Article by Victor Dergunov in Seeking Alpha
So, what’s wrong with gold? You would think that at a time of higher growth and inflation, falling interest rates, the easiest monetary policy in history, monstrous debt, and an ever-expanding monetary base, gold would be going through the roof, but it’s not.
Here’s what I think is happening:
CPI (consumer inflation) is surging to some of its highest levels in the last 25 years. 5.4% is relatively high, and we have not seen such elevated inflation on a sustainable basis since the late 1980s/early 1990s. There were some comparable readings in the lead-up to the financial crisis of 2008, but high inflation may turn out more persistent than many market participants anticipate this time.
If you think that consumer inflation looks hot, look at producer prices. Here we see about a 12% YoY increase in final demand goods prices. This reading illustrates the surging costs producers are paying for raw materials now, costs that companies will very likely pass down to consumers in coming months and quarters. Therefore, we can expect to see even higher consumer inflation going forward.
An average basket of everyday purchases hasn’t shot up in price this fast in nearly 30 years. The bottom line is that inflation is rising sharply, and there doesn’t appear to be anything transitory about the move.
Moreover, we see that while the 10-year was substantially higher during prior times of elevated inflation, it is much lower this time, and the long-term trend is still lower. This steady downtrend illustrates that while investors could get substantial yields in the Treasury markets during times of elevated inflation in the past, that is not the case this time.
If adjusted for inflation now, the 10-year yields around a negative 4% in “real interest.” This dynamic of negative real interest yielding treasuries should continue going forward. This phenomenon is bullish for gold as the yellow metal essentially competes with Treasuries for market share in the safe-haven asset market. While demand for gold is lackluster right now, it will likely increase as demand drops off for negative yielding real rate investments like Treasuries and other bonds.
The Fed’s Not Raising Rates Any Time Soon
You don’t need to worry about rates going up any time soon because the Fed is not raising them. There is a zero percent probability that the Fed will move the Fed funds rate up this year.
Besides the continuous need for ultra-low rates to keep economic activity expanding, there is the enormous national debt burden to consider.
Towering at over $28.57 trillion, the national debt burden is stupendous. The U.S.’s national debt to GDP ratio is now above 128%, and America’s total debt is approaching 144% of GDP. This level of debt is remarkably high. Given that much of the national debt is comprised of U.S. Treasuries, Treasury yields must remain subdued for debt servicing payments to stay manageable.
The U.S. (taxpayers) dished out nearly $420 billion in debt servicing payments alone over the last fiscal year. Now, this is at an average rate of just around 1.5%. Imagine what would happen if the 10-year was closer to 3%, and debt servicing was around that same rate for a year. Yes, we would be looking at annual debt servicing payments of $700-800 billion (in one word, “unsustainable”). The immense debt burden is one of the primary reasons why the Fed may never raise rates notably again.
If we look back on the monetary base, the base was only about $50 billion when the buck was still pegged to gold in 1960. Back then, throughout the late 30s, 40s, 50s, and 60s, the price of gold was steady at around $35. Gold only began to appreciate in the 1970s as the dollar decoupled from the gold standard then.
Suppose we look at 1960 to the late 1990s, the monetary base expanded by about 1,000% (from roughly $50 billion to around $550 billion) in this time frame. Likewise, gold showed a very similar appreciation, about 1,000% from $35 in 1960 to around $385 by the late 1990s.
If we look at the pre-financial crisis era, the monetary base appreciated close to a trillion dollars, roughly a 1,900% gain from the 1960’s level. Gold also gained about 1,900% in the same time frame, moving from $35 to around $700.
However, with all the monetary inflation of late, we start to see a significant lag in the price of gold. As of right now, we’re looking at about a 12,000% increase in the monetary base since 1960. Yet, gold is up by only about 5,000% in the same time frame.
This lag factor could be because market participants believe that excess liquidity will get extracted from the market at some point, or maybe it’s just different this time. However, it seems likelier that the market is simply behind the curve right now, and the price of gold will probably catch up. A 12,000% gain from the $35 level would put the price of gold at around $4,235, roughly a 135% gain from its current price. Also, this monetary expansion cycle is not over yet. Therefore, gold could potentially go to $5,000 or higher over the next several years, which opens the door to many possible buying opportunities.
The Bottom Line
We are in a remarkably favorable environment for gold right now. Inflation is at its highest level in decades, interest rates are at meager levels, Fed policy is ultra-accommodative, the national debt is sky-high, and the ……
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