One can’t talk about the gold market without examining the unprecedented role that central banks are playing on a global scale in terms of both monetary and fiscal policy.
History is littered with terrible consequences born out of well-intentioned ideas and policies. The Great Chicago Fire started on October 8, 1871. To this day, it is the event that all other fires are compared. Although devastating, The Great Chicago Fire paled in comparison to the Peshtigo Fire in Wisconsin that also began that very day. Anywhere from 1,500 – 2,500 people were killed, and Peshtigo remains the deadliest fire in United States history.
In 1876, in response to Peshtigo and other fires, the United States Forest Service was created. One of the main goals of the agency was wildfire suppression. It made perfect sense. As evidenced a few years prior, fires are both costly and deadly. If an agency could somehow control and suppress fires, we would all be the better for it. Of course, this strategy worked brilliantly. Brilliantly that is, until certain unintended consequences began to emerge.
By the 1960’s it became evident that no new Giant Sequoias were growing in California. Although less frequent in numbers, forest fires were becoming far more intense and difficult to extinguish. You see, what few people understood is that fires are an essential part of the life cycle of a forest. They clean out the old and the dying plant matter so new growth can flourish. As it turns, the tag line of a famous commercial of my youth holds true. “It’s not nice to fool with Mother Nature.”
I tell this story because I believe we are seeing the exact same situation playing out due to the actions of our Federal Reserve. Alan Greenspan took over as Fed Chairman in August 1987. Two months later on October 19, the Dow Jones Industrial Average dropped 22.6 percent. In response, Chairman Greenspan affirmed the readiness of the Federal Reserve to serve as a source of liquidity to support the economic and financial system. I have no doubt that he was unequivocally well intentioned. For markets, however, Greenspan’s comments were tantamount to an all-clear sign. The Greenspan Put was firmly in place, and the S&P went from 250 in the fall of 1987 to 1,500 by the summer of 2000.
The move higher fueled in large part by the policies of the Greenspan Federal Reserve. Today, we have a Fed balance sheet approaching $4.8 trillion – a balance sheet born from literally saving our system of finance. A balance sheet created from sincere motivation.
Like my earlier example of the Forestry Service, we are learning that although we can postpone the components of naturally occurring cycles, we cannot eliminate them. Perhaps even more importantly, we should not attempt to eliminate them. It is my contention that the unintended consequences of the historic accommodative nature of our Federal Reserve are vast and beginning to manifest themselves in the following ways.
Emboldened Central Banks
Market participants have been conditioned to believe that the Fed put is still in place. This has led to an unhealthy level of complacency. Currency moves that historically have taken place over days if not months now occur in minutes on almost a daily basis. The safe haven that has been the bond market has become anything but. Global central banks, having witnessed the perceived success of our Fed policies, have been emboldened to act in kind. Without question, The Fed stepped in when they needed to and bailed out the entire system. But the leverage at the root of the problem didn’t go away. It was just moved and now resides with our Federal Reserve. The $4.8 trillion balance sheet sits atop cash reserves of about $65 billion. This translates to a balance sheet levered about 73-1.
For comparison, and comparison only, Lehman Brothers was levered a little over 30-1 when they imploded. On the flip side of the coin is The IMF with a balance sheet that is levered about 6-1. To combat these problems, we are witnessing the engineered devaluation of currencies all around the globe. Look no further than the actions taken by The Peoples Bank of China on August 10 as proof positive. So in a world of fiat currencies, what does that mean for the United States dollar’s reign as the reserve currency? I will let you think about that, but as we continue to see the IMF grow in both scope and strength, one can only wonder if a new paradigm is beginning to emerge with the IMF being the ultimate backstop.
Gold Rising and Falling
Almost by definition, the global race to zero will not end well. This, of course, leads us to gold. If a few years ago, you would have outlined the geopolitical events, currency swings, headline risk, and unprecedented central bank activity, and asked me to forecast the price of gold, I would have said easily north of $3,000 and probably a lot higher than that.
On September 9, 2009, Barrick Gold announced they were selling $3 billion of stock to purchase back all of their existing gold price hedges. Barrick was so confident in the continuation of the gold bull market that they took a $5.6 billion charge to their 3rd quarter earnings. If you recall, this coincided with gold trading up through $1,000 per ounce. Two years later, gold had rallied another 80 percent and was trading north of $1,800 per ounce. In September 2009, Barrick was a $38 stock. By April 2011, Barrick was trading north of $55.00 per share. Fast forward to today and we see ABX trading around $6.50.
This is not to pick on Barrick Gold specifically, or the industry in general. But I can almost guarantee the following: The same boards that suggested, implored, or bulldozed these companies to buy back their gold hedges are now castigating them for their less than stellar stock performance. The industry faces tremendous pressure to do something and I do not envy their situation. With that said, much like the airline industry, once one participant acts, the rest usually follow suit. It remains to be seen who blinks first. However, what also remains to be seen are the ramifications of central bank policies on the gold market. With over 8,000 tons, the United States is still the largest holder of gold in the world. Germany remains number two with about 3,500 tons and in a not so quiet third place is the aforementioned IMF with close to 3,000 tons.
To that point, a headline in January 2013 caught my attention. The Bundesbank declared they would bring back to Germany 374 tons of their gold domiciled in Paris, and 300 tons stored in New York. They didn’t come to that decision lightly. And lest you believe that Germany’s decision was a one off, I direct you to the repatriation efforts of The Netherlands, Belgium, and Venezuela, just to name a few. They are all clearly concerned about something and I believe it is centered on their growing concern with central bank activities and general mistrust of the fiat currency system.
Furthermore, although the price of gold has languished for quite some time, from everything that I have heard and read, the physical gold market has never been stronger. Chris Carrera has been involved in the gold market for close to 30 years. He has forgotten more about this market than I will ever know and his attention to detail and focus is unrivaled. One of his sayings resonates now. Nobody cares about the gold market until they do. The stock market is a story every day, but very few people wake up concerned about the price of gold. With that said, I hope everyone in this room is ready, because in my opinion gold is about to be a story once again.
This analysis is adapted from Guy Adami’s speech at the CME Group 2015 Precious Metals Dinner