As I pointed out in my last article, I expected continued selling of gold by the big boys; the Hedge Funds, Mutual Funds and Professional traders to close out the year and they didn't disappoint. The largest ETF; SPDR Gold Shares (NYSEARCA:GLD) saw an outflow of 12.9 metric tons last week.
Holdings of gold by SPDR Gold Shares, the world's largest exchange-traded fund backed by the metal, fell last week by 12.9 metric tons to 801.22 tons, according to a weekly report issued by the plan administrators. Still, GLD shares closed Friday at $117.12, up from $115.94 the week before. Daily share volume last week fell to 4,191,110 from 11,995,433 the prior week, the report says.
December 31st we saw a fall in the Dollar Index down below 80 again as seen in the following chart but it has now rebounded to above the 80 mark again sitting at 80.56. 80 seems to be the line in the sand at present and I'll explain why I expect a stronger dollar below which may still have a negative effect on gold.
Monthly Dollar Chart
I also mentioned in that article that I expected a January rise because the hedge funds, mutual funds and professional traders would be buying back what they sold in December. Gold got an early start in the last day of trading last year as it rose $23 from its intraday low of $1,981 and presently has climbed another $27 from to start January. It still has not broke its 52 week closing low of $1,192. If you owned gold in December and sold it, there probably isn't much to change your attitude towards precious metals now and would want to l be back in the trade.
You can see from this longer term chart that we are still in a dollar short term uptrend since April of 2011 and the price of gold has fallen since that bottom. The question a buyer of gold has to ask, is will the dollar break down from here or continue higher? I am in the camp that it will break higher. This isn't what a gold bull wants to hear, but for me to say this, it simply means that I am more negative on the yen and euro which make up 70% of the Dollar Index. If those go down in value, the dollar, by default, benefits. This is also the premise I will be explaining more in my upcoming book, "Illusions of Wealth."
Is a Euro Fall Coming?
I have to give Axel Merk of Merk Funds credit as he has been bullish on the euro and it has outperformed the dollar the last 6 months. I had a chance to ask him a few questions as to his thinking last July of 2013 and his reasoning to be bullish was that the euro had no budget deficits to deal with, unlike the U.S. I have to believe that the euro's run is over though. Many see it as being vulnerable in the New Year. See Euro rises against dollar and yen but seen vulnerable.
We remain skeptical of euro strength and will be watching funding rates in the first days of the new year for signs that the liquidity squeeze which supported the euro mid-December is continuing to fade," said BNP Paribas analysts in a note.
This recent rise in the euro was the result of ECB liquidity to banks, basically kicking the can down the road as the Fed has been doing here in the U.S., hoping the banks would use the funds they received from the Fed to make loans and stimulate the economy. Bank lending in the U.S. up to this point has been non-existent as they sit on $2.3 trillion. What the ECB is now contemplating doing is continuing to lend banks new money but with strings attached; they can't use the money to shore up their terrible balance sheets like the U.S. banks have, but instead forcing them to use the money for business loans.
ECB President Mario Draghi concurs. He said, "We are ready to use any instrument, including another LTRO if needed, to maintain the short-term money market rates at a level which is warranted by our assessment of inflation in the medium-term." Of course there is no inflation, but banks in Europe are still sitting on terrible balance sheets as seen in the following headlines.
- Bad loans at European banks hit $1.7 trillion
- Bad debts still rising for banks in Italy's Lombardy-BOI
- Spanish banks' bad loan ratio rises to record
- Budget will increase bad loans, warns Bank of Portugal
- Greece's Piraeus Bank warns of rising bad loans
This however is the central bank's plan in dealing with the 3 year loans they gave banks in 2011 and 2012 that will come due late 2014 and early 2015. When these loans were first announced, the euro fell. I expect the euro to fall more when they finally announce the implementation of this plan. This will be dollar bullish.
There is also the reasoning that the countries that make up the euro can't print their own money as fellow Seeking Alpha contributor Shareholders Unite wrote about in The Ticking Time Bomb Under the World Economy.
Japan Prime Minister Abe Shinzo does have the ability to weaken the value of the yen versus the dollar and euro. I believe Japan had no choice. They lead the civilized world in debt to GDP ratio (see table below) and have to do something to keep their exports more than imports and keep GDP growing so they can rely less on the potential of even more government intervention or the selling of their 1.1 Trillion of U.S. Treasuries.
