Digging into the details of why this precious metal is likely to continue climbing, even from here
Gold is going to $1,790 (that’s from UBS) …
Gold is going to $1,900 (from TD Securities) …
Gold is going to $3,000 (from Bank of America) …
Though the price-targets vary, nearly all the big-bank analysts agree on one thing today …
Gold is headed higher.
Now, a skeptical investor might say “wait, oil prices have plummeted. Consumers have been locked inside not spending money. Even when we re-open the economy, it will be a staged comeback, which means half-speed. All of that is deflationary. And isn’t deflation bad for gold prices?”
To that, another investor might say, “deflation? The Fed just threw $6 trillion in new dollars at the economy! We’re about to suffer hyperinflation so these gold price targets are way too low!”
Both investors have a point.
Today, let’s discuss this and more. But I’ll offer you the takeaway ahead of time …
It’s very likely gold is headed higher — potentially much higher (though don’t expect it to be in a straight line).
In today’s Digest, we’ll look at why this is from three perspectives: 1) what’s here now, 2) what’s coming tomorrow, and 3) what we hope never comes.
Let’s jump in …
***What’s here now
Friends, let’s give a warm welcome to negative real interest rates.
To make sure we’re all on the same page, there’s a difference between a stated (nominal) interest rate and an interest rate after adjusting for inflation.
For example, if you’re getting 4% interest in a savings account, yet inflation is at 2.5%, then the “real” interest rate is just 1.5%.
Real interest rates reflect the actual purchasing power of your dollars — and at the end of the day, this is really what matters.
Take the 1970s …
In that decade, we saw nominal interest rates climb to nearly 20%.
A saver’s dream, right?
Inflation was so high that real interest rates reflected a much bleaker picture about the average investor’s purchasing power.
The chart below shows real interest rates in the 1970s mostly remaining below 2%, and even going negative.
Source: World Bank
***Today, the combination of near-zero interest rates plus inflation means we’re in a negative-real-interest rate environment
Below, you’ll see the 10-Year Treasury, adjusted for inflation. Its real interest rate is -0.43 as I write.
Negative real interest rates steal wealth from people who are savers. That’s because people with money in a low-yield bank account, or perhaps in a low-yield bond, are actually losing money in terms of their purchasing power after adjusting for inflation.
So, why would people invest in these wealth-destroying assets?
Well, many wouldn’t — which is why a huge rotation tends to happen in this type of environment … from these wealth-eroding assets … into gold, which pushes up gold’s price.
See for yourself …
Below, you’ll find the 10-Year Treasury Inflation-Index (in blue) alongside the price of gold (in orange) over the last decade. You can see a clear, inverse correlation.
As real rates drop, gold climbs. As real rates climb, gold falls.
On Tuesday, Federal Reserve Bank of Chicago President Charles Evans said he “doesn’t think there will be reason to raise rates anytime soon.”
We just came through a long expansion, although we are in a much different environment right now, I think interest rates will remain low for a quite a long time.
Translation — negative real interest rates are here for the foreseeable future.
***Let’s now turn to “what’s coming tomorrow”
So, here’s where we get into a discussion about inflation versus deflation.
We’re officially in a recession.
Last week, we learned that the U.S. economy contracted 4.8% in Q1. This was the first negative GDP reading since the 1.1% decline in the first quarter of 2014. It’s also the largest decline since the recession in 2008 when GDP dropped 8.4%.
So, what’s the relationship between a recession and deflation?
In a recession people lose jobs. Without jobs, there’s far less spending on Main Street.
There’s also fear of the future. So, even those people with jobs tend to spend less. After all, they’re worried they may lose their own jobs, or simply be ill-prepared for whatever economic pain lies beyond the horizon.
This decrease in consumer spending pushes down the price of all types of goods. Desperate sellers have to lower prices in an attempt to lure shoppers back into a store.
I just saw this with friends here in Los Angeles who own a wine shop. As lockdowns hobbled their business, they responded by offering a “25% off” campaign on wine purchases over $100 to try to bring customers out of the woodwork.
This sets up a dynamic wherein you can buy the same products today for fewer dollars than they cost yesterday.
This is deflation … and it’s likely right around the corner.
(For everyone in the inflation camp, hold onto that — we’ll circle back shortly.)
***At face value, this deflationary-dynamic would seem bad for gold
After all, a dollar that can buy more “stuff” can also buy more gold. That’s basically the same thing as gold becoming cheaper.
But it’s not a black-and-white dynamic.
Take our most recent deflationary period around the 2008/2009 financial crisis. Economists suggest we were in a deflationary environment from December 2007 through June 2009.
Below, you’ll see the S&P 500 and the price of gold during that period. Gold ended 24% higher, while stocks fell 36% (over 50% at their lowest point).
But if there was deflation, why didn’t gold’s price end lower?
Because the turmoil in the economy was resulting in fear … and when investors are fearful, they often turn to gold.
Remember, gold produces no cash-flows to help us value it. It doesn’t generate profits we can measure.
So, when it comes time to value gold (put a price on it) what drives its demand turns out to be … emotions.
And what we usually find is that deflationary periods coincide with some sort of economic turmoil that produces fear, which pushes investors toward gold.
***Plus, keep in mind, even if gold’s nominal price falls during a deflationary period, gold can still make investors wealthier
How? Simple — gold’s purchasing power increases.
If I told you that the price of your gold was going to fall $100 an ounce, yet that same gold you own would be able to buy you, say, a much nicer car than before, would you really care about the $100 price drop? I suspect not.
