Quantitative Easing vs Price of gold (and the US dollar...)

29th Jul '20 by Philip999

14 comments 619 reads

With central banks busy printing money and the huge correlation in the price of gold rising to all time highs I'd love to stimulate some discussion about what the eventual outcome look like?

In the short term the Fed are now on QE4 and the UK and Eurozone have also joined the party, I don't suppose any knows the comparative figures worldwide? It's difficult to see how money printing will stop in the short term as governments deal with the fall out of Covid in the second half of this year and beyond. Handy link here which is a quick summary.

Where will this all end? Japanese low interest rates and low growth for the next 20 years or will inflation start to rise?

Gold has been the safe haven of choice and it's difficult to see how this will change, certainly in the next 6 months with US election uncertainty, Brexit and US Chinese tensions. On this theme the dollar is coming under pressure as well.

Penny for your thoughts?

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Alphaflight

30th Jul '20

The “true” or Rothbard-Salerno money supply measure (TMS) - is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth. This measure of the money supply differs from M2 in that it includes Treasury deposits at the Fed (and excludes short-time deposits, traveler’s checks, and retail money funds).

As you can see from the chart, the Fed’s balance-sheet was already growing in late 2019 with the quantitative easing the central bank refused to call quantitative easing. But total Fed assets surged to over $7 trillion in June. That set a new all-time high and propelled the Fed balance sheet far beyond anything seen during the Great Recession’s multiple rounds of QE. The Fed’s assets are now up more than 600% from the period immediately preceding the 2008 financial crisis.

The last gold bull run ended because “the market” believed the central bankers when they said that interest rate normalization would take place…well it didn’t and it won’t.

Some people in the mainstream are speculating that gold could be near its top. But that would assume the money printing is about to come to an end.

Jack Corsellis

With significant inflation here, and likely to be for some time, buy commodities! (and gold)

As the dollar continues to breakdown (via deliberate intentions) I think the new bull market for commodities will get underway... is already underway.

Lots of headwinds coming our way potentially:

According to Reuters, a report from the investment banking unit of Bank of China warned that China should prepare for potential US sanctions by switching away from the Dollar-centric SWIFT system, and increasing use of its own financial messaging network for cross-border transactions in the mainland, Hong Kong and Macau.

According to the BOC report, which was co-authored by a former foreign exchange regulator, greater use of the Cross-Border Interbank Payment System (CIPS) instead of the Belgium based SWIFT system would also reduce exposure of China's global payments data to the United States. The bank's chief economist Guan Tao was previously a director of the international payments department of State Administration of Foreign Exchange (SAFE).

The report looked at potential measures the United States could take against Chinese banks, including cutting off their access to the SWIFT financial messaging service, the primary network used by banks globally to make financial transactions.

"A good punch to the enemy will save yourself from hundreds of punches from your enemies," the report wrote, amid deteriorating relating between the world's two largest economies. "We need to get prepared in advance, mentally and practically."

The report said that if the United States were to take the extreme action of cutting off some Chinese banks' access to dollar settlements, China should also consider stopping using the U.S. dollar as the anchor currency for its foreign exchange controls.

jwebster

Bloomberg has some charts which show the relationship between money supply and the gold price is volatile and not really tradable, but the relationship between real interest rates and gold is stronger at least in the short term. Recently the real interest rate in the US has been dropping and gold rising.

In the really long term gold holds its value - there are some interesting calculations going back to the Roman age comparing the price of gold back then to wages at the time, showing gold has held its value across 2000 years.

In other words, holding gold on a big picture multi-year period is a good idea on the increasing money supply theme, but not so useful as a short term price indicator.

In the short term if real rates are dropping, the gold price tends to rise as a quick reaction, as gold doesn't have a yield so reducing interest rates boosts gold as a store of value, versus the alternative of bonds/money market.

As for the outcome for all this QE there are various scenarios.

