Archive for money supply

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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U.S. Election Results: Best of All Possible Worlds for Gold

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(Posted: November 7, 2012)

Tuesday’s election outcome - with President Obama returning to the White House, the Democrats retaining a weak majority in the Senate, but without enough seats to overcome a Republican veto on important legislation, and a strong Republican majority in the House of Representatives - may be the best of all possible world’s for gold investors.

Just a month ago, on October 5th, gold reached an 11-month high just over $1,795 an ounce.  Since then, in the run up to yesterday’s election, the yellow metal slumped as low as $1,672 - reflecting the prospects that a Romney victory might bring a reversal in economic policies, a reversal that would be “unfriendly” to gold.  Beginning late last week, as the polls shifted back in favor of Obama gold again rallied, nearly touching $1,730 before settling down on speculative profit taking in paper markets.

Gold prices are likely to remain volatile, continuing to exhibit big day-to-day and week-to-week ups and downs as the market sorts out the long-term consequences of four more years like the last four years - four more years of recession-like economic activity or worse, four more years of fiscal gridlock with annual trillion-dollar federal deficits, and most importantly for gold-price prospects, four more years of accommodative Federal Reserve monetary policies.

With the election now behind us, the market’s short-term attention will re-focus on possible Federal Reserve policy initiatives that may be discussed or even initiated at the December 12th FOMC policy-setting meeting.  There is already talk of further quantitative easing, expectations of which could soon become a strong up-side price driver.

From a longer-term perspective, the Obama Administration will likely continue to endorse aggressive monetary stimulus as the only game in town to counter recessionary tendencies in the U.S. and global economy.  Moreover, when Chairman Bernanke’s term expire in 2014, President Obama is likely to appoint another monetary “dove” to head the Fed.

Similarly, the financial markets (including the market for gold) will increasingly react to the impending “fiscal cliff” mandating a combined $500 billion in tax increases and spending cuts beginning at the start of the new year - that is unless Congress and the Administration can agree to a more tolerable solution to American’s fiscal profligacy - or more likely, Washington will simply “kick the can down the road,” by agreeing to revisit deficit reduction at some later date.

However this sorts itself out, America is following Europe down the road toward ill-timed fiscal restraint, restraint that will only exacerbate recessionary tendencies, and force the Fed to counter with still more stimulative monetary policies.

These and other positive price drivers and physical market fundamentals could form a “perfect storm” for gold in the closing weeks of 2012 - and, quite possibly, we could see the metal approach or even surpass its record high by year-end or early 2013.

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Gold: Treading Water in Turbulent Seas

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Gold has been somewhat of a disappointment to many analysts and investors who, as of a few months ago, were still anticipating higher prices again this year.  But the year is not over, nor is gold’s long-term secular bull market.

With eleven years of advancing prices already chalked up on the scoreboard, the long-term secular upswing has five-to-ten years of life still ahead - and maybe more.  Along the way, expect continuing volatility, periods of consolidation, and occasional corrections, corrections sometimes so severe that some will prematurely and incorrectly call the game over.

We are now in one of those periods of consolidation when the market takes a breather and adjusts internally, preparing for the next major move.  So far this year, the yellow metal has traded well beneath its all-time high of $1,924 an ounce recorded this past September 6 and well above its subsequent low near $1,520 in late December.

Instead of forging new ground, the price in recent months has been merely treading water, seemingly stuck in a trading range between $1,620 and $1,696, awaiting some external news or internal market development to push the price beyond these temporary technical barriers.

Although I believe the odds of an upside breakout are significantly greater than the probability of a breakdown, I caution that a fall back to $1,520 - or even lower - is certainly possible before gold resumes its long-term ascent.

While physical demand from the key Asian markets - China and India - and from the official sector (that is from central banks) may fuel gold’s long-term secular advance, it is developments in the macroeconomic and world financial sphere that are most likely to influence gold in the days, weeks, and months immediately ahead.

U.S. Economic News and Expectations of Fed Policy

Good news for the U.S. economy - news that diminishes expectations of further U.S. central bank monetary accommodation - hurts gold at least among institutional traders and speculators on Wall Street and at financial institutions around the world.  This has been the group that has been most responsible for last September’s swift correction and the subsequent ups and downs in the metal’s price.

As I have written frequently in the past, these players betting in futures and other derivative markets collectively may have great sway - but only for so long.  Ultimately, it is the physical market - real world supply and demand - that determines the long-term price trend.  And, developments in the physical world have been and will continue to be propitious for the yellow metal.

