European Central Bank President, Mario Draghi, has been trying to lower the value of the euro by promising to pursue inflation with a vengeance. His inflation rhetoric was stepped up during a speech he gave to Germany on November 20th of this year. In that speech Mr. Draghi vowed to “do what we must to raise inflation as quickly as possible.”
Draghi’s efforts to crush the euro have somehow been taken by Wall Street as a great opportunity to sell gold. But there shouldn’t be a person alive having an IQ greater than a mentally challenged ameba that can rationalize why it is appropriate to sell gold simply because of Mario Draghi’s obsession with creating inflation and destroying the euro.
Most investors will tell you that the primary driver for the price of gold is the direction of the U.S. dollar index (DXY). Therefore, the only due diligence Wall St. recommends regarding the direction of the gold market is to take a perfunctory glance at the DXY, and to hit the sell button on paper gold (N:GLD) ETFs if it is up. While it is true that the purchasing power of the dollar is a key metric to judge the direction of gold prices, the DXY will only tell you what the dollar is doing against a basket of 6 other flawed fiat currencies.
The main component of the dollar index is the euro currency, which represents nearly a 58% weighting in that basket of currencies. Therefore, if the euro is falling the dollar index usually rises, regardless of the fundamental condition of the currency. When it comes to valuing gold investors must first determine what is going on with the real, or intrinsic, value of the dollar. Inorder to truly access the intrinsic value of the dollar you must determine: the level of real interest rates, the rate of growth in the money supply and the fiscal health of the U.S. government. When analyzing the dollar using those metrics, it becomes clear that the intrinsic value of the dollar is eroding and, therefore, should cause the dollar price of gold to increase regardless of what is going on with other fiat currencies.
The 1-Year Treasury note is now yielding just 0.49%and the increase in year/year core Consumer Price Inflation is up 1.9%. Therefore, real interest rates are now negative, which should reduce investors’ appetites to hold dollars, as it increases their willingness to buy gold. Negative real interest rates also cause consumers, businesses and governments to borrow more money. When money is borrowed into existence, the supply of money grows. Increasing the money supply reduces the value of dollars already in existence; especially when those dollars are growing faster than the mine supply of gold—which historically runs about 1-2% per annum.
The YOY change in M2 money supply growth is 6%. Since total U.S. economic output is around 2%, the supply of goods and services is growing far below the rate of money supply growth. This causes aggregate prices to rise and reduces the intrinsic value of the dollar, while boosting the value of gold.
Finally, our government just agreed to suspend the debt ceiling through mid-March 2017. U.S. debt stands at over $18.6 trillion and is larger than our GDP.
More importantly, U.S. debt amounts to nearly 600% of all annual Federal revenue. And despite our politicians’self-praise for bringing deficits down from crisis levels, October’s deficit, which marks the start of the 2016 fiscal year, totaled $136.5 billion -- up 12.2% from October 2015. The sad truth is debt and deficits are running far away from our tax base and will need to be massively monetized for years to come.
The simple truth is the U.S. dollar is under increased assault from negative real interest rates, years of money printing courtesy of the Fed, and a national debt the government will try to inflate away – these facts aren’t made less painful just because the Europeans are on a mission to destroy their currency. The announcement by Draghi that he will move heaven and earth in an effort to immediately create inflation should be sending the citizens belonging to the nineteen member nations of the European Union who use the euro into a panic. Central bankers are causing the holders of all fiat currencies to eschew that paper in favor of gold.
But in today’s world of trading robots and dullard money managers, the algorithms are programmed to sell gold ETFs whenever the DXY is in the green. However, once it becomes clear that the economies of Europe and the United States are not that different, the ECB and Fed will have similar monetary policies. When that happens the U.S. dollar will rollover against the euro and send Wall Street scrambling back into gold ETFs, as the intrinsic value of the dollar takes a dramatic step lower.
Global central banks are printing fiat currency at a record pace in order to keep borrowing costs at an all-time low. Indeed, all fiat currencies have gone extinct throughout history. Massive and unprecedented money printing on a global scale will not alter history’s fate.