One is inflation of course, although we haven't seen much of this in general goods because the supply curve is not fixed, i.e. due to internationalisation of production, cheap goods stay cheap as supply increases easily (China). Assets with more fixed supply have gone up since 2009 think property, stocks, etc. Also things not manufactured, e.g. private education, healthcare. So inflation may well come but perhaps not in the obvious places.

But another scenario is financial repression. This is where the govt debt is so high, any increase in the interest rate would force default, so the government forces rates down -> negative and mandates certain institutions to buy it (insurance companies, pensions, the central bank, etc.). Also taxes rise. So expect funny things to happen eventually like paper money is withdrawn all transactions/savings must be electronic so governments can tax deposits (negative interest rates). All this forces savers to pay for borrowers (the state) over time.

The big loser will be pensions, especially the defined benefits. No idea how these will ever be funded, they are effectively bust. Suspect the whole lot gets nationalised eventually.

In the long run holding cash is quite risky as it will get attacked from multiple angles. Gold is an option to store value.

jwebster:

You'll find this interesting:

http://pricedingold.com/uk-house-prices/

Note that UK house prices measured in gold are back at their year 1990 level:

Philip999

CP0001, thats a fascinating graph and really shows the magnitude of FEDs balance sheet. From a fiat currency perspective is it just a case that everyone is as bad as each other? I continue to search for some for of data to see who the worst culprit is!

Regarding gold being at its top, I guess $2000 is a huge psychological barrier , although in real terms we're not even close to the previous gold top when you adjust for inflation. It's not that I'm a particular gold fan, it's just hard not to see gold benefiting from a the additional money printing in the years ahead.

Hi JWebster,

What a brilliant and insightful post, thank you. I do agree about holding gold as an option to store value, is part of the answer how long governments can kick the can down the road? At what point will QE start a meaningful rate of inflation... or will it?! With globalisation at risk (US vs China) will this be the inflationary trigger that kick starts inflation or will it be something else... or anything? Look at Japan for example.

I did listen to podcast recently discussing electric money, China are already quite far down the road apparently and some more liberal nations are looking seriously at it (Sweden being one of them). I can't imagine many will be happy with the government having full visibility on everyones personal finances, more so than they already do so I guess. It does seem like the next obvious step and Bitcoin was an obvious precursor.

31st Jul '20

Yes, a govt issued digital coin will come. Huge benefits for the govt in the sense the ledger of transactions will be held centrally. So when you buy/sell anything the transaction is verified and recorded by the Govt. Perhaps the BoE is given this task.

The result is cash becomes easily taxable. VAT is an obvious place to start it can be collected in real time by clipping the ticket. Likewise tax on property transactions, duties and the like. Negative interest rates can be simply charged on daily balances.

Vert impactful on retail banks as their ability to create money through taking deposits and creating loans is gone. Banks will dissolve into more of a credit reference agency and collections shop. Thus, the Govt will take on the role of directly controlling the exact size of the money supply.

China has lead the way on this but it'll come here eventually.

I wonder about Gold and Silver that the Govt pulls them into a wealth asset tax regime to prevent leakage. Certainly the Gold price would go to the moon in the above scenario. Also Govts may need to co-ordinate the rollout of this similar to the international disclosure requirements on cross-border financial activity using bank deposit data, to prevent flight to the lowest denominator.

BitCoin et al would likely get a second wind as they use a private ledger.

Banks, pension companies are all dead under this scenario. I wouldn't buy HSBC, Lloyds, L&G at any price as a long term investment.

Interesting times. Still think Gold and Silver are good options as these events unfold.

Yes Sterling has been a poor store of value in the past - see GBPUSD rate below going back to 1960

Another positive of Gold is it removes you from Sterling currency risk and the ebbs and flows of the Uk economy (mostly ebbs it seems !)

Hi Philip999,

Yes I agree. I don't even think gold has got started yet however. Nevertheless these things are subjective.

