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What do changes in GLD’s bullion inventory tell us about the future gold price?

January 30, 2016

Physical gold ‘flowing’ into GLD and the other gold ETFs does not cause the gold price to rise and physical gold flowing out of gold ETFs does not cause the gold price to fall. The cause and effect actually works the other way around, with the price change being the cause and the flow of gold into or out of the ETFs being the effect. I’ve covered the reasons before (for example, HERE and HERE), but cause and effect are regularly still being mixed up in gold-related articles so I’m revisiting the topic.

The Net Asset Value (NAV) of a gold ETF such as GLD naturally moves up and down by the same percentage amount as the gold price, so a change in the gold price will not necessarily require any change in the size of GLD’s bullion inventory. It’s only when GLD’s market price deviates from its own NAV that a change in bullion inventory occurs. For example, assume that the gold price gains 10%. In this case, GLD’s NAV will gain 10% and there will be no increase or decrease in GLD’s inventory as long as GLD’s market price also rises by 10%. However, if GLD’s market price rises by 11% then gold will be added to the ETF’s inventory to bring its market price and NAV back into line, and if GLD’s market price rises by only 9% then gold will be removed from the ETF’s inventory to bring its market price and NAV back into line.

Note that the manager of the ETF doesn’t have to initiate anything in the above-described process. The ETF’s Authorised Participants (APs) initiate the process in order to generate arbitrage profits. More specifically, a deviation between market price and NAV creates an opportunity for the ETF’s APs to pocket risk-free profits by selling or buying gold bullion and simultaneously buying or selling ETF shares.

All ETFs work the same way. That is, there’s nothing special about the way GLD works. The modus operandi ensures that the market prices of ETFs usually track their NAVs very closely.

Why, then, does the following chart show a long-term positive correlation between the gold price and GLD’s bullion inventory?

Because traders of GLD shares tend to get more optimistic about gold’s prospects and buy more aggressively AFTER the gold price has risen, causing GLD’s market price to rise relative to its NAV and prompting arbitrage that results in the addition of bullion to the ETF’s inventory. And because traders of GLD shares tend to become more pessimistic about gold’s prospects and sell more aggressively AFTER the gold price has fallen, causing GLD’s market price to fall relative to its NAV and prompting arbitrage that results in the removal of bullion from the ETF’s inventory. The correlation is far from perfect, because GLD traders won’t always become increasingly optimistic in reaction to a price rise or increasingly pessimistic in reaction to a price decline.


A final point worth making is that the annual change in GLD’s bullion inventory has always been very small relative to the total size of the gold market. Given the size of the total aboveground gold supply, there is very little chance that a few hundred tonnes per year moving into or out of GLD’s coffers could have a significant effect on the price.

So, the answer to the question “What do changes in GLD’s bullion inventory tell us about the future gold price?” is: nothing.

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The original Fed versus today’s Fed

January 26, 2016

In a recent blog post, Martin Armstrong wrote: “This constant attack on central banks is really hiding what the problem truly is — government. When the Fed was created, it “stimulated” the economy by purchasing corporate paper. The Fed was NEVER intended to buy government bonds. The politicians did that for World War I and never returned it to its purpose.” That’s not entirely true. Also, it’s naive to believe that the Fed would benefit the overall economy if it were restricted to its originally-intended purpose.

Contrary to Mr. Armstrong’s assertion, the Federal Reserve Act of 1913 actually does enable the Fed to buy government paper. Specifically, Section 14 of the Act states:

Every Federal reserve bank shall have power … [to] buy and sell, at home or abroad, bonds and notes of the United States, and bills, notes, revenue bonds, and warrants with a maturity from date of purchase of not exceeding six months, issued in anticipation of the collection of taxes or in anticipation of the receipt of assured revenues by any State, county, district, political subdivision, or municipality…

More generally, the Federal Reserve Act gave Federal Reserve banks the power to purchase short-term commercial paper (bills of exchange) and short-term government paper, and to set the discount rates associated with these purchases.

