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You Have to Start Somewhere?
On Wednesday the Federal Reserve reduced (aka tapered) its monthly bond
buying purchases by $10 billion from $85 billion to $75 billion. After the
Federal Open Market Committee meeting outgoing Chairman, Ben Bernanke, said:
“Reflecting cumulative progress
and an improved outlook for the job market, the committee decided today to
modestly reduce the monthly pace at which it is adding to the longer-term
securities on its balance sheet.”
He also commented that the Federal Reserve is committed “to doing what
is necessary to get inflation back to target [increased back to 2%]” and
“the action today [tapering] is intended to keep the level of accommodation
the same overall.” [Emphasis ours]
To put into context the significance of what the mainstream media would
have you believe is a meaningful change in Fed monetary policy, we present
the following chart of the Federal Reserve’s Balance Sheet, courtesy of David
Franklin at Sprott.
Source: Bloomberg and Sprott Asset Management
This chart shows two things. The first, and not so important, is how
insignificant a $10 billion reduction in bond purchases really is. The
second, and more important is, the colossal expansion of the Federal Reserve
Balance Sheet since 2008.
Before introducing QE, the Fed’s balance sheet was only $940
billion. Currently, it sits at just under $4 trillion. And, a projection by
Sprott places it at $5 trillion by the end of 2014.
If their forecast is correct, which is perfectly reasonable given the
current rate of expansion, it would mean that between 2008 and the end of
2014, the Fed will have increased its balance sheet by 5 times! Keep in
mind that it took the Fed 95 years, between 1913 and 2008 to grow its balance
sheet to just under $1 trillion.
This is a massive amount of money printing. And, wherever this money goes,
it’s going to raise the prices of whatever it touches.
We can already see the impact it’s having on U.S. stock markets as they
bounce around in record territory on relatively low volume. The impact is
also evident in bond markets where interest rates have reached historic lows.
For now, inflation is showing up in asset prices rather than ordinary
goods and services. The Fed, based on their comments we quoted above, are not
concerned about inflation showing up in goods and services, but they ought to
be.
The Fed maintains that the purpose of its QE program is to stimulate
economic growth and in the process create jobs. However, as we
explained in our September 20th Weekly entitled “Ben Bernanke is just
Stringing you Along”, the Fed is more concerned about suppressing
interest rates and funding massive U.S. budget deficits than economic growth.
That’s not to say that they are not interested in economic growth. The Fed
is trying to stimulate the economy, but not in the manner often reported
(i.e. by providing liquidity to banks to spur lending).
In actuality, they are hoping that the effect of printing an unprecedented
amount of new currency will debase the dollar and make U.S. exports cheaper,
thereby stimulating the economy.
This explanation, however, is not palatable for U.S. trading partners,
Treasury debt holders, or the general population so the alternate explanation
is given.
A Sure Bet
Ben Bernanke is famous for saying that the Fed could “raise interest
rates in 15 minutes if he had to.” It didn’t take 15 minutes on
Wednesday!
Julia Coronado, the chief economist at BNP Paribus in New
York and a former Fed economist commented in regard to the Fed’s tapering
announcement, “as soon as they [the Fed] started talking about tapering,
they raised interest rates.” [Context added]
In a previous Weekly, we presented the chart below which illustrates the
affect comments made by Ben Bernanke, regarding tapering bond purchases, had
on interest rates. The rise between the two red lines indicates roughly a 25%
increase in borrowing costs for the 10 Year Treasury.
Now that the QE program will reportedly be tapered in January, interest
rates have responded in a similar fashion. On Wednesday, the UST 10Y opened
at 2.86% and closed at 2.89%, an increase of 1.48%. This trend continued for
the rest of the week with the UST 10Y at 2.94%, reflecting a rise of 2.72% as
of this writing.
Taking into consideration the time period when tapering was first hinted
at, May 22 to today, Treasury rates have risen 31%.
Rising interest rates are a big problem for the Fed for a couple of
reasons. The thousand words reflected in the chart below shows the
first reason.
The approximate U.S. National Debt is currently a mind boggling
US$17,252,995,875,875. The interest paid on this debt so far in 2013 is
US$254,199,540,000 (i.e. $254 billion). If you haven’t seen the
astonishing speed at which these two numbers are escalating check out:
www.usdebtclock.org.
The above amount of interest represents 7.3% of the current U.S. budget of
$3.49 trillion. Thus, any significant rise in interest rates on $17.3
trillion dollars spells t-r-o-u-b-l-e!
The second problem the Fed has with rising interest rates is the inverse
relationship between interest rates and bond prices. The Fed holds just over
$2 trillion in Treasury bonds, so when rates rise, their (and everyone
else’s) Treasury holdings lose value.
The bottom line is, when you consider the real reasons for QE, the Fed
can’t taper. It’s trapped. Therefore, interest rates must stay
low. And in relative terms, given the almost imperceptible impact a
monthly reduction of $10 billion has, as shown in the earlier Sprott chart,
they haven’t done much in the way of tapering.
