world’s largest economy hence they are seeking other safer currencies such as the pound and the Swiss Franc. The buck has dropped against the euro prior to a report projected to show factory orders stagnated in June. This report will confirm speculations that US economy is faltering just hours after the Institute for Supply Management’s Index showed that manufacturing in the US contracted in June.

Further, the US currency fell as safe haven demand was hampered by surge of demand of the Asian stocks which rose for the fifth day. The yen was also affected by the advance by the Asian stocks. This led to an increase in demand for commodity related currencies such as the Australian dollar which rose to within two-months high. Mike Jones of Bank of New Zealand Ltd in Wellington said that the US economy has been slowing down and further negative reports would only add to speculations of further easing which is negative for the greenback.

The greenback dropped by 0.1 percent against the euro to trade at \$1.2582 at the start of trading in the Asian Session today. It had advanced by 0.7 percent yesterday. The dollar increased slightly against ht yen, trading at 79.59 from earlier level of 79.51. The euro increased against the yen from previous reading of 100.00 to 100.14; Japanese yen had advanced by one percent against the euro yesterday.

As the MSCI Asia Pacific Index of stocks rose by 0.6 percent, the Australian dollar increased by 0.2 percent against the dollar to trade at \$1.0268; it had earlier touched its highest since May 4 of \$1.0278.

Disclaimer
Tradervox.com is not giving advice nor is qualified or licensed to provide financial advice. You must seek guidance from your personal advisors before acting on this information. While we try to ensure that all of the information provided on this website is kept up-to-date and accurate we accept no responsibility for any use made of the information provided. Opinions expressed at Tradervox.com are those of the individual authors and do not necessarily represent the opinion of Tradervox.com or its management.

Tradervox.com is a Forex News Portal that provides real-time news and analysis relating to the Currency Markets.
News and analysis are produced throughout the day by our in-house staff.

## Real-Forex Daily review- 03.07.2012

Daily Market Analysis by Real-Forex

Tracking the EUR/USD pair

Date: 02.07.2012   Time: 17:53  Rate: 1.2589

Daily chart

The price has stopped at the 1.2436 price level and created a large green candle in the weekend. Breaching the 1.2750 price level will indicate that an uptrend is building up while this level is the neckline of the “Double bottom” pattern which has a target around the 1.3090 price level. On the other hand, if the price will not break the 1.2750 price level and will move downwards under the 1.2436 price level will indicate that the price will descend at first stage to the last low on the 1.2290 price level.

You can see the chart below:

4 Hour chart

Date: 02.07.2012   Time: 18:07 Rate: 1.2586

Last Review

It is possible to see that the price stayed under the Bollinger’s moving average which is used as a dynamic resistance, as long as the price is under this MA it is located in the bearish area of the Bollinger bands. Breaking of the 1.2440 price level will probably lead the price towards the “Wolfe waves” pattern target on the crossing of the price with the line connecting between points 1 and 4 (around the last low at the 1.2290 price level). on the other hand, stoppage at the current area will sign that it is possible to see a correction in size of a third of the last downtrend (blue broken line), meaning the 1.2560 price level.

Current review for today

The price has stopped at the 1.2440 support level, jumped to the 1.2690 price level and stopped at this level while correcting the last move upwards by exactly 38.2%. Stoppage of the price at the current area and its breaking of the 1.2690 price level will probably continue the uptrend while its first target is the last peak on the 1.2750 price level. On the other hand, breaking of the 1.2580 price level will probably continue the correction with targets at the 1.2550 and the 1.2516 price levels.

You can see the chart below:

GBP/USD

Date: 02.07.2012   Time: 18:19  Rate: 1.5690

4 Hour chart

Last Review

It is possible to see that after the price has stopped at the 1.5540 price level for the first time, it made an ascending move towards the trend line connecting the lows (the line connecting between points 2 and 4) and stopped at this area. It is possible to assume that the short move upwards was actually a correction to the last downtrend (red broken line) and as it is written on yesterday’s review, breaking of the 1.5540 price level will probably continue the downtrend towards the “Wolfe waves” pattern target around the 1.5400 price level.

