Gold: Money Velocity Takes Centre Stage

I may have shocked a lot of gold bulls with my recent prediction that the Fed will “taper to zero” over the next 12 – 18 months. 

I’ve likely shocked the bears even more, with my view that the taper is extremely gold-bullish.

Does the amount of OTC derivative debt that has imploded, vastly exceed all the money that has been printed with QE1, QE2, and QE3?  I think the answer is yes.  For QE to be inflationary, more money must be created than destroyed.  

Since the financial system almost shut down in 2008, most OTC derivatives have been valued with “mark to model” accounting.  When the Fed buys them, they get marked to market.  In that transaction, if more money is destroyed than is created, it’s deflationary.

Inflation is not simply a product of an increase in the money supply.  It is created by an increase in the number of times that money changes hands.  Central banks call that “money velocity”.

That’s a chart of M1 money supply, courtesy of the Federal Reserve Bank of St. Louis.  It’s clear that since the Fed’s money printing programs began in 2008, M1 has skyrocketed.

As QE began, gold rose strongly.  That’s partly because investors anticipated inflation would occur.  It’s also because the rise of the Chindian (China and India) middle class created substantial demand for gold jewellery, unrelated to the QE programs.  When inflation didn’t materialize, Western institutions sold gold, and bought the stock market.

This M1V chart (M1 velocity) is interesting.  While the supply of money grew aggressively during the 2008 -2013 period, the velocity of money collapsed.

That situation now appears to be changing.  M1V has suddenly stopped declining and there’s a significant breakout from a bullish wedge pattern.

Many top economists believe the economy tends to lag the stock market by about six months.  I agree.  In the first two quarters of 2014, the economy could show impressive growth in GDP and employment numbers.

Many top economists believe the economy tends to lag the stock market by about six months.  I agree.  In the first two quarters of 2014, the economy could show impressive growth in GDP and employment numbers.

Such growth would meet the Fed’s requirements for a steady and gentle taper.  All that begins well, unfortunately, does not always end well. 

Across the waters, inflation is becoming a significant concern in India, while economic growth has weakened.  Most of the inflation is supply-side, so it is difficult to reverse. Importantly, that inflation can be exported. 

While the US central bank issues policy guidance tomorrow, so does the Indian central bank (RBI).  They are widely expected to raise some interest rates.

Also, Shinzo Abe and Haruhiko Kuroda in Japan are engaged in an extremely aggressive QE money printing program.  The printed money does not seem to be directed at OTC derivatives, as much of it is in America.  Thus, the inflationary ramifications are serious.

By the summer of 2014, US economic growth should cause a serious rise in M1V.  Banks loan aggressively when growth is strong, and I expect a major rise in bank loans in the first half of 2014. 

If heightened M1V is combined with exported inflation from Asia to create powerful inflationary pressures in America, the Fed should begin to taper much more aggressively.  When push comes to shove, the Fed will likely choose to fight inflation, rather than promote growth. 

Professional fund managers watch money velocity very carefully.  That’s a daily GDX chart, covering about two years of time.  Many gold managers have been forced to sell large amounts of gold stock in recent months, due to redemptions from demoralized investors.

The enormous volume that I’ve highlighted in green probably signifies an exit from gold stocks by the money supply crowd, and an entry by power players focused on M1V, Japanese QE, and relentless Chindian demand for gold jewellery. 

What would happen to the American stock market in mid-2014, if the Fed began to express serious concerns about inflation, and announced a huge increase in QE tapering? What would happen if they did it repeatedly?  The Dow would probably crash, and a stampede into gold stocks would likely follow very quickly. 

The Indian elections may coincide with a startling rise in US M1V and cost push inflation in Japan.  The main opposition party is the BJP, and they just announced they are considering a platform to end all forms of taxation in India. “Toeing the view of his predecessor, BJP President Rajnath Singh said the party will take a view on a demand for removal of all taxes and replacing them with a single transaction levy. Former BJP chief Nitin Gadkari earlier this month favoured complete abolition of Income, Sales and Excise tax. Addressing a conclave of realtors' body CREDAI, Singh said 7-8 taxes are imposed on even an unemployed person.” – India Economic Times, Dec 14, 2013.

Horrifically, the Western world political leaders are being turned into entities that resemble rotary phones.  Gold jewellery demand in Chindia is surging far beyond the estimates of the best bank analysts.  China has announced a reform revolution to increase freedom.  They have also authorized more agents to act as official gold importers, to handle the surging demand of citizens for gold jewellery.

If India abolishes taxation and replaces it with a simple bureaucracy-free transaction levy, which analysts now say could double government revenues, companies in the West would pour funds into India.  FII (foreign institutional investment) could look like Niagara Falls pouring into India. That would produce a parabolic spike in money velocity in the West.  While most analysts think inflation is a thing of the past, I think it’s likely to stun most investors in 2014, and create a violent tapering event.  In order to prevent a stock market crash, or at least reduce its size, the Fed is likely to cut interest rates while tapering.  That’s pouring gasoline on an inflationary fire.  It will simply accelerate the rise of inflation, and create the need for even more aggressive tapering. 

That’s the daily gold chart.  The stokeillator is sluggish, but rising.  In the short term, the actions of the Fed on December 18 are likely to determine whether gold charges towards $1300 or declines towards $1195. 

Gold, silver, and precious metal stocks probably stand to benefit most from a violent taper to zero, but how many investors are really poised to profit, if it happens?

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Stewart Thomson 

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Stewart Thomson is no longer an investment advisor. The information provided by Stewart and Graceland Updates is for general information purposes only. Before taking any action on any investment, it is imperative that you consult with multiple properly licensed, experienced and qualifed investment advisors and get numerous opinions before taking any action. Your minimum risk on any investment in the world is: 100% loss of all your money. You may be taking or preparing to take leveraged positions in investments and not know it, exposing yourself to unlimited risks. This is highly concerning if you are an investor in any derivatives products. There is an approx $700 trillion OTC Derivatives Iceberg with a tiny portion written off officially. The bottom line:  

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