Secondly, the whole concept of economic stimulation by central banks in general and the Fed in particular is one of world history’s greatest-ever cases of mission creep. A central bank cannot possibly stimulate an economy by lowering interest rates and creating money; all it can do is distort an economy and exacerbate the boom-bust cycle. Although the theoretical framework had not yet been fully developed by the likes of Ludwig von Mises, this was generally known by economists at the time of the Fed’s establishment in 1913 and explains why there was no mention in the Federal Reserve Act of the Fed taking actions in an effort to modulate the pace of economic growth. Unfortunately, economics is the one science that has taken a giant step backwards over the past 100 years. Whereas there was originally no intention of having the Fed interfere with market rates of interest and react in a counter-cyclical manner to shifts in economic activity, most economists can no longer even envisage an economy that is free from central-bank manipulation.

Thirdly, while it would be a great improvement if the Fed were limited by the rules that originally governed its actions, it is important to understand that the problems (the periodic bank runs and financial crises) that the Fed was set up to address are the result of fractional reserve banking. Rather than eliminate fractional reserve banking, which would have been the correct solution, a central bank was established as a work-around. This is mainly because some of the most powerful and influential people in the country were bankers. Not surprisingly, most bankers like having the legal power to create money out of nothing.

My final point is that the Federal Reserve Act of 1913 was a foot in the economic door. Once the foot was in the door it was always going to be just a matter of time before the entire body had wormed its way in. The reason is that the powers of central banks grow in the same way as the powers of governments, with each intervention leading to problems that create the justifications for more interventions and with the occasional crisis providing the justification for a quantum leap in power. To put it succinctly, the mission creep was inevitable.

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How much longer will the gold-mining bear market last?

January 25, 2016

(This post is an excerpt from a recent TSI commentary.)

Intermediate-term rallies in the gold-mining sector can happen during general equity bull markets and general equity bear markets, but on a long-term basis the gold-mining sector trends in the opposite direction to the broad stock market. An implication is that to get a new bull market in gold-mining stocks there will probably have to be a new broad-based equity bear market.

A good argument could be made that an equity bear market got underway last July, but at this stage the vast majority of market participants still believe that the bull market is intact. In general, people are very nervous about the short-term while remaining optimistic about the stock market’s long-term prospects. What would shake the long-term optimism of a critical mass of investors?

Based on what happened in 2000, an SPX break below the August-2015 low that was not quickly reversed would probably do it. This is the point we are trying to make with the following chart comparison. The chart compares the HUI and the SPX during the 12-month period beginning March-2000, or the 12-month period commencing just prior to the start of a cyclical stock-market decline.

Notice that the SPX bear market began with a sharp decline from a March high to an April low, after which there was a 4-5 month period of choppy trading that resulted in a test of the March high. At the time the March high was being tested hardly anyone believed that a bear market was underway. The market then began to trend downward and in October the SPX traded below its April low, but the downside breakout was quickly negated and there was a collective sigh of relief. It was still apparent to almost all market participants that they were dealing with a bull-market correction. Then, in November, the SPX again breached its April low and the breakout was not quickly negated. This was the point of recognition — the point when a critical mass of investors came to suspect that an equity bear market was in progress. This was also the point when the gold-mining sector commenced a bull market.

One of the reasons that the bear market in the gold-mining sector has been unusually long is that the general equity bull market has been unusually long. The general equity bull market is probably over, but very few people know it yet. Enough people to provoke a major trend change in the gold-mining sector will probably know it after the SPX makes a sustained break below the August-2015 low.

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Gold miners hiding poor cost control

January 23, 2016

Anyone who closely follows the mining industry would be well aware that gold producers operating in Australia and Canada were given a large bottom-line boost over the past 18 months by large declines in the Australian Dollar (A$) and the Canadian Dollar (C$). In some cases, the favourable exchange-rate movements are hiding poor cost control.

Looking at the situation from one angle, the financial boost stems from a relatively high selling price for gold in local currency terms. Looking at it from a different angle, the financial boost stems from a lower reported cost when costs are converted to US dollars. For example, if a Canada-based gold producer has a stable cost per ounce in C$ terms during a year when the average C$/US$ rate falls by 10%, then in US$ terms its costs have declined by 10%. In such cases the decline in the US$ cost/ounce shouldn’t be portrayed as if it were due to smart management, but, perhaps not surprisingly, some management teams have given themselves public ‘pats on the back’ for cost improvements that were solely the result of the change in the exchange rate.

