Archive for economics

Suffering Gold

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(Posted: June 18, 2013)

Gold continues to suffer under a cloud of bearish expectations.  Its price has been trending lower for some 20 months now - and, at recent lows, it is off some 30 percent from the September 2011 all-time high of $1924.

A growing number of investors, analysts, and journalists are already writing obituaries for the decade-long bull market and foresee only a grim future for the yellow metal.  These naysayers, most prominently economist Nouriel Roubini who gained some renown for predicting the financial-market debacle of 2008, point to a number factors to support their bearish predictions.

They say inflation will remain subdued, the U.S. dollar will continue to appreciate, interest rates will rise, Europe will pull through without sovereign defaults, and the central banks of some deeply indebted countries with substantial gold reserves (like Italy or Spain) may sell some of their official gold reserves.  Moreover, they say gold has been over-hyped and don’t see why investors would want to own an asset that earns no income.

It seems to me that the bears have a fairly provincial view and a limited understanding of gold’s increasingly bullish long-term fundamentals.  By “provincial” I mean they are ignoring more than half the world - the half that loves gold and will accumulate more.  They seem to think not much is important to the future of gold outside the United States and Europe.

Instead, the gold bears are ignoring much of what goes on beyond Wall Street and America’s shores.  What happened to China, India, the Middle East, Turkey and other gold-hungry countries?  Have these countries ceased to matter in the gold-price calculus?

Quite the opposite: In the next few years, if not longer, households, institutional investors, and central banks in these countries will continue to acquire huge quantities of gold - and most of these acquisitions are for the long term.

Buyers are not speculating for short-term gains but accumulating for long-term security.  In other words, much of this gold changing hands today won’t come back to the world market even at much higher prices levels.  This will contribute to a growing shortage of available physical gold - guaranteeing steep price increases for the yellow metal in years ahead.

Indeed, looking out beyond the next year or two, demand for gold in these gold-friendly countries will be enough to move the metal’s price higher even if economic and investment conditions in the United States and Europe remain inhospitable for gold.

What’s more, the gold bears are dismissing the certain consequences of unprecedented global monetary creation.  With the central banks of virtually every major economy inflating money supply with abandon, gold’s detractors are forgetting the iron-clad law of supply and demand . . . and the eventual certain devaluation of most, if not all, the world’s currencies - measured in terms of their purchasing power for actual goods and services.

The gold bears are also overly optimistic about U.S. economic prospects and the implications for U.S. monetary policy.  Those who adhere to a rosy economic scenario are expecting a shift in monetary policy later this year in which the Fed begins dialing back on the monthly dose of monetary stimulus.  This increasingly prevalent viewpoint has, in recent months, weighed heavily on the gold price and, indeed, the day-to-day variations in market expectations of future monetary policy explains much of the short-term gold-price variation so far this year.

In contrast, a faltering U.S. economy accompanied by persistently soft employment-market conditions and the declining pace of consumer-price inflation - could trigger a surprisingly robust recovery in the price of gold, - especially if monetary policy shifts into an even more accommodative mode.

The Fed is targeting a decline in the unemployment rate to 6.5 percent and a rise in the inflation rate to at least two percent.  As long as these targets remain illusive, the Fed is likely to continue its program of Treasury and mortgage debt purchases, known as quantitative easing, at $85 billion per month - and if the economy falters, as I think it might, financial markets may be surprised to see an even more stimulative monetary policy, surely a recipe for higher gold prices.

As noted above, financial markets have been increasingly anticipating an early reduction in the pace of quantitative easing, a “tapering” or scaling back in the pace of monthly bond purchases.  As a growing number of gold traders and investors begin to doubt the rosy economic scenario - possibly due to a spate of disappointing economic news - gold could rally enough to reverse the gold market’s recent downward price momentum and reestablish the long-term bullish uptrend.

Federal Reserve Chairman Bernanke has repeatedly warned us not to expect any reduction in monetary stimulus until the labor market shows meaningful signs of improvement - and this seems unlikely anytime soon.  Indeed, employment-market conditions are worse than the headline unemployment rate suggests - wages are stagnating, the workweek is shrinking, the number of part-timer workers seeking full-time employment is growing, and a rising number of discouraged workers are dropping out of the work force. This is a recipe calling for more stimulus, not less.