The vast majority of people in the UK financial industry really don't understand or indeed value gold. I myself have a masters degree in finance as well as a degree in physics, I used to work for one of main investment banks before retiring and up until about 10 years ago I was completely clueless about gold and attributed no value to it.

If we look at the last 20 years since 2000, all currencies except for the Swiss franc are down 82-88% in real terms. Remember the central banks are all hoarding gold and continuing to acquire more, meanwhile they issue fiat money to us plebs:-)

Gold behaves a little bit like a put option on the economy (but unlike a put option, gold has no counterparty risk). Gold is the ultimate hedge basically .

pgs501

I have been thinking for a while the strongest bull case for Gold is "What else am I going to hold?".

The Super low interest rate environment (and reasonable expectation this will continue for a long period of time now) has had these effects on many other asset types and people are logically saying that at these prices my future return in other assets looks poor / risky.

1. Low interest rates & QE have driven down yields on government bonds to the extent that Greek 10 year government debt is currently yielding just over 1%; you are having to deal with some pretty poor countries to get any sort of return. That has then had a similar if diluted impact on the corporate bonds with everyone reaching for yield. Given these are the largest pools of cash a lot of bond investors cash could easily be leaving the bond market and simply being replaced by central bank printed money. I was amazed at a recent comment from Paul for example that actually all the additional government debt that has been issued by Rishi recently has basically just been bought by the BofE down the road. At these prices the best case scenario is almost zero return, and any thought that some countries will fail on their now even larger debts will cause a large loss for the investor.

2. For the stock market in general where the market is almost ignoring the enormous recession that is in full flow currently many will see at best low positive returns, at worst a big drop. There may be big winners in the next few years (big tech becomes bigger tech is one of my expectations) but far more losers than winners appears likely to me. As an aside I believe in a market like now services like Stockopedia will become even more valuable to me to ensure I do not buy some dross / highlight successfully growing companies that will quickly go for a premium.

3. Commercial property looks to be in serious trouble all over the Western world with Covid accelerating it. After 3 months of people relying on online orders and it working pretty well a lot of habits will have been formed. Prior to Covid the UK (19%) & USA (16%) had the highest sales % online, post Covid restart that could easily be 25-30%. Footfall and rents were already under downwards pressure and now it looks grim. Of course the REIT discounts on NAV show the price reflects this but will the discount shrink back and investors get a short term gain or the discounts remain as the NAV's drop over the long term?

4. Residential property depends on the geography quite a lot but people are understandably hesitant to leverage up at the moment. I can see a pretty good argument if you are a conservative investor (the type of cash that is getting priced out of the bond market as will not reach further for yield but not keen on stock volatility) getting into a residential REIT with a low leverage rate and decent discount but it appears less obvious to me.

4. Cash returns look fairly pathetic all around.

As such "let's just buy gold" appears pretty logical and as long as enough people are coming to that conclusion what else matters for the gold price? It is not like this was ever an asset backed by fundamental earnings anyway.

Leamas

Great posts CP001.

Thanks Leamas.

Really enjoyed reading everyones comments, I think PGs501 sums it up perfectly when he (she?) says... What else am I going to hold?

Does anyone have a preference on how to play the gold price/outlook? I've been holding 4 gold funds for the last 3 months, 2 focussed on large scale producers and 2 on the junior market. All are mostly safe jurisdictions in N America and Auss, with little debt to no debt and low cash costs. I like the leveraged play as it's hard to see the gold price not being generally supportive in this current environment and for the rest of the year and beyond. Even if the price of gold tails off by 10-20 percent these miners should in theory be kicking out record profits and I'd hope to see the junior sector play catch up as M&A activity kicks in. Of course all speculation on my part.

I still think theres value in the equity space and by hook or by crook the economy will recover I'm just being very sector/location specific generally as this should act as a natural hedge to my gold positions and I'm 50% cash at this stage!

Quantitative Easing vs Price of gold (and the US dollar...)

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Philip999

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