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Macroeconomic Prospects and the Price of Gold

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September is typically a seasonally strong month for gold . . . but the markets have once again surprised gold optimists with another breakdown in the yellow metal’s price. 

Contributing to gold’s September price retreat has been a modest appreciation of the U.S. dollar vis-à-vis the British pound and other European currencies.  This episode of dollar strength – and gold-price weakness – has been driven my several factors:

  • For one thing, rising expectations among some currency traders that Scotland might vote to separate from the United Kingdom when the Scots go to the polls later this week has damaged the British pound.
  • And, by lending emotional support to separatist movements elsewhere in Europe, the possibility of Scottish devolution has weighed on the euro as well.
  • For another thing, a growing number of Fed watchers and gold traders have come to believe recent signs of a recovering U.S. economy might give the U.S. central bank leeway to advance the timing of next year’s widely anticipated upward adjustment in short-term interest rates.
  • At the same time, with the European economies stumbling anew, the European Central Bank has recently lowered euro interest rates – and, to the euro’s further detriment, there has even been some talk of an ECB program of quantitative easing later this year or next.

Much of the selling that has taken gold down a notch in the past week or so has occurred in futures and over-the-counter “paper” markets.  This latest round of selling was likely triggered by – and was certainly aggravated by – program traders and institutional speculators reacting to bearish technical indicators.

Somewhat surprisingly – and in contrast to previous episodes of gold-price weakness during the past few years – gold exchange-traded funds have registered some net inflows in recent days . . . while physical demand from Eastern markets has not yet responded to the recent fall in prices – although it will once the price appears stabilized and downside risks have apparently abated.

Despite occasionally better economic indicators, I remain pessimistic about the broad macroeconomic prospects for the U.S. and other the other old-world industrial economies. 

I’m not alone: The Organization for Economic Cooperation and Development (the OECD) has just cut its growth projections for the United States and other major economies.  The Europeans are sinking back into recession.  Growth in China and other newly industrialized economies are slowing.  And, in the United States, housing and labor-market indicators remain depressed and depressing.

Prior to the financial crisis of 2008, many years of excessive spending by households and governments – much on borrowed money – have left us overly indebted and incapable of sustaining growth in personal consumption consistent with healthy employment and housing markets.

In my view, the aging industrial economies will remain anemic – continuing to underperform for a very long time to come, suffering from what some economists have labeled “secular stagnation.” 

Regardless of any current talk to the contrary by central-bank policymakers, I believe the Fed may not only keep interest rates near zero for longer than anticipated by U.S. and world financial markets – but also may reinstate its program of quantitative easing or implement other stimulative policies sometime next year.

Unprecedented easy-money policies have kept the U.S. and world economies from slowing to a standstill or worse . . . but at what cost?

One unintended consequence has been the emergence of gigantic bubbles in stocks, bonds, and many other assets – including fine art, vintage cars and other collectables, New York City apartments, and Midwestern farmland, to name a few.  Indeed, gold is one of the few assets that looks relatively cheap!

It’s hard to imagine how the radical monetary policies of the past several years might end – but it probably won’t end well. 

Something’s got to give when asset prices and debt levels increase faster than the overall economy – measured by corporate profits, household incomes, or the broad measures of gross domestic product.

Today’s economic conditions simply do not justify today’s record-breaking stock prices.

Just look at the facts:

  • The bull market on Wall Street is now over five-years old, the second-longest bull market in the last 100 years.
  • The Dow Jones Industrials stock-market index has shot up more than 10,000 points since the last recession . . . and it is roughly 3000 points above its 2007 cyclical peak.
  • Moreover, the various measures of stock-market valuation – such as the S&P 500 price-to-earnings ratio – are at or above levels that have signaled past Wall Street reversals.
  • Cassandra-like Nobel economist and Yale professor Robert Shiller says that the stock market’s price-to-earnings ratio – a key measure of market valuation – is now indicating extreme overvaluation, to an extent that has not been seen since the top of the last bull market ending in 2008.

Any way you slice it, stock prices are now out of sync with current and prospective economic conditions.

As a result, the upside potential for stocks, bonds, and other bubbly assets now appears extremely limited – and, as with any speculative mania, there is great downside risk.

Many of us had thought the Fed’s easy-money policies would underwrite record-high gold prices.  But, so far, gold has not benefitted from easy money nor shared the overvaluation present in other asset markets.

As the broad investment markets have moved from one high to the next, it has been difficult for investors with short-term time horizons to retain their precious-metals holdings and sacrifice expected gains from equities and other rapidly appreciating assets.

Paradoxically, one unexpected side-effect of the “bubble economy” has been a three-year pause – or correction – in the long-term uptrend in the price of gold.

How did this happen?

To a great extent, many of the institutional investors and speculators, who had years earlier been keen on gold exchange-traded funds and paper gold proxies, have shed their sizable gold exposure in order to participate in the upward march in equity prices on Wall Street.

But, bull markets do not live forever – not even on Wall Street.  Sooner or later, stock prices must falter.  And, when sentiment turns, investors will be quick to discard equities and other inflated assets – and gold will be the beneficiary.

Meanwhile, just as stock and bond markets continue bubbling to new all-time highs, they are increasingly out of sync with U.S. and global economic prospects and political risks. 

Sooner or later, Today’s asset bubbles will burst.  They always do . . . and gold will be the beneficiary. 

But, even if I’m wrong about the economy . . . even if somehow world stock and bond markets continue moving higher for years to come . . . even if the U.S. and other major economies return to health with sustainable growth . . . and even if the Fed pulls a rabbit out of a hat, engineering a return to normative monetary policies without greatly disrupting business conditions . . .

Even if I’m wrong about all of this:  Gold will still appreciate smartly over the years to come on the strength of Asian demand . . . with China and India leading the way as voracious gold consumers and investors.