The example I’ll highlight is Lakeshore Gold (LSG), a junior gold producer operating in Canada. I’m picking on LSG because it’s a stock that almost everyone loves at the moment. I quite like it too, although I currently don’t own it and wouldn’t buy it at the current price.

All the information needed to figure out LSG’s cost performance in local currency (C$) terms is available in the financial statements issued by the company, but in its press releases LSG usually reports cost/ounce figures in US dollars only. For example, for 2014 it reported an AISC (all-in sustaining cost) of US$872/oz and for 2015 it reported an AISC of US$870/oz, which superficially looks like, and is certainly portrayed by the company as, evidence of good cost control. However, almost all of LSG’s costs are C$-denominated and the average C$/US$ exchange rate was about 13% lower in 2015 than it was in 2014. This means that LSG’s cost/ounce in US$ terms got a 13% benefit from 2014 to 2015, or, to put it another way, a stable cost/ounce performance in US$ terms masks a double-digit cost/ounce increase in C$ terms.

A similar conclusion (a double-digit deterioration in LSG’s mining efficiency from 2014 to 2015) is reached if the operating cost/ounce is determined by dividing the total C$-denominated production cost by the number of ounces produced.

The stock market often doesn’t care about declining efficiency as long as the bottom-line is improving or is expected to improve, but it’s something that investors should be aware of.

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Swiss to vote on stopping banks from counterfeiting money

January 21, 2016

The Swiss Constitution contains something called the Volksinitiative (Peoples’ Initiative) that enables Swiss citizens to launch a referendum aimed at changing specific provisions within the Constitution. Launching the referendum requires the collection of 100,000 valid signatures in support of a “yes” vote within an 18-month period, after which the proposed constitutional change gets put to a national vote. A particularly interesting proposal has garnered the required signatures and will be put to a national vote within the next couple of years (probably in 2017). I’m referring to the Vollgeld Initiative, a proposal to eliminate the power of commercial banks to lend new money into existence.

In most countries around the world, commercial banks have the power to create new money by making loans. The process is called fractional reserve banking and has been around for hundreds of years. It has also been the root cause of the boom-bust cycle and economy-wide financial crises for hundreds of years. Furthermore, there is nothing beneficial about the process to the economy as a whole, although having the ability to create money out of nothing certainly helps banks to expand their balance sheets.

Due to the economic problems caused by allowing banks to create money and the fact that it is unjust for banks to have special privileges under the law, voting “yes” to this proposal would be a step in the right direction. However, it would only be a small step, because the Swiss National Bank (SNB) would still have the power to create an unlimited amount of money out of nothing and the government would decide how the new money was introduced into the economy. In other words, the commercial banks end up with less power (good) while the central bank and the government end up with more power (bad).

That the framers and supporters of the Vollgeld Initiative don’t perceive a major problem with increasing the government’s control over money indicates that they have far too much trust in government and don’t have a good understanding of how monetary inflation affects the economy.

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Some gold bulls need a dose of realism

January 19, 2016

There’s a lot right with John Hathaway’s recent article titled “An ‘Acute Shortage’ in Gold Can Boost Prices“. There’s also a lot wrong with it, beginning with the title. There is not now, there has never been and there never will be a shortage of gold*, the reason being that gold is not ‘consumed’ like other commodities. However, my main bone of contention isn’t with the fatally-flawed argument that a gold shortage is looming.

The main problem I have with Hathaway’s article is that it repeats the nonsensical story that the gold price has been forced downward over the past few years to an artificially-low level by the relentless selling of “paper gold”. Like many gold bulls, Hathaway apparently hasn’t noticed that a major commodity bear market has unfolded and that the gold price has held up incredibly well. So well, in fact, that relative to the Goldman Sachs Spot Commodity Index (GNX) the gold price is at an all-time high and about 30% higher than it was at its 2011 peak.

Rather than imagining a grand price suppression scheme involving unlimited quantities of “paper gold” to explain why gold isn’t more expensive, how about trying to explain why gold is now more expensive relative to other commodities than it has ever been.


