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(Excerpts from a
speech to the 7th annual CHINA GOLD & PRECIOUS METALS SUMMIT,
Shanghai, China, December 5th through December 7th, 2012)
Gold in recent months has been stuck in a trading range
between $1675 and $1750 an ounce - disappointing many bullish investors and
quite a few gold-market analysts (like myself) who had expected the yellow
metal to be ending the year approaching - or even exceeding - its all-time
high-water mark near $1924 recorded back in September of 2011.
Recent attempts to rally higher have been thwarted by
stepped-up speculative selling and softer physical demand with many buyers
now conditioned to wait for the next dip.
At the bottom of this range, bargain hunting in the
form of stepped up physical demand from central banks, sovereign wealth
funds, and some of the gold-friendly hedge funds has created a floor under
the market.
Changes in the aggregate gold holdings of
exchange-traded funds (ETFs) have been a fairly consistent leading indicator
of future gold prices over the past few years. Globally, gold ETFs purchased
nearly 250 tons (about 800 million ounces) this year through November - and
the total quantity of ETF gold held on behalf of investors now amounts to more
than 2,600 tons.
It may well be that money flowing into gold
exchange-traded funds is a consequence of the very accommodative monetary
policies now being pursued by the Federal Reserve and many other major
central banks across Europe and Asia - with rapid central-bank money growth a
causative factor explaining both strong demand for ETF gold and the long-term
upward trend in the metal’s price.
My own reading of the Federal Open Market Committee
minutes from its last policy-setting meeting - along with statements and
speeches by various Fed officials in the past few weeks - suggests there is a
good chance the Fed will announce further expansionary monetary-policy
measures in the next few months.
Predictions (from the OECD and other respected
forecasting groups) of a worsening synchronized global economic slowdown -
and a spreading sense of global gloom and doom - are contributing to the
Fed’s sense of urgency, boosting the odds of further monetary
accommodation sooner rather than later.
This fourth round of Quantitative Easing (or QE4) is
likely to have more bang for the buck compared with QE3, which included among
its measures the sale of short-term Treasury securities to fund its purchase
of long-term Treasury notes and bonds.
With its inventory of short-term securities now mostly
depleted, any future purchase of long-term securities must be funded with
newly created bank reserves - which is, in essence, printing new money - some
of which will find its way into gold and probably other asset markets.
Surprisingly, America’s fiscal crisis - and the
much-discussed approaching fiscal cliff - have had little observable and
immediate influence on the price of gold in recent weeks and months, if only
because amid all the confusion, no one really knows how this crisis will sort
itself out.
But, however it sorts itself out, we expect some
combination of spending cuts and revenue hikes are in America’s
economic future.
Unfortunately, a more restrictive U.S. fiscal policy is
exactly the wrong medicine for an ailing economy at this critical time,
raising the odds of a recession or worsening recession-like conditions
characterized by a palpable deterioration in employment/unemployment
indicators for the U.S. economy.
This bad news for the economy is - as bad news often is
- good for gold.
Fiscal policies that promise slower business activity,
falling after-tax household incomes, reduced household spending, slower
recovery in the housing and construction sectors increase the likelihood of
still-more stimulative Federal Reserve monetary policies.
America’s inability to get its fiscal house in
order is compelling the Fed to pursue an aggressive monetary policy. But
printing more money - indeed printing unprecedented quantities of money -
will, sooner or later, result in a resumption of the U.S. dollar’s
long-term downtrend both at home and overseas . . . and, as night follows
day, a substantial and unprecedented appreciation of the dollar-denominated
gold price.
Indeed QE4 may be right around the corner . . . and QE5
could come by mid-to-late 2013 . . . as the Fed struggles to prop up a
still-faltering economy. If the past
is a reliable predictor, these efforts by the Fed (and similar policies by
other major central banks) suggest much higher gold prices ahead.
Whatever monetary- and fiscal-policy choices are made
by the old industrial nations - the United States, Europe, and Japan - these
economies and most other industrialized and emerging economies together face
at least a few more years of painfully slow growth - and, for some, outright
recession!
It took years, if not decades, for the United States
and most other major economies to get ourselves into this mess - by consuming
more than we could afford, with money we didn’t have, accumulating debt
we couldn’t possibly repay!
Debt can be a magic economic elixir - at least for a
while. It allows consumers, investors, governments and, indeed, entire
nations to borrow from the future . . . in order to accelerate consumer
spending, investment, government services and entitlement programs, and even
military spending - much of which has been purchased in recent years against
the promise of repayment some day in the future . . . in some cases by our
children and grandchildren.
Moderate amounts of debt-driven consumption and
investment may, at times be an acceptable and low-risk mechanism to
accelerate economic growth and raise a country’s standard of living.
But a happy outcome requires wise spending on goods and
services that ultimately increase the borrower’s ability to repay - in
other words, spending that ultimately generates higher rates of economic
growth.
Instead, for the past few years - and probably the next
few years - the legacy of high debt levels will limit private- and
public-sector spending . . . and assure the persistence of painfully poor
rates of economic activity with unacceptably high rates unemployment.
In certain cases, a nation (or a business) may
kick-start economic growth by repudiating and writing off its outstanding debt
- in a sense, starting anew . . . but this would-be solution brings its own
set of risks and dangers to the borrower.
