Short And Sweet: Fed's New Policies A Longer-Term Positive For Gold Price

The Fed's public relations department has to be working overtime altering, amending and otherwise explaining its new stance[s] on monetary policy. While disinflation and the possibility of deflation occupied market sensibilities, the Fed pointed to its target inflation rate of 2% as proof that stimulus was still on its agenda. Now that producer prices have exceeded that level (and rather significantly as reported in this newsletter last month), articles began to appear in the financial press about a new, much higher inflation target in the 4% range (Wall Street Journal, 4/2/2017).

Also, two powerful members of the Fed's decision-making team, William Dudley, president of the New York Fed, and vice-chair Stanley Fischer, both went public with pronouncements buttressing the accommodative policy message Janet Yellen delivered in her press conference following the Fed's most recent rate-setting meeting.

Even before the Fed's new public relations effort pushing policy accommodation, the gold market was firming up. "Money managers," says Bloomberg's Luzi-Ann Javier, "cut their bullish bets on bullion by the most since 2015 in the week ended March 14. The next day, Federal Reserve Chair Yellen reiterated that monetary policy will remain accommodative for 'some time,' easing market fears that there might be more than three rate hikes this year. Her words sparked the biggest gold rally since November."

Gold And Silver Off To Great Start In 2017

The gold and silver markets have regained momentum from earlier in the year. Gold prices have pushed back over the $1250 per ounce mark and silver is is once again trading above the $18 per ounce level. There should be even more back-pedalling among short-sellers in the gold and silver futures markets in the weeks and months ahead as the idea of a looser monetary policy sinks in.

Gold is up over 9% thus far in 2017 and silver is up over 15% – two of the best performers so far this year among primary portfolio assets. (For a full schedule of asset performers thus far this year, please scroll to the bottom of the page.)

Bedeviled Fed, stretched investors

A recent study conducted by the New York Federal Reserve found that 33% of the U.S. population would be unable to raise $2000 in a month if needed. Likewise, as the character in the accompanying Ed Stein cartoon illustrates, even if one had significant savings the returns are laughable.

In an article titled, "The Fed is Bedeviled by Keynes' Paradox," Bloomberg's Danielle DiMartino Booth frames the essential economic problem as follows:

"Tack on an overabundance of debt tied to student loans and car payments and it’s easy to connect the dots to the record number of Millennials who continue to live with their parents. At the opposite end of the demographic spectrum, the statistics are equally harrowing. Baby Boomers are carrying unprecedented debt levels relative to prior generations of retirees and rightly [are] overwhelmed at the prospect of retiring on fixed incomes."

"As Keynes’s paradox dictates, retirees have nothing but impossible choices to make. Either they sleep with one eye open, hoping they don’t outlive their prudently stashed savings which are not keeping pace with the rising cost of living. Or they sleep with the other eye open, with their principal at risk, the price they pay for being exposed to risky securities whose returns do outpace inflation. Paradox indeed."

The Pension Tsunami

Unfunded pension obligations have become so large that they now threaten the financial stability of the cities and states charged with funding those liabilities. A good many city and state plans including most notably – Illinois, California, Chicago, Houston and Dallas – have problems deep enough to jeopardize their credit ratings, according to a Bloomberg article, titled "Pension Crisis Too Big for Markets to Ignore."

Back in 2015, the International Monetary Fund issued a warning that pension funds "could pose systemic risks to the U.S. financial system." "Unfunded pension obligations," says Bloomberg, "have risen to $1.9 trillion from $292 billion since 2007." (A less-forgiving Stanford University study puts that figure at just over $5.5 trillion.)

Though concerned about the stability of their own pension savings, most Americans are unaware of the potential knock-on effect of pension funding problems on the rest of the financial system. With millions of baby boomers retiring annually, those problems have become both magnified and are increasingly a subject addressed in the mainstream financial media. If you are looking for a "left field" event suddenly being visited upon the financial markets, a good candidate would be the over-burdened national pension system.

The Problem In A Nutshell. . .