What about inflation and the dollar?  Investors and observers of the gold scene have been misled by the very low reported rate of consumer price inflation and by the apparent strength of the U.S. dollar in world currency markets.  I don’t know anyone who really believes that inflation is near zero.  It may be low, but not that low . . . and, eventually, all that new money the Fed is creating month after month will come home to roost.

Gold prices have been restrained by the “appearance” of a strong U.S. dollar.  But, in reality, the currencies of all of the old industrial-world countries are devaluing together as each country attempts to increase international competitiveness and boost exports.  These currencies - including the euro, the pound, the Swiss franc, the yen, the Australian dollar and others - are all losing value in terms of their true purchasing power - only the dollar’s decline may be a bit slower than most others.  This “beggar-thy-neighbor” competition is reminiscent of the Great Depression . . . and must surely be supportive of gold.

Stay tuned to this space - and my more frequent twitter posts @NicholsOnGold - for on-going gold-market analysis and commentary.

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CAPTIVE GOLD: A Quick Note on the Current Market

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(Posted: June 4, 2013)

For now, gold remains captive to the flow of U.S. and global economic indicators and prospects . . . especially those that may influence Federal Reserve monetary policy.

With the U.S. economy far from a satisfactory and self-sustaining recovery, the news is likely to become increasingly positive for gold — with diminishing expectations of imminent “tapering” (that is scaling back the Fed’s monthly bond-buying program) eventually replaced with talk of additional monetary stimulus of one sort or another.

Home in the Range

At the moment, however, gold appears range-bound between $1370 and $1420 — bouncing around within this range on the release of every relevant economic indicator and every comment on prospective monetary policy from one or another Federal Reserve official.

Paradoxically, a significant break out of this trading range — either up or down — is likely to boost buying interest. On the upside, if the price moves much above $1420, the momentum and other program traders will begin migrating back to the bullish camp. On the downside, if prices move much beneath $1370 (and even more so near $1320 (if we ever see gold prices back to this bargain price level), physical demand from all corners of the globe will underpin the market and lead to a swift increase in buying.

Paper vs Physical

It is important to distinguish between the paper markets, which are reactive to the daily news flow and where most of the short-term speculative trading is occurring . . . and the physical market, which has been — and will continue to be — a giant sponge soaking up every ounce of gold available at prevailing prices and premiums.

Much of the “paper trading” is among a small number of dealers and institutional speculators — not only in the transparent futures markets, but also (and sometimes more so!) in the largely opaque and unregulated inter-dealer over-the-counter markets, also known as the “dark pools” of liquidity where high-volume trading goes on virtually unnoticed. For more, see my May 15th post “Dark Pools, Program Trading, and the Decline of Gold.”

And, I would include in this group of short-term paper traders the hedge funds that for several months now have been lightening their gold holdings (mostly in the form of gold ETFs) in order to participate in, and benefit from, the upward march in world equity markets.

I expect when markets turn — that is when Wall Street turns down and gold prices begin convincingly moving higher — we will see a reversal with some of these funds rushing back to gold, contributing to a surprising recovery in the metal’s price.

Gold is Forever

Importantly — and in contrast to the paper markets where trading is very short-term oriented — the physical markets have an increasingly long-term orientation. The Chinese (both on the Mainland and across Greater China) are accumulating gold, not to resell for a quick profit as prices recover, but with the intention of holding forever as an inheritance to be passed on to future generations.

Many retail buyers of bullion coins and small bars in Western markets are also long-term holders with little intention of taking profits anytime soon.  These buyers are motivated more by fear than by greed — Fear of financial market breakdown, fear of monetary debasement and future inflation, fear of an uncertain economy, fear of government intervention in personal affairs, and so on.

Indian demand is less certain and typically more price sensitive — with sellers, often led by housewives selling a bangle or two, emerging on rupee-denominated gold-price rallies. The country’s central bank, the Reserve Bank of India, and the Finance Ministry raised import duties earlier this year and have taken other regulatory actions to discourage gold imports, which after oil are the country’s second biggest commodity import and a major contributor to India’s gaping current account deficit. These efforts are increasing the domestic price premium over the world price, assuring a rise in illegal imports, and ending the sale of old scrap gold to world markets. In any event, Indian gold buyers will gradually adjust to the higher domestic price and demand will return to past levels dependent on local economic conditions, especially in the farming sector, which is traditionally an important buyer of gold.

