Today the FOMC's (Federal Open Market Committee) comments following its notice not to change US interest rates, marked the point at which it would not step onto the path of a harder currency in the way they so strongly urged the EU countries to do. It is also politically opposite to the effect implicit in Tea Party people talk - I say 'effect' instead of 'policy' because I do not believe the TP actually has a policy or understands the implications of what it says.
Regardless, the FOMC comments opened the way for an imminent return to QE2, or the second coming of the Quantitative Easing experiment. When this happens, it will be a point of no return. The Bernanke-Geitner duo will speak and it will happen. As I said in an earlier blog, this was first tried years ago by Japan and is given prominence for that country's economic "lost decade".
As a backdrop, the predominent recent US guru wisdom has been that there would be no "double dip" in GDP, just slow but steady growth. By Sept 20 a wrench seemed to be thrown into that scenario when the Fed announced that the decline had ended a year ago! As Obama was politely asked that same day on TV by some of his most supportive public, to be told now that this was a year of recovery after bailouts, QE1, etc was scarcely credible.
Whispers had been saying the amounts deployed were not big enough. Now the result was clear. Even the slightest future downtick would put "double dip" in play. And as we have said before, the only tool left to the Fed and Treasury would be QE2.
The anointed god of bonds, Bill Gross of PIMCO, was already standing by on CNBC. Within a minute after release of the FOMC statement, Gross said it could only mean a decline in the dollar*. Almost simultaneously, charts of spot gold spiked to a new current high approaching $1,290/oz, while the US dollar abruptly commenced a renewed stage of its fall. Stock markets rose in unison. However, before the day's close at 4pm, the market began to reassess the consequences. By 5pm, Larry Summers, Director of the Obama Council of Economic Advisors had announced his resignation.
If QE2 does happen, new consequences being unleashed by the "solution" will eventually have to be fixed. An important part of those problems will occur in non-indexed public and private pensions as yields disappear and fixed incomes progressively fall. The fix is unlikely to be pretty. When rates rise - which will happen again at some point - bond values and pension assets will be crushed.
Whatever policyspeak may sound like, investors should instead take what it says on the cop cars as the greater reality -"Deeds Speak".
* His unspoken message (known as "talking your book"): Get out of your weak cash and into the safety of US Treasuries. He may not tell those same potential investors when to get out, until PIMCO has already vacated stage left at a profit. PIMCO is the world's largest bond investor.
James Carville, Bill Clinton's famed campaign manager is reputed to have joked "Once when I was asked what I would want to be if could have all the power in the world I would have said "God" - now I would say a bond fund".
Tuesday, September 21, 2010
Tuesday, September 14, 2010
The Gold Conundrum
The combination of unusually contradictory economic signals plus political and social crosswinds have meant extraordinary volatility and confusion in debt and equity markets. Expectations and explanations for the action in gold are no exception. As the spot market rose to new highs today, September 14, disbelief appears extremely high. What is going on?
"Gold bugs" have always been derided. This has made it pretty hard for investors that are already involved or considering that section of the market to believe in their rationale, lest they have been unwittingly infected by "the bug" or considered part of the tinfoil hat crowd.
For the moment, let's set aside thoughts about Indian jewellery demand, absence of industrial use and the repeated view that it is a relic of an earlier order of international settlements that eventually outlived its reason for existence until the Nixon era. The first is too small to have anything other than seasonal effect; it's true, there really is no industrial demand on the horizon and the prospect of the IMF or other bodies adopting some widespread form of gold-related standard among nations appears unlikely any time soon. Then there is is the debate that we are more likely entering a deflationary period (declining aggregate prices) than an inflationary - even hyper-inflationary - one.
In this writer's view, at present the monetary issue is the key. Observations that the current environment has deflationary characteristics have supportable evidence, but a lot of it - not all - involves the rear-view mirror. The public perception of well-being typified by the seemingly permanent decline in Walmart pricing is ending as originating and transportation costs rise. US consumers are struggling with personal balance sheets by curbing consumption and paying down debts. For now, Canadians are busily going in the opposite direction, increasing their debt. The divergence will not be permanent.
Areas of future influence where governments have the least control, such as worldwide food prices, are much more inflationary than those such as interest rates that are under vigorous, ongoing government suppression. US rates and the value of the US dollar relative to other currencies are the most significant influencing factors in the gold price.
Since US rates are the lowest in the world (the Japanese yen is not a currency for international settlement), the US treasury bonds that must be sold to fund the US trade deficit, increasingly cannot be sold in sufficient quantity to foreigners. The shortfall in purchases therfore has to come from the US government itself. This puts it in the position of being both the seller and a buyer. The result affects the US government's own balance sheet. The combination of these policies, when extended over an unusually long period of time such as is the case today, comes with an unavoidable delayed cost. Due to the nature of its markets, gold is an erratic but inexorable measure of these effects, when measured in US dollars.
Historically the international mechanism compensating for these effects occurs through differences in interest rates between nations. Debtor nations, of which the US is by far the world's largest, will usually have the highest rates. The problem is that simultaneously, as issuer of a currency that in better times was accorded the status of reserve currency, meaning the one that all other settlements can be paid with, there is a huge conflict.
As a current core aspect of US government policy, the American interest rate shock absorber has been disabled. Throughout the exercise, official salesmanship says US policy is one of "maintaining a strong dollar." In the short term it is a situation with no political prospect of change. As a result, gold gradually and unofficially resumes the role of adjustment mechanism.
Notice that official US talk dismissing a rising gold price as meaningless, is completely consistent with its misleading "strong dollar" sales pitch. The key to the gold price conundrum is that for the remainder of this policy period - for whatever time it continues - the effect of these policies is the true driver of the gold price and the market is the enabler.