"The average current retiree pension, not including retirement health benefits – for a state/local government worker with 30 years of service is $67,762 per year. There are 10 million Californians over the age of 55, 25% of the total population. If all of them received a pension of $67,762 per year, that would cost $677 billion dollars, 32% of California’s aggregate personal income of $2.1 trillion. Do you think people who are retired should collect state-funded pensions worth more on average than the earnings of people who work? Do you think this is feasible?" – Ed Ring, PensionTsunami.com

BoA-ML Says "Long Gold" In Anticipation Of Manias, Panics And Crashes

Bank of America/Merrill Lynch is warning its clients to prepare for manias, panics and crashes. "Normalization," says Michael Hartness, the bank's chief investment strategist, "from a 5,000-year low in rates, 70-year low in G7 fiscal stimulus, 35-year high in the US-German rate differential, an all-time high US stocks vs. [the rest of the world], a 75-year low in bank stocks is unlikely to be peaceful; long gold in anticipation of potential manias, panics, crashes."

He Goes On To Say:

"The beneficiaries of rising inflation and rates are many. The long-run price relative of real assets (real estate, commodities, and collectibles) to financial assets (stocks and bonds) is at its lowest level since 1926. Bull markets in real assets have coincided with war and fiscal stimulus programs in 1940s, rise of inflation in 1960s and 1970s, and 9/11 & China accession to WTO in the early years of this century. Higher inflation and interest rates are consistent with real assets outperforming financial assets: since 1970, relative performance of real assets 83% correlated with inflation.

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Related, in-depth reading:

BlackSwansYellowGold: How gold performs in periods of deflation, chronic disinflation, runaway stagflation and hyperinflation

Black swans: A chronology of panics, manias, crashes and collapses from 400 BC to present

"You say: 'I did not think it would happen.' Do you think there is anything that will not happen, when you know that it is possible to happen, when you see that it has already happened?" - Seneca, 62 AD at the time of Emperor Nero's debasement of Roman coinage

Brexit Least Of Europe's Problems

"The European Union," says The Telegraph's Ambrose Evans-Pritchard, "is encircled on the outside, split three ways on the inside, and is saddled with a corrosive currency union that is still not established on workable foundations and is likely to lurch from crisis to crisis until patience is exhausted. Europe’s economic 'Lost Decade', and the strategic consequences that stem partly from this failure, have emboldened enemies and turned the Continent into a dangerous neighbourhood. The EU now badly needs a friend on its Atlantic flank. While it would be undignified for any British government to exploit these circumstances (and Theresa May is certainly not doing so) this is the diplomatic and military reality as Britain triggers Article 50."

Europe prays that Italy will pay its debts and that its banks won't fail. It prays that France will not elect Marine LePen president. It prays that Germany will not get fed up with the EU and lead, rather than oppose, its dissolution. It prays that Turkey will keep the immigration problem within its borders. It prays Trump will not abandon NATO. It prays these things and much more. . . . . And then there's the harsh, present reality of Brexit. I'm not so sure it is the least of Europe's prayers simply because the reality is so concrete – so "in-your-face" as we Americans might put it.

Inflation And Negative Real Rates Will Push Gold To $1400-$1500

According to Incrementum AG, "gold prices are projected to rally to levels last seen four years ago, as rising inflation and negative real interest rates combine to boost demand." The Lichtenstein group stated "prices may climb to $1,400 to $1,500 an ounce this year. Gold prices have already climbed year to date, and investors are approaching the new presidential administration with caution as it tries to implement its political and economic agendas. These uncertainties, along with the upcoming France elections, the lingering Brexit process, will increase demand for safe-haven assets such as gold. The real pick up in momentum might start at the beginning of summer," said Ronald-Peter Stoeferle, managing partner. "It's in the very early stages of the bull market, so everybody is still kind of cautious or slightly negative, but this will improve."

Will Islamic Finance Transform The International Gold Market?

"Islamic countries themselves," writes International Banker, "are also now likely to begin offering gold products to investors. Wealth-management companies in countries with more developed financial markets, such as Malaysia, Saudi Arabia and the United Arab Emirates, could start to introduce gold-backed ETFs, similar in structure to the SPDR Gold Trust. The new standard may also enable Islamic financial institutions to grow their businesses through the creation of products designed for saving, hedging and portfolio diversification. Although more gold-investment products are expected to be deemed as permissible in the future, derivative contracts such as futures and forwards remain prohibited. Nevertheless, the exposure of what is effectively a new asset class to the Islamic world is bound to have a significant impact on world gold prices going forward."

