Feature Stories | Jun 28 2018
This article was first published for subscribers on June 14 and is now open to general readership.
Research house Incrementum believes the tides are changing for global monetary policy, the reserve currency and technology. Such a changing of the tides could lead to another global crisis, from which gold would again provide a safe haven.
-QE now swinging to QT
-QE has only served to fuel even more excessive debt
-US dollar hegemony under threat
-Gold and Bitcoin can be friends
By Greg Peel
“The tides they are a-changing,” suggest gold analysts Ronald-Peter Stoeferle and Mark J. Valek, with apologies to Bob Dylan, in their extensive “In Gold We Trust” report entitled Gold and the Turning of the Monetary Tides. Stoeferle and Valek are partners at Incrementum AG, an independent investment and asset management company based in Liechtenstein.
The report puts forward the premise that gold has now re-entered a bull market.
The reversal from QE to QT has provoked “remarkably little attention” in public discourse, the analysts note.
They refer here to the end of quantitative easing by the US Federal Reserve, after a period of “tapering” the purchases of US Treasury bonds, originally instigated in 2009 as a means of supporting ultra-low interest rates. Initially the Fed maintained the size of its balance sheet by replacing maturing bonds but as of last year is no longer doing so, such that the balance sheet is now shrinking.
This is being described as “quantitative tightening”, and is supported by incremental Fed rate increases.
It is expected this week that the European Central Bank will announce a timetable for the winding down of its own QE program, which it was slower to implement than the Fed in response to the GFC. The Bank of Japan continues to conduct QE and is not expected to announce any change at its policy meeting this week, but with global QE now giving way to QT, the pressure is on.
The consequences of this monetary U-turn “could be dire”, the analysts warn, because the “monetary amphetamine” of QE that prevented a relapse into crisis in the post-GFC era has come with numerous side-effects.
One the one hand, QE has affected global debt excesses from the outset. ECB president Mario Draghi promised to do ‘whatever it takes’ and that policy should have bought time for Southern European countries on the brink of collapse post GFC to undertake structural reforms and debt reduction. Conversely, near-zero and below-zero interest rates have only served to encourage the accumulation of more debt.
On the other hand, investors have “grown familiar” with today’s supposedly less risky capital market environment and have “fallen in love with it,” the analysts point out. But now dark clouds are gathering on the interest rate horizon.
In terms of “grown familiar”, with the collapse of Lehman Bros now approaching its tenth anniversary there is a cohort of “experienced” investors, brokers and analysts who have never known anything other than ultra-low interest rates and rising stock markets – US in particular. How can one not “fall in love” with such a market environment?
It was Shakespeare who popularised a metaphor originally coined by Chaucer – “love is blind”.
Global Monetary Order
Transitions in the global monetary order are occurring in small, and sometimes hardly recognisable, steps, but the trend is clear, the analysts suggest: de-dollarisation and the reshaping of a unipolar (US dollar reserve currency) world monetary regime into a multipolar one.
The process is being driven by geopolitical polarisation and rhetoric that promotes global divisiveness above unification, the analysts note.
Cue Donald Trump.
European politicians in particular see Trump’s ascension as an opportunity to “escape the shackles” imposed by the US. The establishment of a single European currency, the euro, was representative of this “emancipation movement” at the turn of this century. There is a “currency war” afoot, and this is being fuelled by intensifying global trade conflict.
While the “trade war” has to date appeared no more than strategic posturing, a rising degree of policy irrationality is serving only to add to economic and political uncertainty. For the US, the loss of currency hegemony could have “far-reaching consequences,” the analysts warn. Falling demand for the US dollar and Treasuries could fuel both inflation and interest rates.
It remains to be seen what effects the debt problem will have on a changing of the tide in foreign exchange policy. One cannot do away with the hard truth, the analysts point out, that one party’s receivable is another party’s liability.
To that point, note, for example, were China to sell its holding of US government bonds, the impact would be mutually destructive for both economies.
The world has experienced a swift technological shift of epic proportions. More and more financial transactions are being executed via smart device and the internet. The advent of crypto-currencies has led to further acceleration of the digitalisation of money.
