Gold to Hit $2,000 as Monetary Velocity Picks Up

Alan J. Mandel--HTDT senior precious metal analyst

There is so much liquidity in the U.S. monetary system even if the Federal Reserve tapers its $85 billion per month bond-purchase program it won’t make a difference.  There is a big misconception that as soon as the Fed stops its bond purchasing program the excess liquidity will dry up and real interest rates will rise. First of all, I don’t think the Fed can afford to taper anytime soon. Even though the Fed keeps throwing petrol on the fire, the U.S. economy does not feel the heat. Growth according to the latest GDP figures are soft and unemployment lackluster after years of quantitative easing.  I’m expecting inflationary pressures to be correlated to monetary velocity and despite short-term volatility, expect gold to hit $2,000 in the long term and possibly higher. Money velocity accelerates with increased money supply coming from bond purchases and can increase prices with heightened economic activity.

In the near term, I expect gold to remain fairly stagnant, testing the $1,300 level during the summer doldrums when many market participants in the U.S. and Europe are on holiday. Although prices can move lower during the summer months as volatility remains high, it is important to keep an eye on the long term price action. It’s only a matter of time before prices push higher.  But since inflation hasn’t shown up in the economy, investors aren’t paying attention to the excess liquidity. According the Consumer Price Index (CPI) and Producer Price Index (PPI) inflation has been nonexistent. That’s because banks and corporations are hoarding cash.  Once they feel a bit more optimistic about the improving economy and are ready to spend and hit the gas, inflation will be driven up as they compete for available goods, services and skilled workers. One positive sign that the economy may be picking up was indicated in the release of the July Institute for Supply Management (ISM) Non-manufacturing Index August 5^th. It showed the pace of growth in the U. S. services sector accelerated to a five month high; it rose from 56 from 52.2 in June. New orders also jumped but the employment index component fell.

 

 

In the U.S., even without troublesome CPI numbers, U.S. Treasury yields have begun to creep up. The common wisdom is that if real interest rates in the U.S. start to rise, it makes the opportunity cost to hold gold greater because gold has no yield. But the World Gold Council said that higher U.S. real interest rates aren’t an automatic weight on gold prices. Real rates around the world will not necessarily follow what the U.S. does. Plus economic activity for the most part remains soft.  A situation could unfold where there are rising interest rates and inflation with slow growth as I mentioned in a previous column.

Gold may have no yield, but that doesn’t mean it has no return. Sometimes gold is given a zero percent long-term return estimate when the metal is used to show its role as a core portfolio asset. But the World Gold Council’s research shows that gold’s average monthly return since 1975 is 0.6%, or an annualized yield of 7.5% nominal return. Gold is not without risk but tends to perform best when there is a low real interest rate environment, defined by WGC as zero percent, which is what the Fed needs to maintain, with monthly average returns averaging 1.5%.   

Finally, one can’t forecast gold prices without also considering the U.S. dollar. With regard to purchasing power, the dollar depreciated in real terms for the past 40 years. This usually happens little by little. In the short term, until the fall, I think the dollar could strengthen, but in the long term, the large scale fiscal and corporate deficits, the bigger balance sheet of the Fed (which was done to try and reinvigorate the U.S. economy), will have a toll on the dollar strength. Going forward in the medium to long term, we may see an environment where many emerging-market currencies and some of the developed market currencies start to play a more important role on the world stage. Dollar weakness usually translates into gold price strength.

So for now, watch for signs of stagflation to push up gold prices - rising interest rates, inflation and slow growth particularly in the U.S., China, Japan and the EU as stimulatory measures fail to reinvigorate those economies but increase the supply, therefore, the velocity of money.

 Reference: www.kitco.com
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