Looking Forward: A Year Of Surprises

by: Paul Nathan


As we enter 2015, we will face many negatives as well as many positives. One of the biggest potential surprises could be what gold does in this year.

The forces of lower oil prices are offsetting the threats of de-leveraging and financial contagion, as we speak.

But cyberwarfare, commodity deflation, and future decisions on fiscal and monetary policy will be among the many influences on the economy in 2015.

Looking Back

In my annual "Looking Forward" article: "Toward Normalization," posted in December of last year, I began by stating:

"Since 2008 I have been forecasting an 'L' shaped economy. Year after year, I've looked at the current economic and fiscal policies of the government, the condition of the financial system, the regulatory environment, taxes, and the Fed's monetary policy. And year after year I've been forced to conclude that we were in for 'another year of L.' And indeed, every year we have stayed in the 2% range, never achieving a typical economic recovery. For six years we have had sub-par growth and persistently high unemployment.

I think that is finally about to change.

The year 2014 should bring an improvement across the board, but with a joker in the deck. Although I think we have a good chance of seeing increased growth in the year, I think the 1st quarter of the year will be challenging. I'm concerned that dislocations can disrupt a natural recovery in the making."

And indeed that's what we saw. The GDP fell significantly in the first quarter, but since then we have had a consistent rise. The average GDP is now running at around 3% absent the first quarter. I also predicted a turn in gold from down to up, and gold moved from $1180 when that prediction was made to near $1400.

As gold and commodities began to turn down I wrote this article.

Here is an excerpt from that article which I think is worth looking at considering where we are now. Things were happening that should not have been happening at that time if we were going to continue the bull run in gold that had begun.

"What we're seeing is serious. It either portends a new round of disinflation, deflation and/or recession, or it's a steep correction that has occurred due to a convergence of factors. Earlier I wrote an article voicing my concern over what I was beginning to see. It was the beginning of my move to reduce my position in precious metals stocks and become a lot more cautious in my trading account.

All was going well until about ten days ago. Suddenly agricultural commodities, oil, and the CRB have all fallen. This means that gas and food prices will fall, and soon. As of today, inflation may have just peaked. It happened very abruptly." (July 2014).

From that point on I began taking profits and reducing my position in gold and silver stocks. I reduced my exposure dramatically. But as of $1140 gold I began adding to positions once again.

From my November 7th article "Why I'm Buying Gold Stocks"...

"No one is predicting today that the 1140 area we just hit is the low, but it might be... right now, precious metals stocks, and commodities in general, and most resource stocks are as oversold as they have ever been in market history. Either the world is heading for a devastating deflationary recession, or these markets will stabilize in here and we'll get a playable bounce. As of today, I'm a buyer of good low cost gold and silver producers."

Gold has since rallied even as commodities have continued to make new lows. I still believe this is a good time to accumulate low cost resource producers with good prospects going forward. But I might add, only with money you can afford to lose.

Looking Forward

I think the biggest surprise in 2015 will be how long interest rates stay low. I wouldn't be surprised if the Fed did not raise the Fed Funds rate all year. Falling commodity prices and the subsequent dislocations they can cause may prevent them from doing so. But even if they do I seriously doubt they will affect the long end of the interest rate curve which has much more of an economic impact on the economy than short rates. Long rates won't move significantly higher until inflation or debt concerns reemerge.

It's important to understand that the Fed only has control of the shortest term interest rates, while the longer end of the curve is market controlled and can move up or down at any time regardless of central bank action. World interest rates are at historic lows and it's not because of central bank monetary policy. It's due to slow growth, low inflation, the lack of loan demand, and non-existent money velocity. If all those factors reversed, so would interest rates, regardless of central bank policy. (We saw that during the Eurozone crisis as many nations' interest rates spiked out of control.)

The biggest threats in 2015, in my judgment, are a deflationary recession which looms in many parts of the world. The continuous fall in commodity prices are still signaling this vulnerability. And now we have the specter of nation states joining rogue hackers attacking our companies, institutions, and infrastructure. Cyber war is now at our doorstep and won't be leaving anytime soon. Both a deflationary recession and cyber attacks have the capability of crippling the world economy.

