We read this excellent summary of where gold is at by Jim Rickards yesterday and thought it was worth sharing with you in full. For New Zealand readers it’s worth noting his point that it is a strong dollar rather than weak gold. The New Zealand dollar has also been affected by this of late and is why gold in NZ terms remains up about 6.5% for the year.
We think his premise about interest rates in the US is a good one. And his overall thesis of how things might play out in the coming months is a good one too. The fact that he is a former insider also means he has his ear close to the ground. Although it’s worth keeping that in mind with all you read from him too.
Overall well worth reading though…
Gold’s Down. What’s up With That?
Gold is trading around $1,100 per ounce, a five-year low, down over 40% from its all-time high in August 2011, and down over 8% this year alone.
According to Bloomberg, hedge funds are net short gold for the first time since records have been kept starting in 2006. Sentiment is abysmal. To paraphrase the brilliant Jim Grant, gold, it seems, has never been more unloved.
All of this is well-known to investors. The question is why, and what does a temporary collapse in the dollar price of gold presage? The search for answers takes us on a journey through the inner workings of this most important and least understood market.
The first issue to consider is what’s called the numeraire. That’s a French term used in mathematics and markets. It refers to the yardstick we use to measure other things. If the U.S. dollar is the numeraire, then gold is down measured in dollars. But if gold is the numeraire, then it’s more accurate to say that gold is constant (that’s what a numeraire is) and the dollar is much stronger.
In August 2011, one dollar got you 1/1,900th of an ounce of gold. Today one dollar gets you 1/1,100th of an ounce of gold. You get more gold for your money. How you look at it depends on whether you believe gold or the dollar is the better long-term benchmark for wealth. I prefer gold, others prefer paper dollars — take your pick.
| “In August 2011, one dollar got you 1/1,900th of an ounce of gold. Today one dollar gets you 1/1,100th of an ounce of gold.” |
Support for this “strong dollar” view comes not just from gold but from every major currency and commodity in the world. Look at the list of things that are down against the dollar over the past year: sugar, wheat, iron ore, copper, oil, natural gas, Canadian dollars, Australian dollars, the euro, the Japanese yen, and so on.
The only reason the Chinese yuan is not down also is because the Chinese have made a strategic decision to kowtow to U.S. wishes, and maintain a dollar peg as the price of admission to the basket used to calculate the value of the IMF’s world money called SDRs. That decision is causing Chinese growth to fall off a cliff, but that’s another story. The point is this is not an age of weak gold; it’s a new age of King Dollar. Therein lies a tale.
The last age of King Dollar started in 1981 with the combined efforts of Paul Volcker and Ronald Reagan to end the monetary confusion of the 1970s. It lasted until the U.S. economy hit the wall in 2007. Importantly, that age of King Dollar prevailed through Republican and Democratic administrations, and included the two longest peacetime expansions in U.S. history, 1981-1989 (92 months), and 1991-2001 (120 months).
The U.S. could afford a King Dollar strategy because we had strong, continual growth during the decades of the 1980s and 1990s. The rest of the world would benefit from weaker currencies that promoted their own exports.
The new age of King Dollar is different. Now we are in a period of weak growth, global debt, and currency wars. When the Federal Reserve and U.S. Treasury green-lighted the strong dollar after 2012, they committed an historic blunder. They assumed based on faulty forecasts that the U.S. was returning to trend growth and could afford a strong dollar, as was previously the case.
Instead, U.S. growth has continued to disappoint. Now the U.S. economy itself is flirting with recession because of this infelicitous mix of weak growth and a strong currency. Meanwhile, the Fed has created asset bubbles (in stocks and real estate) and asset crashes (in gold, oil and currencies) under its misguided policies.
A foreseeable consequence of a strong dollar in a weak economy is deflation. Collapsing dollar prices for a long list of currencies and commodities is the result. The Fed is trying to offset this deflationary tendency with zero rates, but it’s not working. At best, the forces of deflation and inflation are cancelling each other out. At worst, deflation will start to win this tug-of-war in the months ahead.
In addition, there are technical factors at play when it comes to gold. Once the dollar price of gold sinks to a certain level, leveraged investors such as hedge funds hit their self-imposed stop loss limits and have to sell. Others who bought gold on margin may be forced out of their positions by brokers. Finally, some large selling has been coming from China in response to the stock market crash there.
| “Hedge funds losing money on stocks sell gold to raise cash to meet margin calls.” |
Hedge funds losing money on stocks sell gold to raise cash to meet margin calls. When hedge funds are in distress, they don’t sell what they want, they sell what the can, and gold fills the bill. All of these factors — stop loss, margin and leverage — add momentum to gold’s downward price movement.
These trends are unsustainable. The Fed will have to blink when it comes to their much talked about rate hike, or else they will cause a global crash. Look for the Fed not to raise rates soon, perhaps for years. The gold selling by weak hands in China and elsewhere will run its course. Once you’re out, you’re out. The strong hands are happy to buy at these depressed levels.
There’s nothing unusual about a 50% retracement in commodity bull markets. On the long road from $200 per ounce to $5,000 per ounce (or higher), a 50% pullback should be expected. If one takes $1,900 as an interim high, a pullback to the $950 to $1,050 per ounce area would be unsurprising. It looks like we’re just about there.
If the Fed maintains its kamikaze tight money mantra in the middle of a deflationary currency war, then gold and other commodities could go a bit lower. My expectation is the Fed will wake up to the damage done and reverse course; possibly even launching QE4 in 2016.
As this plays out over the next few months, look for commodity and currency markets to hear the message that the Fed will achieve inflation “whatever it takes.” Once that message sinks in, gold will once again shine.
Regards,
Jim Rickards
for The Daily Reckoning
P.S. I’ll be speaking here in Vancouver on Friday. If you want to listen to every word that’s said between now and my speech, including Rick Rule and Doug Casey, click here immediately.
James G. Rickards is the editor of Strategic Intelligence,the newest newsletter from Agora Financial. He is an American lawyer, economist, and investment banker with 35 years of experience working in capital markets on Wall Street. He is the author of The New York Times bestsellers Currency Wars and The Death of Money. Jim also serves as Chief Economist for West Shore Group.
| “In August 2011, one dollar got you 1/1,900th of an ounce of gold. Today one dollar gets you 1/1,100th of an ounce of gold.” |