SEMI-MONTHLY FISCAL/MONETARY REPORT – HISTORICAL VOLATILITY – CAN THE FED SAVE US ?
February was a very volatile month, most noticeably the last week of the month, apparently driven by the worldwide concern about the coronavirus. We say “apparently” because we view the coronavirus to be the catalyst for an overdue decline, rather than the real cause. The cause will prove to be the distortions (over the last forty years, even more the last twenty years, and especially the last ten years) of normal monetary supply and demand created by promiscuous central banks around the world. In any event, the selling was emotional and indiscriminate, especially last week. Gold bullion and the gold miners were both doing nicely, up over 3% and 7% respectively until the panic selling of everything last week. Gold bullion closed the month down a fraction of one percent and the miners closed down more than 10%. This kind of price action in gold and the gold miners is disconcerting for sure but not surprising in a market panic almost unprecedented.
We wrote our normal month end letter to investors in our investment partnership the first day of the new month, and, at 2 pm yesterday, after talking about how bad February had been, I wrote “For better or worse, we report as of the month end, which in this case could be the low point. For what it’s worth, as I finish this letter, gold bullion is up 1.3% today and our portfolio is up almost 4%.” If I were to write the letter right now I would say that gold bullion is up 6% we are up 12% for the first day and a half of the month.
So much for short term trading commentary. More importantly:
All the fundamental developments in the worldwide economy point to much higher gold prices and much, much higher prices of the gold mining stocks. We look back, below, at the price action of the precious metals sector in the last crisis, that of ’08-’09.
The two charts below, that of “GLD”, the ETF that tracks gold bullion, and “GDX”, the ETF that tracks the gold mining sector. The chart shows the price performance from the middle of 2008, through the bottom of early ’09, and then the recovery through the end of ’11. You can see that GLD and GDX both declined, with the stock market, until the fall of ’08, started recovering before the general market bottomed in March ’09. From the bottom, over the next two years, GLD went from about 70 to 180, up 157%, and GDX went from 18 to 62, up 244%.
It is important to note that the monetary stimulus that supported the worldwide economy ten years ago, and drove the price of gold and the gold miners so much higher, will of necessity be dwarfed by today’s needs.
In the fall of ’08, the five year US treasury note was at about 3% and the two year was around 2%. The Fed drove them down to about 0.7% and close to ZERO, respectively, while printing about $3.5 trillion. The starting point today is about 0.7% for both the five year and two year treasury, interest rates can’t be lowered by much. It therefore falls to the printing press to provide the stimulus and it will likely be a lot more than the last $3.5 trillion. By the way, the Federal Reserve Assets in ’08 were only $1T, ending at $4.5 trillion which were supposed to be reduced in a stronger economy. The economy got just a bit stronger (averaging 2.3% GDP growth) but the Fed balance sheet only was reduced to about $3.7T. It then was expanded again, through bond purchases last fall (which coincided with a strong stock market), then stopped growing in January, which may have foreshadowed the stock market collapse in February.
Today’s starting point for the Fed balance sheet is just over $4T and the ending point could be $10T. It always takes more (financial) heroin to maintain the (monetary) high. The last installment of this unprecedented monetary adventure took gold and the gold miners up well over 100% (the miners more than the bullion). The next trip should be even more dramatic, especially for the gold miners. As we’ve said before, while gold is down about 18% from it’s high of 1900 in 2011, the gold miners are down well over 50%. At the same time, the gold mining companies are far better managed, strategically positioned, and with stronger balance sheets than ten years ago.
The US Fed Reserve’s aggressively lowered the Fed Funds Rate by 50 bp a couple of hours ago. It is an interesting commentary that the stock markets rallied, but have now given up their gains and are down for the day. Our conviction is that the Fed, and the other Central Banks around the world have become impotent. Each round of stimulus the last twenty years has been increasingly less effective in stimulating growth. It is called a “diminishing marginal return on investment”. Monetary stimulus has run its course. It then falls back to the need for more fiscal stimulus, in the form of tax cuts, etc. That will have a limited effect, also, but will explode the deficit.
All of the above is supportive of much higher gold prices, and much much higher prices for the gold mining stocks.