Harris & Ewing Zines March 1940 National Press Club Building newssstand, Washington, D.C.
Stoneleigh: Given the fervour over gold, and the fact that our view of it differs from that of many other commentators, it seems fitting to review our position on gold ownership. Firstly, the goldbugs are right that physical gold is real money (unlike paper gold, which is just another Ponzi scheme). It has held its value for thousands of years and will continue to do so over the long term. However, that does not mean that gold prices cannot fall or that purchasing gold now is the right way for everyone to preserve capital. Timing is critical, and people's circumstances are different. Those circumstances determine their freedom of action, both now and in the future.
Gold has recently seen a sharp speculative spike on fear as to the future of fiat currencies. The price shot up to over $1200/ oz, with a rise (nearly vertical recently) of over $300/oz in a matter of months. Sentiment has reached an extreme of 97% gold bulls, leaving very few additional people to drive the existing trend further. It has become almost universal received wisdom that gold can only rise in price (and the US dollar continue to fall) given current circumstances. In other words, herding behaviour has taken the trend just about as far as it can for the time being. (Of course, denominated in other currencies, the move has looked quite different.)
Commodity tops, like equity bottoms, are often sharp, as fear is an acute emotion. The reversal, when it comes, is also typically a sharp move. While the longer term future of fiat currencies is indeed bleak, that should be tomorrow's fear, not today's. When fear gets ahead of itself, it sets the stage for a pronged move in the opposite direction. That happened with equities in March and is what I would argue is about to happen to gold.
What begins as a speculative reversal is likely to be extended by the effects of deflation during the next stage of the decline, which in my view is rapidly approaching. Deflation knocks the price support out from under almost everything, as people sell whatever they can in order to raise scarce cash. 'Whatever they can' is the operative phrase. They won't be able to sell what they would like to, as no one will want what they would like to off-load. They will have to sell things of enduring value, such as precious metals. Those who are forced to sell at the wrong time will end up selling a valuable asset at a bargain basement price.
Buyers for most things will be few and far between, as those who still have cash will be unwilling to part with it. The vast majority of the effective money supply is credit, and credit is evaporating. As that happens, it will become increasingly apparent how little actual cash there is, and how important access to it will be. Rising unemployment and cuts in benefits will make access to cash more and more problematic. The value of cash, relative to available goods and services, will rise. While fiat currency has no long term future, cash will be king while deflation lasts. Liquidity will mean flexibility in an uncertain world, and that will translate into opportunity at the most critical time in all our lives.
Internationally, the US dollar should temporarily be the biggest beneficiary of a substantial flight to safety. The dollar should therefore rise not only in relation to goods and services domestically, but also in relation to other currencies. Those who hold dollars can therefore expect to do very well, provided, that is, that they manage not to lose them to a systemic banking crisis.
Those who buy gold now will be paying a premium price for it compared to what they might pay once deflation has exerted its effects. They might be buying at such a premium only to have to turn around and sell at a loss if they have not addressed their situation from a big-picture perspective. Holding debt, or not having sufficient liquidity in reserve, are the main reasons one could be forced to sell at a bad time. People need to deal with those circumstances before they consider buying gold. Some will be able to deal with the higher priority factors and still buy gold as an insurance policy, but others will not. The fewer one's resources, the harder the choices one will have to make, as it simply will not be possible to do everything. (Pooling resources with others will get you further down the list of possible preparations.)
Liquidity will be vital to cover living expenses in the absence of credit, especially as we move further towards a pay-as-you-go future. Eliminating debt is important given that servicing debt will become increasingly difficult. The ability to service debt depends on both access to scarce cash and interest rates. Interest rates on private debt are likely to diverge sharply from the prevailing rate on short term government debt. In other words, credit spreads will widen dramatically. While the short term government rate will be very low, at least in nominal terms, private debt will attract a much greater risk premium as deflation accelerates. All rates will be higher in real terms than in nominal terms, as the real rate will be the nominal rate minus negative inflation. This factor will keep central bankers mired in the liquidity trap (pushing on a string), and will magnify the burden of debt for everyone else.