Current review for today

The price went back to the 1.5540 support level and went back to check the trend line which connects the lows (points 2 and 4). Breaching of the 1.5716 price level will indicate that it is possible that the price will check again the last peak on the 1.5777 price level. on the other hand, breaking of the 1.5660 price level will indicate that the price is headed towards the closest support on the 1.5613 price level.

You can see the chart below:

AUD/USD

Date: 03.07.2012   Time: 22:17  Rate: 1.0248

4 Hour chart

Last Review

The price is currently struggling at the 1.0075 price level in its attempt to breach it. Proven breaching of this level will indicate that it is possible that the price will continue towards the last peak at the 1.0224 price level. On the other hand, stoppage of the price at this area and breaking the 0.9980 price level will lead the price towards its first target on the 0.9940 price level, this is the “One in, one out” pattern target (red broken lines). Breaking of this level will probably lead the price towards the 0.9900 price level, this is a 50% Fibonacci correction level of the uptrend described with blue broken line.

Current review for today

The price did break the 1.0075 price level and reached the target of the last review on the 1.224 price level and even passed it. At this point the price is checking whether the resistance level can be used as a support, while breaching of the 1.0278 price level will continue the current uptrend. On the other hand, breaking of the 1.0224 price level will indicate that it is possible that we will see a correcting move towards the 1.0171 price level at first stage, this is a 38.2% Fibonacci correction level of the move upwards )blue broken line).

You can see the chart below:

Daily Market Analysis by Real-Forex

## “QE3 Probability” Could Boost Gold, No Need for Gold Standard “Until Money Collapses Completely”

London Gold Market Report
from Ben Traynor
BullionVault
Tuesday 3 July 2012, 07:30 EDT

SPOT MARKET gold prices traded close to \$1610 an ounce for most of Tuesday morning in London, after breaking through the \$1600 mark during the earlier Asian session.

Silver prices touched \$28 an ounce for the first time in nearly two weeks, while stocks and commodities also gained after disappointing US manufacturing data led to renewed speculation that the Federal Reserve might launch a third round of quantitative easing, known as QE3.

US manufacturing activity fell last month, according to the June ISM purchasing managers index published Monday. The ISM PMI was 49.7 – down from 53.5 in May and below analysts’ consensus forecast, which was around 52. A PMI score of less than 50 indicates contraction.

“The dimmed economic outlook leads to expectations of more stimulus, which will weaken the Dollar and help metals,” says one trader in Shanghai, adding that “silver will be relatively weaker than gold due to its industrial nature.”

“Over the last few weeks US numbers have worsened a lot,” says Eugen Weinberg, head of commodity research at Commerzbank.

“This has brought about the probability of QE3 – which is probably the most important reason for the market to believe in gold.”

The Federal Reserve last month chose not to launch an additional round of QE, instead extending its bond maturity extension program Operation Twist, which aims to lower longer term interest rates by selling shorter=dated securities and buying longer-dated ones.

“We are unlikely to see a big add-on after Operation Twist was extended,” reckons Dominic Schnider at UBS Wealth Management.

“Unless things fell off the cliff. And remember, when things did fall off the cliff in 2008, gold fell as well.”

Sales of gold coins by the US Mint were down 40% in the first half of the year, compared to the same period last year, although June sales beat May’s for the first time in three years.

Over in Europe, goods prices received by producers fell 0.5% in May, according to official Eurozone producer price index data published Tuesday.

“Businessmen don’t like prices going down,” says Lord Robert Skidelsky, professor of political economy at Warwick University, speaking on BBC Radio 4 Monday on a program looking at whether a gold standard would make the financial system more stable.

“It means they produce at one price and then may have to sell at a lower price…they prefer prices to be going up [because] they reckon their profits as a markup of their costs.”

Skidelsky adds that “although [western economies have] been printing money, it hasn’t been too much money”.

The time to worry, says Skidelsky, is when prices “accelerate and the value of money collapses completely…then of course you go back to gold”.

Here in London, Bob Diamond has resigned as Barclays chief executive. Diamond has been under pressure since Barclays was fined a record £290 million last week, after the bank admitted some of its staff had sought to manipulate Libor, the London interbank offered rate used as a worldwide benchmark.

Marcus Agius, who resigned as Barclays chairman on Sunday, will now return to lead the hunt for Diamond’s successor.

Over in Asia, traders report that the rise in gold prices since the weekend has led to a fall in demand for physical bullion.