Perhaps the most important reason gold has not been able to move higher in recent months - despite relatively firm physical demand - has been signs of an early springtime for the U.S. economy, particularly the improving employment, output, and consumption statistics.  As a result, talk of another round of quantitative easing (QE3) has diminished - and the short-term speculators trading paper gold, having earlier this year preferred the short side of the market have in recent weeks begun to lose interest.

Despite the political imperative to dress up the economic statistics ahead of the November elections, I think the economic news will likely be disappointing to those envisioning a rosy scenario.  The positive signs of recovery result not from any fundamental improvement or return to health in the American economy but from faulty seasonal adjustments affected by the unusually mild winter and early spring across much of the United States as well as the unusual economic performance itself in the past several years that have overpowered seasonal influences.

It remains unfathomable to me just how the United States economy can sustain a healthy recovery accompanied by falling unemployment broadly defined and rising consumer spending in the face of election-year uncertainties, a depressed housing sector with foreclosures continuing apace, cutbacks in state and local government spending and more public-sector layoffs ahead, and a heavy burden of private and public-sector debt.

What America needs for long-term health is more saving by households and government - not more spending by consumers and a dysfunctional federal government unable to control its addictive spending habits.

In the meanwhile, odds favor additional monetary accommodation, if not before the November elections, then soon thereafter . . . and as financial markets take note of the still anemic economy and rising probability of Fed easing, gold will respond with a major move to the upside.

Europe’s Festering Sovereign-Risk Crisis

The crisis still festering - and likely to worsen - in Europe is a long-term positive for gold although, as in the recent past, the short-term consequences could be quite the opposite.

The European Central Bank (the ECB), along with other European national banks, remains under great pressure to provide financial market liquidity and keep a lid on interest rates.  This is not an easy task with institutional investors unwilling to accept more sovereign debt unless the perceived risks are offset by higher rates of return.

Unfortunately, higher interest rates push borrowing countries - like Spain, which has been much in the news lately - into untenable fiscal deficits and strengthen the case for default among their citizenry.

Default by one or another country on its sovereign debt would probably initiate a wave of defaults among the fiscally weaker European economies - and could trigger a “Lehman-like” moment as major banks and other financial institutions holding European debt suddenly find themselves insolvent and in need of government bailouts once again.

In any event, further ECB monetary creation will debase the euro and most other European currencies - eventually producing higher rates of inflation, not just in Europe but globally, while encouraging central banks around the world to hold more gold in lieu of euro-denominated assets.

Unfortunately for gold investors, the euro-crisis may have just the opposite effect on gold prices in the short run as flight capital seeking a safe harbor in turbulent seas gives the greenback a false appearance of strength not only against the euro but against gold itself.

But, ultimately, as inflation accelerates and lenders - particularly emerging nation central banks and other institutional investors around the world - lose faith in the dollar as a store of value, gold will win out.

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Gold - Just an Innocent Bystander

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“At some point, however, we will see a correction, perhaps a sizable one.  After all, even strong bull markets never move up in straight lines.  I would not be surprised to see gold stumble - falling back $100, $200, or even $300 - before prices begin working their way higher once again.”

That was my view published on NicholsOnGold.com in late August.

Gold has certainly taken a dive - and could stumble further in the days immediately ahead - but I think we will see the yellow metal begin its comeback sooner rather than later, possible in the next few days.

This summer we raised our year-end price forecast to $1,850 an ounce - but remained reluctant to adjust our expectations upward as the price moved past this level and briefly traded over $1,900 an ounce in early September.

Although physical demand in world bullion markets remained firm, it seemed to me that the price was moving up too fast too soon as institutional speculators extended their “long” positions in “paper” derivative markets.

Shoot the Speculators

Now - rather than any dramatic reversal in world physical markets - it looks like the precipitous price decline in recent days can be blamed entirely on these same speculators (including some prominent hedge funds and the trading desks of the big Wall Street banks) reversing their positions or cashing out of gold altogether.

Nothing that has occurred in the past few days in any way diminishes my long-term enthusiasm about gold-price prospects.  The same bullish gold-market fundamentals and macroeconomic trends that I have been discussing for many years now remain in place and promise significantly higher gold prices over the next five years or longer.

It is important to remember that violent sell-offs in equity and other asset markets typically spill over into the gold market . . . but after an initial selling wave, gold tends to disassociate itself from and act independently other asset markets.

