Gold and the Turning of Monetary Tides
Kitco Commentaries | Opinions, Ideas and Markets Talk
Featuring views and opinions written by market professionals, not staff journalists.
Some time ago, the newest edition of famous In Gold We Trust report was released. So, why should we trust in gold in 2018?
The main theme of the latest report is the unfolding sea change in the global monetary order. The authors focus on the turning of the tide in terms of monetary policy, i.e. the fact that the Fed switches from monetary easing to monetary tightening. They point out that in addition to hiking interest rates, the U.S. central bank also started quantitative tightening, i.e. reducing the size of its massive balance sheets. Ronald-Peter Stoeferle and Mark J. Valek believe that its importance is underestimated by the investors. When liquidity is withdrawn from the markets, the “everything bubble” may burst.
We don’t agree. The Fed believes that all the problems are liquidity problems. If there is something wrong happening, all we need to do is pump some liquidity. If liquidity is so great, withdrawing it must necessarily cause some problems. However, it is a very simplistic, hydraulic view of the economy. Many problems are structural. Liquidity will not solve them. It doesn’t help insolvent companies, as solvency is something different than liquidity. We are really surprised that such great analysts as Stoeferle and Valek adopted that Keynesian/central banking perspective. What we mean is that there might be bumps on the way, but so far they seem to be manageable. Quantitative tightening could be lethal for the financial markets if it had been unexpected (remember the taper tantrum?). But it was smoothly telegraphed and the investors managed to adjust.
Anyway, the authors correctly note gold’s fascinating strength. It’s true that it remains in a sideways trend, but it does so amid the Fed’s tightening cycle, a rising greenback and accelerating economy:
Despite rising interest rates, monetary policy normalization, and a still solidly performing stock market, gold held its ground last year. Admittedly, the gold price isn’t really going anywhere at the moment. It is still dancing the cha-cha-cha – “one step forward, one step back, one step sideways”. Naturally everybody wonders how much longer this will continue.
Indeed, that’s a great question. The report is clearly pessimistic in this context. The authors provide us with popular bearish arguments: the current expansion is unusually long, interest rates are on the rise, the yield curve became almost flat, etc. In the past, we refuted all these arguments. In short, the current expansion is atypically long, because it is very slow. Some scars heal for a long time. Interest rates are rising, while the yield curve is flattening, because the Fed tightens its monetary policy in the response to the solid performance of the economy.
The authors also believe that the gold/platinum ratio may be another interesting recession indicator. They argue that “the current high gold/platinum ratio prompts the conclusion that the ratio is a sign of economic insecurity driven by monetary instability.” However, as we explained in the August 2017 edition of the Market Overview, the price of platinum has been declining due to changes in the automotive industry, so it’s not necessarily a sign of an imminent recession.
The report concludes that the U.S. dollar is likely to lose its hegemony, a recession is around the corner, and we are at the turning point for the gold bull market:
We will stick to our conviction that we are currently in the early stages of a new gold bull market, which has been temporarily slowed down by the election of Donald Trump. The expectations of the political newcomer were clearly excessive – as we warned last year – and continue to harbor large potential for disappointment. As pointed out earlier, we can see significant upward potential, especially in the commodity markets, which now command extremely attractive valuations in a historical context, both in absolute and relative terms.
It might be true, especially that people tend to be the most optimistic about the economy or the stock market at the top. Fiscal policy is a joke and Trump is a joker. However, investors should remember the words of Howard Marks: “being right, but early in the call, is the same as being wrong.” Stay tuned!