Who’d want to be an investor in this market right now?
Last Thursday we witnessed a media headline titled “Investor Interest in Gold Waning With Fed Rate Increase Looming. Just a day later came the headline that read “Dollar and Stocks Fall, Bonds Advance With Gold After Jobs.”
The catalyst for both headlines was ongoing speculation surrounding the potential for US rate increases, influenced by the latest US economic data – in this case employment figures.
On Thursday the media reported on a third consecutive week of lower filings for jobless benefits, which saw a surge in the US dollar and corresponding fall in the gold price, as markets factored in a rate rise. Then on Friday it was reported that US job creation had fallen to its lowest level in six years – triggering a recovery in gold and a corresponding fall in the US dollar.
The point of all of this is to indicate firstly how fragile the US economic recovery actually is and secondly how pointless much of the so-called ‘expert’ economic analysis actually is. A rate rise that was considered a ‘certainty’ by the experts just a week ago is now considered a virtual ‘impossibility’. All this based on a simple reversal in one key piece of US economic data.
The Fed has consistently ‘talked tough’ with respect to interest rates, seemingly recognising the dangers of keeping rates too low for too long. It also points to US economic growth as clear evidence that its ‘easy money’ policies have been working.
However, the Fed cannot have it both ways.
In my opinion the current situation reflects not only question marks over world economic growth – it also underlines the frailty of the US economic picture (something the Fed won’t – or can’t directly admit – for fear of spooking markets).
The Dow Jones at record levels doesn’t necessarily reflect a robust economy – it’s in many respects a reflection of an equity market that’s been pumped full of Fed-administered hot air.
One lesson here is that the Fed’s great monetary experiment since the recession ended in 2009 looks increasingly like a failure. Recall the Fed’s theory that quantitative easing (bond buying) and near-zero interest rates would lift financial assets, which in turn would lift the real economy.
But while stocks and speculative assets like junk bonds and commercial real estate have soared, the real economy hasn’t. It’s been described by some as the worst economic recovery since World War II. And it will be interesting to see if financial assets now fall to match the slow real economy.
Markets of course have been completely comfortable with the ‘easy-money’ scenario continuing, as it helps maintain the value of already-inflated share and property investments. To this point the game of musical chairs has continued, with the day of reckoning continually pushed back further.
For years now there have been calls for Fed action on interest rates.
As far back as February 2012, President and CEO of the Federal Reserve Bank of St. Louis, James Bullard, argued “the Federal Reserve should start raising interest rates next year.” At the time he disagreed with the Fed’s decision during January 2012 to keep interest rates exceptionally low to bolster the US economy.
As he argued back in 2012, many years of near-zero rates risks causing "disaster." Keeping rates low for several quarters is very different from keeping them there for years, which punishes savers. The Fed’s easy money policies have distorted market prices and encouraged destabilizing financial speculation.
The biggest concern lies in the fact that financial markets have become so dependent on QE and artificially-suppressed interest rates, that it’s now very difficult for the Fed to reverse these policies without major repercussions. The Fed however is talking seriously about raising rates, something it should have done more than two years ago.
All of this of course is good news for gold, which remains the ultimate ‘insurance policy’ for investors and which has stabilized and strengthened so far during 2016.
Legendary investor and philanthropist Stanley Druckenmiller recently made news when he told investors to sell their stocks and buy gold (actually he said gold is his largest currency position).
And as Michael Lewitt wrote cleverly this past week in The Credit Strategist, “For the most part, the so-called smart money hit a wall right around the time the Fed pulled the plug (temporarily most likely) on its epic monetary experiment and terminated QE and started toying with raising interest rates. The “smartest” thing about all this money was that it figured out how to ride the wave of easy Fed policy after the financial crisis (after losing huge sums during the crisis). Once that policy ended, most managers stopped looking so clever.”
While the Fed and mainstream media keep telling us that the US economy is healthy, the facts tell a different story. Trade and demand are weak, while manufacturing is hovering just above recession levels. Internationally, eight years after the financial crisis, virtually all central banks are still engaging in crisis-era policies, with little prospect of reviving economic growth.
We’ve discussed this in previous articles, highlighting the fact that ordinary wage-earners, retirees and those on fixed incomes in the US have been by far and away the biggest losers. They were losers then as a result of the immediate effects of the GFC and they are still losers today.
How well Wall Street has done from easy money is illustrated by a recent report by Bank of America. Analysts added up the results of 606 global interest-rate cuts since the collapse of Lehman Brothers and the $12.4 trillion worth of central bank asset purchases following the rescue of Bear Stearns. The results represent a clear victory for Wall Street over Main Street.
For example, the team found that for every job created in the U.S. so far this decade, companies spent $296,000 buying back their stocks. At the same time, an investment of $100 in a portfolio of stocks and bonds since the Federal Reserve began quantitative easing would now be worth $205. Over the same time, a wage of $100 has risen to just $114.
For every $100 that U.S. venture capital and private equity funds raised at the start of 2010, they are now raising $275, but for every $100 of U.S. mortgage credit extended five years ago, just $61 was extended and accepted.
As US commentator David Rosenberg points out, the US labour market is anemic – despite headline numbers suggesting otherwise. Mr. Rosenberg believes that the lack of strong wage growth is a sign that the US is far from full employment.
“There are officially eight million unemployed, but in reality, when all the underemployment is accounted for, that number is far closer to 20 million. The definition of the labour force renders the unemployment rate a meaningless statistic. There are a ton of folks not in the traditional labour force who would readily take a job if offered one”, he says.
The employment-to-population ratio is a disappointing 77.7% for those aged 25-54 years old compared to 80% in early 2008 and 78.8% in September 2008 at the time Lehman Brothers collapsed. This means the Fed may be about to embark on a tightening cycle with the employment-to-population ratio at its lowest level in decades.
So what does this mean for gold?
Since the release of the minutes two weeks ago, gold has been on a downward trajectory. Historically, there has not been a strong correlation between the Fed’s monetary policy and gold; however the past decade has seen a much higher correlation.
As we’ve previously discussed, the multi-year rally in gold was driven mainly by the Fed’s ultra-loose monetary policy in the wake of the GFC. And it was the end of the Fed’s bond-purchase program that led to sentiment turning bearish on gold during late 2013.
Central bank policies of inducing negative real rates to ‘incentivize’ borrowing has expanded the money supply and devalued currencies – in turn forcing investors to chase riskier assets in order to generate returns. Many mums-and-dads investors, along with the Chinese, Indians and Russians, have sought refuge in gold. Debt is inherently inflationary if you have the ability to print your own currency.
The implementation of a negative interest rate environment should in our view be viewed as a clear signal that Central Banks are well and truly out of ideas. Negative interest rates are an unprecedented phenomenon – and a clearly desperate measure to try and arrest declining economies that are burdened by enormous debt levels.
The gold price is however the antithesis of paper money. The last few years have seen gold reaching record levels measured in most emerging economies’ currencies, but languishing against the US dollar. However, growing economic uncertainty could well result in a strong rise in gold against all paper currencies – including the US dollar.
Accordingly, I maintain confidence in our base-case gold price forecast of between $1,100 and $1,300 during 2016.
