Listen to this article
The dollar gold price would seem to have decisively broken down, with a trend that appears sustainable for the next several months, probably at least to the end of this year.
Anthropomorphising markets is not sensible, but to indulge in that for a moment, it looked as though gold wanted to break through $700 an ounce, tried its best, but failed.
Gold is telling a different tale than the equity markets, but the equity markets have hundreds of billions of private equity dollars (in the US), and a huge, though less quantifiable, pot of domestic savings (in China) to propel them beyond sensible levels. Gold is telling us that there is more asset price deflation ahead of us in the US, principally through a housing market that will be weaker for longer, and a commodities price peak later this year.
A big trend break in gold tends to precede one in other commodities prices by at least six months. For the moment, there is still an extraordinary amount of money going into commodities funds. Commodity fund managers I know are still finding large pools of institutional money washing towards them. Apart from trend-is-your-friend thinking, supported by five-year charts, this seems highly dependent on the assumption that the Chinese authorities will fail to rein in real growth, and on the Fed’s assumption, based on its creaky standard econometric model, that US growth will resume in the second half of the year. Gold thinks otherwise.
Gold takes Ben Bernanke, the Fed chairman, other central bankers, and their staffs, seriously. The central banks believe that their guide, the Dynamic Stochastic General Equilibrium model, is giving them the right signals. They would disdain the simplistic trend-is-your-friend thinking of half-educated traders, but there is a lot in common between believing in trend charts and believing in the DGSE model. Both serve you well most of the time, but are not good at calling turns in markets or economies.
The problem that traders have with depending on the trend to be their friend is that by the time you can see that your friend has abandoned you, you’ve burned through your original and variation margin. In other words, you’ve already lost a lot of money.
The problem that central bank economists have is that at the turning points in the economy, when correct judgment on their part is most important, the data their models depend on is at its most unreliable. As one economist friend of mine says, “There is a huge statistical fog around the US economy. Every number surprises on the upside and on the downside.”
This is because behaviour patterns are changing. Builders know the bell has rung on their industry, and are already preparing themselves for long hard times. Invisible illegal immigrants who were working off the books and buying goods are now drifting back across the borders to their home countries. You can’t extrapolate from past behaviour, which is what charts and models do, because that behaviour is changing.
Mr Bernanke is a man of unquestionable intellectual integrity. That is a problem. Alan Greenspan, who was arguably a lesser theoretical economist, was a far craftier Fed chairman. While he had a theoretical rationale for his actions, that “risk management” policy was merely the public face on his more instinctual reactions to obscure microeconomic data, the collection and perusal of which was his main obsession.
This was not as consistent or theoretically defensible as Mr Bernanke’s inflation targeting, but it did serve him in avoiding the policy overshoots that the present Fed approach risks bringing about.
The Fed’s models now tell it that the US economy’s growth rate will turn back up later this year. That means that it, and its counterparts in Europe and elsewhere, will stick to tighter policies longer than they probably should to avoid an asset price deflation soon. But it’s been the monetisation of asset price inflation in the US that has maintained the balance sheet of the consumer.
The builders and buyers know, if the Fed does not, that the housing market “correction” will last a lot longer. The private equity tribe knows it is dependent on the continued availability of liquidity from the credit derivative market. The credit derivatives people are telling the private equity people that there is a limit on the capacity they can provide. I wish the Fed board could hear the open pessimism of many of the credit derivatives professionals I know, many of whom are figuring how best to position their firms and their careers for a prospective bust.
Within a year, though, the gold bear market will have run its course, and Mr Bernanke’s other academic speciality, depression avoidance, will be called on. He and his counterparts in Europe, Japan and China will be called on to keep the global Ponzi scheme going, because the real economies cannot stand a bust in the financial economies. In anticipation of that rapid reversal, gold will take off as it hasn’t for a generation.
So sell gold now, but wait for it to begin a dramatic rally next year.