Considering only US economic and monetary fundamentals, the gold price is now a lot higher than it probably should be relative to the general level of commodity prices. I think that the strength can be explained by the precarious global economic and monetary situations, but the point is that a knowledgeable and unbiased observer of the markets shouldn’t be scratching his/her head or feeling the need to get creative when coming up with justifications for gold’s current US$ price.

Hathaway actually knows the real reason for gold’s downward trend in US$ terms, because at one point in the article he writes: “The negative investment thesis [for gold] seems to rest upon confidence that central bankers, and the Federal Reserve in particular, will steer a course away from radical monetary experimentation that will return to a normal structure of interest rates and robust economic growth.” Yes, that’s it in a nutshell.

Gold’s perceived value is the reciprocal of confidence in the central bank and the economy. Although some of us strongly believe that the confidence was and is misplaced, it’s a fact that confidence in the Fed and the US economy has generally been at a high level over the past few years.

*Note: If it could be validly argued that a genuine gold shortage (as opposed to a temporary shortage of gold in a particular manufactured form) was likely or even just a realistic possibility, then gold would no longer be suitable for use as money. Fortunately, it cannot be validly argued.

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Record use of the word “record” by a company that missed guidance

January 15, 2016

In a press release after the close of trading on Thursday 14th January, B2Gold (BTG, BTO.TO) used the word “record” eleven times to describe its own performance for the December quarter and for all of 2015. It was “record” full-year and quarterly production, “record” sales, another “record” year, “record” this and “record” that. With all these records you could be forgiven for not noticing that annual production came in below the bottom of the company’s guidance range.

Maybe it’s a character flaw of mine, but I think that before the management of a mining company runs victory laps and gives itself big pats on the back for having achieved record results, it should at least reach the bottom end of its own forecast.

At the other end of the scale we have Endeavour Mining (EDV.TO), which also reported “record” annual production after the close of trading on Thursday. One difference is that EDV’s “record” production was comfortably above the top of the company’s guidance range. Another difference is that EDV only used the word “record” once in its press release — in the context of “outstanding health and safety record”.

Here is a picture of the difference between putting out press releases that make it seem as if you are doing a good job and actually doing a good job.


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Another way to look at the ultimate boom-bust indicator

January 15, 2016

I consider the gold/GYX ratio (the price of gold relative to the price of a basket of industrial metals) to be the ultimate boom-bust indicator. With monotonous regularity, the gold price trends downward relative to the prices of industrial metals during the boom periods and upward relative to the prices of industrial metals during the ensuing busts. Not surprisingly, given economic reality, in addition to being an excellent boom-bust indicator the relative performances of gold and the industrial metals is also an excellent indicator of general (societal) time preference.

Time preference is the value placed on consumption in the present relative to future consumption. In particular, rising time preference involves an increase in the desire to buy consumer goods in the present and, by extension, a decrease in the desire to save or make long-term investments, while falling time preference involves a growing desire to put-off current consumption in order to save or make long-term investments. As an aside, interest rates naturally stem from time preference in that all else being equal — which it often isn’t — people will prefer getting an item now to getting the same item at some future time. For example, even if there is no credit risk, a dollar in the hand today will always have a higher value than the promise of a dollar in the future. The greater perceived value of the present good relative to the future good can be expressed as an interest rate.

Major trends in time preference go hand-in-hand with the boom-bust cycle. During booms fueled by monetary inflation people temporarily feel richer and spend more freely, largely because debt is cheap and easy to come by. This means that booms are accompanied by rising time preference (a greater eagerness to consume). During the ensuing busts, the mistakes and recklessness of the preceding boom come to light. There is a general “pulling in of horns” as the focus turns to the repairing of balance sheets and the building-up of cash reserves. This means that busts are accompanied by falling time preference (a greater desire to save).

Gold is no longer money, in that it is no longer commonly used as a medium of exchange. However, it is widely viewed as a safe and liquid financial asset, rather than a commodity to be consumed. This causes it to perform similarly, relative to other metals, to how it would perform if it were money. In particular, during a period when there’s a general increase in the desire to immediately consume and a concomitant reduction in the desire to hold cash in reserve (a period of rising time preference), the gold price will trend downward relative to the prices of most other metals. And during a period when there’s a general increase in the desire to hold cash in reserve (a period of falling time preference), the gold price will trend upward relative to the prices of most other metals.

