The Fire Fueling
Gold by 321 Gold | October
11, 2013
Gold took quite a beating
in September, bucking its seasonal average monthly return
of 2.3 percent. The political battle between President Barack
Obama and Congress, China’s Golden Week, and India’s
gold import restrictions likely weighed on the metal.
September’s correction only adds to
the negative sentiment toward the precious metal. The assumption
from many market pundits is that gold is no longer attractive
as an investment. With rising rates and continuing low inflation,
U.S. investors believe they have a solid case for selling
their holdings.
However, this could be a premature assessment,
causing these bears to potentially lose out on a lucrative
position.
Allow me to use an ice cube to explain.
One of the strongest drivers of the Fear
Trade is real interest rates. Whenever a country has negative-to-low
real rates of return, which means the inflationary rate
(CPI) is greater than the current interest rate, gold tends
to rise in that country’s currency.
Our model tells us that the tipping point
for gold is when real interest rates go above the 2-percent
mark.
Consider the ice cube, which shows how new
equilibriums can have significant effects. At 31 degrees,
H2O is a solid chunk, but when the temperature increases,
the mass slowly begins to turn into a liquid. Above 32 degrees,
ice changes form from solid to liquid, but it’s still
made of hydrogen and oxygen.
Because money is like water, when many other
economic dynamics, such as population growth, urbanization
rates and changes in government policies, reach their tipping
point, the velocity of money tends to be altered.
As global investors, we watch for changes
in these trends to know how to invest in commodities and
markets, find new opportunities and adjust for risk.
So, how close to gold’s tipping point
are we? In other words, what is the real interest rate today?
As you can see below, Treasury investors continue to lose
money, as the 5-year bill yields 1.41 percent and inflation
sits at 1.5 percent. This is nowhere near the 2 percent
mark.
I would be worried about gold if real interest
rates solidly crossed the 2 percent threshold for an extended
amount of time, because it would have a dramatic effect
on gold as an asset class. In a high interest rate environment,
gold and silver lose their attraction as a store of value.
In order for that tipping point to happen,
rates would need to continue rising above inflation, and
inflation would need to remain low. These are the forecasts
made by many gold sellers today; however I wouldn’t
get too trigger happy just yet, as recent data challenges
these assumptions.
Take the monthly unemployment figure, which
is one of the primary indicators the Federal Reserve studies
when evaluating the economy.But depending on the definition
of an unemployed person, the numbers reveal different results.
The official U3 unemployment rate, the exact
figure Ben Bernanke uses, tracks the total unemployed as
a percent of the civilian labor force.
The broadest gauge calculated by the Bureau
of Labor Statistics (BLS) is the U6 unemployment rate. For
this number, the BLS adds in all those people who are marginally
attached to the labor force, plus people working part-time
but want to work full-time.
What does “marginally attached to
the labor force” mean? These people are neither working
nor looking for work but indicate they want a job, are available
to work and have worked during some period in the last 12
months. These marginally attached people also include discouraged
workers who are not looking for work because of some job-market
related reason.
Then there’s a measure of the labor
market the BLS tracked prior to 1994. This is the seasonally-adjusted
alternate unemployment rate that statistician John Williams
continued to calculate. It’s basically the U6 plus
long-term discouraged workers.
While the figures closely followed one another
from 1994 through 2009, there’s recently been a shift.
U3 and U6 have been trending downward over the past few
years, whereas Williams’ ShadowStats unemployment
rate shows a noticeably upward trajectory. Perhaps the official
unemployment figure overstates the health of the economy?
Based on the jobs market, a limited housing
recovery and regulations that have been slowing down the
flow of money, the Fed may have no choice but to raise rates
very gradually to keep stimulating the economy.
Then there’s the suggestion of inflation
manipulation. Even though the U.S. has been reporting a
low inflation number, things feel more expensive to many
Americans. Disposable income has been growing less than
inflation in recent years; perhaps that’s why many
people feel “squeezed.”
Also consider Williams’ chart below.
It shows monthly inflation data going back for more than
a century. The blue and grey shaded areas represent BLS’
historical Consumer Price Index (CPI). You can clearly see
the wild swings of inflation and deflation, especially during
World War I, the Great Depression, and World War II, as
well as the stagflation of the 1970s and early 1980s.
However, shortly after disco, bell bottoms,
and episodes of “All in the Family” faded from
memory, the U.S. adjusted CPI, not once but twice, first
in the early 1980s and again in the mid-1990s. If you use
the pre-1982 calculation, you end up with a much different
inflation picture. This is the area shaded in red.
Figures don’t lie, but liars figure
Way back in 1889, statistician Carroll D.
Wright, in addressing the Convention of Commissioners of
Bureaus of Statistics of Labor, talked about the impartial
and fearless presentation of its data, using the above play
on words. He said,
“The old saying
is that ‘figures will not lie,’ but a new saying
is ‘liars will figure.’ It is our duty, as practical
statisticians, to prevent the liar from figuring; in other
words, to prevent him from perverting the truth, in the
interest of some theory he wishes to establish.”
For patient, long-term investors looking
for a great portfolio diversifier, a moderate weighting
in gold and gold stocks may be just the answer. And, today,
when looking across the gold mining industry, you’ll
find plenty of companies that have paid attractive dividends,
many higher than the 5-year government yield.
Check out a discussion of some of these
gold miners in my recent blog post about the Denver Gold
Forum.