If you hold too little liquidity or are in debt, you could easily be forced to sell any precious metals you hold at the worst possible time. In general terms, I would not suggest holding precious metals unless you are reasonably confident that you will not need to rely on the wealth they represent for many years. If you can hold metals for the long term, they will be very valuable indeed. Gold should hold its value better than silver, as a greater proportion of silver's value is related to its industrial uses, and those attributes will be undervalued during a depression.
I would expect gold to bottom early in this depression, but I doubt if it will be possible for ordinary people to buy it at its nadir. During the last depression, gold was confiscated without compensation, and I think it likely that the same thing will happen again. A ban on owning gold would not stop you from owning it, but it would make ownership far riskier, and would make trading it for anything else you might need a very dangerous business indeed. You would have to go through 'informal channels', where these exist, and trying to do that with something representing a very concentrated source of value is generally unwise, to put it mildly.
Gold ownership is very much a double-edged sword. Personally, I think it far more important for those who have surplus resources to put those resources into obtaining as much control as possible over the essentials of their own existence. There are many hard assets one could buy now that may not be available later - assets that you could use to feed yourself, keep yourself warm or provided clean water. This is a much more important use for your wealth than owning something you intend to bury in a hole in the ground and sit on. Gold ownership really only makes sense for those who are wealthy enough not to have to make hard choices between competing priorities. If you can afford to do it all without making compromises, then gold is a good insurance policy. If you are not in such a fortunate position, that kind of insurance may be a luxury you can't afford.
After the Fed’s latest announcement on January 25, in which the central bank said very little more than the obvious ("exceptionally low" fed funds rate at least through late 2014), we have returned to typical speculations about how much “money printing” (or quantitative easing) by central banks we will see in upcoming months to accompany these low rates. Perhaps the Chief Speculator is Tyler Durden at ZeroHedge, who never backs down from an opportunity to re-assert (or manufacture) the near-term bullish arguments for gold. This article will review some of the more notable and ridiculous opportunities seized over the course of only a few day following the FOMC release. Each one was a relatively short and sweet post that showcased a nifty-looking correlation chart. I do realize that Durden wasn't claiming any of these posts as an extensive and irreproachable analysis, but the fact is that he decided to put them up for a reason. Soon after the Fed’s announcement, ZH ran the following headline and analysis [emphasis mine]:Market Now Pricing In $770 Billion Increase In Fed Balance Sheet As we have pointed out previously, the primary if not only driver of relative risk returns (because in a world of relative fiat value destruction, it is all relative, except for gold which is revalued relative to all on a pro rata basis), will be who of the big two - the Fed and the ECB - can print more. And up until now, at least since the end of December when the market "suddenly" realized that the ECB's balance sheet has soared to unseen records, the consensus was that it was the ECB that would be the primary source of easing. Especially when considering that there is another ~€500 billion LTRO due on February 29. Yet today's rapid reversal in the EURUSD, driven by Bernanke's uber-dovish comments suggest that something has changed and that the Fed is now expected to ease substantially. How much? For that we look to the latest balance sheet cross-correlation, where if we go by simple correlation, the market is now pricing in (based on the EURUSD cross ratio) that the relationship of the two balance sheets will rise from a multi year low of 1.08 as of a few days ago to 1.15, at least based on the rapid move in the EURUSD higher as can be seen in the chart below. Indicatively, the actual value of the two balance sheets is €2.706 trillion for the ECB and $2.92 trillion for the Fed (or a 1.08 ratio). So now that the EURUSD has risen as high as it has, it implies that the pro forma "priced in" ratio is about 1.15. But wait: one should also factor in the fact that the ECB's balance sheet will rise by at least another €500 billion in just over a month, which will bring the ECB's balance sheet to €3.2 trillion. Which means that to retain the 1.15 cross balance sheet relationship, the Fed's own balance sheet will have to rise to $3,687 billion, or a whopping $767 billion increase!"
