An Open Letter on Gold -- Opinion
By Michael Weiser
NEW YORK ( TheStreet) -- There are two prerequisites to understanding this communication: a working knowledge of basic Yiddish terms and the belief that gold, above all else, is a contrarian trade driven by a healthy distrust of politicians and the fiat currencies they attempt to control.
It is facile and fashionable (not to mention alliterative) to dismiss such investors as gold bugs, but politicians and central bankers have done little to disabuse a growing number of us that we are, in any respect, wrong. However, for a number of reasons -- not the least of which is a recent change in the political rhetoric -- we are at what seems to be an inflection point in the gold trade, which likely will be determinant of gold prices for 2011 or at least until the 2012 election cycle gets into full swing.
Since September 2007, when the Federal Reserve began its current easing cycle, gold has been the primary tool available to investors for expressing their concern about dollar debasement. At its initiation, quantitative easing round II only served to heighten a sense of dollar helplessness felt by investors; even as investors were beginning to clue into a modest growth recovery, the Fed was (and is) clearly preoccupied with job growth. However, QE2 has succeeded in further levitating equity prices and inflation concerns, the latter driven by rising prices of commodity inputs and expressed in higher long rates. Taken together, these developments have armed investors with tools other than gold (being long stocks and short bonds) to use in expressing their concerns about the effects of dollar debasement.The course of the Fed's public emphasis on the full employment plank of its dual mandate seems headed for an inflection point of its own. Over the next 120 days, traders will spend hours and no small amount of spit debating the need for, and likelihood of, a third round of quantitative easing. I may be an amateur observer of politics at the Federal Open Market Committee table but the makeup of that group seems no less supportive of easy money than last year's group, especially with the departure of Kevin Warsh and the likelihood that President Obama will replace him with someone of the same mind as Chairman Ben Bernanke and Vice Chairman Janet Yellen. It has proven dangerous over the last three years to sell short the Fed's resolve and ability to supply ample liquidity to the market. For example, reinvestment of proceeds/maturities from prior investments in short-term bonds and mortgage-backed securities into longer-term Treasuries may lack the headline punch of a new round of quantitative easing but it keeps the printing presses rolling. Should the political consensus be lacking for a QE3, I have healthy respect for the ability of the Treasury and Fed to find other central banks willing to buy longer-term paper instead. (Maybe it will be the Saudis riding to the rescue, eager to curry the administration's favor and avoid the fate of Egypt's Hosni Mubarak.) All of this makes me invoke the words of my dear friend and economist Arnold Simkin: "Pay no attention to the man behind the curtain, money will be printed!" Meanwhile, the price of gold threatens to establish meaningful new highs, driven by tumult in the Middle East. In the short term, the bullish threat to dis stasis (I am a native Chicagoan) is a near-term top in long rates, which have had a 150-basis-point run in the 10-years since August. Unless Paul Ryan and the bond vigilantes (Remember Paul Revere and the Raiders?) can convince investors that commodity inflation is seeping into the core, this run may be about done, and along with it, go the worst of investor concerns about the likelihood of a withdrawal of liquidity by the Fed anytime soon. It is here that we may hear more draying about unemployment, housing prices and, yes, discussion about a third round of QE that could push gold prices much higher this year. This also would be bullish for equity prices, which hate competition from rising bond yields, and which thrive on Fed-induced liquidity. Meanwhile, bearish for gold prices would be the first signs of the Fed normalizing its policy. A gezhuntah jobs report (where gezhuntah = creation of 300,000 or more private-sector jobs) or consecutive semi-gezhuntah reports where about 200,000 or more jobs are created in the private sector, would probably do the trick. Either or both could put an early end to QE2 squarely on the table and force voting members of the FOMC -- especially those representing the regional banks -- into a defensive posture. In this instance, gold would move away from the epicenter of asset pricing and the predictions of Doug Kass and others for dramatically lower gold prices -- and likely through the 200-day moving average at $1,300 an ounce - would be fulfilled. Gold prices might then stay depressed until the 2012 election cycle begins to heat up, and volatility puts a cap on other asset prices and a floor under gold. At first glance, daily charts would seem to support the bearish case. The 50-day moving average appears poised to cross over the 100-day although the last time this happened, in September, the 50-day kissed the 100-day and gold went on its merry way. The current smooching could occasion a top in long rates and the aforementioned resumption of rising gold prices. A breach of the 100-day by the 50-day would send prices much lower. We're likely to find out Friday. Bullish or bearish, I either need to cut my exposure to the SPDR Gold Trust (GLD) and gold stocks, or pay the options bandits for a hedge that takes me through Friday's nonfarm payrolls report where anything (save a World Series appearance by the Chicago Cubs) could happen. There is another, exogenous factor potentially affecting gold prices. As the Obama administration continues its campaign to convince corporate leaders that it is not really the collection of statist/anti-capitalists that we all know it to be, a really dollar-positive idea is resurfacing: allowing corporations to repatriate earnings held overseas by implementing a tax cut or granting them an outright tax holiday on such earnings. (Of course, this is just the sort of tool employed by the Bush administration that was criticized by Obama as an act of fat-cat welfare just months ago but which now is an investment in the hands of he and other progressives.) While I doubt that corporations will be as eager as they once were to bring money home given the investments they need to make overseas to support the income they generate there, enough gelt would be repatriated to put a short-term floor under the dollar and discourage higher gold prices. Whatever the outcome, I need to get me a hedge. Over the longer term, it is hard not to be bullish about gold prices. Unless the 2012 election brings us the kind of hard-dollar resolve that the combination of Ronald Reagan and Paul Volcker gave us in 1981, dollar influence will continue to wane. Even then, the need of central banks in China, India, Brazil, Indonesia and Russia to diversify their foreign exchange holdings will lead to increased demand for gold. Something like 88% of all currency reserves are held in dollars, euros or yen. As we speak, all three currencies are being debased, so there should be little wonder about the appetite of developing countries to hold a currency, the supply of which is not subject to the whim of other men. Finally, there is core inflation. Eventually, the Fed may succeed in its goal of creating some. If it does, in the time between the green shoots of wage inflation first appear and the Fed succeeds in breaking the back of inflation expectations, gold is likeliest to hit its high for this cycle. Think back to 1981. In the period between G. William Miller's aborted term as Fed chair and his successor, Paul Volcker's breaking of the back of inflation, gold rose to $850 an ounce, or $2,200 in today's dollars. History, as Huck Finn's alter ego once observed, may not repeat itself but it certainly does rhyme.
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