Stepping Back for the Big Picture

Regular readers know we are big fans of Greg Canavan and Vern Gowdie of The Daily Reckoning.  They have a great way of explaining what main stream media tends to ignore, looking at the bigger picture, and all with an Aussie context.  Those following the gold market know it has had a rough couple of weeks as growing expectations of a June or July US rate hike is seeing a strengthening USD and downward pressure on gold.  Our most recent discussion on this is here.  Greg recently summarised it in his own way as follows:

“But there is the little issue of the strengthening US dollar. Global interest rate divergence (meaning higher rates in the US and continued easy money in Europe and Japan) is not a positive global macroeconomic backdrop.

This divergence means the US dollar will strengthen against the yen and the euro. It will also put pressure on the Chinese yuan again, as China competes in the export market against Japanese and European goods.

From a macro perspective, a strengthening US dollar is a headwind for the global economy. That’s because it’s the world’s reserve currency. A strong US dollar puts pressure on commodity prices and emerging markets. It represents a tightening of global liquidity.

So, as you can see from this dynamic, the world economy is trapped in a no win situation. Higher rates in the US drains liquidity from the rest of the global economy and leads to a slowdown…which then leads to lower US interest rates and an increase in global liquidity and economic activity.

And around and around we go. So keep this in mind while the narrative of ‘higher interest rates are good’ grows stronger over the next few months.

Higher interest rates are indeed good. They are the only mechanism that will rid the economy of speculation and wasteful investment. Higher rates will cause short term pain, but they will also increase long term productivity, which is the Holy Grail of sustainable economic growth.

But it just won’t play out like that. Debt levels are too high all around the world to risk higher rates. The only option is to try to generate enough inflation so that nominal rates rise while real rates stay low. The real interest rate is the nominal rate minus inflation.

Right now, the market is buying the Fed’s preferred narrative. That is, the US (and global) economy can handle higher rates. That’s leading to higher stock prices and an unwinding of bets on gold in particular.

As someone who thinks gold is at the start of a new bull market, this is not too concerning. In fact, after such a strong run, a pullback is always healthy. In the same way that the hedge fund speculators are pouring back into oil (via the futures market), the same thing has happened with gold over the past few weeks.”

As a long term strategic investor, one could ‘step back’ and personally test the logic of Greg’s argument.  If you agree, as we do, you could see a path that might see you riding the gold bull (being overweight gold and light shares) while the world ‘takes its medicine’, and has the crash it needs by normalising rates.  You might then sell down your higher priced gold weighting and go overweight the bargain shares before the long term productivity wave Greg discusses.  The trick of course is the stepping back bit.  Not many share-centric advisors or superfunds will do that…  Note too we are not saying ‘sell everything, buy gold and silver’.  There is always the fact that no one really knows what will happen next, so a diversified portfolio is always prudent.