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TheStreet Open House

Gold's Historic 2008 Journey to TARP from Stearns

Stocks in this article: GLDBACJPMAIGEURUSD=X

NEW YORK (TheStreet) -- It was a bizarre scenario in which people opted not to take gold.

President George W. Bush on Oct. 3, 2008 was signing into law the unprecedented Troubled Asset Relief Program as the global financial system crumbled amid an investor dash to sell assets, and despite gold's appeal as an alternative currency, it was clear that the liquid asset humans wanted to hold was the U.S. dollar.

"As bizarre as it was, you would think that would be the time you would need to buy gold [but], the immediate dash for cash was really just to get U.S. dollars," says Graham Leighton, a precious metals trader at Marex Spectron.

From a 2008 high of $1,023.29 an ounce the day after JPMorgan (JPM) acquired investment bank Bear Stearns with the help of a huge loan from the Federal Reserve Bank of New York, to a year low on Oct. 24 of $695.40, gold holders across that timespan saw the precious metal lose 32% of its value.

To put it into perspective, 2013's volatile and historic gold trade -- the yellow metal plummeted 13% in just two consecutive trading days in April -- witnessed a 29% decline to its year-to-to-date bottom from its high.

Bear Stearns' March 16 fire sale, which injected fear in the markets, triggered gold's first-ever pop above $1,000 an ounce (not adjusted for inflation). It was a classic fear trade: Investors view gold, when part of a portfolio, as an asset hedge against crises or inflation, among a few other characteristics. The logic among those who bet on gold during crises is that if all else fails -- nuclear fallout, collapse of financial systems and other doomsday scenarios -- the precious metal will, as it has for millennia, retain its appeal as a store of value.

Gold immediately spiraled lower and continued a downward trend into June. The price would not return to its March 17, 2008 all-time closing high until September 2009. The Bear Stearns shock rippled through markets as participants slowly digested the deepening housing and credit crisis the nation's banks faced. Rumors days later quickly spread that Lehman Brothers was on the verge of a similar collapse. By April, economic data showed U.S. gross domestic product shrank by 2.7% in the first quarter of the year.

Traders in gold and commodities by then were already seeing cracks in the financial sector. One source who was working at a large financial institution at the time says the firm was quoting out a commodity basket deal that went out to tender against several other banks. The source says their firm lost the deal to Lehman Brothers because it had put up its funding rates significantly.

Traders who were doing deals on a daily basis and were in competition with other banks that had significantly better funding rates suggested something was wrong. In other words, Lehman Brothers and others who knew they were in trouble well ahead of the financial crisis were raising funding rates to raise more money to pay off bad debt.

The summer of 2008 brought a brief reprieve from March's calamity. Lehman Brothers didn't fail, the banking system continued to function, despite a credit crunch and housing worries. The gold market became range-traded -- a term technical analysts use to classify an asset that exchanges between a certain high price and low price without breaking through either level. A range trade often occurs when the fundamentals of an asset class don't change, and no outside events affect the market. From the end of March until the beginning of August, gold failed to lift above $1,000 but never dropped below $900 an ounce.

"And then, of course, the world changed," says George Gero, precious metals strategist at RBC Capital Markets.

Gold dropped 8% in August and seemed to be in free-fall until reaching the world-changing events of September.

Lehman Brothers filed for bankruptcy and Bank of America (BAC) announced its intention to buy Merrill Lynch on the 15th. The New York Fed moved to bailout American International Group (AIG) on the 16th. Federal regulators seized Washington Mutual as JPMorgan acquired its banking operations on the 25th, and Congress failed to pass TARP as the three major U.S. indices posted historic one-day losses on the 29th.

Gero, who traded his first gold contract on the floor of the New York Mercantile Exchange in 1974, recalls it was a "tough" period. He didn't know if colleagues would be around the next trading day, and he went home every night with a sore throat and sore feet.

Paul Christopher, chief international strategist at Wells Fargo Advisors, in 2008 was working for a hedge fund that traded gold.

"Sunday nights had become my least favorite time of the week because all kinds of bad stuff was happening on the weekends in those days," says Christopher.

Mumblings grew to shouts by Sunday Sept. 14 of an impending Lehman Brothers bankruptcy.

Jeffrey Sica, chief investment officer at Sica Wealth Management, was a managing director at Wachovia then and recalls eating a 4:30 a.m. breakfast the day the Lehman news erupted.

"The biggest question that we had was that when Lehman collapsed whether it was an isolated event or whether it was a systemic event," said Sica. The same day, Bank of America agreed to buy Merrill.

"We began to see that everything that we were being told about Lehman Brothers being an isolated event was false," says Sica.

What was bad news that day for equity markets -- a 4.7% drop for the S&P 500 -- proved a boost for gold. The yellow metal closed higher by 2.8%.

Gold trended higher through the tumultuous September events by grabbing eight winning sessions against four losing days to close out the month as traders piled into the precious metal as a safe haven hedge against a system-wide financial collapse.

Congress on Sept. 29 struck down the Treasury Department's legislation to purchase banks' troubled assets -- commonly known as the bailout -- fueling gold's 1.2% gain as the S&P suffered one of its worst ever losses of 8.8%.

The winning streak halted by Oct. 1, and gold dropped 2.7% on Oct. 3, 2008 -- the day President Bush signed TARP into law.

While the bulk of the financial sectors' troubles occurred in September, the full impact of the economic collapse occurred the next month. It was in October that all major asset classes suffered severe losses.

The S&P 500, the benchmark U.S. equity index, tumbled 17%; oil hemorrhaged 16%; and gold plummeted 18%. Mayhem gripped Wall Street as every firm sold as many assets as possible to remain liquid while markets went dry and credit froze. One of the lone gainers that month was the U.S. dollar index, which rose more than 7.5%.

Gold analysts and traders say firms were selling their gold positions for cash to cover losses and margin calls for portfolios.

"Forced liquidation ... in as short of a timeframe as possible," says Christopher. "That was a big part of the story."

"It became a game of who had margin, who had liquidity and who didn't, and the margin clerks, whose job it is to make sure that the firm that they are employed by remains solvent, were casting positions overboard willy-nilly," says Dennis Gartman, editor and publisher of The Gartman Letter.

"In times of a liquidity crunch, in times of perceived huge systemic risk in other financial institutions and the troubled European banking system on its knees needing dollars, in hindsight it probably made a lot of sense to sell your gold," says Robin Bhar, head of metals research at Societe Generale. "I think it mystified a lot of people, but it was truly a roller coaster ride."

"Looking back now, the reaction of gold makes sense because at that time everything that could be sold was sold off. It was a case of wanting to find liquidity in order to cover losses elsewhere," says Joni Teves, precious metals analyst at UBS. "And that has been a typical behavior of gold where if it's a massive cross-assets selloff, it will be sold along with everything else."

Gold prices reached a low on Oct. 24, but rallied to finish the year up about 3.5%.

While gold outperformed the U.S. dollar from January through August in 2008, the dollar consistently from September through December showed greater strength, and a haven of demand among edgy investors as it closed the year up 6%.

"When the s*** really hits the fan, they want dollars," says Leighton.

-- Written by Joe Deaux in New York.

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