By Edmund Moy and Michael Stojsavljevich
have grown in value from the $400 level to over $1900 in the span
of 10 years. But since last September, gold has been sliding
downward and has been in a holding pattern around $1600 since about
October of 2011. What is causing the holding pattern, how long will
it last, and once it ends, will gold go up or down?
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Gold Prices Correlate with Fiscal Burden
When trying to forecast the price of gold, the most common
methods are to correlate gold to either commodities or fiscal and
Most commodities like gold and oil correlate well for short
periods of time so many assume that oil prices are a good indicator
for where gold prices will go. But gold has additional attributes
that most commodities do not have: it is a luxury good as jewelry,
a financial asset as coins and bars, and is highly liquid. That is
why gold prices correlate more closely with fiscal and monetary
policy while oil prices correlate more closely with consumer demand
and GDP growth.
Which fiscal and monetary indicators correlate best with gold?
Inflation, interest rates, and the trade deficit all correlate
better than commodities but each has their hard-to-explain
Evidence suggests that gold and the U.S. federal debt ceiling
have the highest degree of correlation as it relates to price
levels when compared to all other factors, with accommodative
monetary policy acting as a catalyst for growth to those price
The reason for the close correlation is that the
is likely the most comprehensive proxy for both fiscal and
Unsound Fiscal Policy + Accommodative Monetary Policy =
High Gold Prices?
Sound fiscal policy is a precondition for a strong and stable
currency, and stable currency creates low and stable gold
However, unsound fiscal policy usually leads to
currency-destabilizing monetary policy interventions such as zero
interest rates, quantitative easing, and currency interventions
designed to keep currencies artificially at existing exchange
rates. Those interventions often result in high gold prices.
While down from $1,900, gold prices are still holding at 400%
above a decade ago, which are a result of continued poor fiscal
policies and which have been enabled by accommodative monetary
policies across the developed world, especially in the U.S. and the
Gold prices will likely remain at this price level until either
the fiscal and monetary policies are fixed - or, as is more likely,
Sound Fiscal Policy Unlikely
Unfortunately, there are no signs that a return to sound fiscal
policy is near. Instead, sound fiscal policy has been replaced by
overspending and fiscal mismanagement. In the US, successive
trillion dollar federal deficits have grown the federal debt from
around $10 trillion to about $15 trillion in the past 4 years
alone. The President and Congress are in stalemate with no prospect
of a budget, much less a balanced or surplus budget anytime
Europe's widespread sovereign funding crisis will likely grow
larger as the GDP in most EU countries contracts to recessionary
levels, leaving a larger funding problem for the ECB and IMF. And,
despite the erroneous accusations that spending restraint is
restraining economic growth, it is the unsustainable fiscal
expenditures that are the root cause of Europe's slow growth.
Rounding out the big three, Japan's fiscal malaise drags on,
having already created two-decades of lost growth.
Central banks across the globe share the blame as well. In
response to the unsound fiscal policies across the globe, central
banks have intervened with ultra-accommodative monetary policies
which have enabled unsound fiscal policies that would otherwise be
For example, zero interest rates and direct quantitative easing
programs like those in Japan and the United States have effectively
monetized the fiscal gaps. The ECB is also engaged in a form of
quantitative easing via its LTRO program, which is a loan program
which delegates quantitative easing measures to the banking
industry, expecting them to buy sovereign bonds.
Putting together these fiscal and monetary mistakes, we term
these global economic policies "accommodative mismanagement."
And the greatest beneficiary of this global accommodative
mismanagement has been precious metals, including gold.
Explaining Gold's Holding Pattern
Why has gold stabilized at roughly $1,600?
Better than expected GDP growth in 4Q 2011 gave pause to gold's
upward move because it raised the possibility that increased tax
revenues would decrease the annual budget deficit, and thus the
national debt would grow at a slower rate.