“Customers went in to pick up gold below \$1560 last week, but now the market is quiet again,” one dealer in Singapore told newswire Reuters Tuesday.

Gold value calculator   |   Buy gold online at live prices

Editor of Gold News, the analysis and investment research site from world-leading gold ownership service BullionVault, Ben Traynor was formerly editor of the Fleet Street Letter, the UK’s longest-running investment letter. A Cambridge economics graduate, he is a professional writer and editor with a specialist interest in monetary economics.

(c) BullionVault 2011

## ForexCT’s Afternoon Market Reports for 3 July 2012

Video courtesy of ForexCT – A leading Australian forex broker, liscensed by the Australian Securities & Investments Commission, offers the MetaTrader4 and PROfit Platform to retail traders. Other services include Segregated Accounts, Trading workshops, Tutorials, and Commodities trading.

## Doubts Regarding Euro-Zone Deal Turn EUR Bearish

Source: ForexYard

Investor doubts regarding the recent deal among euro-zone leaders caused the euro to start off the week on a bearish note against several of its main currency rivals. Opposition to parts of the agreement from Finland and the Netherlands led to concerns about whether the euro-zone will be able to assist debt ridden countries like, Spain and Italy. Turning to today, traders will want to continue monitoring developments in the euro-zone. Should there be any additional opposition to the latest plan to combat the region’s debt crisis, the common currency could see additional losses.

## Economic News

### USD – USD Falls vs. JPY Following Poor US News

The US dollar turned bearish against the Japanese yen during afternoon trading yesterday, following the release of a disappointing US ISM Manufacturing PMI. The news sent the USD/JPY down over 30 pips immediately following its release. The pair eventually found stability around the 79.40 level. The dollar had more luck against the euro, as investor doubts regarding a recent agreement among euro-zone leaders to combat the region’s debt crisis resulted in risk aversion. The EUR/USD fell over 80 pips over the course of the day, eventually reaching the 1.2580 level.

Turning to today, a lack of significant US indicators means that any dollar movement is likely to be a result of euro-zone news. Traders will want to pay attention to announcements regarding the details of last week’s agreement between EU leaders. Should it become clear that their plan is not feasible, investors may continue shifting their funds to safe-haven currencies, which could help the dollar against the euro and AUD during the European session.

### EUR – Euro Falls as Details of Euro-Zone Agreement Emerge

Opposition from Finland and the Netherlands regarding a recent agreement by EU leaders to establish a permanent bailout fund for debt-ridden countries in the region turned the euro bearish throughout the day yesterday. In addition to falling over 80 pips against the US dollar, the common currency also dropped more than 125 pips against the JPY. By the end of the European session, the EUR/JPY was trading below the psychologically 100.00 level.

Today, euro traders will want to watch for additional developments regarding last week’s pledge to bring down borrowing costs in the region. With opposition to the plan growing among more stable nations in the region, the euro could see further losses against the dollar and yen. Later in the week, attention should be given to the euro-zone Minimum Bid Rate. Analysts are forecasting that the ECB will cut interest rates by 0.25%, which if true, may result in additional euro losses.

### Gold – Gold Rebounds amid Disappointing US News

After falling during the first part of the day due to euro-zone worries, gold was able to rebound later in the day following a worse than expected US manufacturing PMI. The US news caused investors to shift their funds to gold, which is sometime considered a safe-haven asset. The precious metal advanced close to \$10 an ounce during the afternoon session, eventually reaching above the \$1600 level.

Today, gold traders will want to pay attention to the US dollar. Should the greenback continue to fall against safe-haven currencies, like the Japanese yen, investors may give the precious metal an additional boost. That being said, any disappointing euro-zone news could result in dollar gains, which may result in gold turning bearish once again.

### Crude Oil – Euro-Zone Worries Lead to Moderate Oil Losses

The price of crude oil fell by just over \$1.50 a barrel yesterday, eventually reaching as low as \$83.20, due to concerns among investors regarding last week’s agreement among EU leaders to combat the euro-zone debt crisis. Opposition to the agreement from Finland and the Netherlands has led to risk aversion in the marketplace, which turned oil bearish.

Today, oil traders will want to pay attention to how the euro performs against the US dollar and yen. Should the common-currency continue to move downward, oil could extend its bearish trend as a result. At the same time, any upward movement by the euro could lead to short-term gains for crude.

