October 1, 2019

The past year has been somewhat surreal in the gold market, as we have the rare occurrence of the U.S. dollar rising in somewhat slow fashion while gold bullion has appreciated about $300 per ounce to trade near $1,500. Historically, a rising dollar and rising gold bullion haven’t gone together, but the distortions that have come with global QE policies are to blame for the breakdown in this inverse relationship.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Federal Reserve rate-cutting cycles in the past have meant a lower dollar and a boom for gold bullion, but the fed funds rate no longer pushes the dollar up or down, but rather the policy of QE or QT. Also, if the Fed is cutting the fed funds rate and the ECB is accelerating QE due to the bad economic numbers from the Old World, the dollar will not decline, as the interest rate differential is in favor of the greenback.

This is why we have a rising dollar, due to accelerating QE from the ECB that pushes the euro lower (as it is the biggest component of the US Dollar Index, at 57%), with rising gold bullion – at the same time.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

How high can gold bullion go in this environment?

Historically, as “the system” prints money via fractional reserve banking and credit multiplier effects, there is generally inflation and depreciation of the purchasing power of money. That makes gold bullion go up in terms of those depreciated dollars. For example, one U.S. dollar has roughly one third of the purchasing power today as it did in 1980, yet gold bullion is not three times the level it was in 1980 because one can argue that near $800 per ounce, gold bullion was overvalued back then.

The tendency of gold bullion to swing from undervalued to overvalued is what makes its comparison to the CPI index problematic. While gold bullion will appreciate with inflation over time, it certainly does not do so with the relentless linearity of the CPI Index.

Still, the excess reserves in the global financial system, which are a function of QE policies by the ECB, BOJ, BOE, and the Fed, are what has given gold enthusiasts the hope that we will make fresh all-time highs in gold bullion. Many wonder why excess reserves – produced by the buying of bonds with electronic credits and placing them on the central banks’ balance sheets – have not produced hyperinflation yet. It is because those excess reserves in dollars or euros are for financial institutions only. While they push the prices of government bonds to unreasonable levels – all the way to negative interest rates – they do not increase the broad money supply in an uncontrolled fashion. Therefore, we don’t get hyperinflation.

Such has been the dynamics of QE, so far. I do not know that we will always be able to avoid undesired inflationary effects, but so far QE politics have managed to produce negative interest rates with no inflation in Europe and Japan. Despite the lack of undesired inflation, I think negative interest rates help gold bullion, as there is no carrying cost for this hard asset, and it offers no yield.

How the China/U.S. Trade War Helps Gold

There has been a rough Chinese yuan devaluation from about 6.20 to about 7.20 (per U.S. dollar) since the trade friction started in 2018. The Chinese yuan exchange rate is controlled by the Chinese central bank as it has $3.1 trillion in forex reserves. Should the Chinese central bank directed by Beijing push the yuan further down, that would cause global inflation to drop and local Chinese inflation rates to increase.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Devaluing the yuan is bullish for gold, as that causes a deflationary shock globally and causes central banks to do more QE. Ironically, QE has not worked very well in either Europe or Japan, other than to help push trillions of government bonds into negative yield territory, but those negative yields have helped the price of gold bullion and kept the dollar strong due to the still-positive interest rates in the U.S.

In the brave new world of trade wars and negative interest rates in Europe and Japan, the combination of a strong U.S. dollar and well-bid gold bullion are no longer the exception but the norm.

About The Author

Ivan Martchev

Ivan Martchev is an investment strategist with Navellier.  Previously, Ivan served as editorial director at InvestorPlace Media. Ivan was editor of Louis Rukeyser’s Mutual Funds and associate editor of Personal Finance. Ivan is also co-author of The Silk Road to Riches (Financial Times Press). The book provided analysis of geopolitical issues and investment strategy in natural resources and emerging markets with an emphasis on Asia. The book also correctly predicted the collapse in the U.S. real estate market, the rise of precious metals, and the resulting increased investor interest in emerging markets. Ivan’s commentaries have been published by MSNBC, The Motley Fool, MarketWatch, and others. All content of “Global Mail” represents the opinion of Ivan Martchev


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