GOLD BEARS BEWARE

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(Posted: March 15, 2013)

Gold bears have been a gleeful group of late, pointing to the recent decline in gold exchange-traded fund holdings as evidence of investor disinterest in the yellow metal.  Gold bears also see the market’s rather lackluster performance over the past year and a half - and the failure of prices to move higher - as further evidence the decade-long bull market has run its course.

Yes, gold has retreated some 20 percent from its September 2011 all-time high (near $1,924 an ounce) to its subsequent low (just over $1,520).

Yes, Gold ETFs have seen some substantial and high-profile withdrawals in recent weeks.

These developments in no way diminish my belief that the bull market in gold has plenty of life ahead with the yellow metal’s price doubling (or more) from recent levels in the next few years.

Historically, cyclical upswings in stocks, bonds and commodities have often been measured in decades and bull markets typically end with a rapid advance to record heights followed by a swift and resounding crash.  This looks more like equity markets today while gold’s appreciation over the past decade has been a measured advance and its recent performance bears no resemblance to a bursting bubble or a mania run its course.

The bears are also pointing to the recent strength of the U.S. dollar in world currency markets and the record highs on Wall Street as confirmation that gold is past its prime.

In my view, the appearance of dollar strength does not reflect a healthy currency.  The U.S. dollar is merely the least unattractive contestant in a beauty pageant of ugliness.  As such, flight capital, especially from Europe, seeking a safe haven has been gravitating to dollar-denominated U.S. Treasury debt.

Nor is the record-breaking streak on Wall Street a sign of a healthy economy.  Who could possibly believe that! It is a consequence of the Fed’s super-accommodative monetary policy and the need for many investors to register positive returns in a near-zero interest-rate environment.

What about the decline in global gold ETF holdings?  For all the attention in the financial press, the nearly 10-percent decline in gold ETF holdings from their all-time high in December really tells us very little about market fundamentals and price prospects.

First, it is quite possible that some of these sales were from institutional investors choosing to buy and hold the real thing, directly and under their own control, rather than hold a piece of paper representing ownership but not directly accessible by ETF investors.

Second, many hedge funds and institutional investors are driven by the need to perform well in short term - and simply could not resist jumping on Wall Street’s bandwagon where profits in the next month or quarter looked more attractive to them.  Once gold again shows some real life (and it will), those who jumped ship will get back onboard, expecting gold to deliver relatively attractive short-term gains.

Third, gold sold by ETFs has to go somewhere - and where it’s been going is of great importance.  On the other side of the market have been central banks, buying for the very long term and unlikely to re-sell anytime soon, perhaps not for decades or longer.  It’s as if the gold has been permanently removed from the marketplace and indefinitely unavailable to meet future demand - not just from ETF investors but also from investors and jewelry buyers of every stripe. This means that prices will have to rise much more than might be expected as more buyers compete for a smaller supply of available metal.

In fact, central banks are likely to continue building their gold holdings in the months and years ahead -so that available supply, what I call “free float,” will continue to shrink as gold moves from weak to strong hands.

Ironically, America’s former cold-war rivals - Russia and China - have been the biggest and most persistent central-bank buyers, followed by a diverse group of newly industrialized and emerging economy nations including Mexico, Korea, Brazil, Mexico, the Philippines, Kazakhstan, Ukraine and others.

Both Russia and China see central-bank gold accumulation as an important step toward playing more important roles in the evolving global economic and political order - while ending America’s dominance in the world monetary system.

Moreover, for those central banks under-weighted in gold and over-weighted in dollars and euros, their motivation has been to diversify their official reserve assets and reduce their exposure to the U.S. and European currencies.  With America unable to address its Federal budget deficit and limit its mounting sovereign debt and with economic policy on both sides of the Atlantic in disarray, central banks around the world have a strong incentive to buy and hold gold as a currency hedge and insurance policy.

When the dollar looks less attractive as a safe haven and easy gains on equities look less certain to investors, gold will once again be the leading beneficiary of the Fed’s easy-money policies.  In the meantime, support for higher gold prices will come from continued central-bank buying as well as strong private-sector demand from China, India, and retail buyers around the world.

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GOLD: Talking Points

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(Posted: February 4, 2013)

In my view, there is a very high probability gold will surpass $2000 an ounce by year-end 2013 - and it could go much higher.  Moreover, by mid-decade, the metal’s price could double or even triple from recent levels.

