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Increased monetary inflation will push gold higher

Commentaries & Views

M2/GDP and Gold:

We're possibly gonna’ get a small increase in 1Q21 GDP, but guess what?  M2, the broadly defined money supply, M2, has increased even faster than the languid GDP of late.  Practically speaking, we're getting much less "bang" for the "buck."  As Dr. Lacy Hunt, in his Hoisington Management 3Q20 missive, related "...each additional dollar of debt in 1980 generated a rise in GDP of 60 cents.  However, since then this ratio has dropped sharply, from 42 cents in 1989 to 27 cents in 2019..."

Note that the price of gold, which largely measures inflation, has related historically closely to the M2/GDP monetary inflation ratio, and especially so over the past seven years through Q420:

CHART I

GOLD PRICE vs. M2/GDP (NOMINAL)

Quarterly; 1Q14 thru 4Q20

FRED (St. Louis Fed) Data and Graph

Nevertheless, it should not be underemphasized that the price of gold – a market measure – can be discounting perceived future conditions, whereas the economic measure of M2/GDP is reflecting current economic monetary inflation conditions.  They don’t always have to track one-another.  However, looking at the FRED graph above, the two measures have been quite close over the past seven years.  This gives: 1) Credence to M2/GDP being at least a part-time gold price indicator and 2) Help, from an economic viewpoint, in understanding what’s now going on – at least in the short term.

That the two lines track closely does not mean that each changes by a similar percentage.  In comparing the two (ordinate, left and right) axes from CHART I, each 0.1 gain of the M2/GDP ratio is equivalent to an increase of $300/oz of gold. With the Q420 M2/GDP at 0.885 an additional increase of 0.1, or 11.3 percent, can mean a higher percentage increase in the average Q420 gold price, or $300/$1874 or 16.0 percent.

It would seem as time goes on – and if M2/GDP continues to correlate with the price of gold – that the percentage growth of the two elements could approach unity.  A drop to $200/oz instead of the $300/oz would decrease the 16 percent to about 11 percent. 

Interestingly, the 0.1 - $300 “relationship” is a decrease relative to that of the two axes shown in the M2/GDP vs. Gold graph for the longer period of 1Q80 – 4Q21. In this case, as shown below, each 0.1 gain in the M2/GDP ratio was equivalent to $400/oz of gold.

CHART II

GOLD PRICE vs. M2/GDP (NOMINAL)

Quarterly; 1Q80 thru 4Q20

FRED (St. Louis Fed) Data and Graph

M2 Money Supply and Fed Involvement:

As shown in the table below, the change in M2/GDP ratio over the last couple of years has been all about M2.

TABLE I

VARIOUS ECONOMIC FACTORS vs GOLD PRICE

2018 thru 2020, by Quarter

Index Data Based on Q118 = 1.000

QTR.

GDP

$B

GDP

Index

M2

$B

M2

Index

M2/GDP

Ratio

M2/GDP

Index

GOLD

Avg.  $/OZ

GOLD

Index

Fed Assets

$B

Fed

Assets

Index

Bank

Reserves

$B

Bank

Reserves

Index

Q118

20,242

1.000

13,893

1.000

0.686

1.000

1,329

1.000

4,419

1.000

2,272

1.000

Q218

20,553

1,015

14,086

1.011

0.683

0.996

1,306

0.982

4,347

0.984

2,097

0.923

Q318

20,742

1.025

14,186

1.021

0.684

0.997

1,213

0.913

4,323

0.960

1,976

0.870

Q418

20,910

1.033

14,276

1.028

0.683

0.996

1,226

0.922

4,128

0.934

1,832

0.806

Q119

21,115

1.043

14,465

1.041

0.685

0.999

1,304

0.981

4,009

0.907

1,679

0.739

Q219

21,330

1.054

14,647

1.054

0.678

0.998

1,309

0.985

3,881

0.878

1,601

0.705

Q319

21,540

1.064

14,932

1.075

0.693

1.010

1,472

1.107

3,796

0.859

1,557

0.685

Q419

21,747

1.074

15,235

1.097

0.700

1.020

1,481

1.114

4,037

0.914

1,614

0.710

Q120

21,561

1.065

15,600

1.123

0.726

1.058

1,583

1.191

4,304

0.974

1,847

0.810

Q220

19,520

0.964

17,668

1.272

0.905

1.319

1,711

1.287

6,753

1.528

3,072

1.352

Q320

21,170

1.046

18,449

1.328

0.871

1.270

1,909

1.436

6,996

1.583

2,790

1.228

Q420

21,480

1.061

19,010

1.368

0.885

1.290

1,874

1.410

7,226

1.635

3,015

1.327

Note that during the two-year period, Q418 – Q420, nominal GDP (which includes inflation), didn’t change that much.  However M2 had gone up almost one-third; M2/GDP went up similarly.  During this time gold went up 53 percent.