In other words, periods of rising time preference are indicated by rising trends in the GYX/gold ratio and periods of falling time preference are indicated by falling trends in the GYX/gold ratio.

On the following chart of the GYX/gold ratio, the periods when the ratio was in a rising trend are shaded in yellow. If you think back to what was happening during these periods you should (hopefully) realise that they were, indeed, periods when societal time preference was rising. Recall how caution was ‘thrown to the wind’ during the NASDAQ bubble of 1999-2000, the real-estate bubble of 2003-2006, the emerging-markets and commodity bubbles of 2009-2010, and the QE-promoted debt bubbles of 2013-2014.

Also, if you think back to what was happening during the unshaded parts of the chart you should realise that these were periods when societal time preference was falling — when investments were revealed as ill-conceived, debts were revealed as unsupportable, and people throughout the economy were collectively spending less in an effort to save more.


The most recent downturn in societal time preference appears to have been set in motion by the bursting of the shale-oil investment bubble. Many people (not including me) thought that the large decline in the oil price would turn out to be a major plus for the US economy. Just like a tax cut, they claimed. It was actually a negative, though, because substantial debt-funded investments had been predicated on the oil price remaining high.

As to how long the current trend will continue, a lot will depend on whether or not the stock market’s cyclical bullish trend is over. If it is over, which it probably is, then the GYX/gold ratio will continue to fall for at least another 12 months.

The final point I’ll make is that in a free economy that didn’t have a central bank, trends in societal time preference would tend to be more gradual and neither a rising nor a falling time preference would be a problem to be reckoned with. Instead, trends in time preference would influence interest rates throughout the economy in such a way as to provide valid and useful signals to businesses and investors.

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Gold mining stocks breaking down

January 12, 2016

The Gold BUGS Index (HUI) dropped sharply on Monday 11th January, but managed to hold above its 50-day and 20-day moving averages by the barest of margins. It therefore hasn’t yet fallen by enough to signal an end to the rebound that began on 17th November.


However, while the HUI is hanging on by the skin of its teeth, several high-profile gold-mining stocks have already broken out to the downside. For example:

1. Despite offering excellent value, KGC clearly broke below support on Monday and appears to be heading for a test of its September low.


2. B2Gold (BTG) broke out to the downside last Friday and extended its decline on Monday. It does not yet offer great value and the recent downside breakout projects significant additional weakness prior to a sustained bottom, but it sure looks ‘oversold’.


3. Royal Gold (RGLD), one of the world’s lowest risk and highest-quality gold stocks, made a new bear-market low on Monday. The price action suggests that the stock is on its way to $30, but the risk/reward is very attractive at $35 or lower.


4. Newmont Mining (NEM) plunged below the bottom of a 3-month price channel on Monday and appears to be heading for a test of its September low.


With the US$ gold price having broken above resistance at $1088 last week and having held above its breakout level during the pullback of the past two trading days, why has the gold-mining sector been so weak?

I think it’s mainly because of what’s happened to non-gold mining stocks. As illustrated below, the Diversified Metals and Mining Index (SPTMN) has fallen by about 20% over the past 5 trading days and plunged to a new bear-market low on Monday 11th January. The gold-mining sector is certainly capable of bucking a general downward trend in mining stocks, but it would take a lot of strength in the gold price to offset the downward pull caused by the sort of general mining collapse seen over the past few days.


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The proverbial “cash on the sidelines”

January 11, 2016

One of the most ridiculous arguments in favour of a rising stock market is that there is a large amount of cash on the sidelines. Regardless of the stock market’s actual prospects, this argument will always be complete nonsense.