Don’t underestimate the bullish influence of official-sector demand on the future price of gold. Indeed, purchases by a number of central banks, especially the People’s Bank of China and the Bank of Russia (which are by far the two biggest buyers month after month, year after year) are unlikely to be sold within our lifetimes. These official purchases are intended not only as a vehicle for reserve diversification and reducing reliance on the dollar, the euro, and other old-world currencies — but are part of these two countries’ strategic goal of raising their respective currencies’ international reserve status and gradually reshaping global monetary affairs.

The bottom line is that when gold turns higher there will be insufficient liquidity and a shortage of available supplies — except at much higher prices . . . and many will be surprised by the magnitude and swiftness of gold’s next big leg up.

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Monetary Policies Favorable for Gold-Price Recovery

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(Posted: April 29, 2013)

Global financial markets will be taking their cues from U.S. Federal Reserve and European central bank policy meetings to be held by the Fed on Tuesday and Wednesday and by the European Central Bank (the ECB) on Thursday.

The consensus among economists who pay attention to these things suggests there won’t be any significant change in Fed policy . . . but, in contrast, there is a strong belief that the ECB will cut European interest rates from their already record low levels.

ECB Expectations

The ECB has seen a disappointing string of European economic data over the past several weeks. Even Germany, which had earlier seemed immune from the deteriorating conditions elsewhere in the 17-nation eurozone, is beginning to feel the pinch.

A cut in European interest rates could be a mixed blessing for gold. Here’s why: Lower European rates could adversely affect the euro in world currency markets . . . making the dollar appear stronger. And, dollar strength has often — but not always — been a short-term negative for gold. It could be that the markets have already priced in a weaker euro/stronger dollar, in which case there may be little gold-price reaction.

Longer term, stimulative ECB monetary policies will be a big plus for gold, not only its euro-denominated price but, reflecting higher aggregate global gold demand, as big plus for the U.S. dollar-denominated price as well.

U.S. Economic Trends

Today’s news on the U.S. economy, with consumer spending up a modest 0.2 percent in March, along with other recent indicators, suggest the feeble recovery may not have sufficient firepower to sustain positive growth, let alone engineer any meaningful reduction in unemployment.

Recent GDP data excluding erratic business inventories, which is the broadest measure of economic performance, puts U.S. economic growth in the first quarter at only 1.5 percent, down from 1.9 percent in the fourth quarter of 2012 and 2.4 percent in the third quarter — taken together not a reassuring trend.

Misguided U.S. fiscal policies — the recent hike in Federal payroll taxes and the sequestration-related spending cuts and layoffs — are already impeding consumer and business spending . . . and this fiscal drag will increasingly retard economic activity in the months ahead.

Meanwhile, global economic trends are also impede U.S. growth: The deepening European recessions and slowing activity — in many of the emerging economies — along with a rising dollar exchange rate against the currencies of important foreign markets for U.S. exports is also retarding growth here in America.

Fed Policies

All of this will be on the minds of policy-makers at the Fed when they meet on Tuesday and Wednesday this week. No doubt their discussions will focus on the economy’s vulnerability, along with the unacceptably high rate of unemployment and the below-target rate of consumer price inflation rate. The core inflation rate (excluding food and energy) for personal consumption expenditures was only 1.1 percent in the first quarter, well below the Fed’s target rate of 2 percent

Although we, along with most other Fed watchers, do not expect any explicit change in monetary policy, the market’s will be parsing Fed Chairman Bernanke’s every word at the post-meeting press conference for any suggestion the Fed may shift their accommodative policies later this year.

With labor markets in distress, inflation below target, and the economy showing signs of stumbling, their will be less talk of an early reduction in monetary accommodation and possibly some nuanced mention of possible additional stimulus later this year.

This would be bullish news for gold . . . and could give the market enough juice to break through overhead resistance.

Technically Speaking

A significant upside gold-price reaction to this week’s news from the Fed and the ECB just might be enough to fuel an upside price advance and restore upside momentum.

Momentum and technically driven trading in futures and over-the-counter derivative markets were responsible for the swiftness and magnitude of selling as gold prices came tumbling down. Although gold certainly remains vulnerable to renewed technically inspired selling — especially if prices stall below recent highs — the potential for high-powered moves on the upside should not be overlooked.