Gold Priced in Yen, Euro's or Dollars - We Are Going Higher Medium and Long Term
Although I cautioned against one more push down in prices for the precious metals, after a possible bounce in January, the medium and long term prices are still bullish. We may get the 50% retracement in gold which would put us in the mid-$900 range. Breaking the $1,000 psychological barrier is something I could see market makers do in trying to deflate the gold bulls. We are already at a 60% retracement for silver. But whether you own yen, euros or dollars, or any other currency for that matter, every country's Debt to GDP ratio is moving higher and higher which will be more and more bullish for gold as time goes on. These debt levels are simply unsustainable when your GDP isn't growing.
Every central bank is throwing money at the banks, hoping to stimulate, but the Velocity of Money is at a standstill to this point. The U.S. banks are just sitting on their hordes of cash to the tune of $2.3 Trillion as I mentioned. When this money flows into the economy it will have its effects, but what would make a banker lock in long term loan rates when they know rates are going higher? Bernanke doesn't want higher rates and can't afford the consequences of them. It would mean more has to be paid from the budget for interest payments on the rising debt. This could slow down the U.S. economy as cuts would have to be made in the budget somewhere. Also, the real estate market which is already stagnating, would mean less could afford homes. So the money will sit at the banks for the time being.
Japan's world leading Debt to GDP ratio has lasted through their deflationary contraction period because they were a net exporter and net creditor and their citizens own 99% of the Treasuries. But their spending policy is catching up to them and the Yen is depreciating quickly versus the dollar with the full blessing of the G20 as they did not criticize Shinzo's move during their meeting in February of 2013. Europe's growth rate isn't anything to speak of.
I see nothing but weakness for the yen and euro over the next couple years. But how quickly will they fall when sentiment stays negative? How quickly has gold fallen when sentiment changed? If the euro reverses course and the yen continues its slide, they represent 70% of the U.S. dollar. Without any real growth in Europe, and a sales tax increase in Japan than can have a negative impact on the economy in Japan, along with perceived stability here in the U.S., this will be dollar bullish.
Being that the U.S. is experiencing some of this Japanese style deflation, it has hurt the price of gold somewhat, despite all of the QE that Bernanke is throwing at it. But you will note the price of gold in yen has moved higher throughout most of their deflation as seen in the following chart. Gold will take on a life of its own in the years ahead despite this talk of inflation and deflation. Gold can rise in every currency and has the last 5 and 10 years.
Is the Economy Stronger?
If you simply looked at the stock market you would think all is well with the U.S. economy as it has moved higher. Consumer confidence has also moved higher on the scale. But the consumer is always the last to know what's going on with the real economy. For that matter, who in government or at the Fed saw the 2008 financial crisis coming?
Many moms and pops you can see are already feeling the pressure. Three out of 4 NFL playoff games haven't sold out including Green Bay at home where their fans won't be able to watch the game on television. A hair dresser client with 35 years at J.C. Penney (NYSE:JCP) said she has seen a drop off in business as her clients postpone the time between hair appointments, don't get extra services like massages and buy lower cost hair products instead of the higher priced salon products. A Midwestern loan officer said his loan business came to a standstill when Bernanke first talked of cutting mortgage purchases 6 months ago as interest rates moved higher. He saw his bank's business pick up again when interest rates fell over the summer and fall, and now the business is at a standstill again as interest rates have moved to the upside with the Fed's promise of tapering $10 billion a month. On a side note, the Midwesterner's bank no longer offers 30 year fixed loans, only adjustable rate loans. Higher rates in the future will kill the economy more, but for now, perception is still that all is well. We will see how long this lasts, especially if Yellen and the Fed can't keep interest rates low through mid-2015 as Bernanke said they have to in his last meeting as Fed Chairman.
The Effects of QE
The effect of the Fed's QE to infinity is going to be felt at some point, not just yet. The deflationary credit contraction is dwarfing anything the Fed has done and the $10 trillion taper the Fed just told us they will implement isn't going to change the fact that more QE is going to come at some point. For now, the Fed has everyone fooled that they are in control and thus a stronger dollar is on the horizon because of this perception. I do believe a higher price of gold is on the horizon as well but there will be some bleeding still to come, especially if we do indeed get a stronger dollar. Recently we have seen both gold and the dollar move higher.
Once gold bottoms out, and I do think it will be doing so this year, we will be off to the races. The Fed won't know what to do as everything they have done will come back to haunt them. They simply won't be able to unload their balance sheet at a profit, especially with higher rates on the way. They also have to keep rates low, but it won't be that simple unless more QE from Yellen is looming around the corner. How will markets respond to it if it comes? Will it be viewed as a sign of weakness?
In a nutshell, we are beginning to see the bounce in gold here in January and it should be followed by a test and breach of the lows. Patience for those invested in gold and silver will be rewarded but you will need a bit more of it.