Rather than outright debt-repudiation, the U.S. Federal
Reserve and the central banks of many other countries are seeking to minimize
the economic pain by pursuing accommodative monetary policies with
artificially low real (inflation-adjusted) rates of interest
By doing so, central banks are sowing the seeds of
future inflation. And, by printing much to much money they are making each
dollar, euro, yen and yuan worth less.
So rather than outright debt-repudiation, central
bankers are depreciating the real future burden of their country’s debt
- and bringing the ratio of debt to nominal GDP down to acceptable levels.
Let’s now turn our attention to one of the
least-discussed prospective developments likely to greatly influence the
price of gold over the next five to 10 years, if not much longer.
This is the rising tide of uncertainty and volatility
in geopolitics, world financial markets, and in the global economy.
One thing is for sure: The future isn’t what it
used to be - and the world today is characterized by a variety of trends and
developments that together are creating more uncertainty and increasing
volatile future.
Perhaps the most important of these is the declining
influence and hegemony of the United States as a global policeman and
enforcer assuring a modicum of predictability and orderliness among nations .
. . along with an expanding number of hot spots around the world, hot spots
where the U.S. can no longer contain, minimize, or postpone the geopolitical,
economic, and financial market fall-out.
At the same time we see America’s power and
influence diminishing, China - and a number of other countries from the the
newly industrialized world - are increasingly expressing and acting upon
their own views, national interests, and priorities - which often differ from
those of the United States.
Here, in East Asia, a rising tide of nationalism,
competition for vital natural resources, and the re-ordering of economic and
political relationships among countries could erupt into more serious and
contentious conflicts - if only by accident or miscalculation as one country
or another flexes its strengthening military muscle.
There are other obvious “hot spots” or
dangerous developments that are now contributing to greater uncertainty and
market volatility - and these are not likely to go away anytime soon.
- At the top of my list is the rising probability of
war between Israel and Iran - likely with the participation of the
United States - over Tehran’s nuclear program.
- Then there is the increasing radicalization of an
already nuclear-armed Pakistan - and the acquisition of weapons of mass
destruction by the Taliban, Al Qaida, or other renegade groups.
- Next, the Arab Awakening across North Africa and
the Middle East is already jeopardizing world oil markets - and prices
at the pump - should Saudi Arabia or the Gulf Emirates follow Egypt and
Syria into increasing political and social disorder.
- Disruptive terrorist attacks by Islamic
fundamentalists or other madmen, either of the violent sort we’ve
already seen in New York or London . . . or of the cyber variety that
could upset not only internet links - but also banking, financial markets,
communications networks, electric power grids, and the like . . . any of
which could trigger a drop in economic growth or worse.
- Let’s not forget the uncertainty and risks -
social, political, and economic - associated with still-unresolved
European sovereign debt, banking insolvencies, deepening recessions . .
.
- As I mentioned earlier, the quickly approaching
“fiscal cliff” in the United States - and longer term - the
unsustainable U.S. federal budget imbalances that ultimately threaten
the U.S. dollar’s role as the leading world currency and reserve
asset.
- With regard to prospects for the Eurozone, I think
it is only a matter of time before first Greece, then Spain, and
possibly other still-sovereign European states decide that the
consequences of more fiscal restraint (and, with it, rising unemployment
and declining living standards) are just too much distasteful medicine
for an ailing and sickly patient - and opt instead to opt out and go it
alone . . . and who knows where this might lead!
Climate change is yet another source of uncertainty and
risk for the global economy - with possible consequences for gold.
Global Warming is already having a significant
influence on farm output, agrarian income, and food prices in some countries
and regions. For example, below-average monsoons this past year hurt harvests
and lowered household income in India’s farming regions - reducing this
past year’s appetite for gold in this traditionally important
gold-consuming country - and likely contributed to a lower metal’s
price in the world market.
Last year’s weather restrained harvests in some
important grain-producing regions contributed to higher food prices and
political turmoil in some countries - most notably Tunisia, where widespread
riots broke out, the country’s political leadership fled (with most of
the central bank’s gold), and the Arab Spring was given birth.
Irrespective of how these and other potential threats
and challenges are resolved, we must recognize that there is today a growing
number and more diverse range of nations, public and private institutions,
and other entities with sufficient economic power, political clout, or
financial wherewithal to greatly affect the global economy and world
financial markets - with possibly significant consequences, one way or the
other, for the future price of gold.
An interesting sidebar to this discussion of
uncertainty and risk has been the development of immediate and equal access
to financial, economic, and political information - information that is incorporated,
often almost instantly and sometimes without being well-understood, into
market pricing for gold along with other commodities and assets.
Taken to its extreme, we have seen the growing
influence of computer-generated, high-frequency, program and technical
trading models that can trigger massive buying or selling of one or another
financial asset (selling that has been aptly named a “flash
crash”) all in a micro-second without any human participation or
intervention.
Gold has always thrived on uncertainly - and, as
uncertainty continues to rise in the years ahead, those who hold the yellow
metal will be amply rewarded.
That said, an important conclusion or piece of advice
for investors, central bankers, and others with an interest in gold: In a
volatile, high-risk, volatile world prudence calls for managing against a
range of risks by looking at how assets inter-relate, rather than searching
for the one or two assets that might perform best in a more certain and
low-risk world.
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