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It’s now nearly two months
since gold registered an
all-time high of $1,227 an
ounce, following a five-month run during which the metal rose
more than $300 an ounce. From a long-term perspective, this is a remarkable
380 percent trough-to-peak
gain from its early 2001 cyclical low point of $255.
Gold’s strength
last year reflected a number of factors:
(1) record worldwide
private investment demand
(thanks, in part, to rising inflation
expectations, pent-up demand from China, and the popularity
of new gold investment vehicles in various markets); (2) net official purchases (after two decades of
net selling) as some central
banks sought insurance against further devaluation of their dollar-denominated
assets; and (3) at times, a weaker
U.S. dollar.
Gold and the Dollar Continue Their Dance
Since then,
mostly reflecting the “strengthening”
U.S. dollar, the yellow metal eased off a bit, falling as low
as $1,075 last week - a correction of some 12 percent - before bouncing back at the beginning
of February.
The catalyst to dollar
strength - measured against the euro,
Europe’s common currency, or a basket of key
currencies - has been heightened fear of sovereign
debt default.
First it was doubts about Dubai-government guaranteed debt that rattled the markets and
gave the dollar a boost.
More recently, market fears that Greece
will be unable to meet its
public debt obligations - and talk that Ireland, Portugal or Spain may follow - has pushed the euro
to its lowest point in six months and
the dollar to its highest
level in five months against a basket of currencies.
It baffles
me that so many foreign-exchange traders and institutional
investors around the world think
of the dollar as a “safe haven” at a time of currency-market turmoil and continued U.S. economic and financial market crisis. Just look at the
facts:
Economic Policy - Limited Choices
President Obama has
just proposed a $3.8 trillion
budget for fiscal 2011 that projects the Federal deficit will balloon to a record $1.6 trillion following last year’s $1.4 trillion deficit - and there is not much hope to
bring the deficit down to acceptable levels in the next few years,
particularly with a persistently weak economy, persistently high unemployment, falling tax revenues, and, eventually, rising interest rates that will push the Treasury’s borrowing costs much, much higher.
Meanwhile, the
Federal Reserve continues, as
it must, to buy Treasury and federal housing agency debt and
to hold its key Fed funds
policy rate (the rate at which it
lends to the banking system)
near zero.
And, it remains
very doubtful that the Fed
can cease financing the growing deficit or withdraw funding
the housing section or raise
interest rates without economic activity falling sharply.
Our dysfunctional government lacks the ability to
deal with America’s
economic problems . . . and the public
lacks both the stomach and
the wallet to take the painful
remedies necessary to put America
back on the right track.
Official Data - Not
As Rosy as It Looks
Moreover, it
will soon become increasingly clear that our economy
is performing much worse than
headlines lead us to believe.
Last week, the Commerce Department reported GDP grew by 5.7 percent in the fourth quarter
of 2009. Not mentioned
widely in the press, 60 percent of this
gain was inventory-related
. . . but not even an increase
in actual business inventories, just a slower pace of inventory
depletion that doesn’t add to industrial activity, real growth, or higher employment.
Instead, domestic
consumption and real business investment, that together indicate the pulse of the economy,
rose by merely 1.8 percent. And, much of
this has been fuelled largely by government
money and Federal stimulus.
Fifteen million
Americans are now unemployed and more than
450,000 workers register for unemployment benefits each week. The “official”
unemployment rate is at 10 percent and likely to
be reported higher in the next month or
two. Counting part-timers looking for full-time employment and those too discouraged
to continue looking for work,
the “actual” unemployment rate is probably close to 20 percent.
Those of us still employed are increasingly anxious and fearful
that we may soon join
our unemployed neighbors. And more “foreclosure” signs are appearing
in neighborhoods across the country. As a result, the household
savings rate is rising - and Americans are spending less.
This is not a picture
that suggests personal consumption, which typically accounts for more than
two-thirds of GDP, will be sufficient to trigger a virtuous circle of spending, business activity, employment, increased tax revenues, and a naturally decreasing Federal budget deficit, as forecast by
the Obama Administration in its
latest budget proposals.
Monetary and fiscal policy - typified by quantitative easing and a rapidly expanding monetary base, along with various
“stimulus” programs
that do little to improve our
national infrastructure or
international competitiveness - are
ultimately inflationary and will debase our currency’s purchasing power regardless of the exchange
rate with the euro or other
key currencies.
More Inflation Than We Think
In fact, it only
takes a trip to the grocery
store to realize that inflation is much higher than
the monthly consumer and producer price data suggest. Recent month-to-month data has been
skewed downward by faulty seasonal
adjustments, but on a year-over-year
basis, the December consumer price index rose
by 2.7 percent and the producer
price index rose by 4.4 percent.
And, even these numbers underestimate actual inflation due to the depressed imputed rental cost of housing
and other adjustments to the data.
Policymakers at
the Fed and within the
Administration base their
policy judgments on the core rate of inflation, which excludes both food and
energy. Because these are the
two sectors where inflation is most likely
to manifest, policy will inadvertently have an inherent inflationary bias.
Policymakers are
also missing the inflationary impulse from abroad via the continuing raise in commodity prices. China, India, and other emerging
industrializing economies
that are leading the world
recovery (and are increasingly less dependent on business-cycle developments in the industrialized world) are committed
to industrial and infrastructure development, and have rapidly growing middle classes demanding improved diets, more automobiles, better highways, bigger homes with dependable
electricity and household appliances.
The likely outcome is rising demand
and much higher prices for key commodities
including oil, steel, copper, cement, platinum-group metals, silver, zinc, specialty metals, and agricultural
goods.
Gold - The Ultimate
Safe-Haven Currency
Against this economic backdrop - especially the inability of America to deal effectively with our economic problems, more of the same from
economic policymakers, and the inevitable
rise in U.S. inflation rates - it is
only a matter of time before the dollar’s
safe haven appeal diminishes and gold regains
its status as the ultimate
safe haven.
Disclosure: No Positions
Jeffrey Nichols
NicholsonGold.com
Managing Director, American
Precious Metals Advisors
Senior Economic Advisor, Rosland Capital
Jeffrey Nichols, Managing Director of American Precious Metals
Advisors, has been a leading gold and precious metals economist for over 25
years. His clients have included central banks, mining companies, national
mints, investment funds, trading firms, jewelry manufacturers and others with
an interest in precious metals markets. Please check his website and register
to his free newsletter by clicking here.
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