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Who knew? Dating advice and economics have a lot in common!
The problem: “I mean, one minute a guy wants to taper, the next minute
he doesn’t. I just don’t feel he’s committed, he just wants to keep his
options open.”
The advice: “You have to just trust your newsletter writers. They’ll
tell you if you’re being jerked around…”
Really?
It came as a big shock!
“The Federal Reserve
unexpectedly refrained from reducing the $85 billion pace of monthly bond
buying.” - Bloomberg
But as far as we’re concerned, it shouldn’t have shocked anyone because
the reasons why the Fed began Quantitative Easing (QE) in the first place
continue to plague the political and monetary landscape.
Federal Reserve Chairman Ben Bernanke indicated that the reason for not
tapering was because “conditions in the job market are still far from
what all of us would like to see” and there is a “concern that rapid
tightening of financial conditions would have the effect of slowing growth.”
Wasn’t this equally true when Mr. Bernanke first announced the Fed’s
intent to taper back in June? At the time, he not only announced the
likelihood of tapering in September, but also suggested that QE could come to
an end in 2014.
Hmm… we wonder what changed his mind.
In a word…Nothing! In fact, we believe that taper
announcements are just Fed tactics. But we’ll get to that a little later.
Why Does The Fed Buy $85 Billion Of Treasuries Each Month?
The Fed steadfastly maintains that it is engaged in Quantitative Easing
(i.e. printing money) for the purpose of stimulating economic growth and, of
course, jobs.
However, the more immediate and practical reason for these herculean and
unprecedented monetary efforts is simply to keep the U.S. government afloat
in a sea of red ink. In case you didn’t know, red ink is bad.
To put it mildly, this is the 900 pound gorilla in the room.
Perpetual trillion dollar budget deficits have to be financed somehow.
And these numbers have become entirely too lofty for our largest traditional
foreign lenders, China and Japan.
They, and others, have significantly reduced their purchases or walked
away completely from the regular Treasury auctions held to sell US government
debt. In addition, some (including China) have been selling their
existing holdings of US Treasury debt in order to reduce their exposure.
We suspect you would also if the government that issued you the debt had
also made it official policy to undermine its value with a program of money
printing to infinity. This is effectively what the Fed declared when it more
than doubled QE3 from $40 billion to $85 billion on December 12th of last
year.
In addition, the Fed announced that these bond purchases would be “open-ended”
prompting the press to nickname it “QE-Infinity”.
Thus, it is clear to us that the more immediate purpose and concern of the
Fed is twofold. First, someone has to show up at these perpetual
Treasury auctions to lend the US government money so they can keep the lights
on.
Second, interest rates on this Treasury debt must not be allowed to rise.
This is because rising rates make the interest payments on the massive debt
very difficult, if not impossible, for the US government to service, let
alone repay any principal without very serious consequences.
Further, rising rates would make the already huge budget deficit even
worse and thus defeat the purpose. Therefore, the Fed buys treasury bonds in
size, to drive down treasury rates with brute force.
Now of course, driving down interest rates might stimulate economic
activity since market interest rates of all kinds tend to be tied to treasury
rates. And some QE3 money flows to banks since the Fed also buys their bond
holdings with the hopes that this money will flow into the economy in the
form of bank loans. But this hasn’t been working.
What is working is that a healthy chunk of the money being funneled to
banks via QE is finding its way into the stock market. We can see this
clearly by noting that the stock market is at an all-time high on very narrow
volume.
Low volume suggests that retail investors are not participating in the
market’s historic performance, and therefore it is hard to explain without
mentioning the presence of QE3.
There is another dynamic of the Feds monetary policy that is somewhat
overlooked.
It is in fact the stated economic policy of The White House to increase
exports as one approach to stimulating the economy. The tried and true
method of doing this in the fiat currency age is by devaluing your currency,
thus making your goods cheaper on international markets.
However, in the case of the U.S. dollar, this isn’t working very well as
the US dollar index has barely moved since QE3 began last September. We’ll
leave the reasons why for another Weekly.
Our main point is that they are hoping the dollar will weaken and thus
will stimulate exports while at the same time undermining the value of the
massive US debt load.
Ultimately, the Fed’s primary purpose for QE is simple, to float the US
government. The accompanying hopes of the policy are that it will stimulate
the economy and/or the stock market, giving the appearance of a growing
economy, and of course, create jobs.
Although the Fed insists that the purpose of QE is not to monetize
government debt (i.e. print money to fund the government), it’s tough to
believe them. This is partially because of the similarity between
annualized QE3 bond purchases and the annual federal budget deficit.
Last year’s budget deficit was roughly $1.2 trillion and so far this year,
the deficit is $755 billion. In the month of August alone, there was a
deficit of $148 billion.