Looking backward, gold is off some $250-$260 from its September 2011 all-time high of $1924 an ounce.  This is a decline of roughly 13 percent - in line with past bull-market corrections.

In the weeks ahead, much depends on institutional speculators at the big banks and hedge funds.  In the past year or so, these large-scale players have made good money trading futures, options, and other leveraged derivatives based on technical trading models and the latest bit of news — economic or political — out of Washington.

As a result, gold prices have been range bound, most recently trading between $1625 and $1695.  There is even some chance the price of gold, under pressure from speculative selling, will temporarily dip lower - but, sooner or later, we should see gold break out on the upside, surpassing $1700, and then resuming its long-term bull-market uptrend.

In brief, here are the key bull points promising higher gold prices ahead:

Continuing official-sector gold accumulation - with China and Russia leading the way as substantial buyers . . . but other emerging-economy central banks are also continuing to build their official gold reserves.

These countries consider their U.S. dollar- and euro-denominated investments to be of higher risk and are trying to raise the proportion of official reserves held in the form of physical gold.

At the same time, private-sector physical demand for investment and jewelry from China, India, and other Southeast Asian gold-friendly countries remains firm - and will continue to grow in the years ahead.

Many investors and jewelry buyers in China, Hong Kong, India, Turkey and elsewhere in Southeast Asia and the Middle East care little of the daily economic and political news out of New York, London and other Western financial centers.  They just know it’s a good time to buy or have spare income seeking a secure home.

Importantly, the recently announced introduction of gold ETFs on the Shanghai Stock Exchange (probably by mid-year) will encourage more gold accumulation by retail and individual investors, just as it has in the United States and elsewhere.

These gold buyers — both central banks and private sector — are long-term hoarders, that is “strong hands” unlikely to sell back to the world market even at much higher prices.  In fact, gold exports from China are prohibited — so any gold that enters the country is indefinitely off the world market and unavailable to meet demand elsewhere.

As a result - unbeknownst to most gold analysts and traders - the physical market is becoming increasingly tight with bullion bars going on a one-way ticket to the Asian markets (as evidenced by the high bar premiums in China and Hong Kong) and to a number of central banks.

Put another way, gold is moving into strong hands — and recent buyers, be they the “man in the street” across Asia or the reserve managers at central banks — are unlikely to sell anytime soon, even at much higher prices.

Sub-par, recession-like, business conditions in the United States with persistently high unemployment — aggravated by inappropriately restrictive fiscal policy - assures continued monetary accommodation by the Fed for at least a couple of years.  Ditto for Europe.

Meanwhile, if it’s politics as usual in Washington - with continued gridlock over Federal spending, taxes, and the debt ceiling - we could see the credit-rating agencies downgrade U.S. Treasury debt, sending the greenback lower and gold higher.

Further Mideast turmoil remains an unpredictable wild card that could give gold a surprising skyward kick.   The possibility of regime change in Saudi Arabia and other Persian Gulf states, renewed unrest in Egypt, Syria’s civil war somehow affecting other nations in the region, hostilities between Israel and Iran - any of these could result in a big jump in oil prices, big enough to aggravate global inflation and retard economic activity.

(For more frequent commentary follow us on Twitter @NicholsOnGold)

Filed under: Gold Briefs | American Precious Metals Advisors, central banks, China, ETFs, Exchange-Traded Funds, fiscal policy, gold, gold price, inflation, Jeffrey Nichols, monetary policy, Quantitative Easing, U.S. dollar|No Comments

GOLD IN AN UNCERTAIN WORLD

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(Excerpts from my speech to the 7th annual CHINA GOLD & PRECIOUS METALS SUMMIT, Shanghai, China, December 5th through December 7th, 2012)

(Posted: December 12, 2012)

Gold in recent months has been stuck in a trading range between $1675 and $1750 an ounce - disappointing many bullish investors and quite a few gold-market analysts (like myself) who had expected the yellow metal to be ending the year approaching - or even exceeding - its all-time high-water mark near $1924 recorded back in September of 2011.

Recent attempts to rally higher have been thwarted by stepped-up speculative selling and softer physical demand with many buyers now conditioned to wait for the next dip.

At the bottom of this range, bargain hunting in the form of stepped up physical demand from central banks, sovereign wealth funds, and some of the gold-friendly hedge funds has created a floor under the market.