At first, when other assets are under extreme pressure, as has been the case this past week, gold’s immediate reaction reflects reflexive selling by institutional speculators - including momentum, program, and other “black box” traders.  Short-term trading in derivative markets may, at times, produce a great deal of gold-price volatility but, in my book, it does not affect the long-term price trend.  In a sense, gold is an “innocent bystander.”

Nothing We Haven’t Seen Before

While the magnitude of gold’s decline seems stunning in absolute terms, keep in mind it is not unusual for gold prices to correct by 10%, 15%, 20% or even more after a run-up the likes of which we’ve seen this year.  Old timers may recall the 1970s, when we saw at least a couple of bigger percentage corrections in the midst of a long-lasting bull market.

Now, from its September 6th all-time high around $1,923 an ounce to this Friday’s (September 23rd) low around $1,628 an ounce in New York trading, we are off just about 15 percent - certainly not so much when you consider the previous advance . . . certainly not so much to those who remember gold’s volatile price history . . . and certainly not so much as to cause much alarm among those who pay close attention to gold’s fundamentals.

Fundamentals Count

And speaking of fundamentals — with the exception perhaps of India — physical demand in recent days has held of fairly well.  Meanwhile, it is not unusual for more price-sensitive trading-oriented Indian gold dealers to pause, at times like this, for the dust to settle before stepping back as buyers.  For sure, there is nothing here to diminish India’s long-term appetite for gold.

Meanwhile, my China contacts report no immediate diminution in retail gold demand from the world’s biggest national gold market.  Driving Asian demand - in India, China, and elsewhere has been the continuing rise in household incomes in tandem with worrisome inflation - and this pro-gold combination is unlikely to change in the foreseeable future.

Watch the Central Banks

For the past few years (in speeches, published articles, client reports, and on my website NicholsOnGold.com), I’ve been talking a lot about the revival and growth of central bank gold interest - and its long-term significance to the market and the future price.

I believe that a few central banks - central banks that have been fairly regular buyers, acquiring gold month in and month out - have already stepped up their purchases in reaction to the lower, more attractive, price levels now prevailing.  And other countries are likely to add to their own gold reserves in the days ahead as it becomes more apparent this correction has run its course.

The central banks of Russia and China (which does not report or publicize its on-going gold purchases) are the first that come to mind, but quite possibly other central banks will also use this episode of gold-price weakness to acquire metal without causing any overt market reaction.

In my book, gold’s own supply/demand situation and other recent-year institutional or structural changes in the gold market per se (such as the introduction and growth of gold exchange-traded funds or the legalization of private gold investment in China) suggest more gold price strength ahead.

And Shoot the Politicians Too

So, too, does the inability and disarray among of our economic policymakers and politicians, those entrusted with our financial and monetary wellbeing, to frame appropriate policies that would deal effectively with today’s economic realities.

Indeed, U.S. and European economic prospects continue to deteriorate, suggesting we will see still more desperate monetary stimulus from the Fed and the European Central Bank (the ECB) before the end of this year.

Here in the United States, the Fed will be facing continued signs of renewed recession or recession-like business and employment conditions.

Across the Atlantic, the ECB will be struggling to prevent the approaching Greek sovereign debt default and the insolvency of some European banks holding Greek sovereign debt.  Some fear this would be a catastrophe far worse than the Lehman Brothers bankruptcy - with dire consequences for the world economy.

While these problems are unlikely to trigger any immediate policy response from the Fed or the ECB in the next week or two, as pessimism grows among investors and traders, expectations of further monetary accommodation could stimulate more investment demand in the days and weeks ahead.

So, too, could U.S. Congressional bickering and inaction on both the U.S. Treasury debt ceiling and on the Federal budget impasse as these issues again become headline news.

Long-Term Buyers Rule

To recap:  Short-term trading in derivative markets may, at times, produce a great deal of gold-price volatility but, in my book, it does not affect the long-term price trend.  What governs the price of gold over the long term are the market’s real-world supply and demand fundamentals - and these have been decidedly bullish and are becoming even more so.  Hence, my long-standing forecast of much higher gold prices in the next several years.

Importantly, to the gold-price outlook, today’s buyers, both private investors and central banks, are likely to be long-term holders.  Much of this gold, once bought, is unlikely to be resold any time soon even at much higher price levels.  For central banks, the holding period will be measured in decades if not longer.  This promises less liquidity, more volatility, and much higher prices in the years ahead.

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