Far be it for me to throw cold water on what many will read as a positive for the gold market, I rather doubt that the World Gold Council-inspired Shari’ah Standard No. 57 on Gold and its Trading Controls will do much to generate the kind of new demand it predicts. In the end, the initiative sounds very much like similar measures introduced over the past several years in India to inspire a paper market for gold. It never developed, despite a monumental effort, simply because it defies the culture of physical gold established in India over centuries.

There might be some peripheral impact in Islamic finance with respect to paper gold ownership but, as has been the case in India, we doubt the volume will be significant enough to make much of a difference. This is not to say that demand for physical gold in Islamic cultures will diminish in the years to come. More likely, it will continue to exert the same strong and important influence it always has.

Quick Story - A few years back, a new client contacted us to do some business. When asked where he had heard about us, he said that he had recently made a trip to the Middle East and he was intrigued by the number of gold souks in Dubai, the city of gold, that had the USAGOLD website running on computers at the back of the display. When he got back to the United States, he decided to contact us as a source for his own investment purchases.

Understanding Numbers: How To Put Millions, Billions And Trillions In Their Proper Perspective

Big numbers do not register with most people. Thinking in millions is difficult. Billions are a major challenge, trillions nearly impossible. The reason for this, says Wall Street Journal columnist Jo Craven McGinty, is that big numbers are usually offered in isolation without the benefit of comparison. People need some sort of measuring stick to give the numbers meaning. She recently offered some interesting tactics for making big numbers meaningful. Here's one of them:

"[T]hink of it [big numbers]," she says, "in terms of time, like Richard Panek, a professor at Goddard College in Vermont and a Guggenheim fellow in science writing. There are 1 million seconds in roughly 11½ days. There are 1 billion seconds in around 31 years. And there are 1 trillion seconds in around 31,000 years. Someone who doesn’t grasp these differences in magnitude is also likely to be clueless when it comes to assessing the impact of chopping $2.7 billion from a $1.068 trillion budget. It’s less than 1% of the total—the proverbial rounding error."

US Debt Likely To Double Over The Next 30 Years, Gold Will Not Wait That Long To Respond

"Considering President Trump's push for big tax cuts and a promise not to touch key drivers of the debt," says CNBC's Jeanne Sahadi, "the picture could worsen. Right now the nation's debt amounts to 77% of GDP. That's already the highest level since the post-World War II era. If current law remains in effect, it's on track to jump to 150% by 2047, according to the latest long-term budget projections from the CBO. The problem is that while both spending and revenue are projected to grow, spending will far outpace revenue." The fact of the matter is that the national debt doubled over the past eight years, and nothing in Washington has occurred to make anyone think the pace of growth will slow. Though, as this article suggests, it might take 30 years for the debt to double, gold is not likely to wait until 2047 to react to such fiscal profligacy. As you can see in the chart below, gold faithfully tracks the national debt and, if anything, it looks like it might have some catching up to do.

Top Investments For First Quarter 2017: Gold Ranked Number 8, Silver Number 2

The first-quarter results for 2017 are in and they will be something of a surprise to those who get their market information from traditional media sources. The top performer was palladium with a 16.75% gain. Silver was second with a 13.61% gain. Gold, which like silver did not receive a great deal of attention, rose quietly but respectably with an 8.0% gain. Among the stock indices NASDAQ did well with a 12.08% gain, but the two major indices – the S&P500 and Dow Jones Industrial Average – finished well below the precious metals with a 5.76% and 4.81% respectively.

Chart courtesy of BarChart.com

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Michael J. Kosares is the founder of USAGOLD and the author of "The ABCs of Gold Investing - How To Protect and Build Your Wealth With Gold." He has over forty years experience in the physical gold business. He is also the editor of News & Views, the firm's newsletter which is offered free of charge and specializes in issues and opinions of importance to owners of gold coins and bullion. If you would like to register for an e-mail alert when the next issue is published, please visit this link.

Disclaimer - Opinions expressed on the USAGOLD.com website do not constitute an offer to buy or sell, or the solicitation of an offer to buy or sell any precious metals product, nor should they be viewed in any way as investment advice or advice to buy, sell or hold. USAGOLD, Inc. recommends the purchase of physical precious metals for asset preservation purposes, not speculation. Utilization of these opinions for speculative purposes is neither suggested nor advised. Commentary is strictly for educational purposes, and as such USAGOLD does not warrant or guarantee the accuracy, timeliness or completeness of the information found here.