Changes in the aggregate gold holdings of exchange-traded funds (ETFs) have been a fairly consistent leading indicator of future gold prices over the past few years.  Globally, gold ETFs purchased nearly 250 tons (about 800 million ounces) this year through November - and the total quantity of ETF gold held on behalf of investors now amounts to more than 2,600 tons.

It may well be that money flowing into gold exchange-traded funds is a consequence of the very accommodative monetary policies now being pursued by the Federal Reserve and many other major central banks across Europe and Asia - with rapid central-bank money growth a causative factor explaining both strong demand for ETF gold and the long-term upward trend in the metal’s price.

My own reading of the Federal Open Market Committee minutes from its last policy-setting meeting - along with statements and speeches by various Fed officials in the past few weeks - suggests there is a good chance the Fed will announce further expansionary monetary-policy measures in the next few months.

Predictions (from the OECD and other respected forecasting groups) of a worsening synchronized global economic slowdown - and a spreading sense of global gloom and doom - are contributing to the Fed’s sense of urgency, boosting the odds of further monetary accommodation sooner rather than later.

This fourth round of Quantitative Easing (or QE4) is likely to have more bang for the buck compared with QE3, which included among its measures the sale of short-term Treasury securities to fund its purchase of long-term Treasury notes and bonds.

With its inventory of short-term securities now mostly depleted, any future purchase of long-term securities must be funded with newly created bank reserves - which is, in essence, printing new money - some of which will find its way into gold and probably other asset markets.

Surprisingly, America’s fiscal crisis - and the much-discussed approaching fiscal cliff - have had little observable and immediate influence on the price of gold in recent weeks and months, if only because amid all the confusion, no one really knows how this crisis will sort itself out.

But, however it sorts itself out, we expect some combination of spending cuts and revenue hikes are in America’s economic future.

Unfortunately, a more restrictive U.S. fiscal policy is exactly the wrong medicine for an ailing economy at this critical time, raising the odds of a recession or worsening recession-like conditions characterized by a palpable deterioration in employment/unemployment indicators for the U.S. economy.

This bad news for the economy is - as bad news often is - good for gold.

Fiscal policies that promise slower business activity, falling after-tax household incomes, reduced household spending, slower recovery in the housing and construction sectors increase the likelihood of still-more stimulative Federal Reserve monetary policies.

America’s inability to get its fiscal house in order is compelling the Fed to pursue an aggressive monetary policy.  But printing more money - indeed printing unprecedented quantities of money - will, sooner or later, result in a resumption of the U.S. dollar’s long-term downtrend both at home and overseas . . . and, as night follows day, a substantial and unprecedented appreciation of the dollar-denominated gold price.

Indeed QE4 may be right around the corner . . . and QE5 could come by mid-to-late 2013  . . . as the Fed struggles to prop up a still-faltering economy. If the past is a reliable predictor, these efforts by the Fed (and similar policies by other major central banks) suggest much higher gold prices ahead.

Whatever monetary- and fiscal-policy choices are made by the old industrial nations - the United States, Europe, and Japan - these economies and most other industrialized and emerging economies together face at least a few more years of painfully slow growth - and, for some, outright recession!

It took years, if not decades, for the United States and most other major economies to get ourselves into this mess - by consuming more than we could afford, with money we didn’t have, accumulating debt we couldn’t possibly repay!

Debt can be a magic economic elixir - at least for a while.  It allows consumers, investors, governments and, indeed, entire nations to borrow from the future . . . in order to accelerate consumer spending, investment, government services and entitlement programs, and even military spending - much of which has been purchased in recent years against the promise of repayment some day in the future . . . in some cases by our children and grandchildren.

Moderate amounts of debt-driven consumption and investment may, at times be an acceptable and low-risk mechanism to accelerate economic growth and raise a country’s standard of living.

But a happy outcome requires wise spending on goods and services that ultimately increase the borrower’s ability to repay - in other words, spending that ultimately generates higher rates of economic growth.

Instead, for the past few years - and probably the next few years - the legacy of high debt levels will limit private- and public-sector spending . . . and assure the persistence of painfully poor rates of economic activity with unacceptably high rates unemployment.

In certain cases, a nation (or a business) may kick-start economic growth by repudiating and writing off its outstanding debt - in a sense, starting anew . . . but this would-be solution brings its own set of risks and dangers to the borrower.

