Golden rocket

As gold again surged to record highs last night on dovish Bernanke comments and weak data, it’s time to revisit the rally.

I first began recommending gold to anyone that would listen in early 2001. I was laughed at.

Later that year, my friends laughed at me again. This time, it was a running joke that I had masterminded the September 11, 2001 terrorist attacks to boost the value of my very long gold holdings.

I sold some of my stake the following week and invested the profits into The Diplomat magazine.

So how did I draw my conclusion about gold?

First and foremost, it was the writing of Doug Noland at Prudent Bear. As the internet bubble burst spectacularly across the year 2000, Doug Noland wrote a weekly column that virtually never mentioned it. Rather, he focussed on the underlying dynamics of the US financial system, in particular the role of the Government Sponsored Enterprises (GSEs) Fannie Mare and Freddie Mac. And how the credit system itself was responsible for the bubble.

During the internet bust, Noland predicted with great precision the ultimate fate of the GSEs. He was proven extraordinarily correct seven years later during the GFC and still hasn’t received due credit.

By 2002, I had gotten in touch with Noland to write for The Diplomat. However, he was unable to do so at the time. Even so, through our conversation I discovered that he had completed his tertiary studies at the University of Western Sydney under a man he loudly sang the praises of, one Professor Steven Keen.

I got in touch with Steve and he wrote a piece for The Diplomat at the end of 2002 as America struggled to avoid the post-bust liquidity trap:

…there was indeed a new economy – it just wasn’t the one advertised. Rather than being built on high-tech manufacturing and labour productivity, the foundations of the new real economy were financial engineering, rampant speculation and debt.

Never before has the private sector risen so rapidly; never before has borrowed money been so freely squandered on frivolous and unprofitable investments; and never before has boomtime productive capacity been allowed to run so far ahead of demand. Individual and corporate debt in the US rose by more than US$5 trillion between 1995 and 2002, taking the ratio of private debt to GDP to its highest level in history; more than 160% and still rising. Manufacturing capacity utilisation never reached the level it attained during the preceding “jobless recovery”. It currently stands at 74%, far below the peak of 91 per cent attained regularly during the 1960s, but not far above the depth of 69% last plumbed during the 1982 recession.

Mr Greenspan’s past invincibility and current impotence are thus the same phenomenon displaced in time. America had salad days when the credit was being spent, but now that the capacity is installed and the fabled profits have failed to eventuate, the accumulated debt is crippling the economy.

The one thing that is keeping the economy going at this point is, predictably, yet more debt, which in an echo of post-1987 America (and Australia) is now financing housing construction rather than share purchases. It is only a matter of time before this zero-sum bubblegame also comes to an end. There is also the prospect of problems like Long Term Capital Management emanating from the enormous sums involved in derivatives (estimated at $US 110 trillion, or over 10 times the size of the US economy).

Mr Greenspan will doubtless wear the opprobium for these calamities as he once wore the garlands, but he is unworthy of either mantle. Central bankers have very little ability to constrain the financial system’s generation of credit, and what powers they once had were jettisoned over time with the fetish for financial deregulation. Their sole weapon today is the short end of the interest rate stick, and as Japan’s dismal performance during the 1990s has shown, low interest rates are as feeble palliative to debt-deflation as high rates were an impediment to irrational exuberance during the bubble.

And what does all of this have to do with today? My friends now curse when I mention gold. But they shouldn’t. The gold rally will be over only when stability returns to US monetary policy, the US (global) credit system and the $US.

For some clue about when that might be, here’s a chart of Japanese interest rates for the past thirty five years. Take note especially of the last sixteen:

The beauty of gold is that it’s a two way bet. Either overcapacity and demand shortage mean currency destroying stimulus is eternal. Or, it goes the other way, and inflation surges back globally via a debased $US and inflating commodities. My own view is we’ll see a dramatic lurching between the two as far as the eye can see.

Make no mistake, gold is very volatile. But in trend terms, the rally has just begun.

Houses and Holes

David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.

He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.

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Comments

  1. And in the last 16 years ( plus) Japanese property has done what? Stock have now “plate.a..u…ed…”; so Gold ‘is it?” ( or The Last Man Standing, anyway). Then where are we off to? Or do we end up with deflated assets across the entire spectrum… and start again? If so, where, please!

  2. Damn! Instead of working in air conditioned offices shuffling bits of paper aimed at reducing productivity some of us might have to go back to work and make things in factories that are not air conditioned! Gad! We might have to sweat! Oh Yuck!

  3. I started on “Gold” when it was about $320. before that I didn’t have any spare cash at all anyway. I bought Gold shares. They did very well. In the GFC they got killed but I was still well in front. Post GFC it was spectacular. I’m no pretty much out of Gold shares and hold a fair amount of physical Gold. Stupidly about 6 weeks ago I sold some ETF’s in Gold and Silver to buy some other resource shares.
    Bernanke is going to ignore inflation. He virtually said so in teh last few days, He is not going to raise interest rates so H&H looks pretty spot on for the future. I don’t think teh RBA will ignore inflation but they will still run a highly negative after tax real interest rate….I’m not too sure what that means for interest rates for the rest of us.

