Home' Australian Resources and Investment : March 2017 Contents Gold therefore closed 2015 in
limp fashion, with market
experts fully expecting the Fed
to follow through on its commitment to
three to four rate increases during 2016.
Gold, however, did the exact opposite.
It surged out of the blocks during early
2016, as it became obvious that the
Fed's rate talk was exactly that -- all talk
and no action -- and gold has sustained
its positive performance right up until
the unprecedented US election result.
And here we are 12 months later, with
the same so-called experts opining that
the Fed will get tough on rates, the dollar
will continue to soar, rates will rise -- and
gold will be in the doghouse. Of course,
we heard all this 12 months earlier under
almost exactly the same circumstances --
and the opposite transpired.
What is incredulous, from my
perspective, is the fact that the Fed,
along with a host of bullish economic
commentators, pointed to the supposedly
robust health of the US economy. They
simultaneously pointed to the surging
Dow as some sort of additional positive
re ection of economic wellbeing.
If things are as economically rosy as
the experts suggest, then why hasn't the
situation justi ed more than the measly
single 25-basis point rate rise that was
implemented in December 2016? The
reality is, of course, that things aren't as
rosy as a booming Dow would suggest.
Helicopter money has in ated equity
prices to an enormous extent, while the
more accurate indicators of economic
wellbeing, such as labour force
participation rates, productivity levels
and real wage growth, point to economic
malaise. Earnings per share (EPS) for
companies have been bolstered by share
buybacks using cheap money, while
actual productivity has stagnated.
The gold price reaction in the
immediate wake of the Trump presidential
victory was interesting, if not bewildering.
The so-called expert consensus that
predicted a price surge to $1500 in a post-
Trump world had evaporated, and even
been replaced with dire price predictions
of a fall to below $1000.
Markets have responded to the
Trump victory in several ways that seem
contradictory. Base metals and the
dollar index have risen strongly based
on in ationary expectations, while gold
and oil had initially fallen based on
de ationary expectations.
In my view, the systemic risks that
existed prior to the presidential election
have not suddenly disappeared. The
reality is that there are three key
factors that will work in gold's favour
-- which markets have completely (or
US dollar strength a negative for
The rst factor relates to the US
dollar itself, and the challenges that
a rising currency presents for the US
economy. Markets have factored in a
Trump growth explosion, with a heavy
emphasis on job creation, a renaissance
in manufacturing and export growth.
But a strong US dollar is a killer
for manufacturing and exports in
particular. Emerging markets will shy
away from purchasing from the United
States when their own currencies are
weakening relative to the dollar.
In my view, now that Trump has
assumed power, there is likely to be a
focus on ensuring that the dollar trends
lower. It would not be surprising to
see stimulus that is targeted towards
growth. Overall, the current dollar level
is not ideal for exports growth, and that
is likely to change in the coming years.
Trump himself has said that the strong
US currency is 'killing American exports'.
The other major consequence of a
very strong dollar is that it is in fact
de ationary, not in ationary. A strong
dollar is destabilising for emerging
market nations that have to pay back
their debt in dollars. A very strong dollar
is indeed de ationary, as are weak
Simultaneously, bonds are also
weaker, based on expectations of rising
de cit spending and in ation. Higher
bond yields would seem to undermine
the idea of higher stock prices,
especially with valuations near all-time
highs (perhaps second only to levels
seen during the dot-com bubble).
Higher rates impact debt servicing
Markets have also failed to take into
account the impact that rising interest
rates would have on the US economy in
terms of servicing the enormous level of
debt that has built up.
The graph adjacent shows the
amount of federal debt outstanding over
the past 20 years. As is clearly evident,
federal debt exploded upwards with
the nancial crisis of 2008 and began
its meteoric ascent to more than $19
Given its sheer size, if the interest
rate on that debt were to rise by
even one per cent, the annual federal
deficit rises by $190 billion. A two per
cent increase in interest rate levels
would up the federal deficit by $380
billion, and if rates were five per cent
higher, the annual federal deficit rises
by $950 billion.
In the case of the United States,
interest rates have been controlled for
some years now through the actions of
the Fed. At the very same time that the
federal de cit has been soaring, the Fed
has been creating trillions of dollars
out of nothing and using this brand-
new money to purchase US debt -- not
directly from the US government, but
through the markets.
In doing so, the Fed has taken
control of interest rates in the short,
medium and long term in the United
States. Thus, there is nothing fortuitous
or 'lucky' about the current very low
interest rates -- rather, they are a direct
result of governmental policies. And if
rates rise, the US economy will have a
But as we've seen over recent years, the
Fed has done a lot of rate jawboning, with
little follow through. And in my opinion,
this situation is likely to continue.
Interestingly, since 2000, gold has
been the top-performing asset class,
winning out over both equities and
bonds by a wide margin, as the graphic
opposite clearly demonstrates.
It's not about higher rates per se,
but real interest rates
How often do we hear commentators
mouthing the line about rising rates
70 • Australian Resources and Investment • VOLUME 11 NUMBER 1
Links Archive December 2016 June 2017 Navigation Previous Page Next Page