Since Ben Bernanke gave testimony before Congress on February 26th, the stock market keeps going higher. Meanwhile, gold and gold mining stocks keep declining. Interest rates have risen sharply recently as risk appetites have increased. Conversely, bond prices have declined. In this environment, the contrarian investor should buy the most hated investments for a portion of his/her portfolio: Dollar-denominated bonds, certificate of deposits, gold and the gold miner ETF GDX.
The Fed is increasing its already large $3 trillion holdings of Treasury and mortgage securities by $85 billion a month. Bernanke has made it clear it will not make any change until unemployment rates fall to 6.5% or lower. He plans to hold short-term interest rates near zero and has no plans to increase rates.
The most important points of testimony were:
Bernanke bragged that despite his easy money policies "my inflation record is the best of any chairman in the postwar period."
Fed has provided $290 billion to Treasury already and any further losses will not exceed the profits already made!
The Fed may never sell the bonds it holds
Monetary policy promotes growth and job creation
There were many other exchanges made between Bernanke and our elected representatives. You should listen to some of the lively exchanges for entertainment, but none of those were more important than the four points above. Bernanke also said:
Quantitative Easing (QE) has not created inflation
The Fed has boosted the Treasury by $290 billion
There is no risk of interest rates shooting up. This is because the Fed may never mop up the QE money by selling the Fed's bond assets.
Growth is back and new jobs are being created.
Isn't all this like eating your cake and having it too? Maybe Bernanke chuckled to himself: "What part of the financial calculus does Senator Corker not understand?" Bernanke never spoke this last sentence. I am just making it up to show how opposite Bernanke's thought process was as compared to some of the Senators who were questioning him. Only time will tell who was right. Wall Street hooked on the easy money by dove Bernanke has partied on, with the stock market continuing its slow melt upwards.
But why are gold and gold mining stock prices falling? Some answers maybe as follows:
There is a perception that new jobs are being created and unemployment is falling. Therefore, there will be no new QE. No new QE and an improving economy with no inflation are all bad for gold.
George Soros sold 55% of his gold holdings in late 2012. This has put gold bulls on the defensive.
Japan's new Prime Minister Abe is determined to turn around Bank of Japan inflation targets with his new "Abenomics" which is Bernanke-style asset purchases. As a result, the Japanese Yen has devalued from about 77 Yen/Dollar in September 2012 to about 96 Yen/Dollar today. A stronger dollar is bad for gold, since gold and indeed all commodities are priced in dollars. This weakening of Yen is perhaps the single biggest reason why gold prices have been falling.
The recession shows no signs of easing in Europe. Bad news keeps coming from the eurozone countries, where Bernanke-style asset purchases are in progress. A currency war between the euro, yen and dollar is in progress for the race to the bottom. The dollar is losing this race, for now, and therefore gold is falling.
As gold drops, the gold miner ETF GDX drops more due to more perceived political or economic risk.
To complicate matters for the gold miners, their accounting procedures have come under a cloud of suspicion. The total cash cost of gold extraction per ounce has been under-reported by almost 50%.
All the bad news seems to have been stacked for gold and even worse news for the gold miners. But where do their investors go from here?
Before answering that question, lets us take a look at the longer trend since 2006, before the bust and boom created by Bernanke.
Chart 1: A comparison of GLD, S&P 500, GDX, FXE and FXA from Q1 2006
The chart above, from Yahoo Finance, shows that while the stock market recovered to pre-crash levels, gold still hovers in the stratosphere. So congratulations, if you were a gold bull during the last decade. Gold handily beat the stock market despite Bernanke's crutches and prop ups. Therefore never fail to look at the long-term picture.
But GDX has given back all gains. Also plotted are euro (FXE) and Australian dollar (FXA) ETFs sold as an ETF in U.S. dollar. The euro has essentially stayed flat over this period. But despite the currency wars, the Australian dollar, a currency backed by natural resources, has shown surprising strength. It has not tracked downwards with GDX perhaps because of the accounting woes of the gold miners. It may also be indicating that the Chinese may continue to import Australian resources. I bring the Australian dollar into the picture since it may be another hedge against the fall of the U.S. dollar and FXA yields 2.92%. But recall the drop in 2008, when both GDX dropped to about $17 and the Australian dollar crashed to U.S. $0.62. Both can drop again to these levels.
Given lots of bad news for gold and gold miners, this would be a good time to accumulate towards the target allocation one already made for gold and gold miners in their portfolio. One should be buying when everybody is selling to get the best price.
GDX would be a riskier buy than gold but returns could be higher when gold prices do rise higher.
Given that the Fed may never exit bonds for fear of increasing interest rates, buy laddered certificates of deposit (CD) as interest rates rise.
If the U.S. dollar strengthens, buy the Australian dollar FXA for diversification and fixed income.
Disclosure: I am long GDX.
Additional disclosure: Long gold