## Technical News

### EUR/USD

Most long-term technical indicators show this pair range-trading, meaning that no defined trend can be determined at this time. Traders may want to take a wait and see approach, as a clearer picture is likely to present itself in the near future.

### GBP/USD

While most long-term technical indicators place this pair in neutral territory, the MACD/OsMA appears to be forming a bullish cross. Traders will want to keep an eye on this indicator. Should the cross form, it may be a sign of impending upward movement.

### USD/JPY

The Bollinger Bands on the weekly chart are narrowing at the moment, indicating that this pair could see a price shift in the coming days. Furthermore, the MACD/OsMA on the same chart appears to be forming a bearish cross. If the cross forms, it may be a good time to open short positions.

### USD/CHF

Both the Williams Percent Range and Relative Strength Index on the weekly chart appear close to crossing into overbought territory. Traders will want to pay attention to these two indicators. If they continue going up, it may be a sign of an impending bearish correction.

## The Wild Card

### USD/SEK

A bearish cross appears to be forming on the daily chart’s Slow Stochastic, indicating that an upward correction could take place in the near future. Furthermore, the Williams Percent Range on the same chart has dropped into oversold territory. This may be a great time for forex traders to open long positions ahead of possible upward movement.

Forex Market Analysis provided by ForexYard.

Disclaimer: Trading Foreign Exchange carries a high level of risk and may not be suitable for all investors. There is a possibility that you could sustain a loss of all of your investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with Foreign Exchange trading.

## Contraction in The US Manufacturing Might Spell Doom

Tradervox.com (Dublin)  – A report by Tempe, an Arizona-based group reported that the manufacturing in the US unexpectedly contracted in June. This is the first time a contraction has been registered since the US economy rose from recession in 2009. Most economists have indicated that the contraction is an indication of a faltering economy, which has raised speculations for third round of quantitative easing.

The ISM index fell from 53.5 registered in May to 49.7 for June indicating a contraction. Any reading below 50 indicates a contraction; the index reflects measures of orders, export demand, and production in the country. After the release, investors showed concern that the Europe debt crisis is taking a toll on the world’s largest economy hurting manufacturers such as Steelcase Inc. and DuPont Co. Analysts are expecting to see more vigilante consumers while companies are expected to cut back on investment. This will have a ripple effect on the employment data and the unemployment claims will probably rise.

According to Neil Dutta, who is the Head of US Economics in New York at Renaissance Macro Research LLC, said that the manufacturing in US is contracting as uncertainty weighs down on business. Further, he added that the Europe crisis has weighed on exports. The recent report on the ISM index is the lowest since July 2009, indicating a downward trend in the US economy. The index averaged 57.3 and 55.2 in 2010 and 2011 respectively. It is expected that this year the average will be at 53.5 on average.

However, Nigel Gault, has indicated that the economy is not in recession. Gault is IHS Chief US Economist in Lexington Massachusetts.  He said that recession is accompanied by ISM readings of lower 40s, where 42.6 is the level that generally shows an expansion in the whole economy. Another report from the Commerce Department showed an improvement in the housing sector where purchases of new houses rose by 7.6 percent in May which is the highest level since 2010.

Disclaimer
Tradervox.com is not giving advice nor is qualified or licensed to provide financial advice. You must seek guidance from your personal advisors before acting on this information. While we try to ensure that all of the information provided on this website is kept up-to-date and accurate we accept no responsibility for any use made of the information provided. Opinions expressed at Tradervox.com are those of the individual authors and do not necessarily represent the opinion of Tradervox.com or its management.

Tradervox.com is a Forex News Portal that provides real-time news and analysis relating to the Currency Markets.
News and analysis are produced throughout the day by our in-house staff.

## Euro Down Before Manufacturing and Jobs Data

Tradervox.com (Dublin) – The euro has started the week on a low after increasing at the close of the week following the EU leaders’ decision to avail funds to recapitalize Spanish banks. The 17-nation currency fell prior to data to be released today shows the joblessness in the region increased to a new record. Further, another report is expected to show the region’s manufacturing contracted. There is speculation in the market that the ECB will reduce interest rate to boost growth in the region during its next rate decision meeting this week.