  4. H&H In my real life I’m an importer helping with the CAD that economists seem to think is absolutely necessary! Originally, post uni, I was a farmer. I looked at it 30 years ago and how the economy was running and I knew I was in the wrong game!
    I was wishing I could get back into it about 4 years ago but I’m a bit too worn out for the work involved these days.

    • I agree BB.

      I was up to the early hours last night trading gold (my only successful intra-day trading is in PM’s) whilst writing.

      Its definitely broken out of its reverse head and shoulder pattern: this looks like an accelerating uptrend.

      The behaviourals are in place, as H&H opined – either currency destroying stimulus will continue unabated, or inflation will not be contained – the trade is no longer contentious.

      Look at the price of gold in Yen during their 2 lost decades. http://goldprice.org/charts/history/gold_20_year_o_jpy.png

  5. It has been said that gold is in a bubble. A cursory check of the charts at sites such as Ktco and goldprice over the past 20-30 years will quickly demonstrate the fallacy of this delusion.

    No one in their right minds could consider gold is ‘in a bubble’ anymore than the stock market is in a bubble.

    Gold, and silver I might add, have been continually and consistantly rising to the point where they could be considered a safer investment than housing or, dare I say it, government bonds?

    Part of what is driving it of course is the desperate efforts of Bernanke and the like to maintain the status quo. Rather like a gambler playing more and more to recover the losses he is accumulating by playing more and more to recover the losses he is accumulating by playing more and more…. and so it goes on.

  6. I didn’t realise you were a gold bug.

    I agree the gold rally will end when sanity returns to US monetary policy. I wouldn’t entirely discount that as a possibility. Outside of Bernanke the Fed is becoming more hawkish, and the Republicans look set to shut down the US government if they don’t get their way on spending cuts.

    If you believe the likes of Adam Carr the US economy (outside of housing) is going gangbusters, so why wouldn’t there be a hike in 2012?

    Adam Carr writes…

    t’s important to note the growing spilt within the Fed regarding stimulus and its appropriateness. There were no formal dissents but the March minutes out last night showed that “a few participants indicated that economic conditions might warrant a move toward less-accommodative policy this year”. Indeed, “participants’ judgment that the recovery was gaining traction reflected both the incoming economic indicators and information received from business contacts. Spending by households, which had picked up noticeably in the fourth quarter, rose further during the early part of 2011, with auto sales showing particular strength.”

    Moreover, FOMC participants noted the “significant decline in the unemployment rate over the past few months” while noting that other labour market indicators suggested a more modest improvement. Fact is, it looks as though the Fed’s risk assessment has changed quite a bit, notwithstanding the overall view that risks were balanced and that “the information received since their previous meeting was broadly consistent with their expectations” (in suggesting that the economic recovery was on a firmer footing). The general flow of discussion, however, paints a different story. This is a Fed that is becoming much less dovish. While Bernanke and Dudley et al may view the recent lift in commodity prices as a transitory inflation spike, the Fed noted they posed “upside risks to the stability of longer-term inflation expectations, and thus to the outlook for inflation”.

    The Fed, it seems, is also at the cross-roads. Nothing is going to change near-term and Qe2 will almost certainly be completed, but if the dataflow continues as is, we may see the balance of opinion change rapidly thereafter. I still think Bernanke and Dudley would love to print more money and will look for any excuse to do so. Qe3 cannot categorically be ruled out then, and indeed there were a few members who thought that exceptional stimulus could be appropriate into 2012. But there is not a lot of data supporting their bias and it looks unlikely to get broad-based support.

  7. Interesting the Keen – Noland connection but I don’t follow Keens “Central bankers have very little ability to constrain the financial system’s generation of credit, and what powers they once had were jettisoned over time with the fetish for financial deregulation”. Noland regularly points out the ‘inflationary’ effect of “timid if well meaning” central bankers.

    And stability in monetary policy & global credit!? Are you suggesting a return to the gold standard? A stable credit system is impossible without a standard measure of value, which the obligations of central banks & their government overlords are not.

  8. Good article.

    Regarding gold being in a bubble it’s clearly not, and gold is about 0.7% of the global investment so take all the other asset classes and you can pick bubbles in stocks due to QE’ing, but there is such a small amount of money coming into PM’s. The prices of Au/Ag could be higher if the COMEX was better regulated, and the volumes on COMEX just can’t be physically delivered if you look at the annual mining output, and the levels in the warehouse.

    Given the global economy is getting more strained, and either the US defaults on say foreign debt, or just keeps on QE’ing and either will support gold/silver moving higher. Additionally, Roubini (5th April Tech Ticker) says he thinks China will hard land by 2013 so that has massive implications for the global economy, and specifically for Australia. Governments/Countries are in a debt trap so PM’s need to part of one’s insurance. Talk of rates going up as well, and that will happen, but it will put more pressure on the sovereign/personal debt. For Australia the 50% of foreign sourced debt will cause housing stress. Not a pretty picture emerging.

  9. I’m worried.

    I was going to add some more gold to my portfolio but we’re all bulls.

    Hopefully we are different (this time).

    • just remember there’s an inch or foot of skepticism here too David H – as I mentioned before, this is probably not the time to be buying physical gold, but rather taking advantage of the next phase in the bull market.

      • Prince, do you mind expanding on what you mean by your last sentence? Be gentle I’m just only a financial novice…

  10. Would love to read MB’s position on the likelihood of deflation/inflation/stagflation – any chance?