What matters is what that gold could get you in terms of other goods or services — not some face-value number.
This suggests an important takeaway — as long the prices of consumer goods are falling more than the price of gold, then gold’s purchasing power is actually increasing … even though, at face value, the dollar-price of gold may be falling too.
But we’re getting a little theoretical here, so let’s move on. The broader point is that “deflation tomorrow” doesn’t automatically mean bad news for gold. In fact, the fear surrounding deflationary events is usually great for gold.
Now, let’s turn toward our last perspective on this, which is something none of us want to see …
***”What we hope never comes”
Let’s start by discussing why this $6 trillion of new dollars from the Fed doesn’t mean inflation tomorrow.
A question for anyone reading this who believes hyperinflation is at our doorstep …
Back around 2008/2009, due to the financial crisis, the U.S. printed trillions of new dollars, as you can see below …
Yet, this avalanche of new money didn’t result in significant, sustained inflation as many feared.
Short answer — because the Fed’s new dollars boosted the monetary base but not the money supply.
To put it simply, even though the Fed created trillions of new dollars (the monetary base), most of it remained parked in the banks, shoring up destroyed balance sheets (which meant it didn’t increase the money supply).
In fact, only a fraction of it actually made its way into the U.S. economy. This prevented inflation.
***Even though the Fed just fired a “bazooka of liquidity” at the Coronavirus, these dollars aren’t going to flood the economy with excess currency either
Because the “velocity of money” is dropping precipitously.
The velocity of money is basically a measure of how many times a dollar is used to purchase goods or services within a stated time period.
So, why is it dropping?
It’s complicated, but in large part, the answer is massive debt plus fear.
In a recession, or a deflationary environment, people either hold onto their money out of fear (which prevents it from circulating in the economy), or they pay down debts (which means those dollars aren’t being used in a productive way that grows the economy).
So, today, money — even trillions in newly created money — is not flying around our economy. Instead, it’s being saved or used to shore up the destroyed personal balance sheets of millions of Americans.
Plus, even if someone wanted to put money to work, the banks are tightening their lending. Two days ago, Bloomberg reported on how lenders have been tightening standards and terms on commercial and industrial loans of all sizes. Meanwhile, banks have been tightening standards on loans to households.
Basically, money is not flowing smoothly around our economy. There’s weak velocity of money.
Unfortunately, you can’t have significant inflation unless there’s at least stable velocity of money.
And that brings us to this chart from the St. Louis Fed showing today’s velocity of money.
Does the below look stable to you?
This is why inflation isn’t our immediate concern.
But that doesn’t mean it’s not a concern…
***Why gold is mandatory to own in preparation for a “worst case” situation
The debt on the U.S. balance sheet just exploded.
Now, our government has run up egregious debts for a long time. Why is today any different?
Because it’s coming at the same time that our economy has been crippled. So, when we compare our nation’s productivity to our debts, it paints a frightening picture.
As of last month, the U.S. debt-to-GDP number passed 100% (104% as of April). In other words, we owe more than we produce.
So, we have the Fed bailing out everything (increasing our national debt) at the same time our economy is shrinking (decreasing our GDP).
Put them together, and it means our debt-to-GDP ratio is going to keep climbing. I’ve read some experts suggest we’ll hit 120%, even 130%.
In related bad news, the Committee for a Responsible Federal Budget recently forecasted that public debt load will likely remain well above 100% until at least 2025.
Okay, so what?
Well, again, this is why we won’t face inflation tomorrow. All these new dollars that are being created will simply be swallowed up by massive, unproductive debt payments … as opposed to being used in productive assets that would build out our economy, while speeding up the velocity of money.
In other words, there’s a huge difference between massive government debt that goes to putting food on citizens’ tables and keeping the lights on, versus massive government debt that supports a thriving economic buildout.
***But let’s jump to the scariest response to “so what?” — it’s what we must avoid
If our economic situation gets worse … if Coronavirus keeps coming back, depressing economic activity … if people continue to require bailout money … basically, when we’ve borrowed so much relative to our national productivity that other nations question our good faith and we have trouble funding the needs of the nation … we could see pressure to change the Federal Reserve Act to allow the Fed to fund the Treasury directly.
In other words, that truly would be our government paying down its debts with phantom dollars.
And that’s when we’d set ourselves on the path of the Germany in the 1920s or Zimbabwe in the late 2000s … which would mean God-help-you if you don’t own some gold.
Now, while I don’t believe that’s going to happen, we’d be foolish to believe it couldn’t happen. Case in point, just weeks ago, The Bank of England agreed to temporarily lend its government money directly.
Thursday’s announcement allows the government to borrow billions of pounds direct from its overdraft with the BoE rather than always immediately needing to go to financial markets which could face further coronavirus-related disruption …
From EPB Macro Research:
Given the relatively small scale of this facility, the GBP (the British Pound) did not collapse … Still, it does start an uncomfortable precedent of direct money printing, an action not currently permitted by the Federal Reserve.
To be clear — I am not predicting we’ll see this in the U.S. anytime in the near future.
I believe we’ll claw our way out of this hardship without resorting to such measures. But today’s discussion wouldn’t be complete unless we mentioned it.
Bottom line, “what’s here now” is good for gold … “what’s coming tomorrow” is most likely good for gold … and “what we hope never comes” would be monumental for gold.
Please go buy some.
Have a good evening,