Essentially, he is saying that the reaction in the EUR/USD pair after Bernanke’s statement had implied that the movers and shakers in the currency markets expected the dollar to be devalued by the Fed in the near future through quantitative asset purchases. Since the pair moved to levels that "imply" a ratio between the size of the Fed and ECB's balance sheets higher than currently established (based on loosely-correlated movements over the course of 2 years), and the ECB is expected to unleash at least another €500bn next month, we can project that the Fed will unleash a response of $767bn (or thereabouts). To Durden’s credit, he provides a partial explanation of why we should probably dismiss this entire train of thought in the very next sentence that he writes.Naturally, that's a simple heuristic based on only what the EURUSD pair is implying. Of course, this is not a scientific way of predicting where Bernanke will go, but that is at least what the market seems to be telling us.
To only say that this mode of prediction is non-scientific is to do all forms of non-scientific economic analysis a huge disservice. It is patently ridiculous to think there is any connection whatsoever between the immediate reaction of a currency pair to a Fed announcement and either the expectations OR the actual value of future asset purchases by the Fed (even ignoring the fact that Bernanke's comments were not much more "uber-dovish" than they have ever been over the past year). It is much more likely that the EUR/USD has simply been moving with the perception of financial risk in the Eurozone this whole time, and perhaps with the expectation of ECB “money printing” since mid-2011. The markets' perception of risk is most certainly tied into the Fed’s QE asset purchases (or the lack of them in 2H 2011) during waves of greed/fear, but all of that is a very far cry from the currency pair acting as a predictive indicator of money printing. Durden almost admits as much above before reverting back to his goal-seeked analysis in pursuit of a predictable conclusion.So at the end of the day, the balance sheets of the world's two biggest central banks will increase by about €500 billion for the ECB and ~$770 for the Fed and $655 billion for the ECB. Incidentally, this analysis assumes all else equal which, with Greece on the verge of default and Portugal potentially in its footsteps, isn't... Thus our question is: gold is not on its way to $2000 yet why again?
It is really unfortunate that such an informative and clever site occasionally feels forced to produce such weak arguments in favor of, what else, gold. The truth is that no one can be certain when Bernanke will decide to pull the trigger on QE3 or how much the Fed’s balance sheet will actually be expanded in nominal terms or relative to the ECB’s balance sheet, and analyses such as the one above provide us with no clearer picture of those possibilities than we had before. It only serves to confuse the issues at hand and provide us with a sense of predictive confidence that we simply can’t have. What we do know is that the Fed’s perpetually low interest rates and the potential for another few hundred billion in QE are very unlikely to make a dent in the ongoing global deleveraging tsunami, and therefore the natural flight to safety away from currencies such as the Euro for U.S. Treasuries and the U.S. Dollar. That is even truer if the ECB floods the European banks with another €500b to €1tn of LTRO funds in February, since very little of that money will actually make it to the distressed consumers, businesses and sovereigns that need it the most. The next day, ZeroHedge asked semi-rhetorically whether Bernanke has become a “gold bug’s best friend”. The logic contained within this brief analysis is similar to the one presented above, as it tries to connect the Fed’s statement and Bernanke’s comments on Wednesday to the subsequent positive returns of gold (and “implicitly silver”) over the 24 hours that came after [emphasis mine].Has Bernanke Become A Gold Bug's Best Friend? Below we present the indexed return of ES (or stocks) and of gold over the past 24 hours since the Bernanke announcement of virtually infinite ZIRP, and the latent threat of QE3 any time the Russell 2000 has a downtick. It is unnecessary to point out just when Bernanke made it all too clear that the Fed has nothing left up its sleeve, expect to directly compete with the ECB over "whose (balance sheet) is bigger," as it is quite obvious. What is not so obvious, is that for all intents and purposes, Bernanke may have unwillingly, become a gold bug's best friend, as gold (and implicitly silver) has benefited substantially more than general risk. Much more. So for the sake of all gold bugs out there, could the Fed perhaps add a few more FOMC statements and press conferences? At this rate gold should be at well over $2000 by the June 20 FOMC meeting.
