A Perfect Storm For Gold?

| About: SPDR Gold (GLD)


According to Diego Parrilla, the central banks of the world have created an environment generating "a perfect storm for gold," a picture not unlike one just presented by Bill Gross.

Ever since the Fed last raised its policy rate in December and has backed off further increases, asset markets (gold, commodities, bonds, stocks) have boomed in possible price bubbles.

With continued Fed reluctance to do anything about interest rates, Mr. Parrilla, along with Mr. Gross, seem to think that the bubbles could continue to grow.

Diego Parrilla, a precious metals specialist, writes in the Financial Times about the possibility of "a perfect storm for gold."

Bill Gross of Janus Global writes in Bloomberg about the global economy that "devolves into Ponzi finance…."

Both claim that these possibilities are the potential consequences of several years of excessively loose monetary policy on the part of central banks around the world. The monetary policies that were followed have resulted in dislocations and dysfunctions within financial markets that will eventually undo the current structure of these financial markets.

As Mr. Parrilla describes it, I have been a member of the group that "tends to have a constructive view of the US dollar and the ability to raise interest rates and normalize global monetary policy…."

Up until the present time, I have been in the group of analysts that have believed that the Federal Reserve would raise its policy rate of interest, support a stronger dollar, and work to settle international financial markets.

Now, however, I think that this scenario is less likely to happen.

So, what is the alternative?

Mr. Parrilla describes a second group, one he contends "tends to be more pessimistic on the global economy and the unintended consequences of monetary policy without limits."

Basically, this second view is a picture of asset bubbles, and does not seem to me to be terribly different from the picture that Mr. Gross presents, although the details might be a little different.

Mr. Parrilla bases his view on three things: first, on the limits of monetary policy; second, on the evolution of risk-taking; and three, on the limits of fiat currencies.

Mr. Gross doesn't seem to subscribe to this third point.

In terms of the limits of monetary policy, Mr. Parrilla writes "Quantitative easing and negative interest rates have been game changers-distorting the valuation of government bonds, breaking the theoretical ceilings in prices, squeezing shorts and underweight positions and feeding what, in my view, is one of the largest financial bubbles in history."

Second, on the "edges of credit markets" there is a bull market "that feeds on itself and benefits the weakest players most…."

Third, "competitive currency devaluations only increase underlying problems and global imbalances."

"Gold and the dollar are best placed to play the role of good money" which is important if your believe Gresham's law. The first stage of Gresham's law, Mr. Parrilla writes, is that bad money displaces good money, but we are starting to enter into the second stage where "good money displaces bad money."

Mr. Gross does not talk about returning to a gold standard although he does write in his latest monthly letter, mentioned in the Bloomberg reference above, "Real assets such as land, gold and tangible plant and equipment at a discount are favored asset categories." Buying gold, therefore, is not off his list of good assets to buy.

The one problem Mr. Parrilla sees in this scheme is "the inability or unwillingness of the US to normalize its monetary policy."

This leaves the door open for a "multiyear bull run in gold."

And, what does the market seem to add to this picture?

Well, the price of gold was at $1,054 on December 17, 2015, the day after the Federal Open Market Committee last raised its discount rate.

Although Fed officials began to provide "forward guidance" for possible interest rate increases in 2016, the market took the price of gold upwards. Its 2016 high came on July 6 when the price closed at $1,374. Currently, the price has dropped off a bit, closing at $1,338 on Monday, but this still represents a 27 percent increase from the date after the December FOMC meeting.

Note that this move seems to have been broad enough to spread into other commodities. The Thomson Reuters/Core Commodity CRB Index, hit a near-term low on February 11, 2016 and has risen 18 percent since that date. Another commodities index, the S&P GSCI GFI Futures Index has risen by 27 percent since the February 11 date.

In another area, the yield on the 10-year Treasury note was 2.29 percent at the close of business on December 16, 2015. On July 8, 2016 this yield was 1.36 percent, and now is at 1.59 percent allowing analysts to talk about the asset bubble in bond prices.

And, then there is the stock market. Although the S&P 500 stock index closed at 2,073 on December 16, 2015, it closed at a near-term low on February 11, 2016 of 1,829. Note that this was the date of the near-term low for the commodity market indexes.

On Friday, the S&P 500 closed at a new historical high of 2,183, a level that is more than 19 percent above the February 11 level.

Mr. Parrilla seems to have some market support behind him with respect to asset bubbles. And, it seems very unlikely that the Federal Reserve will raise its policy rate again this year…or even next years…given the state of both the US economy and the global economy.

Furthermore, as Mr. Gross agrees with this as cited in the Bloomberg reference, the Federal Reserve will do little or nothing to reduce the size of its balance sheet.

This would mean that the value of the dollar will not get stronger and this will end up with the possibility of more "competitive currency devaluations" and more efforts to use different forms of financial engineering to achieve higher yields.

Seems like this would be all be consistent with Mr. Parrilla's picture of "a perfect storm for gold" and Mr. Gross's view of the global economy devolving "into Ponzi finance."

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.