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BookmarkWhy 2013 could be the best year to buy gold since 2008
Quantitative easing, the oft-referenced $85 billion per month shelled out by the Federal Reserve, comes down to the purchase of two kinds of securities — U.S. Treasury paper (bonds, notes and bills) and mortgage-backed securities. The Federal Reserve buys the Treasury paper from the federal government and the mortgage-backed securities from commercial banks. The first is a direct form of monetization (money printing); the second is an indirect form since a good portion of those funds are in turn also used by the banks to purchase Treasury paper. The two together comprise the bulk of what appears on the Federal Reserve’s balance sheet as “reserve bank credit.” At the present that figure stands at just over $3.2 trillion — up about $2.4 trillion since the beginning of the financial crisis in late 2008.
When you superimpose the gold price over reserve bank credit on a chart, it looks like this:
At first glance, it looks like reserve bank credit and the gold price are correlated, but what is really going on with this tandem is that they are both being pushed by the same force — a bad economy. It causes the Fed to print money and investors to buy gold.
The Financial Times ran an editorial the other day explaining why some top-notch hedge fund managers — like Paul Singer, John Paulson, Stanley Druckenmiller and David Einhorn — don’t like the U.S. Federal Reserve or chairman Ben Bernanke, the father of the QE policies charted above.
“His [Druckenmiller's] concern,” the editorial explains, “is not the risk of inflation, which has prompted investors such as Mr Singer and John Paulson to load up on gold. Instead, it is a broader concern that has been voiced by growing numbers of the most powerful and influential professional investors: that by pushing down interest rates and buying up government bonds, the Fed is warping the norms of economicbehaviour.”
Most importantly capital, according to this group, this misallocation of capital has hasdriven ordinarily risk-averse investors into dangerous financial waters. “What kind of entity,” warns Seth Klarman, another hedge fund manager, “drives the return on retirees’ savings to zero for seven years in order to rescue poorly managed banks? Not the kind that should play this large a role in the economy.”
It is these kinds of distortions, though, that create opportunities in investment markets, which leads me to the reasons why I went to the trouble of compiling and publishing this chart:
First, reserve bank credit has gone vertical since November’s near-term bottom — up over 15%. The Fed might reverse or moderate its purchases at some point in the future, but at the moment, it has the pedal to the metal. While Ben Bernanke couches his rhetoric and keeps the markets guessing, he quietly – in reality — engages the Fed what could be a new round of quantitative easing. In short, the markets should be paying attention to what the Fed does, not what it says.
Second,, the gold price, as a result of its recent plunge, has crossed decisively under the reserve bank credit trend line. The two developments together have made for an interesting chart divergence — the sort of thing that catches the attention of technicians and value investors alike, particularly if it defies logical explanation. This latest correction, more than any I can remember, has the experts scratching their heads. (Please see “Illogical dumping. . .” below.) When an upward or downward spike in the market proceeds sans logical underpinnings, a snap-back rally or correction often follows. The last such incident in the gold market occurred in 2008. The market sold-off roughly 30% at the height of the financial crisis, and then regained and superseded those losses before 90-days had elapsed. (From there the market climbed to all time highs in 2009.)
Third, should the quantitative easing program finally ignite price inflation, we might see an entirely different chart pattern emerge — a different kind of divergence. Gold could go vertical while reserve bank credit stays level or heads south depending on the Fed’s ability sell-off the securities it accumulated during the quantitative easing stage.
That same Financial Times editorial concludes with this important observation on the behavior of hedge funds and hedge fund managers:
“‘Part of the pressure comes from knowing, or sensing,” says Richard Fisher, president of the Dallas Federal Reserve, “that at some point you are going to get a reversal. If I was in my old business I’d be looking around [asking] how am I going to make money without taking undue risk?’ It is a big problem for the masters of the universe. They live for distortions in markets, which provide them with opportunities to throw billions of dollars at a brilliant trade that will push prices back in line with reality. Successful hedge fund managers make their reputations by being clever, brave or fast enough to seize on these chances.”
One of those distortions looks like it may have materialized in the 2013 portion of the gold-reserve bank credit chart. The press greatly emphasized the withdrawals at the gold exchange traded funds over the past several months. What it failed to mention is that there are two sides to every trade. Someone was selling, but someone else was buying (and I’m not talking about just Chinese mothers and Japanese housewives). Even now the gold price has rallied off its lows, and someone is buying the mini-corrections we have seen since the big dump in April. If the longer term pattern on our chart reasserts itself, a significant upward adjustment in the gold price could be in the cards — a change of course that could end up making 2013 the best year to buy gold since 2008.
