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Gold and the Economy

Dr. Kal Kotecha
0 Comments|February 25, 2019

TO JOIN OUR FREE REPORT, PLEASE VISIT WWW.STOCKTRENDSREPORT.COM AND WWW.JUNIORGOLDREPORT.COM

Is this the time gold bulls have been waiting for?

Currently, gold and gold stocks have been range bound. A major part of the stock market hype has recently been focused on the emergence of the cannabis sector and that’s where people have been gravitating. Before that it was cryptocurrencies. And before that was the popularity of e-wallets and mobile.

In 2018, the central bank raised interest rates four times. Unemployment is expected to fall in 2019 but rise again in 2020. President Trump has made a promise to increase GDP to 4%. However, that is faster than what is healthy and would more likely create a boom that would then lead to a bust. The inflation rate in 2018 was 1.9% and is expected to be the same in 2019. It is expected to rise to 2.1% in 2020 and 2021. As this will be close to the Fed’s target inflation rate, this will give them an opening to raise interest rates to more normal levels. (Kimberly Amadeo: 2019)[1]

Interest rates are currently projected to rise at least twice in 2019 reaching 3%.  With the cost of borrowing rising, people are inclined to spend less as they start to worry about cash insecurity. 

To me…these predictions and numbers above are basically gibberish…here is what I believe.

I believe the next up and coming crisis in 2020/21 (2021 being deeper), will be a debt crisis – government, consumer and corporate and because we kept steaming this debt engine for so long, the crash will be so much deeper. Unlike 2008, this up-coming crisis should be a “meltdown”. For example, the crash of 1931 was longer and worse than the crash of 1929…the crash of 1929 essentially just pulled the rug out. And when I speak of and predict a downturn, I am not merely speaking in the broad terms of the stock market, rather the overall health of the economy including political structures.

During the aforesaid downturn, the Fed will probably launch another round of Quantitative Easing once its too late and realize the economy is spiraling downward but that is going to take a bad situation and make it worse. It probably won’t work like the last QE and it shouldn’t cause wealth to ‘artificially’ rise – instead it may have the opposite affect.

It will most likely be hard for the Federal Reserve to continue raising interest rates unless inflation really goes out of whack because currently, they have a 21+ trillion dollar debt and a mere 1% increase would amount to $200 billion+ per year in extra interest payments. Total US debt including pensions is over $70 trillion – households have over US$15 trillion in debt and businesses also have over US$15 trillion in debt.

Currently we are in a ‘bubble economy’. Consumers are in debt and the fed keeps fueling the fire of debt making it worse.

If you look at bonds, with the hike in interest rates, bond prices rise and yields fall, making them less attractive as investments.  Add to that, a perceived insecure government economic climate increasing the loss of faith in government bonds and as a consequence you can expect bipolar markets as they venture into extreme volatility. 

With the current political climate in the US, it’s pretty clear that we can expect more political unrest.  Whether they throw President Trump out of office or whether they keep him in, it is not likely that the economy will stabilize any time soon. 

In a slow economy, when governments have run out of ways of financing their borrowing and want to keep the economic engine running so it does not come to a screeching halt, they have the option to print excess money.  However, this is clearly not ideal as it will have the affect of reducing the value of money and creating higher inflation rates. Prices are rising, people are borrowing and governments are spending.

I hope my predictions are wrong – no one wants to see an economic collapse but if I am right – how can we protect ourselves? Buying gold could be one of the responses.

I am not a fool to believe that gold is going to be $10,000/ounce anytime soon – that would mean an end to a civilized economy and if anyone tells you that gold is going to the level or above has probably been smoking up a bit too much.

The general historical pattern is that when the economy is rocky, gold is solid and when the economy is solid, gold is rocky.

Let’s take a quick look at some historical periods of financial crisis.

The first to take a look at is the stock market crash of 1929.  Millions of Americans were on a high, crazily over-buying stocks resulting in stocks selling for prices higher than they were worth.  Ultimately this was not sustainable and the market came crashing down.  Professional investors and other people lost their life savings.  By 1933 nearly half of American banks had failed and unemployment reached epic proportions of 30%.  History.com (2010)[2]

In a bid to end the wild stock market speculation, the Feds raised interest rates. The US economy went into recession and the Great Depression.  The ensuing bear market lasted 4 years.  

At that time the price of gold was US$20.67/ounce. This price remained fairly constant until 1933 when it jumped to US$32.32/ounce (onlygold.com).  During these years, people lost faith in stocks and turned to redeeming paper currency for gold.  As gold prices began to rise, people began hoarding gold causing the prices to increase even further. In a bid to tame the market, President Roosevelt outlawed private ownership of gold coins, bullion and certificates. Americans had no choice but to sell their gold to the Feds. In 1934, the Gold Reserve Act was passed and gold shot up to US$35/ounce. This resulted in a lower dollar value and healthy inflation. Kimberly Amadeo (2019)[3]

The financial crisis of 2008 is considered to be the worst economic period since the Great Depression. It began in 2007 with a crisis in subprime mortgages, Housing prices and starts declined leading to a crisis in subprime mortgages and subsequently the situation developed into a full-blown international banking crisis with the collapse of Lehman Brothers on September 15, 2008.  Wikipedia[4]  & Manoj Singh (2017)[5]

Faith in the US economy was shattered and gold remained in the $US800’s/ounce.  Three short years later, in 2011, it hit an all-time record high of over US$1900/ounce.  Gold was seen as a safe haven.

