When the Fed Flips to Ease, Gold Will Shine

When the Fed Flips to Ease, Gold Will Shine

Australia is the world’s second-largest producer of gold. Only China produces more gold than us.

The difference, though, is that China doesn’t sell their gold outside of the Middle Kingdom.

China keeps ALL the gold it pours.

Australia, on the other hand, exports almost 95% of our gold.

Yes, you read that right.

Of the near 300 metric tonnes of gold we dig up, refine and pour into fine gold bars, we send virtually ALL of it elsewhere.

Leaving very little behind for our own uses.

And a couple of years ago, the Perth Mint noted that two-thirds of the gold held at the mint was for international investors….

Do you know why? Because few Australians understand why gold is important.

But, it MUST be important. After all, we are sitting on some of the largest gold reserves in the world. And there is a massive international demand for the metal.

Yet, there is no local demand for it. Why?

In fact, after years of research, I’ve come to the conclusion that more Aussies hold Bitcoin than gold.

I have made it my job here at The Daily Reckoning Australia to educate Australians on what gold means for you.

And this week, I have a very special resource coming your way.

I’ve insisted my publisher release a book called ‘The New Case for Gold’ by Jim Rickards.

For the past decade, I’ve traded and bought physical gold. And this book lays out the most comprehensive case for why YOU should own physical gold.

I believe I need to get this book into the hands of as many Aussies as possible.

A century ago, gold was ‘money’. Yet several decades and much political meddling later, people have lost that connection.

But that’s ok. That’s why I’m here.

Today, I’ll hand you over to Jim. He’ll show you what’s driving the price of gold for now.

And then tomorrow, I’ll walk you through why every Aussie should have a little gold on hand.

Until then,

Shae Russell Signature

Shae Russell,
Editor, The Daily Reckoning Australia

When the Fed Flips to Ease,
Gold Will Shine

Jim Rickards, Strategist

Jim Rickards

Investors in physical gold naturally cheered when gold broke out of its narrow trading range in mid-October and rallied to the US$1,235 per ounce level where it now rests.

The prior narrow trading range of US$1,185–1,215 per ounce that prevailed from July to October was the longest such period of low volatility since December 2015.

We forecast that gold would break out to the upside as it did in the 2015 episode, and that’s exactly what happened.

We now have a higher base level for still further gains in the months ahead.

What’s most amazing about this breakout is that it happened under the most adverse possible conditions.

Real Federal Reserve interest rates (nominal rates minus inflation) have been rising steeply.

Net asset purchases by the big four Western central banks (Fed, European Central Bank, Bank of Japan and Bank of England) dropped sharply in 2018 and are set to go negative in 2019.

As seen in the chart below, the Fed’s balance sheet has contracted by US$300 billion in the past year.


Source: The Daily Shot

The Fed is not printing money; they’re burning it.

While many investors still complain about QE (quantitative easing), they may not be aware that the Fed is engaged in ‘QT’ (quantitative tightening).

The Fed stopped printing money in 2014. From 2014-17, the Fed kept the balance sheet unchanged.

Then in October 2017, the Fed began to reduce its balance sheet in a belated effort to ‘normalise’ in preparation for the next recession. The Fed is no longer printing money; they are burning it.

This balance sheet normalisation is in addition to a rate increase cycle, which began with Janet Yellen’s ‘lift-off’ rate hike in December 2015.

In the past three years, the fed funds target rate has moved from 0% to 2.25%.

It is set to move as high as 3.25% by the end of 2019. The combined effect of QT and rate hikes is estimated to be equivalent to rate increases of 2% per year.

Since there is little inflation in sight, most of that rate increase is real, not nominal. We are witnessing one of the fastest rate-tightening cycles in the past quarter-century.

Ditching conventional wisdom

Why does this matter for gold? The answer is that bank deposits and US Treasury yields compete with gold for investor dollars.

Both gold and US Treasuries are considered safe havens in times of political or economic stress. But US Treasuries have a yield and gold does not.

Therefore, when real rates are rising, gold becomes less attractive and funds flow into US Treasuries.

At least that’s the conventional wisdom.

Not this time. Yes, rates are going up and monetary conditions are tightening, but gold is doing just fine. What this means is there is fundamental support for gold despite the monetary headwinds.

The source of that support is not difficult to discern.

Russian and Chinese buying continues, but they have been joined by major purchases by Turkey, Iran, Poland, Hungary and others.

Major Western central banks stopped selling gold in 2010. Mining output is flat at just over 2,000 tons per year.

When you combine growing demand with flat supply, you get higher prices despite higher interest rates. That much is clear.

What is interesting is what happens to gold prices if the central banks flip from tightening to ease.

Right now, they have no plans to do so.

The Fed is committed to its path of 1.0% interest rate hikes per year and further balance sheet reductions.

The ECB has announced plans to stop QE later this year and eventually raise rates later in 2019. The Bank of Japan and Bank of England have also indicated they want to raise rates but may wait a while before doing so.

All of the major Western central banks are either tightening or preparing to tighten. Where’s the ease?

The ease will come in 2019 when the central bank growth forecasts crash into reality.

Recession in 2019

The reality is that the world is experiencing a global slowdown in growth.

Even the US saw growth slow from 4.2% in the second quarter to 3.5% in the third quarter to a projected 2.9% for the fourth quarter, according to the Atlanta Fed.

Those are better numbers than other countries’, but the trend is down.

It seems consistent with the idea that the Trump tax cuts gave the economy a one-time bump but a return to the low growth of the Obama years (2.2% annually from 2009-2016) may be in the cards. Fed tightening is not helping the Trump growth story.

It’s important to bear in mind that the Fed has the worst forecasting record of any major government agency or financial institution.

If the Fed is raising rates because of expected strong growth and emerging inflation and neither that growth nor inflation materialise, then the tightening will be seen as another policy blunder courtesy of the Fed.

The result could be a US recession in 2019.

Once that scenario unfolds, the Fed will quickly reverse course and move to a ‘pause’ in interest rate hikes. After that comes a halt to balance sheet shrinkage and then finally rate cuts.

If gold has performed well in the face of Fed tightening, the scenario is for even stronger price increases once the Fed flips to ease.

Gold could sail past $1,300 per ounce and make its way to US$1,400 per ounce as the Fed eases in the face of slow growth.

Today’s price of US$1,235 per ounce will seem like a bargain in hindsight.

All the best,

Jim Rickards Signature

Jim Rickards,
Strategist, The Daily Reckoning Australia