by Tony Davis – Atlanta Gold & Coin Buyers ……….
The Federal Open Market Committee (FOMC) surprised the financial markets on Wednesday of last week when they announced that they would begin tapering their $85 billion a month bond buying program. The reported tapering is $10 billion a month, which should reduce the asset purchase program from $1 trillion to $900 billion a year. The stock market spiked following the announcement while the gold and silver markets experienced a sharp selloff. Several days later the price of gold is struggling to remain above $1,200 an ounce, while silver appears to have stabilized in the mid $19 range.
The investment community appears to have turned bearish on gold, as evidenced in part by the following article from Market Watch http://blogs.marketwatch.com/thetell/2013/12/23/golds-safe-haven-role-is-over-societe-generale/. While Wall Street may be of the opinion that there’s no longer a need to invest in gold as a safe haven, we believe that there are at least 900 billion reasons why gold (and silver) should continue to remain a sound investment in the years to come.
Interest Rate Fueled Recovery
By all accounts, the recovery that we’ve experienced in the financial markets over the past few years has been an interest rate fueled recovery. In other words, the massive amount of quantitative easing that has been conducted by the Federal Reserve has helped to reduce long term interest rates; thus reducing interest rates below free market markets. Cheap money has helped companies to report record level profits, which has helped to catapult the financial markets to its highest levels ever. In fact, the Dow is set to close above 16,000 for the first time ever.
While low interest rates appear to be the primary source of the recovery in the financial markets, the Fed’s tapering will likely cause interest rates to slowly rise. As interest rates increase, companies will be less prone to seek financing, which will reduce growth rates and profitability, likely resulting in a pullback in the financial markets. The descent could be slow or precipitous. In either event, gold and silver will likely be viewed as a hedge against a declining market.
Record Level Monetary Base
The Federal Reserve’s efforts since the market crash in 2007 – 2008 have been unprecedented. Never in our country’s history has the Federal Reserve expanded its monetary base as they have over the past few years. As you can see from the following monetary base chart from the St. Louis Fed, the Fed’s asset base was below $1 trillion until 2009.
Since that time, the Fed has been expanding at nearly parabolic rates. The current monetary base is nearly $3.8 trillion. At an expansion rate of $75 billion a month, the asset base will exceed $4 trillion by the spring of 2014! If the economy was truly on firm footing, there would be no need for the Federal Reserve to continue to add to their asset base at nearly unprecedented levels. One miss step and we could very well see the financial markets reverse course, which could result in gold and silver being a safe harbor investment.
Strength of the Dollar
Historically, the strength of the dollar and the price of precious metals have been inversely correlated. In other words, when the dollar strengthens, the price of gold and silver tends to underperform, while a weak dollar is typically positive for the precious metals market. While the Fed’s announcement has resulted in a short term strengthening of the dollar, a quantitative easing program consisting of monthly asset purchases of $75 billion over time will cause downward pressure on the dollar. Furthermore, if the reported tapering of $10 billion a month translates into weaker than expected employment data, the Fed could reduce course and very well resume their $85 billion a month buying program or even increase their efforts. Devaluation of the dollar should bode well for gold and silver.
As you may be aware, the Federal Reserve has a dual mandate. It’s to promote maximum employment while maintaining price stability, or an acceptable level of inflation. The Fed has announced over the past year on more than one occasion that they will continue to maintain their accommodative monetary policies while unemployment remains above 6.5% and inflation remains below 2%. The official unemployment rate is 7% while the inflation rate (through November 2013) is 1.2%. While the rate at which the Federal Reserve has increased its monetary base is hyperinflationary, the money supply, which is oftentimes referred to as the velocity of money, remains relatively tepid. The following M1, or money supply chart, shows how the increase in the monetary base has translated into an increase in the money supply:
Once financial institutions begin to lend again, we could potentially see high future inflation rates, due in part to fractional reserve lending. Fractional reserve lending only requires that banks keep a fraction of the total loan amount on reserve. Historically, precious metals have been one of the top performing asset classes during periods of high inflation.
In summary, we believe that there are 900 billion reasons to remain invested in gold and silver. Considering that this is an interest rate fueled recovery, the financial markets are likely to pull back if and/or when interest rates rise. While the Federal Reserve has begun tapering, they’re still on pace to purchase unprecedented levels of long term bonds, and are rapidly approaching an asset base of $4 trillion. Continued quantitative easing should put downward pressure on the dollar, which historically has boded well for gold and silver. Lastly, while inflation has remained relatively tame thus far, future lending could result in high inflation rates (in part through the fractional reserve lending system), in which case gold and silver should be top performers.
Tony Davis is the owner of Atlanta Gold & Coin Buyers, a full service Atlanta based coin and bullion dealer specializing in buying, selling and appraising coins and coin collections of all types and sizes. Visit his website at www.atlantagoldandcoin.com for additional information on the products, services and educational resources offered by his company. Tony can be reached at [email protected] or at 404-236-9744.