Further question marks over the US economy are good news for gold

GAVIN WENDT: We discussed recently the Fed’s decision to delay the inevitable – the scaling back of its $85 billion a month stimulus program – as being reinforcement of our negative view on the US economy.

The Fed also warned that an increase in interest rates would threaten to bring expansion to a halt.

As we’ve previously highlighted, the US sharemarket rally has been built on flimsy economic foundations.

Trillions of dollars-worth of hand-outs, bail-outs and stimulus to high-risk corporates that were deemed too-big-to-fail have led indices to record highs.

But this doesn’t necessarily provide for a healthy and sustained recovery.

Clear evidence of the stuttering nature of the US economic recovery came recently in the form of plummeting consumer confidence levels and jobless claims that were above expectations.

US consumer confidence sank to its lowest level in eight months on the back of the budget stand-off and the potentially lasting impacts on economic growth.

The Bloomberg Consumer Comfort Index declined to -36.1 in the period ended October 20, the lowest since February, from -34.1.

 

The report showed more households were pessimistic about the economy than at any time in the past year, despite resolution of the debt issue.

Whilst the number of Americans filing applications for jobless benefits fell by 12,000 to 350,000 during the week ended October 19, this was higher than the 340,000 median estimate from 48 economists surveyed by Bloomberg.

As we’ve described it previously, the US is essentially a market that’s been pumped to the max with Fed-administered financial steroids.

This of course will generate growth to some degree, but like the performance of the steroid-administered athlete, how sustainable is it and what are the potentially harmful longer-term consequences?

The US has mortgaged its future by bringing forward future consumption in an attempt to stave off what could have been a deep and prolonged recession, with the financial taps being left open for far too long.

The result is that the financial sector has become addicted to what was intended only to ever be a short-term pain reliever – not a long-term remedy for the economy’s ills.

Monetary stimulus and ultra-low interest rates are creating all sorts of distortions within the US economy, with the result that asset values and share indices have been pushed to record levels as a result of the flood of ‘easy money.’

The best example of this (or worst depending on your perspective) is how the US share market now rallies on disappointing economic news.

Commonsense normally dictates that a string of poor economic data would take the gloss of markets – but that’s not the case in the current environment.

In the US, weak data generates positive market momentum because traders know there will be more Federal Reserve largesse in the form of the continuation of ‘easy money’ to the tune of $85 billion a month.

Those that have been the biggest beneficiaries of the Fed’s generosity (i.e. Wall Street) have enjoyed an immensely profitable past few years, through share and property investment.

This has come at the expense of savers and retirees on fixed interest incomes, who have seen their living standards slide dramatically due to the Fed’s policy of maintaining low interest rates.

Unemployment has fallen (to some degree), but the negative case (reduced number of participants in the labor force, lower wages, fewer hours worked, reduced full-time and increased part-time employment) is overlooked by many.

Despite the booming sharemarket, more US citizens are today living on food stamps, the labour participation rate has fallen, home affordability is declining for the vast majority of Americans, living standards are deteriorating, the divide between rich and poor has never been greater, and savings are being wiped out by ultra-low interest rates.

Inflation has also been kept in check by the fact that the velocity of money has remained remarkably slow.

However, the large accumulated store of funds can best be viewed as an enormous tsunami of capital poised to flood the system.

When it does, systemic inflation will be the inevitable consequence.

The share market and property booms in the US are driven by investors who have access to low-cost investment capital, not necessarily by strong market fundamentals.

And with bubbles effectively forming, the Fed is right to consider the negative impact of rising interest rates and inflation in the context of the US economy.

We’ve long held the view that such a scenario would be the trigger for the next phase in gold’s price run.

So far the Fed has managed to keep inflation in check, despite the massive blow-out in the money supply.

 

So far the velocity of money has been slow, meaning inflation has been kept in check.

But it won’t last forever – after all, you cannot undertake monetary expansion on such a mammoth scale without major longer-term economic consequences.

The real driver of the gold price is negative real interest rates (defined by nominal interest rates minus inflation).

Central bank policies of inducing negative real rates to ‘incentivize’ borrowing, expanding the money supply and devaluing currencies, have increasingly forced investors (particularly mums and dads investors) into real assets like gold and silver.

And I don’t see this situation really changing anytime soon, despite journalists pointing to a softer gold price and by association predicting its demise.

Individuals and central banks will continue to covert gold, because when it comes to risk-free wealth preservation, gold does a far better job than any other asset you can think of.

This brings me to an in interesting article I came across this week on Mineweb, related to the insurance value of gold in an investor’s portfolio.

The article referenced Mike Tyson of all people and the fact that he is currently launching his autobiography.

Whilst the controversial pugilist isn’t famed for his eloquence, Iron Mike’s best boxing tip – that “Everyone has a plan until they get punched in the mouth” – is a much more relevant comment than the former world heavyweight champion might ever have intended.

‘Insurance’ is a good word when it comes to gold.

The biggest advantage between gold and many other forms of difference is that once you’ve buy it, your gold never becomes worthless or expires.

No, you don’t plan on needing it. But you don’t want to get punched in the mouth without it!

We anticipate the gold price to trade comfortably around the $1,250 to $1,350 mark for the foreseeable future.

Gavin Wendt is the founder of Minelife, publisher of the MineLife Weekly Resource Report