Rather than outright debt-repudiation, the U.S. Federal Reserve and the central banks of many other countries are seeking to minimize the economic pain by pursuing accommodative monetary policies with artificially low real (inflation-adjusted) rates of interest

By doing so, central banks are sowing the seeds of future inflation.  And, by printing much to much money they are making each dollar, euro, yen and yuan worth less.

So rather than outright debt-repudiation, central bankers are depreciating the real future burden of their country’s debt - and bringing the ratio of debt to nominal GDP down to acceptable levels.

Let’s now turn our attention to one of the least-discussed prospective developments likely to greatly influence the price of gold over the next five to 10 years, if not much longer.

This is the rising tide of uncertainty and volatility in geopolitics, world financial markets, and in the global economy.

One thing is for sure: The future isn’t what it used to be - and the world today is characterized by a variety of trends and developments that together are creating more uncertainty and increasing volatile future.

Perhaps the most important of these is the declining influence and hegemony of the United States as a global policeman and enforcer assuring a modicum of predictability and orderliness among nations . . . along with an expanding number of hot spots around the world, hot spots where the U.S. can no longer contain, minimize, or postpone the geopolitical, economic, and financial market fall-out.

At the same time we see America’s power and influence diminishing, China - and a number of other countries from the the newly industrialized world - are increasingly expressing and acting upon their own views, national interests, and priorities - which often differ from those of the United States.

Here, in East Asia, a rising tide of nationalism, competition for vital natural resources, and the re-ordering of economic and political relationships among countries could erupt into more serious and contentious conflicts - if only by accident or miscalculation as one country or another flexes its strengthening military muscle.

There are other obvious “hot spots” or dangerous developments that are now contributing to greater uncertainty and market volatility - and these are not likely to go away anytime soon.

• At the top of my list is the rising probability of war between Israel and Iran - likely with the participation of the United States - over Tehran’s nuclear program.
• Then there is the increasing radicalization of an already nuclear-armed Pakistan - and the acquisition of weapons of mass destruction by the Taliban, Al Qaida, or other renegade groups.
• Next, the Arab Awakening across North Africa and the Middle East is already jeopardizing world oil markets - and prices at the pump - should Saudi Arabia or the Gulf Emirates follow Egypt and Syria into increasing political and social disorder.
• Disruptive terrorist attacks by Islamic fundamentalists or other madmen, either of the violent sort we’ve already seen in New York or London . . . or of the cyber variety that could upset not only internet links - but also banking, financial markets, communications networks, electric power grids, and the like . . . any of which could trigger a drop in economic growth or worse.
• Let’s not forget the uncertainty and risks - social, political, and economic - associated with still-unresolved European sovereign debt, banking insolvencies, deepening recessions . . .
• As I mentioned earlier, the quickly approaching “fiscal cliff” in the United States - and longer term - the unsustainable U.S. federal budget imbalances that ultimately threaten the U.S. dollar’s role as the leading world currency and reserve asset.
• With regard to prospects for the Eurozone, I think it is only a matter of time before first Greece, then Spain, and possibly other still-sovereign European states decide that the consequences of more fiscal restraint (and, with it, rising unemployment and declining living standards) are just too much distasteful medicine for an ailing and sickly patient - and opt instead to opt out and go it alone . . . and who knows where this might lead!

Climate change is yet another source of uncertainty and risk for the global economy - with possible consequences for gold.

Global Warming is already having a significant influence on farm output, agrarian income, and food prices in some countries and regions.  For example, below-average monsoons this past year hurt harvests and lowered household income in India’s farming regions - reducing this past year’s appetite for gold in this traditionally important gold-consuming country - and likely contributed to a lower metal’s price in the world market.

Last year’s weather restrained harvests in some important grain-producing regions contributed to higher food prices and political turmoil in some countries - most notably Tunisia, where widespread riots broke out, the country’s political leadership fled (with most of the central bank’s gold), and the Arab Spring was given birth.

Irrespective of how these and other potential threats and challenges are resolved, we must recognize that there is today a growing number and more diverse range of nations, public and private institutions, and other entities with sufficient economic power, political clout, or financial wherewithal to greatly affect the global economy and world financial markets - with possibly significant consequences, one way or the other, for the future price of gold.

An interesting sidebar to this discussion of uncertainty and risk has been the development of immediate and equal access to financial, economic, and political information - information that is incorporated, often almost instantly and sometimes without being well-understood, into market pricing for gold along with other commodities and assets.