In comparison, QE3’s $85 billion per month in bond purchases equates to
$1.02 trillion a year. Despite the Feds assertions to the contrary,
it’s strange that the amount of bond buying needed to stimulate the economy
is very similar to the federal government’s budget deficit.
For all of the reasons stated above, we really didn’t take the Fed’s
threat to taper seriously. Neither did many other astute market observers. We
think “taper talk” is a tactic utilized by the Fed to present and instill the
perception that they will, one day, return to responsible monetary policy.
If they didn’t try to portray this image, they would essentially be
telling the world and more importantly, their creditors, “we plan on
printing money forever thereby making all of your dollar denominated assets
worthless.”
The Fed’s “taper talk” is just like a married man telling his girlfriend
for the past year that he will soon, when the time is right, leave
his wife. I’ll let you in on a little secret…the married man and the Fed are
both lying!
The bottom line is that QE to infinity remains official US monetary policy
and as a result, the Fed will continue to print money and in the process
devalue the US dollar. And this, of course, is good for gold!
Gold Is The New Dollar For China
At the risk of being cliché, printing oceans of US dollars, which is the
currency that gold happens to be traded for on international markets,
encourages those looking to protect their wealth to choose gold.
An excellent example of a country looking to protect its wealth in this
manner is China. We mentioned above that China has stopped showing up at US
Treasury auctions in size and has been diversifying their massive US dollar
denominated reserves into hard assets at a rapid pace.
Nowhere is this more evident than in the gold market and China’s buying
has ramped up to historic levels this year.
Even though we have mentioned it before, it’s always worth noting that
alongside their historic imports, China is the world’s largest gold producer,
mining over 400 tonnes annually, and they do not export an ounce. For
comparison, its closest competitors produce less than 300 tonnes.
Continuing on with research from our recent “A Giant Sucking Sound
from the East” article, where we analyzed the import data tracked by the
Hong Kong Census & Statistics Department, China has, as of the end of
July, imported 866 tonnes of gold.
This is an extraordinary amount and represents roughly 60% of the total
global mine supply, excluding China’s production. As you can see in the
chart below, since the Global Financial Crisis in 2008 and the beginning of
QE, China’s gold buying has increased dramatically.
We doubt that this is a coincidence. We believe it is a direct response
from China to destructive US monetary policy. And given the
“open-ended” nature of QE, we have every reason to believe that China will
continue to increase their heightened level of gold buying.
The Slack and the Pull
We wrote last week about India, arguably the world’s largest gold
consumer, and their anemic August gold imports.
We cautioned that due to government restrictions, typically strong Indian
gold imports could be curtailed this fall, during the all-important
festival season. Note that we said imports. India’s gold demand
will not subside. This is reflected in the recent all-time highs of the
domestic gold price in Rupees.
For now, the Indian government appears committed to doing whatever it
takes to impede gold imports. Because they were successful in August,
it is plausible that they may continue to be successful in the near term.
This could cause some slack in gold demand. We don’t believe,
however, that they can maintain this policy indefinitely.
On another front, this week’s QE forever commitment may have created some
extra and possibly new pull from other parts of the world that could take up
some of India’s slack.
Gold’s response to the announcement that QE-Infinity marches on was a 4.1%
increase, its biggest move in 15 months. A big contributor to this move was
significant ETF buying. This represents a meaningful turnaround from the ETF
outflows earlier this year that were feeding unprecedented Asian (i.e.
Chinese and Indian) demand.
Another potential QE-Infinity implication is that as US citizens realize
the Fed really does not intend to taper, they may take Asia’s hint and begin
diversifying in greater numbers away from the dollar and into gold. This
would be a favorable development in terms of increased gold demand.
Higher Gold Price = Higher Gold Shares
For the reasons discussed above and the massive structural gap between
gold supply and demand (which we write about frequently), we firmly believe
the gold price is going higher.
And as we never tire of pointing out, a great way to take advantage of a
rising gold price is by buying the shares of promising gold miners that offer
strong leverage to the gold price. For this reason, you should check out our
Comparative Analysis Table below.
It provides many critical metrics to use in evaluating and comparing gold
mining companies. Its purpose is to help discerning investors pick the most
promising gold producers, which have already begun to profit strongly from
the rising gold price.
Despite last week’s pullback, gold is up roughly 14% from its interim low
near $1,190 on June 27th. As a result, the majors in our Model
Portfolio are up between 20% and 45% since that time. Shouldn’t your
portfolio have some exposure to these returns?
(Click the image to enlarge)
That’s it for this week. Thanks for reading!
Regards,
RJ Wilcox
Jeremy@goldminersreport.com
www.goldminersreport.com
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