M2 is currently all about the Fed; in fact, in a recent conversation with Dr. Hunt, he related that with the decline in bank loans for the last couple of quarters the Fed has been pretty much the sole contributor to M2.  He referred me to the Fed’s H.8 statement (see attached extract.)

The Fed contributes to M2 by increasing its asset purchases and implementing other quantitative easing programs.  Regarding asset purchases alone, from 2020, or Q419 – Q42020, the Fed added $3.19T in assets or 84 percent of the $3.78T M2 addition.  Most of the Fed’s asset addition took place during early 2020. 

In June, Fed chairman Powell stated that the Fed would buy monthly $80B in treasuries and $40B in Government Sponsored Enterprise debt.  This has been iterated in various announcements since. Also, the Fed will continue the zero-interest rate (0.00-0.25 percent) Fed Funds program.

Short-Term Outlook Qualifications:

Is this $120B/mo. ($1.44T/yr.) enough to maintain the Fed’s zero interest Fed Fund program in view of the increasing fiscal legislation costs?  The 12/27/2020 Covid stimulus package costing $0.9T, is still playing out; together with this, Congress passed continuing budget resolution caps of $1.3T for each of FY2020 and FY2021.  (FY20: 9/30/2109 to 10/1/2020.)

From Table I, the Fed added $3.2T in assets from Q319 to Q320 – or about as much as the $3.2T FY2020 budget deficit.  The CY20 budget deficit is $4.1B, given addition of the $0.9T Dec. stimulus.  This amount was appreciably more than the current $1.44T/yr. Fed asset addition program.

Further regarding 2021, another Covid relief program is on the table, this time for a estimate $1.9T.  Although the Republican Senate has put forth a much more constrained substitute of $0.6T, it is likely that the final enacted legislation will be much closer to the original Biden number.  The importance of the loss of the two Republican Senate seats from Georgia, and the resulting Democratic controlled Senate, should ensure a liberal amount.

Another Biden proposal for 2021 is the $1.7-2T “Green” program, under the purview of John Kerry, Biden’s new “climate czar.”  This program will also need Fed support.  Further, as Biden points out, while the Green program will increase jobs and GDP, there’ll be a sizable downside to the oil & gas business.

Looking ahead, the proposed Covid Relief ($1.9T) and “Green” ($2.0) programs almost equal the $4T CY20 congressional budget deficit.  Even if these programs were to be funded at lower levels, it is assumed, being so early in the year, that other stimulus programs could arise. 

What could these other programs be?  Re Biden’s campaign promises, the following list is

from the BBC News “Joe Biden: Where does He Stand on Key Issues?”, 1/19/21 article:

  • Expansion of Obama care, $225B/yr over next decade
  • Student Loan Forgiveness at $10K/person
  • Adding $200/mo. for Social Security payments
  • $400B Pledge to Use Federal Dollars to Buy American Goods; 2021 Plan to Invest $200B in US-Made Materials, Services, R&D
  • Expansion of Tuition-Free Colleges and Universal School Access

“Balanced” against these deficit funded would-be programs are the forthcoming gains in GDP – due to the stimulus and especially the Covid vaccine application.   This GDP “bounce” might occur in the latter part of 2021.  We are all familiar with the vaccine uncertainties involved including speed and coverage (including those who are resistive to taking the vaccine), side effects, resistance against new Covid strains (such as those from S. Africa and S. America which may require another vaccine) and especially the time-table re the return of the populace to pre-Covid economic performance.

Israel, which currently has inoculated one-third of its population and over 80 percent of those over age 60, has seen a dramatic drop in cases from those inoculated.  However, a 2/5/2021 NY Times “Israel’s Vaccination Results Point a Way Out of Virus Pandemic” article also states:  “…Despite its successes, Israel remains vulnerable.  After a dip in new cases at the end of January, the average rate is climbing back up again.  The contagiousness of the B.1.1.7 variant may be partly to blame, along with lower compliance with the current lockdown compared to previous ones…”  (Further, the inoculation of the Palestinian population has yet to be addressed.)    