While on the subject of negative predictions, I should mention that for the first time in over three years I do see a scenario where gold could soar. This is a big change for me. There has been nothing in the last several years, including 2011, where predictions of $5000 gold were rampant, that indicated anything of the sort. The best bull case I could muster up was my gold call at $1180 last year, and we did move up a quick $200. That was based on higher world growth and higher inflation which we did see in the first half of 2014.

So what would cause gold to not just rise, but to soar? The answer is a continuation of governments demanding gold. In my 50 years of monitoring the international monetary system, I have never seen anything like the move by so many governments to take physical possession of their gold held in America. Why now is unclear. But the fact that they are is sufficient, if continued, to create a run on gold by institutions, investors, the public, and finally speculators. That could push gold substantially higher very quickly.

With all this said, I consider the above scenarios a low probability, but they are visible ones, and ones I will be watching closely. More likely, we will see a continuation toward normalization with a slow increase in growth, inflation, and interest rates worldwide. Gold's stabilization is suggesting that this is the direction we are heading today.

The reason I consider the negative economic potentials less probable than the positive ones, is that there is less leverage in the system: leverage has been reduced in the world because banks and corporations are holding greater amounts of capital - record amounts in fact. This lessens the probabilities of a credit event anything like what we saw in 2008.

And the dramatic fall in oil is first and foremost a tax cut to most people of the world. Low oil prices will benefit most of the major economies which are oil consuming nations - the US, China, Japan, Europe, India - the largest, most developed nations of the world. And even if there is a credit event, it is not likely to create structural damage to the American economy and will likely pass quickly. We are strong enough to withstand a shock or two.

And finally, there is a lot less speculation in the world today. Consumers, home buyers, and investors have become very conservative since the financial crisis. Economic stagnation and disinflation has kept a lid on the system as a whole. The disinflationary recessionary bias weighing on the world for years is still with us today. However, the US has slowly pulled away from its influence. We are slowly returning to normal. The big question for 2015 is will the rest of the developed world follow.

I ended my "Looking Forward: Toward Normalization" article saying that I thought we would end the year in the US with the economy looking much better at the end of the year than the first of the year. And indeed we see an economy on the mend. The return to normalization is a process that should continue in 2015. The greatest likelihood is that we continue to grow at 2.5 to 3% GDP with inflation and interest rates remaining low in the first quarter, but rising a bit for all of 2015. More importantly, world growth should increase a little and deflationary fears subside.

The net result on gold should be a gentle increase over the year leading gold back to the $1300 area. With oil falling, wages stagnant and most other prices stable, costs to miners should stabilize or fall. The subsequent spread between stable to falling costs and rising metal prices should lead to a return to reasonable multiples and values of mining stocks. They should climb from ridiculously oversold levels to much higher levels as long as the perception is that the free fall is over and the trend is now up.

Possible positive surprises in 2015 include tax reform, the reparation of the trillions of dollars held abroad back home and employed, and the beginning of what I call the "debamafication" of America. That amounts to a reduction of taxes, fees, and mandates in healthcare. The Supreme Court will decide this March whether Obamacare, as structured, is in fact legal. A Supreme Court against subsidies provided by the federal government could pull the rug from under Obamacare as we know it.

And the reduction of regulations in Dodd-Frank legislation will undoubtedly be initiated by the new US Senate. Even now the Volker Rule passed by Dodd-Frank has been postponed for another two years due to the fact that no one can agree on what it means or how to implement it. That will most likely be a recurring theme in 2015, as more regulations, taxes, fees, and mandates already passed and scheduled to go into effect next year, will be either killed, postponed, or replaced. These positive factors could add to growth, wages, and corporate profits in 2015.

However, I understand the list of things that could go wrong dwarf the list of things that might go right, so this year's "Looking Forward" more than most, is simply an educated guess based on probabilities. What will actually happen in 2015 will be dependent on political, economic, and monetary decisions not even made yet. As an investor, I will take reality as it comes - one day at a time. In these markets, I've learned lately to take them one hour at a time. Such is the world we live in today.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.