Of course in the world of global politics and international hegemony, it cannot be ignored that the US's single biggest creditor, China, has now become the world's largest gold producer. China is now putting in place its own policy of allowing gold to become a more important component of its currency policy. Part of this is being done by changing internal Chinese regulations to ecourage wider domestic investment in the metal but especially wider opportunity for Chinese citizens to invest in gold-related stocks.
Among these planned market vehicles, certain of them are identifiable as "dragon's head" national champions in which elements of the Chinese government itself has a stake. It will be interesting to see if this policy will induce some level of switch by investors to Chinese gold stocks from Chinese real estate. Not only are real estate prices viewed as unsustainable, but there have been calls for real estate prices to be moderated in the Chinese market for social reasons.
On the other hand, as well as providing a new investment alternative, such a directed capital reallocation should avoid pushing funds into and thereby exerting pressure on other domestic prices to feed inflation. For China, gold investment opportunities may achieve that goal.
At the same time, success for investors would increase the "wealth effect" for a growing middle class. This is needed to pick up slack in export demand and shifting it internally. In turn it also mitigates the otherwise negative effect from a trade standpoint from the resulting higher value that will take place in the Chinese yuan.
Such an increase in the relative value of the Chinese currency has been loudly demanded in US political circles for several years. China appears now in the process of putting this demand into effect as a change in its economic policy. I expect it could be evident by Q2 2011.
There is a saying, "watch what you wish for", because unintended consequences abound.
Disclosure: long CGG-T
"Gold bugs" have always been derided. This has made it pretty hard for investors that are already involved or considering that section of the market to believe in their rationale, lest they have been unwittingly infected by "the bug" or considered part of the tinfoil hat crowd.
For the moment, let's set aside thoughts about Indian jewellery demand, absence of industrial use and the repeated view that it is a relic of an earlier order of international settlements that eventually outlived its reason for existence until the Nixon era. The first is too small to have anything other than seasonal effect; it's true, there really is no industrial demand on the horizon and the prospect of the IMF or other bodies adopting some widespread form of gold-related standard among nations appears unlikely any time soon. Then there is is the debate that we are more likely entering a deflationary period (declining aggregate prices) than an inflationary - even hyper-inflationary - one.
In this writer's view, at present the monetary issue is the key. Observations that the current environment has deflationary characteristics have supportable evidence, but a lot of it - not all - involves the rear-view mirror. The public perception of well-being typified by the seemingly permanent decline in Walmart pricing is ending as originating and transportation costs rise. US consumers are struggling with personal balance sheets by curbing consumption and paying down debts. For now, Canadians are busily going in the opposite direction, increasing their debt. The divergence will not be permanent.
Areas of future influence where governments have the least control, such as worldwide food prices, are much more inflationary than those such as interest rates that are under vigorous, ongoing government suppression. US rates and the value of the US dollar relative to other currencies are the most significant influencing factors in the gold price.
Since US rates are the lowest in the world (the Japanese yen is not a currency for international settlement), the US treasury bonds that must be sold to fund the US trade deficit, increasingly cannot be sold in sufficient quantity to foreigners. The shortfall in purchases therfore has to come from the US government itself. This puts it in the position of being both the seller and a buyer. The result affects the US government's own balance sheet. The combination of these policies, when extended over an unusually long period of time such as is the case today, comes with an unavoidable delayed cost. Due to the nature of its markets, gold is an erratic but inexorable measure of these effects, when measured in US dollars.
Historically the international mechanism compensating for these effects occurs through differences in interest rates between nations. Debtor nations, of which the US is by far the world's largest, will usually have the highest rates. The problem is that simultaneously, as issuer of a currency that in better times was accorded the status of reserve currency, meaning the one that all other settlements can be paid with, there is a huge conflict.
As a current core aspect of US government policy, the American interest rate shock absorber has been disabled. Throughout the exercise, official salesmanship says US policy is one of "maintaining a strong dollar." In the short term it is a situation with no political prospect of change. As a result, gold gradually and unofficially resumes the role of adjustment mechanism.
Notice that official US talk dismissing a rising gold price as meaningless, is completely consistent with its misleading "strong dollar" sales pitch. The key to the gold price conundrum is that for the remainder of this policy period - for whatever time it continues - the effect of these policies is the true driver of the gold price and the market is the enabler.
Of course in the world of global politics and international hegemony, it cannot be ignored that the US's single biggest creditor, China, has now become the world's largest gold producer. China is now putting in place its own policy of allowing gold to become a more important component of its currency policy. Part of this is being done by changing internal Chinese regulations to ecourage wider domestic investment in the metal but especially wider opportunity for Chinese citizens to invest in gold-related stocks.
Among these planned market vehicles, certain of them are identifiable as "dragon's head" national champions in which elements of the Chinese government itself has a stake. It will be interesting to see if this policy will induce some level of switch by investors to Chinese gold stocks from Chinese real estate. Not only are real estate prices viewed as unsustainable, but there have been calls for real estate prices to be moderated in the Chinese market for social reasons.
On the other hand, as well as providing a new investment alternative, such a directed capital reallocation should avoid pushing funds into and thereby exerting pressure on other domestic prices to feed inflation. For China, gold investment opportunities may achieve that goal.
At the same time, success for investors would increase the "wealth effect" for a growing middle class. This is needed to pick up slack in export demand and shifting it internally. In turn it also mitigates the otherwise negative effect from a trade standpoint from the resulting higher value that will take place in the Chinese yuan.
Such an increase in the relative value of the Chinese currency has been loudly demanded in US political circles for several years. China appears now in the process of putting this demand into effect as a change in its economic policy. I expect it could be evident by Q2 2011.
There is a saying, "watch what you wish for", because unintended consequences abound.
Disclosure: long CGG-T
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