Gold Looking Forward

The halcyon days for gold in the late 1970s were distinguished by soaring inflation and double-digit interest rates, both of which are conspicuously absent. Geopolitical upheaval around the globe is an obvious analog to that period, but now it has had the effect of pushing the dollar higher-ironic, given the low esteem in which the U.S. is held in much of the world.

Massive Fed money printing has totally failed to produce the inflation that was widely predicted. In fact, Ed Yardeni Research, posits that QE ironically has had a deflationary, rather than inflationary, impact.

Much of the abundant, cheap Fed-created credit has gone to finance projects to expand supply, not just demand. For instance, expectations of booming demand for commodities, in part from China, spurred expansion of supplies. In addition, opportunities in U.S. oil production made possible by hydraulic fracturing and easily available financing in the junk-bond market, helped spur the shale boom. Along with globalization, these supply-side boosts have kept a cap on prices of tradable goods.

At the same time, the Fed’s simulative policies were supposed to mean an inevitable rise in interest rates. But nearly six years after the Bernanke Fed cut its key short-term rate to virtually zero, it’s still there. The near-universal prediction is that the liftoff will take place next year.

The Treasury securities market doesn’t see signs of inflation. Each time the Fed talks about raising short-term rates, the inflation premium in long-term government bond yields comes down.

Long-term bond yields should remain low as a result, which should underpin the stock market. Lower-risk stocks that act like bonds, such as utilities and health care, should do best, with lower bond yields, rather than market expectations of higher future earnings.
Based on our recent history, a period of low inflation, near-zero interest rates, and sluggish growth would seem an incongruous time for gold to shine. Gold, after all, is supposed to be an inflation hedge.

But there is a precedent for the metal to act well in a disinflationary or deflationary period: the 1930s, when countries devalued to gain global markets. So, with central banks printing money like never before, maybe it really isn’t so different this time.

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