It’s been a rough week for goldbugs. It’s been a rough week for everybody.
As we write this on St. Patrick’s Day night, gold investors are still smarting from a decline of almost 10% last week. Bullion slipped 5.1%, and fell below the 200-day moving average.
Traditionally, gold is supposed to act as a counterweight to stock market and economic volatility. But it didn’t do that last week! Gold and stocks fell together – right along with oil prices. Brent crude fell to under $30. This was a systemic drop where everything except short positions was highly correlated in the short term.
For example, Russia has been aggressively buying gold for its sovereign fund. But a sharp drop in oil prices hit the Kremlin in the pocketbook, say Goldman Sachs analysts, forcing Russia to cease gold purchases, and possibly even dump some gold to raise cash.
Silver, platinum and palladium dropped, too – partly because these metals have industrial applications, but manufacturers are pulling in their horns with the uncertainty – reducing demand at the margins.
Meanwhile, downside volatility starts to feed on itself: Leveraged investors in all publicly traded asset classes were forced to sell holdings to cover margin calls – and gold is no exception.
All this together created a perfect storm for gold, and just about everything else.
We saw a rebound today, Tuesday, March 17th, as value investors jumped back into the market. Massive monetary stimulus from the Federal Reserve, as well as other central banks around the world, was successful in luring investors back into the market.
The Bank of Japan, for example, announced an 84-day dollar funding operation worth over $30 billion – its biggest such action since the 2008 crisis.
The concerted efforts of Congress, the Trump Administration, the Federal Reserve and central banks all over the world seems to have put the brakes on a rapidly-developing deflationary spiral, and given some bulls and value investors some incentive.
For the moment, anyway.
Outlook for Gold Post Corona Virus
Longer term, the winds are favorable to gold and precious metals and other “hard” assets.
For example, although Goldman Sachs analysts now project a sharp recession in the 2nd quarter and have slashed their 2020 U.S. economic growth outlook from 1.2% to 0.4%, and warned Monday that stocks could sell off another 16% before they recover, they are sticking with their 12-month price target of $1,800 per ounce for gold. Though their intermediate price points projected in the last article are out the window.
“we maintain our bullish outlook on gold, as the larger-than-expected shock to the global economy will likely lead to greater risk aversion,” Goldman Sachs’ analysts wrote in a note published today.
Fiscal Policy and Gold
Gold, of course, tends to benefit from profligate spending. And today was no exception: The last couple of days saw the Keynesians take over, with massive stimulus occurring on both the fiscal and monetary policy fronts.
Fiscally, the federal government is ramping up a stimulus package that looks to be in the range of $1 trillion or more – counting new spending, the effects of a payroll tax holiday, and delayed income tax payments. It’s too early to know the details: Congress and the Trump Administration need some time to hammer it out.
The delayed income tax payments will theoretically be recouped later – but only from companies that aren’t filing for bankruptcy and individuals who haven’t been pushed out of work.
The other spending? Not so much.
The result is going to be a big addition to our already massive budget deficit. And China’s situation, with their even greater debt levels, is likely to be even worse (though they’ll fudge their numbers, as they always do.)
Congress will very likely be happy to inflate their way out of the mess. They always do that, too.
Monetary Policy and Gold
On the monetary policy side, we saw the Federal Reserve forced to intervene in the commercial paper markets, in order to keep the commercial paper market functioning. Large employers often float short-term debt – unsecured notes of anywhere from 1 to 90 days - in the money markets to ensure they can make payroll. If it seizes up, millions of paychecks may bounce – if they get issued at all.
The Federal Reserve Open Market Committee opened up a window to buy that debt, to ensure employers could make their payrolls. The Treasury Department backed that plan with another $10 billion of actual taxpayer money (not the usual unicorn dust the Fed sprinkles on banks when they want to boost the money supply).
"Commercial paper markets directly finance a wide range of economic activity, supplying credit and funding for auto loans and mortgages as well as liquidity to meet the operational needs of a range of companies," the Fed's board of governors said in a statement. "By ensuring the smooth functioning of this market, particularly in times of strain, the Federal Reserve is providing credit that will support families, businesses, and jobs across the economy."
And speaking of unicorn dust, the Federal Reserve announced it has conjured up enough unicorn dust to buy up $700 billion in mortgage and treasury bonds from banks. The banks’ balance sheets are thus magically credited by $700 billion, thus freeing banks to lend many times that amount in fiat currency.
Additionally, the Federal reserve threw savers under the bus in order to further stimulate borrowing. They did this by pushing interest rates down to almost zero.
If another crisis hits, the Fed will be out of ammunition. The same with Congress. Their only alternative will be to debase the currency further, and accept the inflation that goes with it.
Savings Confiscation and 'Bail-In'
Well, they have one other option: A “bail-in.” The opposite of a bail-out. That is, government could decline using taxpayer funds to bail out a failing bank, and instead allow banks to confiscate a portion of all deposits.
Bang: A bank closes on a Friday, and by Monday, all the depositors see their balances cut in half or more.
It seems too outrageous to contemplate here in the U.S. But we’ve been sheltered. We’ve already seen this kind of confiscation occur in Cyprus, most famously. And savers avoided it in Italy in 2017, with the failure of Veneto Banca and Banca Popolare di Vicenza, by only the narrowest of margins.
It’s a drastic measure. But it’s on the table.
Direct ownership of gold coins and bullion is an important hedge against this precise kind of wealth confiscation.
Inflation Pressure Will Increase
Borrowers love inflation. It means they get to borrow a dollar worth 100 cents, and repay them with dollars worth 97, 95, 93, 90 cents… and so on and so on.
The U.S. government is a huge borrower. So they won’t be doing much to curb inflation. It’s going to be up to the Federal Reserve to do that.
If they do what it takes to stem the inflationary trend, long term, you don’t want to be in stocks or other paper assets.
If they don’t, you also don’t want to be in stocks or other paper assets.
As hedges go, there’s no perfect hedge other than shorting the market. But gold should prove to be a better hedge than other commodities like oil.
The Big Picture
Meanwhile, let’s put things into perspective:
If you look at a gold chart for the last 30 days, the wild swings in gold prices look pretty nauseating.
But if you take a longer view – just one year’s trailing price history, the story looks very different.
The volatility we saw in gold prices over the last week have been very technical in nature, not fundamental. Prices reacted to short-term swings in sentiment, as well as mandatory and quickly-resolved trading situations like margin call-covering sales.
Longer-term, fundamentals are favorable for gold prices:
- Interest rates and quantitative easing will have further eroded the purchasing power of the dollar – and just about all the other worlds’ currencies, too.
- We’ll have a much higher national debt
- As oil recovers, Russia will start buying gold again – contributing to demand.
Meanwhile, the increase in volatility is actually helping some investors – asset allocators who own gold as a part of a larger, diverse portfolio. The more volatile the markets, the more effective their rebalancing strategies.
This is why gold belongs in nearly any portfolio of any significant size: It’s an important asset class in its own rite.
Right now the outlook is positive, long-term.
In the short-term, we may see some significant volatility, as nobody knows for sure yet how the coronavirus crisis will play out.
David Schroeder is an investor with more than 25 years of experience, investing in Stocks, Options, Metals, Futures, and Real Estate and is a strategist at Monetary Gold.
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