The reason is that all of the cash in the economy — every single dollar of it — is always effectively on the sidelines, because money must always be held by someone. Money never goes into any market; it just gets shuffled around between the bank accounts of buyers and sellers. For example, when Bill buys Microsoft shares from Bob, no money goes into Microsoft or into the stock market. What happens is that money gets transferred from Bill (the buyer) to Bob (the seller), with the total amount of money on the ‘sidelines’ and the total amount of money in the economy remaining unchanged. It’s the same story with every other transaction involving the use of money to buy something. It’s amazing that you can become the chief executive or the chief investment officer of a company with billions of dollars under management and not understand this basic monetary concept.

The fact is that the amount of cash on the sidelines at any time is simply a function of the preceding amount of monetary inflation. If the money supply has grown then the amount of “cash on the sidelines” will have grown by the same amount. A consequence is that the amount of cash on the sidelines grows almost every year, regardless of whether the stock market rises or falls. For example, the amount of cash on the sidelines in the US was a lot higher just prior to the 2008 market collapse than it was three year’s earlier and the amount of cash on the sidelines will almost certainly be at a new all-time high a year from now irrespective of what happens to the stock market in the meantime.

So, equity permabulls, stop insulting my intelligence by telling me that stock prices will be supported by the record amount of “cash on the sidelines”.

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Gold makes a new all-time high!

January 7, 2016

Gold is obviously not close to making a new all-time high in terms of the US$ or any of the other major currencies, but it has just made a new all-time high relative to the basket of commodities included in the Goldman Sachs Spot Commodity Index (GNX). This means that gold has never been more expensive relative to commodities in general than it is today.

Just imagine how expensive gold would be if it weren’t the victim of a never-ending price suppression scheme!*


*Just in case it isn’t obvious, I’m being sarcastic.

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Minimum Wage Wrongheadedness

January 6, 2016

Both the proponents and the opponents of a government-imposed minimum wage tend to use data in an effort to make their respective cases. In particular, if they are in favour of a higher minimum wage they cite examples of increases in the minimum wage being followed by stable or lower unemployment to supposedly refute the argument that higher unemployment would result from a government-enforced wage hike for the lowest earners, while those on the opposite side of the fence cite examples where a higher rate of unemployment followed a minimum-wage increase. However, whether arguing for or against the minimum wage or a higher minimum wage, such arguments are misguided. The reality is that there are so many influences on the general level of employment that it isn’t possible to separate-out the effects of the minimum wage.

As is usually the case with questions regarding the effects of a policy on the overall economy, questions about the consequences of minimum wage legislation cannot be properly answered by referring to historical data. For one thing and as noted above, it will never be possible to identify what changes in the employment situation stemmed from the minimum-wage change and what changes were due to the myriad other influences. To put it another way, although economists like to use the term “ceteris paribus” (meaning: with all else being the same) in their writings, in the real world all else is never the same. In the real world there will always be countless differences between the same economy during different time periods and between different economies during the same time period. Furthermore, unlike the physical sciences it is not possible to do experiments in economics in which a single input is adjusted and the resultant change in the output observed/measured.

In economics, the overall effect of a policy must be deduced from first principles. In the case of the minimum wage, the principle of relevance is the law of supply and demand. To be more specific, the relevant principle is that, “ceteris paribus”, the quantity of a good demanded will fall as its price rises. The fact that all else is never the same in the real world means that it will never be possible to separately measure the effect on employment of increasing the minimum wage, but it is axiomatic that artificially raising the price of anything, including the price of labour, will result in the demand for that thing being lower than would otherwise be the case. That is, it is axiomatic that fixing the minimum price of labour significantly above where it would be in a free market will result in higher unemployment. No data are required.

As an aside, those in favour of hiking the minimum wage almost always word their arguments to make it seem as if the legislation only imposes restrictions on employers, but it’s important to appreciate that the legislation also restricts job-seekers. There are undoubtedly people who would gladly accept payment below the government-set “minimum wage” in order to gain the skills and experience that would make them more valuable to employers in the future, but minimum-wage laws prevent these people from offering their services for less than the limit set by the government. Do-gooders would prefer that these people were dependents of the State rather than be productive and get paid less than some arbitrary lower limit.

In conclusion, advocating for a higher government-mandated minimum wage and including as part of your case the assertion that employment will not be adversely affected is equivalent to holding up a sign that reads: “I am clueless about the most basic principle of economics”.

