Monday, March 31, 2014

What’s Ahead for Gold

by Bill Bonner

Discarded Booster Engine

We spent all of yesterday bumping along dirt roads on our way from the ranch to a small seminar organized by our old friend Doug Casey.

One of the major topics: What’s ahead for the gold price?

Here, in advance, we give our view.

Gold took off like a rocket at the start of the year. But despite rising global political tensions, and the Fed’s continuing economic pretensions, this week, gold started to look more like a discarded booster engine falling back to Earth.

We don’t know why gold rose so rapidly, but we have a good idea of why it fell…

Liquidity Moves Markets

First, investors discounted the political tensions. Who really cares if Crimea is a part of Russia? Nobody.

Second, what has changed at the Fed? It continued to taper QE at its recent policy meeting. But by moving away from a fixed unemployment target to more “qualitative” measures, it reserves the right to take the taper off the table any time it wants.

As author of A New Depression: Breakdown of the Paper Money Economy, Richard Duncan, puts it, “Forward guidance is very nice, but it is liquidity that moves the markets.”

The Fed is providing plenty of liquidity. But this liquidity is going into risk assets, not into “anti-risk” assets. Stocks are a risk asset. Gold is not. Most investors are confident the Yellen Fed has matters under control. They see US stocks going up and ask themselves: What’s to worry?

With nothing to worry about, and the memory of a 180% gain in S&P 500 fresh in their minds, why would they want to buy gold?

Third, the worry that usually moves gold most is inflation. It was that worry that sent it up 20 times in the 1970s… when consumer price inflation rose over 10%. Consumer price inflation is not something that people are worried about now. And for good reason.

It’s the Money Supply, Stupid

As any economics professor will tell you, the CPI goes up when the quantity and velocity of money increases faster than the output of goods and services. QE increases the monetary base (the sum of hard currency in circulation and banks’ reserve balances with the Fed). But it’s money supply (which also includes bank deposits and retail money market mutual fund shares) that matters when it comes to inflation.

But increases in the money supply depend on the creation of new bank deposits through new bank lending. And although money supply is growing, banks aren’t lending enough to make for a worrying increase in the quantity of money.

Meanwhile, the average household income is lower than it was when the recession ended in 2009. So, the average American has less money to spend. And under pressure, he is more careful about spending it, too. This decreases the speed with which cash changes hands in the economy – the velocity of money – putting more downward pressure on consumer price inflation.

What Next?

Gold investors see all this. They know consumer price inflation is not a problem right now (at least as it’s officially measured). They must wake up in the morning… check the CPI reading (just over 1% right now) … and go back to sleep.

The time will come, of course, when the CPI gets up and does the boogaloo. But not now. Here is what we see ahead for gold prices:

1. The economy stays sluggish, but doesn’t go into reverse, and the Fed continues to taper.

2. US stocks fall, as the Fed removes its support, causing the Fed to end the taper.

3. US stocks recover, as the Fed wades in with more intervention, then fall more.

4. The Fed panics and introduces more aggressive (money from helicopters?) moves.

5. Gold soars.

More to come …

June Gold

June gold, daily – click to enlarge.

The above article is from Diary of a Rogue Economist originally written for Bonner & Partners. Bill Bonner founded Agora, Inc in 1978. It has since grown into one of the largest independent newsletter publishing companies in the world. He has also written three New York Times bestselling books, Financial Reckoning Day, Empire of Debt and Mobs, Messiahs and Markets.

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