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Gold has been
holding steady in the the $1,600-$1,800 band since
early October. This could be attributed to consolidation after last summer's
historic run up to $1,895, but I think this wait-and-see attitude reflects
current market sentiment toward the US dollar.
In fact, the
first few days of April have seen a sharp dollar rally and decline in gold.
This is rooted in deflated expectations of a third round of Quantitative
Easing (QE3) after the most recent Fed Open Market Committee (FOMC) meeting.
Once again, the markets are responding to the headlines while losing sight of
the fundamentals.
This is
especially peculiar because the Fed did not explicitly take QE3 off the
table. In fact, according to the minutes, if the recovery falters or if
inflation is too low, the Fed is already prepared to launch QE3. While there
is not much chance of low inflation, I'll explain below why the recovery is
not only going to falter - it's going to evaporate like the mirage that it
is!
Trade Deficits
The Obama
Administration is touting recent job growth, and while this is a pleasant
story to hear in an era of massive unemployment, it disintegrates when put in
context. The 227,000 jobs gained - which merely kept the unemployment rate
steady at 8.3% - were counterbalanced by a much worse trade deficit tally:
$52.4 billion, the highest level since just before '08 crash.
The trade
deficit is a real measure of whether our jobs are producing enough wealth to
pay for our consumption. If we were adding productive jobs, I would expect
the deficit to be shrinking. A look at the data shows that employment
increased by only 16% in the primary and secondary sectors, where we need
them the most. The majority of new jobs are still inflated sectors like
healthcare (26%), temp work (20%), hospitality (19%), and consulting (16%),
which will disappear as fast as they appeared when the bubble collapses. This
is what we saw in finance and real estate when the housing bubble burst in
'08.
Imagine the
trade deficit is like a corporate balance sheet. You hire a bunch of new
employees for your company, but instead of making bigger profits, you find
yourself losing even more money than when you started. Are you going to hold
on to those people?
Stress Tests
While
President Obama is focused on jobs, the Fed has been promoting a recent round
of "stress tests" that show the financial system to be in good
shape. Unfortunately, yet again, the headlines are not what they seem.
The recent
tests were designed to measure big banks' ability to survive another
significant drop in housing and stock prices; but those bubbles have already
largely popped. What the tests failed to account for is what I consider the
most likely scenario: rapidly rising interest rates amidst a dollar crisis.
Interest
rates are the real risk. I think the Fed knew the banks would fail this test,
so they simply ignored it. It wouldn't be the first time the Fed has turned a
blind eye to a bubble market. For years, Chairman Bernanke and other Fed
officials denied the housing bubble existed; and as late as 2008, well after
it popped, they assured us the damage would be contained.
Supporters
say the Fed knowingly didn't account for interest rates because the central
bank has complete control over them. Many in Washington and on Wall Street
honestly believe that the Fed can continue to print money to buy Treasuries
without increasing inflation. A scenario in which the Fed is forced to choose
between US government bankruptcy and US dollar collapse seems impossible.
In fact,
higher interest rates are not only possible, but probable. The stress tests
assume long-term Treasury note yields stay under 1.8%; but that figure is the
current six-month low on the 10-year, which is already dragging along its
historical floor. As I write, yields are already up to 2.2%. The post-war
average is about 5.2% - high enough to crater today's banking system.
Remember, the
rate needed to break the back of inflation in 1981 was a whopping 20%. At
that level, there wouldn't be federal tax money left for the military,
Medicare, Social Security, or even law enforcement - it would all be going to
interest payments.
Even now,
interest rates are a complete farce. In 2011, the Fed purchased 61% of new
Treasury debt, compared to virtually none before the financial crisis
started. This shows that at current rates, demand for US debt is already
drying up.
Extended Interest Rates Pledge
It should be
no surprise, then, that the Fed has paradoxically celebrated economic
recovery while pledging to keep interest rates near zero through 2014.
First, even
with an economic recovery, these low rates will continue to drive precious
metals higher. Anyone who says this "recovery" will sink the gold
market is misunderstanding what drives the gold prices - inflation.
Second, the
Fed wouldn't be keeping rates so low if the recovery were genuine. If I say
to you, "Yes, you can now ride a bike," but I refuse to take off
the training wheels, would you believe me?
The truth is
that Bernanke knows the recovery is phony and is using inflation to mask it.
This bodes doubly well for gold.
CPI
Another fever
notion is that inflation isn't really a threat, no matter what the Fed does.
This is borne of the belief that "deflationary forces" are so
strong that no amount of printing will overcome them. Core CPI figures are
cited as proof.
Last quarter,
Core CPI was up only .01% in February (the latest figure). This sounds low
until you add in food and fuel - then it jumps to .04%, yielding an
annualized figure of over 5%. This is well above the Fed's self-proclaimed
target of 2% per annum, yet we hear no explanation or apology.
The reality
is even worse, as the true rate of inflation as calculated by independent
observers is closer to 10%. This means you can expect gold to rise 10% per
year just to maintain your purchasing power.
Consider the
price of gas which is almost $4 a gallon. President Obama is pledging to
release oil from the strategic reserves to keep the price down - but it's not
a supply problem. Those reserves are for a short-term crisis that disrupts
the oil supply, but there is no disruption - oil is flowing. Oil production
in the US is the highest it has been since 1993 and consumption is down below
'97 levels due to the recession. After all, there's no reason to buy gas to
commute if you're unemployed. The problem is inflation making the money we
use to buy gas worthless.
Proof? A couple
of pre-'65 silver dimes can still buy you a gallon of gas, while a couple of
post-'65 base metal dimes won't even buy you a pack of gum in the convenience
store.
The dollar
has lost so much value that the government actually loses money on every penny
it creates. Not because they're made of copper, that became too expensive
long ago. They're actually made of zinc - a metal so cheap it's priced by the
metric ton - and they're still too expensive.
So, where's
the inflation? Everywhere!
Recovery Fever Will Be Broken
It's becoming
very easy for a skeptical observer to poke through the veil of recovery.
Unfortunately, most market participants still seem to hang on Uncle Sam's
every word. This is a great danger for our economy and a great opportunity
for the wise investor.
When an asset
like gold moves sideways for a while, even those with good instincts get
complacent. They start to view this as the "price level" rather
than an extended dip below true valuation.
Recovery
fever will wear off as Washington is forced to release propaganda that is
more and more incongruous with facts on the ground. And gold will resume its
climb in earnest.
Peter Schiff is CEO
of Euro Pacific Precious Metals, a gold and silver dealer selling reputable,
well-known bullion coins and bars at competitive prices. To learn more,
please visit www.europacmetals.com or call (888) GOLD-160.
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