Many a respected, old-hand financial market “guru”, such as Berkshire Hathaway’s Warren Buffet or JP Morgan’s Jamie Dimond, has dismissed crypto-currencies as a passing fad. Other equally respected commentators disagree. What all can agree on is that the underlying “blockchain” system that supports Bitcoin and lookalikes is here to stay.
Steoferle and Valek are convinced of two truths.
Firstly, crypto-currencies, and especially the underlying decentralised ledger technologies (blockchain), will fundamentally change business and possibly the reality of the global monetary order.
Secondly, gold and crypto-currencies are friends, not foes. (Some have suggested digital money could herald the “death” of gold.) In fact, suggest the analysts, a collaborative approach would play to the strengths of both. The first gold-based crypto-currencies are already underway.
Impact On Gold
What does the turning of the tide in each three of the above factors, the first signs of which we are now seeing, mean for the price of gold?
The current state of financial markets is ensuring headwinds for gold, the analysts note.
Equities remain in a bull market. Volatility is low. Real estate is still the investment preference in many places. Economic growth is robust. CPI inflation remains relatively low. US interest rates are rising. Central banks are becoming more hawkish (QT not QE). Crypto-currencies are stealing the limelight from gold.
What decidedly distinguishes the current phase from the run-up to previous stock market crashes (1929, 1987, 2000, 2008) is simultaneously high values for both stocks and bonds, the analysts point out. (Note: a low bond yield implies a high bond price.) Historically, the negative correlation of stocks and bonds has meant bonds helping to contain stock market losses.
In theory, bond prices can go no higher than they did when the Fed was still in QE mode, unless some drastic event forces the Fed into negative interest rates.
Research from Deutsche Bank shows that an equally-weighted index of stocks and bonds is currently trading at the highest level since 1800.
Eventually all markets regress to the mean. The law of gravity could catch many portfolios on the wrong foot, the analysts warn. The typical response is to rush to a safe haven. Bonds will not play that role this time around, leaving real estate and gold, and now possibly Bitcoin, as the safe haven choices. Stoeferle and Valek are convinced that in such a scenario, gold will be amongst the biggest beneficiaries.
The analysts believe gold should benefit from a dynamic environment of fundamental change. But what of the short to medium term outlook for the gold price? To that end, Stoeferle and Valek have considered four scenarios.
Scenario A is that of a genuine boom, with real economic growth in excess of 3%, in which monetary policy is normalised at a real rate (nominal minus inflation) in excess of 1.5%. USD gold price forecast 700-1000/oz.
Scenario B sees a muddling through, growth and inflation both running at 1.5 to 3%, and normalisation not yet achieved. Forecast 1000-1400/oz.
Scenario C is of an inflationary boom, with growth and inflation both exceeding 3%, and normalisation not yet fully successful. Forecast 1400-2300/oz.
Scenario D is the adverse scenario of economic stagnation or contraction of less than -1.5%, sparking a reversal of monetary policy. Forecast 1800-5000/oz.
To date, the gold price has moved in a range of scenarios B and C. The critical issue, the analysts suggest, is whether monetary normalisation (QT) will prove successful. A recession is overdue. The changing of the monetary policy tide could trigger one in 6 to 24 months.
Gold has typically performed well in recessions, as both a safe haven and protection against inflation. In the past six recessions, going back from the GFC to the early seventies, the gold price has increased by an average 20.8%.
To the analysts, the risk/reward profile of gold seems “extremely” attractive. The prospect for silver may be even better, they note. Thus it follows the risk/reward profile for gold miners is “excellent”, and maybe even better for silver miners.
Gold offers effective protection against inflation and crises, not the least in situations for which the details are not predictable.
The analysts also note that the trend of global central banks reducing their gold reserves, which began last century, has now reversed. Emerging markets in particular – China, Russia, India and Turkey included – have boosted their reserves drastically, which suggests a declining trust in the US-centric monetary and global political regimes.
And Incrementum’s Inflation Signal has indicated rising inflationary tendencies since September last year.
The central point, Stoeferle and Valek suggest, is that the global boom, fuelled by ultra-low interest rates and the never ending expansion of money supply and credit, is on shaky ground. The analysts believe the likelihood of boom turning into bust is much higher than the mainstream currently expects.
“We therefore anticipate a significant global economic dislocation with a substantial effect on the gold price in coming years.”
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