If gold prices can break through key resistance points and post further significant gains in the days ahead, the machines will turn increasingly bullish — and they have the buying power to drive prices much higher in a blink of the eye.

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That Was the Week That Was: U.S. Economic Policy and the Future Price of Gold

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(Posted: February 28, 2013)

Over the past year, short-term changes in the price of gold, both up and down, have largely mirrored shifting expectations of U.S. Federal Reserve monetary policy and the reaction of short-term institutional speculators operating in futures, ETF, and other “paper” derivative markets.  The past week - with gold first falling sharply then recovering smartly, and then dropping again - has been no exception.

To little surprise, gold registered its biggest one-day gain of the year on Tuesday as Federal Reserve Board Chairman Ben Bernanke, in his semi-annual report to Congress, eased market fears of an early reversal in the central bank’s super-stimulative monetary policy.

Gold-price weakness in the past couple of weeks prior to Tuesday’s swift price rise has owed much to confusion and ambiguity about prospective Federal Reserve monetary policy - confusion prompted by the Fed’s own minutes of its January policy-setting meeting and public pronouncements by some Fed officials advocating an early reversal in the Fed’s exceptionally accommodative policies.

During Tuesday’s report to Congress, Bernanke unambiguously reiterated the central bank’s commitment to maintain its program of quantitative easing (otherwise known as printing money) thereby triggering a swift gold-price advance.

But what the Lord giveth the Lord taketh away: On Wednesday, his second day of Congressional testimony, the Fed Chairman seemed to backtrack (at least to many of the traders calling the tune for gold these days), saying the Fed might review its exit-strategy from easy-money policies some time soon.  And, predictably, the gold price swiftly tumbled.

What’s the truth about prospective Federal Reserve monetary policies? After all, this is a crucial determinant of the future price of gold. Surely, Wednesday’s promise to review its exit-strategy is not a signal that the Fed has any intention of altering its easy money course any time soon.  For this reason, I think the latest sell-off will be short lived as traders and other gold-market participants reassess monetary policy prospects for the year ahead.

I’m of the view that the U.S. economy is somewhat weaker than portrayed by recent official statistics and news accounts of the economy’s performance.  Moreover, fiscal drag this year - and public uncertainty over prospective tax and spending policies - could steal as much as 2.5% from U.S. gross domestic product and push the economy into renewed recession sometime this year.

Washington’s inability to come together with a pro-growth fiscal-policy mix puts much pressure on Bernanke’s Fed to maintain - and possibly even step up - its on-going program of quantitative easing and extremely low interest rates.

Automatic across-the-board Federal spending cuts (sequestration), or even more sensibly managed spending cuts with or without some form of tax increase, or simply kicking the can down the road - whatever the outcome, fiscal drag is likely to further retard economic activity, raising the likelihood of continued - or even increased - Federal Reserve monetary accommodation in the months ahead.

What are the sources of fiscal drag?

  • First, households are continuing to adjust to this New Year’s payroll tax hike by spending less;
  • Second, some Federal spending cuts, either sequestered (automatic) or negotiated by Congress and the Administration, will likely take place in the weeks and months ahead;
  • Third, an increase in Federal taxes, possibly by closing some of the loopholes now enjoyed by business and high-income households, will likely be agreed to sooner or later.
  • And, fourth, more spending cuts and tax increases at the state and local level across the country,

In the current political and economic environment - with many households still suffering and deeply in debt, and with the unemployment rate still unacceptably high and the numbers of long-term unemployed or under-employed growing, and with fiscal drag likely to make things worse - the Fed remains the only effective policymaker able to mitigate the economic suffering.

It’s principal policy tools are monetary accommodation - otherwise know as quantitative easing through the on-going purchase of U.S. Treasury and Agency debt to the tune of $85 billion per month - and maintenance of near-zero interest rates with the hope of stimulating bank lending, consumer spending, home purchases, and business investment.

Of course, these are also inflation-producing policies - and very much pro-gold.  They always have been - and likely always will.

For all its talk to the contrary, the Fed must be well-aware of the ultimately inflationary consequences of  quantitative easing.  Indeed, Bernanke’s Fed must be tacitly counting on higher inflation to erode the real burden of debt (measured by the ratio of debt to gross domestic product) in order to restore household balance sheets sufficient to encourage a meaningful recover in personal consumption, without which the economy will continue to under-perform and unemployment will remain painfully high.

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