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Don Coxe, a contributor to Globe Unlimited's Inside the Market, is chairman of Coxe Advisors LLP and is an advisor to several commodity funds. He has been consistently ranked as a top portfolio strategist and received a lifetime achievement award from Brendan Wood in 2011.
Why is gold struggling in response to the news that the Fed is continuing to print money at an awesome (or scary) pace? Isn't it the monetary metal that should be soaring in price along with the monetary base – as it did for years?
Answer: the markets have finally collectively come to agree with the Fed and with the liberal economic establishment that what matters is actual rises in measured inflation. Fear of future inflation has succumbed to a belief that the economies of the industrial world will stay so weak for so long that central banks have to keep pumping out money and keeping short-term interest rates near zero – and that inflation can only come some long time in the future when GDP growth returns to "normal" levels. Then, we'll find out whether the monetarists (now despised) will be vindicated. Until then, the threat is deflation, not inflation.
Gold is the ultimate bad news story. It's what you want to own when inflation and/or financial collapse beset the industrial world. Stable – albeit struggling – economies and barely-measurable inflation don't draw buyers for gold. That is the new consensus.
Gold's roaring bull market after the crash came primarily from the growing fear that the beleaguered euro would implode. The second-largest volume currency in the industrial world is not like the others: it is not specifically backed by any government, tax system, army or navy: it is the ultimate triumph of paper money – a meta-currency, for a world in which most leading novelists are post-modernists who are unconstrained by the basic disciplines that have guided writers since Homer.
Gold touched $1,900 (U.S.) an ounce when it looked as if many or all of the so-called PIIGS (Portugal, Italy, Ireland, Greece, and Spain) would default on their bonds. The balance sheets of banks across the euro zone were stuffed to grotesque obesity levels with bonds of these struggling governments from the implicit recovery policies in which bad governments were backed by bad banks. That seemed to mean to frightened investors that the result would be the age of gold long foreseen by skeptics of the printed paper promises of politicians.
That didn't happen to any government except Greece, which got partly bailed out.
Result: gold rolled over and plunged $700 an ounce, rallying only pathetically, despite the Fed's surprise announcement that it would continue to boost its balance sheet at an annual rate of a trillion dollars – at a time the U.S. fiscal deficit remains at towering levels.
Why?
Despite the pledge of European Central Bank (ECB) President Mario Draghi to "Do whatever it takes" to save the euro, the ECB has reduced the size of its monetary base by almost the same percentage amount the Fed has grown its base – roughly 29 per cent. European governments' deficits are modest compared to the USA's. European bank stock prices have been soaring, permitting the beleaguered banks to issue more equity to strengthen their enfeebled balance sheets. Moreover, Angela Merkel came into the election with a huge lead, promising continued stability for the euro zone.
Result: the euro has, since July, strongly outperformed the dollar, responding to significantly improved economic news across the zone. That has proved to be great news for China, which exports far more to Europe than to the USA, and Chinese economic numbers have been surprising on the upside. Japan, the world's third biggest economy, is experiencing its first boom in two decades.
So there is reason to be bullish about global growth, even if the USA continues to limp. (Were it not for the spectacular growth from fracked oil and gas, the U.S. economy would be performing worse than most European economies. Obama claims credit for the growth, even though he and his most vocal supporters are viscerally hostile to the oil and gas industry.)
So, if global economic news has been stronger than expected, and European and Japanese stock markets have been much stronger than expected, optimism about a sustained recovery is growing, but inflation is not.
No wonder gold struggles.
But what if gold were to switch – in postmodern fashion – from being 'the bad news metal' to being 'the good news metal'?
Businesses have learned in the past two decades to hold their inventory-to-sales ratios at minimal levels. Since there seemed to be no threats that replacing them would mean higher costs, lean and mean have been the golden mean for CFOs and purchasing managers. Technology made razor-thin just-in-time inventories possible – and a necessary ingredient in effective management.
But the crash imposed another – more brutal – discipline on most corporations: slash capital expenditures. With unemployment soaring and consumers terrified, a deep recession spread rapidly across the industrial world.
Unlike past recessions, the climb from the depths has been slow, halting, and disappointing. The new normal for corporations to protect and grow their stock prices has been to use corporate cash to increase dividends and buy back stock, thereby rewarding executives on their stock options. Borrow big time at tiny interest rates, and don't use the cash for capex: distribute the money to stockholders.
And so comes the likely renaissance for gold – and gold miners.
At some point, if growth continues to increase, the perilously low inventory-to-sales ratios will be threatened. The crossover point from near-zero inflation to observable inflation will come when a new fear emerges: Purchasing Managers' Shock–PMS for short.
That has been the inflation ignition point in previous cycles as companies started bidding aggressively to replace inventories, and their suppliers could no longer meet rising demand because their effective capacity utilization rate constrained their ability to increase sales.
So, gold investors, don't keep trying to find bad economic and financial news to justify hanging on to your holdings. Yes, the recovery rates in Europe and the U.S. are modest enough that bad news may return, triggering a run-up in gold.
But, at this hinge in global economic history when growth and recession are so tightly balanced, you may well find that you stand to win from strong growth, producing rising inflation, forcing central banks to raise rates, hitting most of the liquidity-driven stock markets hard.
At that point, those trillions of dollars' worth of paper money printed with such abandon will become gold-owners' best friends.
Good economic news will prove to have been good for gold.
Keeping a safety shield in gold and gold stocks against either the return of inflation with the return of strong economies or a return to grim times may be the cheapest insurance you've ever bought.