Taken to its extreme, we have seen the growing influence of computer-generated, high-frequency, program and technical trading models that can trigger massive buying or selling of one or another financial asset (selling that has been aptly named a “flash crash”) all in a micro-second without any human participation or intervention.

Gold has always thrived on uncertainly  - and, as uncertainty continues to rise in the years ahead, those who hold the yellow metal will be amply rewarded.

That said, an important conclusion or piece of advice for investors, central bankers, and others with an interest in gold: In a volatile, high-risk, volatile world prudence calls for managing against a range of risks by looking at how assets inter-relate, rather than searching for the one or two assets that might perform best in a more certain and low-risk world.

Filed under: Gold Briefs, Speech | American Precious Metals Advisors, central banks, China, economics, ETFs, Exchange-Traded Funds, fiscal policy, gold, inflation, Jeffrey Nichols, monetary policy, Sovereign Wealth Fund, U.S. dollar|No Comments

U.S. Monetary Policy: Good News for Gold Investors

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We have long expected further monetary easing by the U.S. central bank . . . but this past Thursday’s news from the Fed was more than most gold investors could have imagined or hoped for.  In reaction to persistent recession-like conditions and continued high unemployment in the U.S. economy, the Fed is now embarking on even more reflationary - and ultimately inflationary - monetary policies.

In a statement following Thursday’s Federal Open Market Committee (FOMC) meeting, the Fed said “If the outlook for the labor market does not improve substantially, the committee will continue its purchase of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in the context of price stability.”

More specifically, the Fed said it will buy $40 billion of mortgage-related debt each and every month until the outlook for employment improves significantly.  At the same time, the Fed will continue its “Operation Twist” program in which it sells short-term securities and buys longer-term Treasury debt.  And, in addition, the Fed stated it is unlikely to raise interest rates from their current near-zero levels at least until mid-2015.

The Fed’s newly adopted quantitative easing (QE3), unlike QE1 and QE2, is open-ended and unlimited.  It will continue until there is evidence of healthy employment market conditions - which could be years away.  And, it may include other policy tools that remain undefined.

All of this is meant to lower mortgage interest rates, stimulate the housing and construction sector, raise prices of existing homes, keep Wall Street’s bull market in tact, and thereby reinvigorate the economy.

So far, gold and silver have been big beneficiaries with big price gains after QE1 and QE2, and now rising in the week before the FOMC meeting in anticipation of more stimulative monetary policies . . . and then, after the announcement, reacting to the even-more aggressive monetary stimulus than even the most liberal observers had expected.

But will these unprecedented Fed policies juice the economy, create jobs, and lower unemployment anytime soon?  I think not.  The real problem is not too little monetary creation . . . or too high interest rates . . . but the unprecedented levels of household and public-sector debt . . . along with extreme anxiety, uncertainty, and fear - in part, arising from Washington’s inability to formulate appropriate fiscal policies.

Even with all this newly created liquidity available for bank lending or sloshing around the financial and commodity markets, lending is not picking up because too many households and businesses are simply considered poor credit risks.

U.S. Treasury debt has already reached such high levels (in proportion to nominal GDP) that last summer the Standard & Poor’s credit-rating agency lowered America’s credit-worthiness . . . and recently another credit-rating agency, Moody’s, has warned it too will lower our rating if America continues running Federal budget deficits without any long-term measures in place to bring down the nation’s indebtedness.

Instead of dealing pro-actively to put our house in order, America faces the so-called “fiscal cliff” with extreme and automatic Federal spending cuts and tax increases set to take affect at yearend - unless Congress and the Administration can come to some compromise, something that they have not been able to accomplish in recent years.

Many of the Fed’s critics claim that its recent and prospective monetary policies will be ineffective and inflationary.  I believe these policies will be effective - eventually - simply because they are inflationary . . . and I believe that Fed Chairman Bernanke knows this as well as, if not better than, his critics.

Through inflation - which is simply the devaluation or debasement of the U.S. dollar brought about by excessive growth in the supply of dollars - the Fed will bring the country’s debt-to-GDP ratio back down to manageable levels, levels at which the economy will be able to once again function properly.

But America’s current economic predicament was years, if not decades, in the making - and it will be years before we can once again enjoy a healthy economy with adequate employment growth and rising prosperity.

In the meantime, we can expect continued accommodative monetary policies from the Fed - with gold prices rising to record heights far above recent levels.

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