The European Central Bank has kept its interest rate at record low since December and it is expected to be lowered further from the current one percent to 0.25 percent on July 5. The euro had the biggest advance against the yen when the EU leaders announced their decision on June 29 as the region leaders sought to come up with decisive measures to curb the regions debt crisis. As the week started, economists are warning that investors should be wary of buying the euro as the outlook for the region remains bleak. Marito Ueda of FX Prime Corp. indicated that he wouldn’t advice on buying the euro at the moment but should wait to see the economic measures that will be taken in the region.

The euro started the week by dropping 0.4 percent against the dollar to trade \$1.2620 in the Asian trading session from its close last week, and later traded 0.3 percent down against the dollar at the beginning of the London session. The 17-nation currency dropped against the yen by 0.4 percent in the Asian market in Tokyo to trade at 100.68 from last week’s close when it rose 2.2 percent. In the London session, the euro has dropped 0.5 percent against the yen to trade at 100.53.

The market is expecting jobless rate in the euro zone to make a 11.1 percent increase from May’s 11 percent. Markit Economics will probably confirm that the manufacturing index remained unchanged at 44.8.

Disclaimer
Tradervox.com is not giving advice nor is qualified or licensed to provide financial advice. You must seek guidance from your personal advisors before acting on this information. While we try to ensure that all of the information provided on this website is kept up-to-date and accurate we accept no responsibility for any use made of the information provided. Opinions expressed at Tradervox.com are those of the individual authors and do not necessarily represent the opinion of Tradervox.com or its management.

Tradervox.com is a Forex News Portal that provides real-time news and analysis relating to the Currency Markets.
News and analysis are produced throughout the day by our in-house staff.

## Jordan Says Cap Enforcement is Appropriate for Economy

Tradervox.com (Dublin)  – The SNB president Thomas Jordan in an interview to be released later that the enforcement of the currency ceiling imposed last year is appropriate to avoid deflation. He added that the bank is determined to keep the minimum exchange rate since it is the right monetary policy for the country’s economy.  The remarks by the SNB President were echoed by the SNB Spokesman Walter who said the bank is doing all it can to hold the cap.

According to Swiss National Bank data, the foreign-currency reserves climbed by 20 percent in the first five months of the year as policy makers defended the 1.20 ceiling which has been beneficial to exporters and has reduced deflation. The strain on the currency increased since investors are buying it as a safe haven currency with the crisis in Europe continuing to escalate. However, the recent EU decision will help the in the SNB’s fight against deflation.

Jordan indicated that the expansion of the bank’s balance sheet is in accordance with the monetary policy and despite the risks associated with that the bank will be able to bear them. Reports from the SNB indicated that the foreign reserves climbed to 306.1 billion francs in May from April’s 247.2 billion francs.

The Swiss National Bank is buying euros which are increasing the number of francs available to the Switzerland lenders. In a statement released by the SonntagsBlick newspaper prior to publishing the full interview, SNB forecasts a safe sail in terms of inflation throughout next year. In the month prior to the introduction of the cap, the franc had increased by 17 percent against the euro causing losses in the export industry. The franc was trading at 1.20120 against the euro at the close of last month. The Swiss currency traded at 94.94 centimes against the dollar.

Disclaimer
Tradervox.com is not giving advice nor is qualified or licensed to provide financial advice. You must seek guidance from your personal advisors before acting on this information. While we try to ensure that all of the information provided on this website is kept up-to-date and accurate we accept no responsibility for any use made of the information provided. Opinions expressed at Tradervox.com are those of the individual authors and do not necessarily represent the opinion of Tradervox.com or its management.

Tradervox.com is a Forex News Portal that provides real-time news and analysis relating to the Currency Markets.
News and analysis are produced throughout the day by our in-house staff.

## How the Gold Standard is Returning Through the Back Door

By MoneyMorning.com.au

Here’s the problem with the debt crisis in Europe…

Every time we see another ailing European nation bailed out, the stakes get higher and higher. As the debt piles up, so do the interest payments. And everyone begins to wonder how long the likes of Greece and Spain can keep up.

If this were a standard loan, like a bond, you would expect some collateral for all this debt – a mortgage over some property, or at least a contractual commitment that’s darned difficult to wriggle out of.