Then also, the longer the U.S. vaccine positive results take to become effective, the more push there’ll be to have more stimulus.  Remember, the Fed’s money creation is to buy assets (other’s debt instruments, e.g. treasuries.)  These assets do not have to be resold by the Fed.  Further, the treasuries’ interest payments are returned by the Fed to the Treasury Department. 

What’s happening is a watering of the booze (currency) and a disproportionate, muddled flow of funds to the wealthy.  And since most of the world’s central banks are following similar policies, the dollar’s relative value should not become overly affected.  This process can go on as long as the people believe in the “full faith and credit” of the dollar.   This is where gold can come in.

In 2019 and early-2020, the economy was showing signs of slowing – or more than a decade after the protracted recovery from the Great Recession.  Then Covid came along and massively magnified this downward trend.  Down the road, the forthcoming “cure” of Covid will greatly, greatly help. Yet, the question remains of how long it will take the growing economic imbalances (“bubbles” and loan deferments), as exemplified by the high level stock market, to become rectified.

In the meantime residential savings are up – to either be spent during a vaccine-induced economic upturn or kept as a hedge for the uncertainty ahead.  Low mortgage rates and moves to the suburbs are resulting in more home-building and auto purchases.

The Short Term (2021) – By the Numbers:

TABLE II

NOMINAL GDP AND M2

FORECASTED GROWTH FOR 2021

SOURCE

GDP

M2

Congressional Budget Office - 2/21

5.60%

- - -

OECD – 12/20

4.48%

- - -

Forecasts.org – 1/21

- - -

  8.93%*

Author’s Forecast – 2/21

- - -

21.04%**

* 12 mo. rate extrapolated, using the average monthly rate developed from the given Jan thru Aug, 2021 data

** This assumes a Congressional budget deficit of $4T for 2021 (equaling that of 2020) and a comparable increase in M2.  Although  the 21.0% may seem high, it is down from the 27.8% M2 gain from Q419 to Q420.

The low-gold-price-increase forecast (from Table II): 

Applying  the Forecasts.org and CBO 2021 percentage gains respectively  to the actual Q420 M2 of $19,010B and GDP of $21,480B from Table I, results in $20,700B and $22,680 for Q421 and thereby a M2/GDP ratio of 0.913.  Subtracting the corresponding Q420 ratio of 0.885 equals 0.028.  If, as shown in the axes of Chart I above whereby an increase of 0.1 equates to $300/oz of gold, the price of gold would go up $85/oz.

The high-gold-price-increase forecast:

Applying OECD’s and my numbers, the M2/GDP ratio for Q421 becomes 1.023. ([19010 + 4000]/[1.0448 x 21,480])  Subtracting the 0.885 results in a 0.138 difference.  This equates to about a $410/oz increase.

The comparable quarterly average (Q420) gold price in place during the 0.885 M2/GDP ratio posting, was $1,874/oz.  Incorporating the above high and low scenario additions results in a $1,960/oz - $2,280, quarterly average price spread.

“Significant Digit” Qualifications:

In summary, there are quite a few assumptions leading up to this price spread.  The discreteness (relative to “significant digits”) of the answers belies some of the less-than-finite assumptions employed.  It is hoped that the “allowances” are countervailing.  Remember also, that the forecast period is only a year, part of which we’re now in.

What this involved process does is to describe the elements underlying a method of forecasting gold price.  We see many other gold price forecasts posted with insufficient reasons given; and sometimes the stated reasons run counter to what appears logical.  It is hoped that the further education gained here will cause readers to demand more explainable forecasts. 

I see that some forecasters are predicting a $2,300/oz gold price posting sometime this year.  This is not far outside of the “high” scenario quarterly level of $2,280/oz derived here.  Further, a daily price high can considerably exceed the quarterly price average. For example, the high daily price of gold (3:00 pm London closing, 8/6/2020) was $2,067/oz on August 6, 2020.  This was over $150/oz more than the 3Q20 average price of $1,909/oz.

Regarding a within-the-2021-year perspective, it would appear that a sizable gold price increase could be fairly early-on.  It is in the latter part of the year that GDP is forecasted to appreciably gain.  Countering this is the shadow of the economy being overextended in asset values and excessive commercial loans.  The “come-uppance” of the latter seems to occur after this year.

Further on, it’s difficult to see - except that the stimulus creating carousel will likely continue. 

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