Economic Chaos v Gold & Silver

Yesterday and in Friday’s Weekly Wrap we discussed the development of China dumping US Treasuries (bonds).  We’ve posted today an article by Greg Canavan which is probably the best explanation we’ve read yet.  If you haven’t gathered, we think this is very important and not simplistically because gold is the safe haven alternative to bonds.

If you’re reading the AFR today you will see a group of economists in the US are now back up again to 40% thinking the Fed will raise rates this month after dropping to 25% during the ‘old news’  of last week’s market crashes.  Indeed they state the Fed wants to, and is looking for excuses to do it, not otherwise.  This is the conundrum we’ve discussed at length – they know they need to, to stop this bubble getting bigger without fundamentals, but they also know if they do last weeks ‘crash’ could well be just a little correction before the real crash.  Again - “bubbles don’t correct, they explode”.

There is support in the gold price on any scenario:

  1. If the Fed raises rates, not only could this trigger a big crash that would see a flight to gold/silver (and particularly with bonds looking decidedly un-safe), but there is a robust view that in doing so they are effectively raising the discount rate by which all investments are measured in the US.  That simply means less investments stack up and you get a declining USD.  There is a strong correlation between falling USD and rising Gold/Silver price.
  2. As above but the higher rates, in a world of zero, sees the USD strengthen, initially putting pressure on gold but then seeing US business decline through global non-competitiveness and easing (QE4) start all over again.
  3. Should, as Greg and many others suggest, there is instead a QE4 response given all the US Treasuries that need buying in the absence of real buyers (but deficits to keep funding), you would expect a complete loss of faith by smart money and again a flight to gold.  
  4. There is an alternative thesis by Bill Holter who draws the distinction between QE which is the Fed printing money to buy off (and hence credit) its member banks and what would be needed in this situation.  He calls it QT and its enormously bullish for gold:

“The Federal Reserve had to buy the $100 billion worth of bonds.  This is "reverse" QE or as they now say "QT" (quantitative tightening).  As the great credit unwind continues, more and more Treasuries from China and other sources will hit the market and force the Fed to buy them.  This will take more and more "space" on the Fed's balance sheet but they will have NO CHOICE unless they want interest rates to skyrocket.  In the end, the inflation we exported for so many years will come washing back on our shores like a tidal wave!”

Our commitment for these daily news pieces is to (normally) keep them relatively short and succinct.  There are many more theories and indeed it is a complicated global financial web we find ourselves in.  The fact is no one knows and that’s why a balance of investments is the prudent way forward.