Now, rising oil prices are limiting the Fed's short term
monetary policy tools by raising inflation levels very close to and
soon, potentially above the Fed's target rate, which reduces the
Fed's ability to deploy new quantitative easing measures and
Both issues have converged to slow gold's price movement,
placing gold prices in an extended holding pattern.
Ending the Holding Pattern
How long the holding pattern will last is uncertain, but we
believe three issues may end the holding pattern this year.
First, our national debt will hit the
U.S. federal debt
ceiling before the end of the year. The administration and Congress
will likely approve a new debt ceiling to nearly $18 trillion
dollars or more.
Second, if GDP growth slows from Q4 2011 levels in the US, cold
water will be thrown on the possibility that our economy will grow
enough that tax revenues to close the fiscal gap without having to
address unsound fiscal policies. The Q1 2012 disappointing growth
is just one data point. Disappointing Q2 2012 numbers could signal
that our mediocre expansion has stalled.
Also more EU countries may follow Greece, Ireland, and Portugal
into the financial abyss, adding new debt concerns globally and
increasing debt financing needs. The numbers just came out for
Spain and they do not look good.
Third, to remedy both our slowing economic growth and the
president and Congress' inability to agree on a sound fiscal
policy, the Fed may have to resort to a new round of quantitative
easing and other currency interventions. Later this year, the Fed
will have more room to act when inflation expectations come down
because of several probable factors: demand destruction in oil
prices, margin contraction in consumer goods, lower housing values
or lower GDP growth. Also by this time next year, year-over-year
comparisons in retail gasoline prices should moderate decreasing
inflationary expectations sequentially.
Will Gold Go Up or Down?
Once gold's holding pattern ends, will it go up or down?
While many investment analysts and the Fed have begun a public
relations effort to dismiss gold's value, one thing remains true.
Sound money is truly the only force capable of bringing the price
of gold down, just as it did in the early 1980s.
Under Reagan and Volcker, inflation and elevated commodity and
gold prices were corrected not by monetary accommodation and fiscal
overspending but by difficult decisions to raise the Fed funds rate
to high levels and to cut taxes to stimulate fiscal revenues. The
economic policies of the early 1980's stand in stark contrast to
today's economic policy of Accommodative Mismanagement, which
instead creates upward pressure on gold.
Expect gold to track with how much the federal debt ceiling will
be raised. Because this is an election year, expect the debt
ceiling to rise to just enough to get through November. But
regardless of who wins the presidential election, the debt ceiling
will have to be raised significantly over the next few years to
accommodate existing fiscal expenditures and slow economic
It seems all too possible that gold prices will push through
$2000 within the next 2 years, making gold an important component
of any wise portfolio strategy.
Last Thoughts and Investment Implications
Currently, growing consternation in Europe over fiscal budgets
and austerity measures has led to an increase in the value of the
dollar as a safe haven play, providing an excellent buying
opportunity for gold.
However, it is unlikely that our nation's unsound fiscal
policies will be corrected anytime soon. It is also unlikely that
our weak economy will become a robust economy anytime soon. As our
debt ceiling rises to accommodate greater deficits, expect gold to
break out of its current holding pattern and rise to levels back
over $1600 in the second half of this year.
Additionally, as we get into 4th quarter of 2012 and 1st quarter
2013, inflationary pressures should decline, led by lower year over
year oil price comparisons, allowing the Fed to resume a more
When that occurs expect a more rapid rise to even higher price
levels for gold. At current price levels, investors should consider
diversifying their portfolio to include some gold.
Mr. Moy was Director of the United States Mint from 2006-2011
and currently is an Officer and Board Member of L&L Energy
). He owns gold in his portfolio, has a gold IRA, and is the
spokesman for Morgan Gold.
Mr. Stojsavljevich served as Chief Strategy Officer at the
United States Mint from 2007-2011 and is currently a Managing
Partner at Episteme Advisory Group, a boutique advisory
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours.
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