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If you ask
most investors what is the main driver for the price of gold they are likely
you tell you that it's the direction of the U.S. dollar. Therefore, the only
due diligence most investors perform is a perfunctory glance at the Dollar
Index (DXY). While it is true that the purchasing power of the dollar is a
key metric to judge the direction of gold prices, the DXY will only tell you
what the dollar is doing against a basket of 6 other flawed fiat currencies.
The main
component of the Dollar Index is the Euro Currency, which represents a 58%
weighting in the basket of currencies. It logically follows, if the Euro is
tanking, the Dollar Index could increase regardless of the fundamental
condition of the U.S. dollar. In order to truly access the intrinsic change
in the value of the dollar you must first determine; the level and direction
of real interest rates, the rate of growth in the money supply and the fiscal
health of the government. When analyzing the dollar using those metrics, it
is clear that the intrinsic value of the dollar is eroding in an expedited
manner.
The Ten year
Treasury note is now yielding 1.85%, which is down in yield from 3.34% a year
ago today. Meanwhile, the year over year increase in Consumer Price Inflation
jumped to 3.4% in November, up from 1.1% in the twelve months prior.
Therefore, real interest rates are not only negative but are falling. Falling
real interest rates reduces investors' appetites to hold dollars and
increases their willingness to buy gold. Negative real interest rates cause
consumers, businesses and governments to borrow more money. When more money
is borrowed into existence, the supply of money grows. Increasing money
supply growth reduces the value of dollars already in existence. The YOY
change in M2 money supply growth is near 10%. Since U.S. economic output is
around 2%, the supply of goods and services is growing far below the rate of
money supply growth. This causes aggregate prices to rise and reduces the
value of the dollar, while boosting gold prices.
Finally, our
government just requested permission for yet another $1.2 trillion increase
in the debt ceiling. U.S. debt stands at over $15.2 trillion and is now
estimated to be larger than America's entire economic output in 2012. The
proposed increase would boost the debt ceiling to $16.4 trillion and would
only be sufficient to last only until the end of this year.
U.S. debt and
deficits are running over $1 trillion per annum and amount to over 700% of
Federal revenue. And just last week, we learned that the monthly budget
deficit climbed to $85.97 billion in December, from $78.13 billion in the
same month a year earlier. The only relief from such debt will be a default
on the part of the United States. A sovereign U.S. default would be
pernicious for the dollar and massively bullish for gold.
The simple
truth is the U.S. dollar is under increased assault from negative real
interest rates, increased counterfeiting from the Fed and a national debt the
government is attempting to inflate away--that truth isn't made less painful
just because a European vacation may be getting cheaper.
Since the
intrinsic value of the dollar continues to deteriorate, long-term investors
would do well to ignore the dollar's temporary and beneficial measurement
against the Euro and focus on its true fundamentals, which are forcing
investors towards gold.
Michael Pento
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