Unlike the 1970’s where interest rates were high because inflation was high, the debt wasn’t spiralling into catastrophic realms as it currently is. And the debt can be seen like a Ponzi scheme.

In a Ponzi scheme, paying off old investors relies on obtaining a constant source of new funds from new investors. The Federal Government relies majorly on systematically obtaining new funds from tax payers and has the power to initiate increases as per their discretion. The general population is seen as a huge pool of funding to draw from without thought as to the consequences of their financial stability or future. This sort of thinking may well have an impact on weakening the economy by compromising the financial security of the workforce. The gap between income and consumption increases and debt levels rise.

As spending continues, the situation becomes impossible and a natural result should be a collapse, leaving financial losses in its’ wake.

When the economy started to improve and inflation rates remained low, gold prices once again fell.

During 2018, gold remained fairly steady, but under the peak of 2011, ranging from a low of just under $1200/ounce to a high in the mid US$1300’s/ounce. So basically, the current economy and future economic outlook, both in the US and internationally are the key factors in determining your position.  Rising interest rates create fear and uncertainty within monetary aspects, prompting investors to look to more stable commodities as they want to create a safe haven. Strong economic growth prompts investors to explore various sectors, and often newer emerging sectors like cannabis, leaving gold by the wayside…but just for the moment.

Currently, gold is considered to be in a bear market.  I’d like to think that it is ‘range bound’.  And what happens when something has been submerged for so long? Investors seem to be in a fearful state but its’ macroeconomic principles are different. Some of the reasons for this include the high value of the US dollar, a strong economy and low inflation.

Every country is looking more at the US dollar right now than gold.  They seem to have an unwavering faith in the almighty US dollar.  But how can consumers continue to have faith in a currency that is backed by nothing, in a country that is over US$21 trillion in debt and inflation could spiral upwards.  So, the answer again could be: Gold

Coming into play against the US economy are the gold-backed currency tactics of China and Russia.

In an attack against the dominance of the USD as a global currency, China and Russia began to work together to put an end to the US/Western currency supremacy.

Both countries’ Central Banks, in the early 2000’s, began stockpiling gold to add to their reserves.  By June 2018, China’s precious metal reserve was valued at US$74.1 billion.

As of December 2018, Russia’s gold reserves stood at US$86.9 billion.  The Central Bank announced in January of this year that they had cut the share of the country’s USD to a historic low, transferring nearly $100 billion into the Euro, the Japanese yen and the Chinese yuan. RT (2019)[6]

On March 26, 2018, China began trading their gold-backed currency, the petroyuan.  Within the first hour over 23,000 crude oil futures contracts had traded with a US dollar value of 1.5 billion.  Tyler Durden (2018)[7]
  https://www.zerohedge.com/news/2018-03-25/petroyuan-futures-open-over-10-billion-notional-trades-first-hour

By doing this they bypassed the USD, trading directly in Chinese currency.  And not being backed by gold, there was nothing the US could do about it as other countries made an easy decision to favor gold over the dollar.  

New tariffs imposed by the US served to further drive business away from the dollar and towards the petroyuan. Regarding Iran, new US sanctions strengthened China’s trading position with the petroyuan.

China and Russia have carefully calculated their moves in their quest to remove the dominance of the US dollar.

As far as the US, talk about the goose that lays the golden egg.  That country has always seen itself as the dominant leader in business.  In all likelihood, they did not anticipate this type of action against their dollar as they proudly claimed the title of world leader.  Being unrealistic in not looking at long-term consequences may well cost them a pretty penny as other countries move aggressively to dethrone and grasp the golden USD from them and turn others to favour gold.

Looking into the demand for gold, in Q3 - 2018 it rose between 1% for technical applications to 28% for bar and coin investors, year-to-date.   In China alone, the world’s largest bar and coin market, the demand rose 25%.  The rise in Iranian demand hit a 5 ½ year high. As the economic situation in that country worsened, the rise in the activity of recycled gold ran up to 50%.  In the gold jewelry market, demand growth reached 6% with growth in China and India outweighing weaknesses in the Middle East[8]. Goldhub (2018)

As far as demand for the same quarter, gold mine production rose 1.9%.  Although some of the largest producing nations experienced double-digit declines in production, these were offset by significant gains elsewhere.

Regarding the other side of the equation, supply, in China, production declined 6%, South African output fell by 10% and in Peru that number was 17%. 

