Gold bears may soon have to think again
Gold investors are debating whether “the bottom is in” for gold – the dollar price is already 19% percent above its seven year low of $1050 reached in December. Many gold experts remain bearish on the view that the dollar will stay strong against other currencies. And market analysts cling to the view that the dollar’s exchange rate determines the gold price.
I say this dominant market view is mistaken, or at least seriously incomplete. And that the bottom is in.
Yes, I agree that what matters for the gold price is monetary demand, not jewellery sales or the supply of newly-mined gold. The huge existing stock of gold has to be willingly held at the prevailing price. But that price is determined by expectations of monetary and fiscal policies and the prospects for gold compared with other investments, notably stocks, not by short-term swings in the dollar’s exchange rates.
On all counts, there is reason to believe that the gold price will trend up.
First, central banks’ monetary policies are teaching us to rate money cheaply. This is because the central bankers lack respect for the money they issue. For them it is merely a tool of short-term stabilization policy. This is seen in talk of measures that dilute the quality of money, such as elimination of large-denomination bank notes, the trend to negative interest rates, and talk of the case for drops of “helicopter money” to spur demand. Such measures are often advocated as “Keynesian”. But I doubt that JM Keynes would have approved of them: he favoured holding money to an objective standard; he never gave up entirely the belief in gold as an anchor.
At the extreme, aggressive use of negative rates would force a retreat from a monetary economy to barter.
As a Bank of England blog explains, the effectiveness of helicopter money depends critically on central banks abandoning their price stability mandates:
“For helicopter money to work, households and firms have to believe that all future central bankers and governments want to abandon inflation targeting. That seems implausible given current institutional set-ups. Convincing people of the policy’s irreversibility will therefore require threatening to impose large costs on society at a future date. While fiscal policy may stimulate growth, the extra kick from helicopter money is either non-existent or comes with a sky-high price tag.”
In my opinion, many of the people who receive helicopter money will treat it as a loan rather than as “free” money. They will fear that the State will want it back, in some form, in future – peerhaps in the form of depreciating currency, perhaps in higher taxes. They will save it, or invest in assets expected to keep their real value as the monetary system disintegrates, such as gold. People have got to be convinced central banks will not stand in the way of rising inflation. The central banks cannot drop money AND take measures to prevent inflation.
More generally, central banks will have to close off all avenues open to citizens who want to hedge their risks rather than spend money.
The fear that governments might be tempted to ban private gold holdings, as America did for many years in the last century, would only spur demand.
Helicopter money is the ultimate indignity for fiat money. If the State thinks so little of it that they give it away free, so we will treat it with the contempt it deserves.
Secondly, there seems a growing risk not only of a global recession but also of its natural accompaniment, widening budget deficits. These will surely be financed by further monetary growth rather than taxation. Indeed, leading economists, such as those at Citibank, are calling for everybody to follow the appalling example of Abenomics:
“To avoid a recession and to avoid a greater slowdown in potential output growth than is warranted because of worsening demographics, the world needs a global version of what we would call ‘Abenomics plus’: expansionary or accommodating monetary policy, a fiscal stimulus and structural reform—but with far more serious structural reform and extended to include material deleveraging.”
No wonder gold is so buoyant
Thirdly, current attitudes can only lead to more currency wars. In the United States, both Donald Trump, the protectionist Republican, and Hillary Clinton, the protectionist Democrat candidate for president are advocating policies that will undermine the role of the dollar. Prospects for other reserve currencies such as the euro, yen or pound look even worse. It is increasingly acknowledged that exchange rate depreciation is the only effective transmission mechanism of modern monetary policies.
The real aim of QE and negative interest rates is to kick your own currency downstairs.
The threat of lower growth and even recession improves gold’s prospects relative to other investments. They cast a shadow over equities. And although government bonds have lived a charmed life owing to fears of deflation and recession, their long-term health is undermined by budget deficits.
Gold has emerged as the only effective portfolio diversifier; other asset classes are closely correlated, as well as global stock markets.
This will lend powerful support for the gold price. Chances are, you will need fewer ounces of gold to “buy” the Dow Jones index in five years time than you do now.
The safety of banks?
Meanwhile, there are likely to be recurrent questions about the banking model. If deflation persists, many banks will be vulnerable. Demand for loans will fall as they become very expensive to service. Governments will try to protect the banks but will be swimming against powerful tides. What is needed is a new model of the financial system giving a central place to equity, with a sharply diminished role for debt.
Gold price forecasts
Given all this, gold analysts may soon have to revisit their forecasts. It is less than four weeks since the experts polled by the LBMA predicted an average price of $1,103 in 2016, only marginally above the 2015 average.
How long before the price overtakes even the most bullish of the LBMA’s panel, the veteran Martin Murenbeeld, who stuck his neck out predicting a “high” of $1,375 and Joni Teves with a predicted annual average of $1,225?
Last week gold was already closing in on them, ending the week at $1,222.
And of course for a relatively weak currency such as sterling, the gold price in pounds has done much better.