CONCLUSION: Keith summed up our latest thoughts on gold in a brief @HedgeyeTV video this afternoon: http://www.youtube.com/watch?v=COWDQhsI3jI. The note below expands upon those high-level thoughts in greater detail, including our updated cyclical outlook for the US economy.
Since the start of NOV, Keith has been trading gold with a bullish bias in our Real-Time Alerts signaling product. This has been a marked shift from having traded gold with a largely bearish bias since late 2011.
From a fundamental perspective, we now anticipate the emergence of distinct tailwinds that are increasingly likely to materialize over the intermediate term. As we detailed in last Friday’s Early Look, we think the most probable cyclical GIP outlook for the US economy is as follows:
- #GrowthSlowing: We think monetary and fiscal policy uncertainty (mostly monetary policy uncertainty) will weigh on consumer and business confidence. Furthermore, GDP comps get difficult as CPI/GDP deflator comps get easier, at the margins.
- #InflationAccelerating: We think domestic disinflation is now a rear-view phenomenon as easy comps and a weak dollar provide upward pressure on CPI and PPI readings.
- #IndefinitelyDovish Monetary Policy: We are increasingly of the view that the Fed is aware of the systemic risk present in the bond market and is potentially setting up to never commence tapering. They will likely accomplish this by setting far-too-aggressive targets for GDP growth and shifting their focus to combating a perceived risk of deflation, at the margins.
CLICK HERE to review the analysis supporting these conclusions in its entirety.
With regards to points #1 and #2, the confluence of #GrowthSlowing and #InflationAccelerating puts an economy squarely in Quad #3 on our GIP model:
Historically, moves by the US into Quad #3 have been bullish for the price of gold, as both the US dollar and real interest rates tend to decline in this economic “state”; the opposite holds true on a move into Quad #1 (i.e. #GrowthAccelerating as #InflationAccelerates), which is where both the reported data and consensus expectations have tracked throughout much of 2013. Given where we’ve been on growth and inflation for much of the year, it would be modest to say that we are not surprised to see gold down almost -26% YTD (we’ve been the bears on gold for much of the past 12-18M).
Again, we think monetary and fiscal policy uncertainty (mostly monetary policy uncertainty) will weigh on consumer and business confidence and we’re already starting to see that in the high-frequency data:
That brings us squarely to point #3 as laid out above: we think Janet Yellen will prove to be the Mother-Of-All-Doves and, perhaps more importantly, we don’t think consensus agrees with this view. The latter point can be seen squarely in the aggregate futures and options positioning amongst speculators (the market has swung heavily into a net short bet on LT Treasuries):
With regards to how the Fed might get there, we continue to think they are out-to-lunch (i.e. way too high) with respect to their 2013E and 2014E GDP growth forecasts. Moreover, they are well below consensus on their 2013 and 2014 inflation estimates and the confluence of both gives them scope to:
- Not feel any pressure to taper in the next few months (because of the perceived “threat” of deflation); and
- Reset market expectations in the following months for when tapering will likely commence to consistently later-than-expected start dates (because growth, and the labor market, will likely surprise their expectations to the downside).
There are two caveats to the aforementioned charts:
- Our forecasts for growth and inflation in 2013E and 2014E are not locked in and are highly subject to change as new data feeds into the algorithm. What our GIP model is designed to do is provide a manageable range for the most probable directional adjustment(s) from the base rate in the absence of incremental evidence. Unlike traditional economic models, we don’t subscribe to the lick-your-finger method of making groundless assumptions about the future state(s) of the economy. Rather, we prefer to let market-based signals and fundamental (i.e. high-frequency) data guide our expectations on a rolling basis.
- The Fed’s forecasts for inflation are for the Core PCE Price Index, not headline CPI. It is very likely that Core PCE does not materially blow through the upside of the Fed’s official target given that: A) the target is a healthy +2% (and potentially higher if they decide to move the goalposts again); and B) there won’t be a ton of upside pressure on the rate of core inflation (via pass-through costs) if headline inflation isn’t projected to come in much higher than that.
All told, we think a waning threat of tapering, at the margins, is likely to serve as a positive catalyst for the price of gold – and other inflation hedge assets – over the intermediate term. The following chart, put together by our very own Christian Drake, highlights the causal relationship between #TaperTalk and the precipitous decline in the price of gold over the LTM:
Are you prepared for Janet Yellen to be a lot more dovish than the market currently thinks she will be? History would side with those of you who are, in fact, getting prepared for just that. The following is an excerpt from a late-2005 speech she gave on the housing bubble to the Conference on US Monetary Policy:
- “How, then, should monetary policy react to unusually high prices of houses—or of other assets, for that matter?... The debate lies in determining when, if ever, policy should be focused on deflating the asset price bubble itself.”
- “In my view, it makes sense to organize one’s thinking around three consecutive questions—three hurdles to jump before pulling the monetary policy trigger. First, if the bubble were to deflate on its own, would the effect on the economy be exceedingly large? Second, is it unlikely that the Fed could mitigate the consequences? Third, is monetary policy the best tool to use to deflate a house-price bubble?”
- “My answers to these questions in the shortest possible form are, “no,” “no,” and “no.””
- “In answer to the first question on the size of the effect, it could be large enough to feel like a good-sized bump in the road, but the economy would likely to be able to absorb the shock.”
- “In answer to the second question on timing, the spending slowdown that would ensue is likely to kick in gradually, because it mainly affects household wealth… So the impact of a gradual spending slowdown could well be cushioned by an easier policy.”
- “In answer to the third question on whether monetary policy is the best tool to deflate a house-price bubble, there are several points to consider. For one thing, no one can predict exactly how much tightening would be needed, or by exactly how much the bubble should be reduced. Beyond that, a tighter policy to deflate a housing bubble could impose substantial costs on other sectors of the economy that would lead to equally unwelcome imbalances.”
- “Taking all of these points into consideration, it seems that the arguments against trying to deflate a bubble outweigh those in favor of it. So, my bottom line is that monetary policy should react to rising prices for houses or other assets only insofar as they affect the central bank’s goal variables—output, employment, and inflation.”
CLICK HERE to access the full transcript of the speech.
Alas, if you thought her predecessor was cool with inflating the bond bubble and all the other intended and unintended #BernankeBubbles, then, by the looks of it, you haven’t seen anything yet. That is, of course, assuming a 67-year-old woman who’s been doing and saying the same exact things for ~50 years doesn’t have a massive change of heart upon taking office as the world’s most important government official – if not human being.
In the history of central planning, crazier things have happened, though. Stay tuned…
Associate: Macro Team