In the United States, growth in supply was at 9% and in Canada 13%.[9]  Goldhub (2018)

However, given the historic popularity of gold, they should have seen that coming. But is the gold trend sustainable?

The peak of gold’s popularity was in the late 70 early 80’s, so is it a cult movement or is it a real phenomenon?

To compare, you look at the 60’s flower child, cult and then the 70’s disco movement, the rock movement of the 80’s (also known as the bad hair movement – not likely we’ll go back to that time any time soon).  Those were all one-off phases in time.  But since the beginning of time gold has indeed been valued, it’s not a one-off, it’s not a phase, it’s a movement that is about, again, to take steam.

We can look at the cannabis market, at this point.  At the beginning it was definitely like a cult movement.  Everyone wanted to have a part of it, be a part of it, and so on.  The wave rode well for a while. Then we had the downslide at the end of 2018.  Lately, the movement has started to pick up a bit of momentum, but it will likely come and go in waves.  While some companies will rise and some will fall, the crop will continue to grow and the interest in the basic product is certainly sustainable in the long term.

That market I know has literally changed a lot of investors lives and we as Canadians here had the first opportunity because most of the stocks are housed and listed here. In addition, legalization was country-wide. 

Comparing the gold market to cannabis, a lot of stocks in that sector have just ballooned in market cap. As we know, that’s also what happened in 2010 with a lot of the junior mining stocks.  As a result, that particular sector can gain favour and focus, leaving other sectors to the side for the moment.

And this is what could happen again to junior mining stocks.  When the commodity is in favour, the underlying investment in companies that specialize in the commodity is in favour.

That’s what was experienced in the gold sector in the early 2000’s after the tech rally came to an end as well as in 2010 to gold and gold related stocks.

One of the other factors to look at is the trend within the general investing population, also known as the fear and greed principle.  When people are greedy, that’s when you should be fearful and sell.  When people are fearful that’s when you should be greedy and buy, but only in certain sectors.

So, for example, when people are fearful in the oil sector it doesn’t mean you should be greedy and buy if macro economic factors do not call for it.   You need to consider supply, demand, land, excess reserve, technology with fracking and so on. 

There are certainly similarities with gold.  The majority of gold stocks are listed on the Canadian exchanges. Unlike tech which is broad based around the world, the world comes to us and to our markets. You have the chance at the first crack at it, again, before outside money starts to pour in as it has in the cannabis market.

The great thing about these bull and bear markets in specific commodities is that you have the opportunity to learn about the next bull and bear markets in these same commodities. 

If you look at silver, it is noted as the poor man’s gold but it does a lot better when gold is going up as a percentage basis.  Conversely, when gold decreases silver decrease more in a percentage basis as well. 

It may be a good time to play the silver market.  The problem is that there are not a lot of junior silver companies.  

This is what we are talking about now, investing over the next 2-3 years or however long the precious metal bull market may take to run because timing is the hardest part, but it looks like we are in the 1st inning or the pre-warmup of the junior mining sector precisely because they have been beaten up so badly. 

Successful investing is about timing. Currently gold is basing and actually has been for quite some time. With the ascension and sudden demise of bitcoin and other cryptocurrencies, gold is still the true hedge against a falling economy.

In conclusion, precious metals investors have been waiting for the gold price to increase, the momentum seems to have started. The metal generally moves favourably when the economy is in turmoil.  As noted above, we may experience an increased economic downturn in late 2019 going into 2020 and sharper into 2021. 

If history repeats itself, then gold may really shine as the benefactor.
 
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[1]Kimberly Amadeo (2019) US Economic Outlook for 2019 and Beyond:  https://www.thebalance.com/us-economic-outlook-3305669

[2] History.com (2010)  Stock Market Crash of 1929    https://www.history.com/topics/great-depression/1929-stock-market-crash
[3] Kimberly Amadeo (2019) : Gold Price History from 30 B.C. to Today  https://www.thebalance.com/gold-price-history-3305646
[4] Wikipedia : Financial Crisis of 2007 – 2008  https://en.wikipedia.org/wiki/Financial_crisis_of_2007%E2%80%932008  
[5] Manoj Singh (2017) :  The 2007-08 Financial Crisis in Review https://www.investopedia.com/articles/economics/09/financial-crisis-review.asp
 
[6] RT (2019)  Russia’s Gold and Currency Reserves Surge for Third Consecutive Year  https://www.rt.com/business/448930-russia-foreign-reserves-growth/
[7] Tyler Durden (2018) :  PetroYuan Futures Open – Over 10 Billion Notional Trades in First Hour  https://www.zerohedge.com/news/2018-03-25/petroyuan-futures-open-over-10-billion-notional-trades-first-hour
[8] Goldhub (2018) Gold Demand Trends Q3 2018, https://www.gold.org/goldhub/research/gold-demand-trends/gold-demand-trends-q3-2018
[9] Goldhub (2018) Gold Demand Trends Q3 2018: Supply https://www.gold.org/goldhub/research/gold-demand-trends/gold-demand-trends-q3-2018/supply
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