As 2015 came to a close, most investors believed that 2016
would be a year dominated by a series of Fed rate hikes. That conviction
solidified in mid-October when comments from multiple Fed officials convinced
many that prior hints that the Fed would stay at zero percent rates had been
false alarms. The Fed delivered on its promise in mid-December by actually
raising rates by 25 basis points. Based on this, gold declined by 10% from
October 14 to the end of the year, nearly matching its six year low.
Many on Wall Street thought the declines would continue into 2016. They
were decidedly wrong.
In the first 14 weeks of the New Year, gold rose 16%.
The first quarter qualified as its best beginning year performance in 30
years (CNBC, E. Rosenbaum, 4/14/16). The reversal was prompted by stumbling
stock markets and a series of sharply dovish turns from central banks around
the world.
Perhaps the main reason people buy gold is as a hedge
against inflation. But uncertainty and fear contributed undoubtedly to
gold’s stellar first quarter rise. But will it continue? Opinions
vary among some of the most revered gold analysts in large financial firms.
They remain focused almost exclusively upon the major historical influence of
the inflation outlook and possible rate hikes. And as a result, the
mainstream financial firms have yet to alter their decidedly bearish outlook
on gold. This could prove positive for those who take the contrarian
position.
In March, Kitco reported that Robin Bhar, head of metals
research for Societe General, forecast an average gold price
of $1,150 an ounce for 2016. Combined with the likelihood that fear and
uncertainty are receding, Bhar believes that there may be a growing
realization that “the risk of an imminent U.S. recession, while not negligible,
is far lower than the markets are currently factoring in.” He
expects the Fed could deliver multiple rate hikes in 2016 and
perhaps several during the course of 2017. If this were to happen, the
dollar should strengthen and gold should fall.
Mr. Bhar’s view is supported by Goldman Sachs’ global head
of commodities, Jeff Currie, who in a CNBC TV interview on April 5threcommended
not just a sell of gold, but a short sale. Given the drift of central
bank policies around the world, it’s hard to imagine why these banks can hold
to these beliefs. This is particularly true in light of how widely and
rapidly negative interest rates are spreading around the world. Bloomberg
reports that as of Feb. 9, 2016, over $7 trillion of bonds, comprising some
29 percent of the Bloomberg Global Developed Sovereign Bond Index, offered
negative yields. Another $9 trillion yielded zero to one percent. It
is widely accepted that this number will grow rapidly as central banks
push yields deeper into negative territory. These rates have already
started to be passed through to consumers, who are being charged
interest on their bank deposits.
Negative rates are now looming so large that on April 15,
the Wall Street Journal dedicated almost its entire “Money &
Investing” section to the global consequences of negative rates, a phenomenon
that has no precedent in human financial history. The section included
five separate articles that detailed the absurdities of negative rates, the
strains they are placing on the financial system now, and the risks they
create for the future.
When bank charges are leveled on cash deposits
that earn no interest, which are held in debased fiat currency, it may become
tempting for more and more individuals to withdraw their funds. Their
alternatives could be to buy stock investments, or to hold physical cash in
the form of bank notes (which may or may not be stuffed into mattresses). A
fall in bank deposits could hurt banks just when they may be hit with
fines and increased regulation. Furthermore, even if arguably remote, falling
deposits could trigger a cycle of further withdrawals. Given that central
banks may confront such a scenario with even more currency debasement,
precious metals could become an alternative form of cost-free cash.
Sovereign debt (including negative rate bonds)
form ‘safe’ holdings in the portfolios of major banks, insurance
companies and pension funds. In fact, one of the stories in the Journal
described how German insurance companies are required to hold large
quantities of “safe” government debt as “assets.” But these instruments
not only offer negative returns, but they are vulnerable to declines in
value if interest rates for newly issued bonds were to rise to anything
approaching ‘normal’ rates. It may be unlikely that these bonds will
allow the insurance companies to meet the promises they have made to
policyholders. A similar dynamic could threaten the financial viability of
the world’s “too big to fail” banks. This is just one more reason that we
feel the world cannot tolerate a return to free market interest rates at this
time.
If the U.S. economy were to further approach recession,
the Fed might have to choose between restarting its Quantitative Easing
program or following Europe and Japan into negative territory. A return to QE
would be problematic on two levels. Firstly, QE has recently been tried by
the Fed, and there is little consensus that it was effective. Also, the goal
of QE is to lower long term interest rates. But as long term rates are
already at record lows in the United States, it is questionable that the Fed
can push them down much further. This leaves negative rates, which work on
the short end of the yield curve, as the more likely option. Notably,
when asked in February at a Congressional hearing if the Fed would consider
moving to negative rates, Chairwoman Janet Yellen refused to take such an
experiment “off the table.”
If negative rates fail to generate growth, and there is no
sign that they will, central banks then may take the next logical step down
the endless stimulus path. They may decide to bypass the financial system as
a pathway to issue newly created fiat money (as in Quantitative Easing), in
favor of delivering money directly to consumers. This is what is known as
“helicopter money,” which the banks could drop from the skies onto an economy
in hopes of getting consumers to spend. (But with consumer demand as low as
it is, it remains to be seen whether consumers will spend such a windfall or
hoard it.) While these policies are still on the fringes of central bank
discussions, they may not be so for long.
It should be apparent that bankers will not be deterred
from trying any policy imaginable that punishes savers
and destroys the value of fiat currencies. As these policies have shown
to fail to achieve their goals, we should imagine that they will be
administered for many years to come.
Having risen so fast this year, and with confusion
apparent even at the Fed regarding the outlook for interest rates, the price
of gold could correct in the short-term. However, over the medium to
long-term we remain very bullish. This view will be validated or
impeached based on the behavior of the Federal Reserve over the next few
months.
This is not a solicitation of any order to buy or
sell.
