How Debt, Quantitative Easing, and Reckless Politicians Will Drive Gold and Silver in 2014
No one knows what 2014 will hold but one thing is for certain: In February, politicians will reconvene in Washington D.C. for yet another chapter of the debt ceiling issue.
The can was kicked down the road yet again and you can bet more political showdowns are sure to come. Why? Because going into this next debate, Republicans and Democrats alike will be forced to stand their ground. If not, then what are they even standing for?
Recently the Fed announced the continuance of Quantitative Easing Part 3, or QE3. The message was that while the economy has been growing, growth has been slower than desired so more stimulus will be needed. It appears that even with historic levels of stimulus, this economy still cannot get back on track.
Back in November of 2008, the first leg of Quantitative Easing was undertaken by the Fed. Over the past five years, many have lost sight of just how much debt we have taken on. If you take a closer look, it’s staggering.
Results of QE Program so far:
On the Bright Side
The positive effects from Quantitative Easing have been suspicious. Five years ago when stimulus began the DOW was around 7,500 and has doubled to over 15,500 today, very close to all-time highs. In recent years the government reported the unemployment rate improved dramatically. After hitting 10.6% in January, 2010, it has fallen to 7.3% in August of this year. Many question the legitimacy of this number, and cite the drop in unemployment to the fact that more and more people have just stopped looking for work altogether.
Historically low interest rates have stoked housing markets across the country and we have seen a powerful recovery from the depths of the real estate crisis. It is hard to say that everyone has benefited when so many have had to sell their homes or face foreclosure, and it is certain that borrowing money can’t get much cheaper. Mortgage rates seem to have bottomed at historic lows, which really is what has been driving most of the demand in the first place.
We have to ask ourselves: What effect will this $3 Trillion experiment have on the fundamentals of the Dollar? In every single instance across history, out-of-control government spending has not resulted in a positive outcome.
Another important thing to consider is what will happen if we begin to slide into a recession? Will QE jump from $85 Billion to $200 Billion a month or more?
Currently, the stock market is totally dependent upon the $85 Billion each month to maintain these lofty levels. Many have compared the stock market’s addiction to economic stimulus to a heroin addict dependent on their next fix. Most people’s retirement accounts are directly linked to the performance of a stock market that is computer-driven and reliant upon free money to maintain current prices.
I don’t think anyone can argue the merits and necessity of QE1 during the brink of economic collapse around 2008. Faith had completely left the system and something drastic had to be done. The problem is, two trillion dollars after QE1, we still don’t have a clear path out and we are reliant upon the government, not free markets, to get the job done. While experts across the globe have debated these facts, only time will tell how this all plays out.
Though there have been a few bright points in the past two years, there still remains a persistent drag on the economy that teeters on a very weak recovery and huge deficits. There is a sense that everyone is still looking over their shoulders for the other shoe to drop, wondering if this dark cloud that has been hanging over the economy will ever dissipate. It’s obvious to us that reliance upon Fed stimulus is a treacherous path that should be traveled with extreme care.
What’s Next For Precious Metals?
As we see it, there are several factors on the horizon that could lead to much higher prices. Here are some of the most important, and plausible:
1. Recession: Should the U.S. economy, which is slowly growing at the moment, begin to slide into recession, the Fed will have no choice except to continue printing. The classic definition of inflation is an increase in the money supply. Inflation has always been the best friend of gold.
2. Continued Political Antagonism: Recent polls show Congressional approval at its lowest point ever. Gold often does best when faith in government is falling. Next February there is no doubt there will be more fighting between parties on Capitol Hill with a strong possibility of another government shutdown.
3. Weakening U.S. Dollar: The U.S. Dollar index is around 5% away from new all-time lows against other currencies.
4. Inflation: Everyone knows that inflation is far worse than the government is reporting. Just ask anyone with a family or bills if it costs more to live today as opposed to five years ago. The reason the government reported inflation figures are around 1.5% is because they don’t include food and energy costs in the calculation anymore.
5. Europe: Much like the debt issues we confronted here in October, the European debt crisis was “papered-over”. It will come to the surface again at some point very soon. Each time the situation comes back into play it has been positive for precious metals and negative for global equity markets.
6. Inelastic Gold Supply: The huge run-up in gold prices over the last decade has done very little to increase supplies. In 2001, total world gold production was 2,600 tons and gold averaged $271. In 2012, total world production was only 3.8% higher, at 2,700 tons, despite a 615% increase in the gold price.
If or When the Fed Tapers, Will Gold Go Down?
I was having this discussion with my friend Frank Beck, chief investment advisor at Beck Capital Management here in Austin. Frank was recently quoted in Barron’s with his thoughts on how the Fed should tackle the difficult subject of tapering.
His suggestion is for the Fed to cut monthly bond buying by a small but steady $4 billion a month until it eventually falls to zero. This would enable the market to slowly digest the event, as opposed to a dramatic, all at once, taper.
If the taper does occur, it will most likely have a negative effect on the stock market and possibly, at first, a negative effect on Gold from a stronger dollar. However, we believe the sell-off in Gold would only be temporary.
Due to rising interest rates, returns on traditional investments like stocks and real estate would begin to falter and investors around the globe who were so dependent upon the “free money” environment from QE would be forced to look elsewhere for returns on their money. One of these places will undoubtedly be precious metals, which over the past few years have returned to very attractive levels.
The uncertainty of how the Fed is going to handle tapering has caused much volatility in stock markets and precious metals prices. In mid-September, many were expecting the Fed to announce a decrease in the bond buying program, but it didn’t happen. Over the next two hours the price of Gold jumped by nearly $75 an ounce from $1290 to $1360!
It’s this type of price action that investors need to be aware of in understanding just how quickly things can change.
Recently the 2013 Nobel Prize winner for Economics, Dr. Eugene Fama, was interviewed on CNBC and referred to unwinding the Fed’s $4 Trillion balance sheet as a “non-event”. On the other side of this argument are investors like Paul Singer of Elliott Management quoted as saying:
“The recent trading environment has felt something like walking into a place and having a sense that something is wrong and dangerous but not knowing exactly what will happen or when. “QE Infinity” has so distorted the prices of stocks and bonds that nobody can possibly determine what the investing landscape would look like, or what the condition of the economy and financial system would be, in the absence of Fed bond-buying.”
While we are not calling a bottom in metals prices, we do believe many of the issues and reasons outlined here are extremely important to consider. At this point in time, nobody really knows what to expect. The fundamentals for higher metals prices haven’t changed at all. In fact, based on the U.S. debt chart below, they are getting stronger by the minute. Even though we live in a world where bad jobs reports are good….at some point logic and reason will return. When that happens, you had better be diversified. Gold currently has 50% upside potential at current levels if it just returns to its all-time high of $1,900 per ounce in 2011.
If you have any questions or need assistance, don’t hesitate to give us a call. For the past 25 years we have been helping people just like you to protect their wealth privately in physical precious metals. 1-800-928-6468.
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