But sovereign bonds come with neither. There’s no collateral and a government can always re-write the contractual rules. The upshot is a growing demand that any new bail-outs must come with some sort of security.

That has many people talking about gold. After all, historically it was the gold standard that provided this security for currencies. So are we, ultimately, heading back to a gold standard?

Well, yes… and no.

Today I want to show you my roadmap for how gold ends up back in the financial system. It won’t be a fully-fledged return to the gold standard. But I do think we will see some serious stockpiling by global authorities in the year ahead. Here’s why…

### Why Gold is the Ultimate Security

Let’s start by considering what kind of collateral the ailing European states can offer.

Well, first they could offer a solemn promise to repay these loans in full. Would that be enough? Certainly not. The German economy isn’t keen on handing over its hard-earned cash on vague promises offered by southern European nations.

So what else? Buildings, plant and machinery? No, too messy; and they’re not exactly mobile. The same problem applies with property. Despite their best efforts, the Greeks are unlikely to be able to sell enough islands to cover their debt payments.

Luckily the Germans have a solution. An influential report by a group of German economists, the so-called ‘German wise men’ has come up with a cunning plan to securitise any new bonds coming out of the southern European states.

The euro rules state that no nation should run up a debt of more than 60% of GDP. Effectively, any debt above this level is simply not allowed. So, the wise men say that any borrowings over and above this amount should be collateralised by the nation’s gold holdings.

They say that if they want nations like Germany to stand behind any new bonds to help finance economies like Italy, or Spain, then they must pledge their gold as collateral.

The good news is that these countries actually do have gold to pawn.

In fact, this is one way I see gold drifting back into the system. And I’m not the only one who sees it that way. Many lenders aren’t hanging around. They’re already picking up gold in anticipation…

### Central Banks Are Stockpiling Gold

Data from the World Gold Council reveals that central banks, largely from the emerging markets, are diversifying their currency reserves by going back into the classic reserve: gold.

It’s estimated that China bought around 490 tons of gold during 2011 – double the estimated 245 tons bought in 2010.

And latest International Monetary Fund figures show the central banks of Kazakhstan, Russia, Turkey and Ukraine were among those who added to their gold bullion holdings last month, reports BullionVault.

In fact the central banks have little choice. The real return (after inflation) on even the most robust government bonds right now is negative. And that places central banks in a bind. They need to diversify their assets. And what better than gold – the money that is no one’s liability. Not only is gold the international currency of central banks, it’s also portable and it comes with no strings attached.

As the financial system continues to convulse, lenders will want to see tangible security to back a bond. If they can’t get it, then they’ll just go for gold itself.

Remember the golden rule… The one that holds the gold, makes the rules!

### What Does This Mean for the Gold Standard?

Ok, so gold is working its way back into the financial system. But that doesn’t mean you should expect to see it in everyday use. Frankly, the world has moved on from the days of gold ducats, florins and sovereigns. If anything, money is going virtual. Soon all manner of things from phones to thumb-prints will be used for transactions of digital money.

The fact that gold is heading into the system to settle international trade balances doesn’t affect you directly. But it does affect the value of our currency on an international stage – and that certainly affects you.

Without the collateral to back a currency, the currency becomes worthless. Think about gold as the score-card among the central banks. Nations doing well get the gold – and their currency appreciates.

Gold gives you a chance to maintain your personal purchasing power. You can put your money into the same asset as the wealthy central banks of the emerging nations. You can be your own, private central bank.

Because of how gold’s traded, the gold price can fluctuate massively… that’s unfortunate. But I suspect that over the long run, gold will maintain its bull path. After all, the gold standard is working its way back into the system through the back door.

Bengt Saelensminde
Contributing Editor, Money Morning

Publisher’s Note: This is an edited version of an article that originally appeared in MoneyWeek (UK)

From the Archives…

The Hard Lesson of a Stock Trader: No Pain, No Gain
2012-06-29 – Kris Sayce

How Gold Prices Look Set to Climb As Banks Crumble
2012-06-28 – Peter Krauth

‘Big Wednesday’ For the Aussie Dollar
2012-06-27 – Dr. Alex Cowie

Three Reasons Why Silver Could Take Off in 2012
2012-06-26 – Dr. Alex Cowie

Who is Winning the Battle Between the Bulls and Bears?
2012-06-25 – Kris Sayce