SEMI-MONTHLY FISCAL/MONETARY REPORT – RISE IN INTEREST RATES A DONE DEAL – GOLD GOES HIGHER!

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March 20, 2017 – Semi-Monthly Fiscal/Monetary Report – First of Three 2016 Interest Rate Rises in 2017 – Why is Gold Price Up?

There are an unusually large number of important moving parts right now. They include: Health care and federal budget debates, federal debt ceiling having been reached, new employment reports apparently encouraging (The nationwide average temperature was 41 degrees, 7 degrees warmer than the 95 year average, which no doubt helped.), physical gold continues moving from west to east, U.S. Fed raises funds rate and suggests two more increases in 2017, GDP reports continue to be anemic, and the US Dollar has finally backed off from its most recent high.

In Discussion of the High Points:

65-70% of the US economy is dependent on consumer spending, and a large concern of Main Street is the cost of health care. The promise to “repeal and replace” the ACA “on day one” was clearly not practical, and it seems clear now that whatever legislation is passed will only “tweak” the current situation, at least in the short to intermediate term. President Trump, and his surrogates, seem to be admitting now that it will be two to three years before the effect of the changes are felt in the form of reduced healthcare costs for the public. This line item does not bode well for better consumer spending any time soon.

Our Federal Reserve has raised fed funds rate by 25 basis points, and points to the possibility of two more increases in 2017. Caveat emptor, always, from Janet Yellen: the decision will be “data dependent”. Should GDP weaken from the already tepid sub-2% level, further rate increases could burden the economy to an unacceptable degree. A stronger US Dollar would likely accompany rate increases, so US exports, in addition to probably weaker home and auto sales would likely result from the proposed rate increases. Yellen’s “go slow” remarks were considered “dovish”, the interpretation being that rates will likely remain historically low for the foreseeable future. In turn, this strengthened the markets for bonds and gold.

The congressional budget debate, just begun, shows increased defense spending to be offset by major reductions in agencies such as the EPA, and is sure to be contentious. Importantly, the current debate deals only with the trillion dollar “discretionary” portion of the federal budget, which is only 25% of the total budget. The suggestions so far indicate a balance between increases and decreases, not a major reduction. Since the annual deficit is running at about 15% of the total budget, and the debt increased in the last twelve months by 25% of the total budget (the difference being “off budget” “investment” spending), even a reduction of 10%, for example, of the discretionary portion, would only be 2.5% of the total budget, and nowhere close to closing deficit gaps. Nowhere in the discussion yet is how to pay for the trillion dollar infrastructure needs or the necessity to reduce entitlements. President Trump explicitly promised not to reduce entitlements, so it will be interesting to see how the administration dances around the 75% ($3 trillion) non-discretionary portion of the federal budget.

The federal debt ceiling has been reached, so government spending is taking place under “temporary” measures. This can go on for a few months, but sooner or later, legislators will have their fifteen minutes of fame in the form of a congressional debate on this subject. The government will not be closed down, but it could cause some concern in capital markets as the US debt burden grows beyond what many economists consider already dangerous levels. I could provide a chart that shows the price of gold following the level of US debt. These two items were tightly correlated over many years, especially since 2000 when both the debt level and the price of gold started rising sharply. The two measures diverged in 2013 as the debt level kept rising but the gold price retreated from a high of 1900 to a low of 1050 and the current level of 1230. Gold would have to be in the area of $1900 per ounce if it were to catch up with the new debt level. Furthermore, I believe there are numerous additional reasons for the price of gold to be materially higher than $1900 in the not too distant future.

Physical gold continues to move from west to east in a major way. The Indian public had been the largest importer of gold in the world, until the Indian government tried to limit gold imports last year to improve the governmental trade deficit. This culminated in an announcement on November 8th, that almost all (turned out to be 86%) paper currency was to be turned in by 12/31 for a new paper currency. This process took place in November & December, predictably creating temporary economic turmoil, including a sharp reduction in the purchase of gold by the public. This process has apparently run its course, the Indian economy is picking up, and gold imports (for the wedding season) are reported to be up 175% from a year earlier. Gold imports in India were down 39% in 2015, still at 558 metric tons (about 19% of worldwide production), so this year’s rebound could be a material influence on the supply/demand equation. The Chinese public, as well as Chinese governmental agencies (the People’s Bank of China being only one) continue to import physical gold at record amounts. It’s possible that India, as described, has at least temporarily dislodged China as the world’s largest importer. North American investors, within the US in particular, are showing a continued relative disinterest in physical gold and related securities.

When Alan Greenspan raised the fed funds rate 17 times, from 2004 to 2006, the price of gold went up by 62%, so higher rates do not prevent gold from rising. With the second rate rise behind us, and two more expected, the worst of expectations may be behind us, likely discounted by investors. This aspect, combined with the other factors discussed above, could provide a powerful influence on the price of precious metals. It’s possible, and even logical, that the gold price increase the last several days, from $1200 to $1230 per ounce, is a harbinger of the trend to come.

Roger Lipton