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Are rising interest rates bullish or bearish for gold?

January 5, 2016

I’ve seen articles explaining that rising interest rates are bearish for gold and I’ve seen articles explaining that rising interest rates are bullish for gold, so which is it? Are rising interest rates bullish or bearish for gold? The short answer is no — rising interest rates are neither bullish nor bearish for gold. Read on for the much longer answer.

I’ll begin by noting what happened to nominal interest rates during the long-term gold bull markets of the past 100 years. Interest rates generally trended downward during the gold bull market of the 1930s, upward during the gold bull market of the 1960s and 1970s, and downward during the gold bull market of 2001-2011. Therefore, history’s message is that the trend in the nominal interest rate does not determine gold’s long-term price trend.

History tells us that gold bull markets can unfold in parallel with rising or falling nominal interest rates, but this shouldn’t be interpreted as meaning that interest rates don’t affect whether gold is in a bullish or bearish trend. The nominal interest rate is not important, but the REAL interest rate definitely is. Specifically, low/falling real interest rates are bullish for gold and high/rising real interest rates are bearish. For example, when gold was making huge gains during the 1970s in parallel with high/rising nominal interest rates, real interest rates were generally low. This is because gains in inflation expectations were matching, or exceeding, gains in nominal interest rates (the real interest rate is the nominal interest rate minus the EXPECTED rate of currency depreciation). Also, the 2001-2011 bull market occurred in parallel with generally low real interest rates.

Very low real interest rates are artifacts of central banks. In the US, for example, the Fed’s actions ensured that the real short-term interest rate on “risk free” (meaning: no direct default risk) debt spent a lot of time in negative territory during the 1970s and during 2001-2011. In effect, “very low real interest rates” means “excessively loose monetary policy”.

Something else that affects gold’s price trend is the DIFFERENCE between long-term and short-term interest rates (the yield-spread, or yield curve), with a rising yield-spread (steepening yield curve) being bullish for gold and a falling yield-spread (flattening yield curve) being bearish. It works this way because a rising trend in long-term interest rates relative to short-term interest rates generally indicates either falling market liquidity (associated with increasing risk aversion and a flight to safety) or rising inflation expectations, both of which are bullish for gold.

As is the case with the real interest rate, under the current monetary system the yield-spread tends to be a symptom of what central banks are doing. If money were sound and free of central bank manipulation, then the yield-spread would spend most of its time near zero (the yield curve would be almost horizontal) and would experience only minor fluctuations, but thanks to the attempts by central banks to ‘stabilise’ the markets the yield-spread experiences huge swings. For example, the following chart shows the huge swings in the US 10yr-2yr yield-spread since 1990. The periodic up-swings in this chart were generally due to the Fed exerting irresistible downward pressure at the short end of the curve while the discounting by the market of currency depreciation risk caused interest rates at the long end to be ‘sticky’.


Last but not least, gold is influenced by the economy-wide trend in credit spreads (the differences between interest rates on high-quality and low-quality debt securities). Gold, a traditional haven in times of trouble, tends to do relatively well when credit spreads are widening and relatively poorly when credit spreads are contracting. This is because widening credit spreads typically indicate declining economic confidence.

If the three main interest-rate drivers (the real interest rate, the yield-spread and credit spreads) are gold-bullish then there’s a high probability that gold will be in a strong upward trend in terms of all currencies and most commodities. By the same token, if the three main interest-rate drivers are gold-bearish then there’s a high probability that gold will be in a strong downward trend in both nominal and real terms. However, it’s not uncommon for the interest-rate conditions to be mixed. The past year is a good example of a mixed interest-rate backdrop for gold in that during this period the credit-spread situation was generally gold-bullish (credit spreads were widening) while the real interest rate and yield-spread trends were generally gold-bearish. The net effect of this interest-rate backdrop was slightly bearish for gold.

In summary, gold benefits from low/falling real interest rates, an increasing yield-spread (a steepening yield curve), and widening credit spreads, each of which can occur when nominal interest rates are rising or falling. You can therefore ignore the “rising interest rates are bearish for gold” and the “rising interest rates are bullish for gold” arguments. The relationship between gold and interest rates is not that simple.

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