What they have done is more of the same posturing tactic, which we have
talked about before, to try and sell the fiction that the economy is
improving.
Suckers!
“Here’s the thing. If you can’t
spot the sucker in the first half hour at the [poker] table, then YOU are the
sucker” [Emphasis ours] – From the movie, Rounders
In our recent Weekly “The Game is over…” we presented the chart
below, which shows the U.S. Debt, the Debt Ceiling, and the gold price over
the last 14 years.
The chart clearly shows that the increase in U.S. debt has been matched by
an increase in the price of gold, with of course, the exception of 2013.
With the continued trend of historic U.S. budget deficits resulting in
rising debt levels and the likelihood of rising interest rates, the money
printing party will have to continue. It’s already manifesting itself in the
form of higher asset prices and it’s only a matter of time before it shows up
in consumer prices.
On the international front, the tide of U.S. money printing has put
enormous downward pressure on the dollar. This serves current U.S.
policy well, as it makes exports cheaper and undermines the value of U.S.
government debt. The trouble with this beggar-thy-neighbor
policy is that other countries usually start doing the same in self-defense.
This is also known as the proverbial race to the bottom, in which
countries engage in competitive devaluations in order to maintain an exchange
rate beneficial to their own exports. As a result, tsunamis of
international currencies flow all over the globe.
This is what explains the high inflation rates that have emerged in
various countries (e.g. Brazil, Russia, and India). In economic terms,
this process is known as importing inflation, in this case from the U.S.
Within this backdrop, it is intriguing to note which countries in the
world hold the largest percentage of their foreign exchange reserves in gold.
In July, current Fed chairman Ben Bernanke told the Senate Banking
Committee that “nobody really understands gold prices and I don’t pretend
to really understand them either.”
In a similar committee meeting in July of 2011, he responded to a question
from Congressman Ron Paul who asked the reason that central banks hold gold?
Bernanke simply replied, “long-term tradition”.
These are odd things for a Fed Chairman to say, given the Federal Reserve
is responsible for setting U.S. foreign exchange rate policy for which 72% of
these reserves are held in gold.
Would you hire someone to manage the foreign exchange reserves of the
U.S., of which 72% consists of gold, who publicly confesses to his bosses
that they only own it for purposes of tradition and further that he does not
understand the price trends of the asset?
Of course we don’t really believe Ben Bernanke when he says such
things. We think this is simply an exercise in obfuscation and
misdirection (aka Fed Speak). In fact, we know monetary officials value
gold highly as a monetary reserve asset.
When Brett Arends, of the Wall Street Journal, asked the U.S. Treasury if
it would consider selling some of the country’s gold reserves to pay the
bills, their response was:
“Selling gold would undercut
confidence in the U.S. both here and abroad…it would also be destabilizing to
the world financial system.”
The curious part of all this is that the U.S. is devaluing the dollar,
which everyone in the world must use to trade for major commodities, but will
not officially sell an ounce of gold to fund historic budget deficits or pay
down debt. Does that tell you anything?
Who are the real suckers?
Closing Thoughts
We have written extensively about China’s likely rapid accumulation of
official gold reserves by their central bank, the People’s Bank of China
(PBOC). Additionally, central banks around the world turned net buyers
of gold in early 2009 for the first time in 20 years, in the aftermath of the
Global Financial Crisis (GFC).
Although, the U.S. is reportedly not adding to its gold reserves, it is
officially not selling them either, notwithstanding the likelihood that they
have leased a significant amount of these holdings to major bullion banks.
This should tell investors a great deal about what central banks are
expecting in the future and gold’s importance as a hedge against inflation
and the potential loss in value of their other currency and sovereign debt
holdings.
These risks have been heightened since the onset of the GFC as a result of
the Fed’s unprecedented QE program and the subsequent competitive devaluation
that has followed. It explains why central banks, especially from Eastern
countries, have made gold a central pillar of their strategic monetary
objectives over the last few years.
If the world’s central banks are preparing for a rainy day by accumulating
and preserving their gold reserves, maybe you should own a little too.
Further, because the value of the yellow metal has been temporarily
depressed, the publicly traded shares of gold producers are historically
undervalued at the moment.
This makes it an opportune time to accumulate the shares of the most
promising gold miners in anticipation of gold’s favorable supply and demand
fundamentals reasserting themselves over the medium to long term. These
shares will offer strong leverage to a rising gold price.
If you are looking to take advantage of this rare window of opportunity to
buy low for the purpose of selling high, click on our Gold Miners Comparative
Analysis Table below, which has a multitude of critical metrics to use in
evaluating and comparing gold mining companies.
Additionally, our Model Portfolio, available to paying subscribers,
identifies the gold miners most likely to outperform as the price of gold
rises.
(Click the image to enlarge)
Regards,
RJ Wilcox
Jeremy@goldminersreport.com
www.goldminersreport.com
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