Granted, the first bolded statement above is quasi-hyperbole, but, then again, it’s not. ZeroHedge and others have been identifying the “latent threat of QE3” in the Fed’s various statements since the early days of 2011, well before QE2 even ended, which may as well be "any time the Russell 2000 has a downtick". The reality is that the Fed has no other choice but to leave open the possibility of further monetary easing in the near future, because otherwise it would be responsible for an uncontrollable downward cascade of markets around the world. And if one is looking hard enough to be vindicated for consistently repeated predictions of money printing to, as Buzz Lightyear would declare, “infinity and beyond”, then one will certainly find latent threats of such printing contained within almost all of the statements released by almost every central banker in the world. What’s much more disturbing is the notion that knee-jerk market reactions to these statements by precious metals (which is fittingly compared to “general risk” in the graph) are somehow indicative of a sustainable price trend. In the next paragraph, we get the caveat that it is not all “smooth sailing” for gold, because rumors of CME margin hikes or actual hikes could surface at any moment and destroy the otherwise developing moonshoot in gold and silver. That’s actually not really a caveat as much as a re-assertion of the flawed premise that market demand for PMs is indestructible outside of centrally-coordinated “takedowns”. What they don’t mention is that debt deleveraging (something quite prevalent these days) is the equivalent of demand destruction, and that’s all a margin hike really is. To top off a series of highly flawed and misleading analyses, Durden follows up the next day with a posting in which he states that Tim Geithner has been added to ZeroHedge’s list of “best Goldbug friends”. Why, you ask? Because there appears to be at least some correlation between increases in the U.S. debt ceiling and increases in the price of gold over the last 10 years. Therefore, the latest increase of $1.2tn in the debt ceiling means Geithner can spend more money for at least a few more months, which means gold can keep going up!
Frankly, I don’t see much of a correlation until at least 2005, besides both the debt ceiling and price of gold steadily increasing over the last decade, which should be no surprise for either of them (excluding the sharp declines in gold price during risk-off phases of 2008 and late last year). To the extent a meaningful correlation does exist, there is really no reason to infer any sort of causation when a whole slew of variables independent of the debt ceiling can explain why gold has generally been on the rise since 2009, including all of the policies that have suppressed the dollar (such as low interest rates and monetization of MBS/Treasuries). Of course there is a connection between the government spending/borrowing and the Fed monetizing debt in unprecedented amounts. The USG already made clear it would be spending/borrowing this money last year (and more), and of course it will end up becoming a huge problem for the U.S. and its currency down the line. How exactly any of that, or this specific instance of Congress raising the debt ceiling, translates into a “green light” for gold to reach $1960/oz. soon is a very different story. It is a story that really has no credible basis in reality and serves only to support a pre-determined objective. Among the plethora of very useful reports/analyses produced by ZeroHedge on a daily basis, these brief postings may not seem like such a big deal. However, they represent a goal-seeked mentality and modus operandi that is frequently on display within the HI/gold crowd and can lead to very misleading conclusions. I can’t be certain, but I’m pretty sure we will see many, many more postings like the ones above over the course of this year, and they will appear almost exclusively when it comes time to discuss gold. None of the above is meant to suggest that the price of gold will plunge into the abyss in the near future, but it is meant to suggest that there are significant risks of gold failing to hold its current valuations around $1700/oz, let alone reach $2000/oz and beyond. These risks are especially formidable when we stop pretending like the Fed, ECB, Bernanke, Geithner or anyone else is in a good financial or sociopolitical position to halt the upcoming waves of debt deflation. We here at The Automatic Earth only ask that you keep these risks in mind as you continue to read and contemplate your future allocations of cash.