Generally we understand
and have learnt that Gold was bullish from
decade because of quantitative easing/money pumping from
central banks but if you look at history understand that it is not 100% true.
Quantitative easing, the oft-referenced $85 billion per month shelled out by
the Federal Reserve, comes down to the purchase of two kinds of securities –
U.S. Treasury paper (bonds, notes and bills) and mortgage-backed securities.
The Federal Reserve buys the Treasury paper from the federal government and the
mortgage-backed securities from commercial banks. The first is a direct form of
monetization (money printing); the second is an indirect form since a good
portion of those funds is in turn also used by the banks to purchase Treasury
paper. The two together comprise the bulk of what appears on the Federal
Reserve’s balance sheet as “reserve bank credit.” At the present that figure
stands at just over $3.2 trillion – up about $2.4 trillion since the beginning
of the financial crisis in late 2008.
When you superimpose the
gold price over reserve bank credit on a chart, it looks like this:
At first glance, it looks
like reserve bank credit and the gold price are correlated, but what is really
going on with this tandem is that they are both being pushed by the same force
– a bad economy. It causes the Fed to print money and investors to buy gold.
The Financial Times ran
an editorial the other day explaining why some top-notch hedge fund managers –
like Paul Singer, John Paulson, Stanley Druckenmiller and David Einhorn – don’t
like the U.S. Federal Reserve or Chairman Ben Bernanke, the father of the QE
policies charted above.
“His [Druckenmiller's]
concern,” the editorial explains, “is not the risk of inflation, which has
prompted investors such as Mr. Singer and John Paulson to load up on gold.
Instead, it is a broader concern that has been voiced by growing numbers of the
most powerful and influential professional investors: that by pushing down
interest rates and buying up government bonds, the Fed is warping the norms of
economic behavior.”
Most importantly capital,
according to this group, this misallocation of capital has driven ordinarily
risk-averse investors into dangerous financial waters. “What kind of entity,”
warns Seth Klarman, another hedge fund manager, “drives the return on retirees’
savings to zero for seven years in order to rescue poorly managed banks? Not
the kind that should play this large a role in the economy.”
It is these kinds of
distortions, though, that create opportunities in investment markets, which
leads me to the reasons why I went to the trouble of compiling and publishing
this chart:
First, reserve bank
credit has gone vertical since November’s near-term bottom – up over 15%. The
Fed might reverse or moderate its purchases at some point in the future, but at
the moment, it has the pedal to the metal. While Ben Bernanke couches his
rhetoric and keeps the markets guessing, he quietly – in reality – engages the
Fed what could be a new round of quantitative easing. In short, the markets
should be paying attention to what the Fed does, not what it says.
Second,, the gold price,
as a result of its recent plunge, has crossed decisively under the reserve bank
credit trend line. The two developments together have made for an interesting
chart divergence – the sort of thing that catches the attention of technicians
and value investors alike, particularly if it defies logical explanation. This
latest correction, more than any I can remember, has the experts scratching
their heads. (Please see “Illogical is dumping. . .” below.) When an upward or
downward spike in the market proceeds sans logical underpinnings, a snap-back
rally or correction often follows. The last such incident in the gold market
occurred in 2008. The market sold-off roughly 30% at the height of the
financial crisis, and then regained and superseded those losses before 90-days
had elapsed. (From there the market climbed to all-time highs in 2009.)
Third, should the
quantitative easing program finally ignite price inflation, we might see an
entirely different chart pattern emerge – a different kind of divergence. Gold
could go vertical while reserve bank credit stays level or heads south
depending on the Fed’s ability to sell-off the securities it accumulated during
the quantitative easing stage.
That same Financial Times
editorial concludes with this important observation on the behavior of hedge
funds and hedge fund managers:
“‘Part of the pressure comes
from knowing, or sensing,” says Richard Fisher, president of the Dallas Federal
Reserve, “that at some point you are going to get a reversal. If I was in my
old business I’d be looking around [asking] how am I going to make money
without taking undue risk?’ It is a big problem for the masters of the
universe. They live for distortions in markets, which provide them with
opportunities to throw billions of dollars at a brilliant trade that will push
prices back in line with reality. Successful hedge fund managers make their
reputations by being clever, brave or fast enough to seize on these chances.”
One of those distortions
looks like it may have materialized in the 2013 portion of the gold-reserve
bank credit chart. The press greatly emphasized the withdrawals at the gold
exchange traded funds over the past several months. What it failed to mention
is that there are two sides to every trade. Someone was selling, but someone
else was buying (and I’m not talking about just Chinese mothers and Japanese housewives).
Even now the gold price has rallied off its lows, and someone is buying the
mini-corrections we have seen since the big dump in April. If the longer term
pattern on our chart reasserts itself, a significant upward adjustment in the
gold price could be in the cards – a change of course that could end up making
2013 the best year to buy gold since 2008.
__
Postscript 1
Illogical dumping raises
questions about causes of metal’s sharp decline
“So extraordinary was the
9.4% collapse on April 15, wrote Howard Simons of Bianco Research at the time,
that the odds against such a move were 20 trillion to one – ‘a lower
probability of occurrence than randomly selecting a [particular] $1 bill out of
pile of singles representing the U.S. national debt.’ These improbable moves
have made gold bugs suspicious, which isn’t unusual. Folks who own gold do so
because they don’t trust the status quo, especially when it comes to
government-issued paper money. But just because you’re paranoid doesn’t mean
somebody isn’t out to get you. They point to bursts of selling on Friday, April
12, which resulted in prices plunging by more than 5%, and to dumping that
resumed the following Monday in Asia, early in the day when markets are
illiquid. That culminated in a 9% collapse by the time the New York market had
settled. But a seller who wanted to unload a large position at the optimal
price would have done precisely the opposite liquidate as discreetly as
possible. Instead, sellers dumped the equivalent of more than 300 tons of the
metal in staccato-like blasts during those sessions.” - Randall Forsyth,
Barron’s, This time, the gold bugs may have a point, 5/18/2013
Postscript 2
The real reason for
quantitative easing
“They know the stock
market is addicted to quantitative easing. What they don’t talk about that I
believe, is that quantitative easing is a means to financing the budget
deficit. The reason they talk about tapering quantitative easing is that the
budget deficit is going to be smaller. It might come back again, because absent
policy change on entitlement programs, the budget deficit is going to explode
higher again in two years. They’re creating the flexibility to match the
quantum of quantitative easing with the size of the budget deficit. That’s
what’s happening.” - Jeff Gundlach, DoubleLine Capital
Above I cautioned that we
should pay attention to what the Fed does, not what it says. If Gundlach is
right, and I think he is, we should regard the government debt situation
as the principle driver for quantitative easing, not the unemployment numbers.
Once that is done, a haunting realization creeps into one’s consciousness: One
can anticipate a reversal in the unemployment numbers at some point down the
road, while hardly anyone believes the parade of federal government deficits is
likely to end anytime soon. That factoid, more than any other, explains why the
Bernanke Fed is so obtuse, contradictory, and in fact, opaque on the future
prospects for quantitative easing. Such realizations explain why Germany is
repatriating its foreign-held gold reserves and why China and Russia are on
long-term programs to domesticate and monetize production from their mines.
They know all too well the consequences of money printing and how one goes
about defending against it. Private investors might take note.
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