Gold Looks Like 'Safe Money' Amid Rising Inflation Expectations

(January 22, 2019 - Rainer Michael Preiss)

The back of the U.S. dollar says "In God We Trust." However, for an increasing number of investors in 2019 the motto increasingly is "In Gold We Trust," as the precious metal could turn into a new bull market this year.

A renewed interest in gold is being driven by a confluence of factors that include the current political stand-off in Washington and the longest government shutdown in U.S. history combined with a late-stage economic cycle, rising global debt levels and an escalating U.S.-China trade war.

Bullion prices are emerging from an 8-year bear market. Gold prices peaked at an all-time high of $1,921 an ounce, when the U.S. Federal Reserve was concluding its bond buying program, known as quantitive easing, or QE2, in September 2011. And by the end of 2015, the metal had declined to a low of $1,046 at around the same time as the Janet Yellen-led Fed increased its key interest rate, the Federal Funds Rate, for the first time in seven years.

Conventional wisdom says that gold is the anti-dollar. That is, whenever the greenback is strong, gold is weak, and vice versa. Gold prices react inversely to U.S. dollar real yields. But Gold is not about inflation on its own, and it's not about interest rates on its own. But it's about the relationship between the two.

Gold prices had been range bound for the last 3 years, but now signs are emerging that it may have reached a bottom and ready to climb again. The Fed is raising U.S. interest rates and scaling back asset purchases to normalize the central bank's balance sheet, while at the same time wage pressure and a tight labor market could lead to rising inflation expectations.

Today, investors are increasingly viewing gold as "safe money" at a time when current Fed Chairman Jerome Powell publicly opined that he is “very concerned about U.S. debt levels” and the Trump administration has started a trade war with one of its largest creditors, namely China. The only winner in a trade war might be inflation.

Gold is an economic constant. It will never become worthless, nor will it decline due to inflation over time like a fiat currency. Gold carries no risk of default, nor can it go bankrupt. So when stocks fall, gold tends to hold its ground (or go up). It's great portfolio insurance.

Clouds that are gathering on the global economy may be parting for gold. Concerns over global economic growth are rising as stock markets gyrate and U.S.-China trade tensions persist, calling into question the Fed’s path on U.S. interest rates. Many economists are trimming the number of U.S. rate hikes expected for the year 2019 from three down to two.

As recessionary concerns build, the U.S. yield curve has flattened, and equities remain under pressure. Gold may find support and move into a new multi-year bull market as investors become more defensive in their portfolios and asset allocations.

J.P. (John Pierpont) Morgan opined that "gold is money, everything else is credit," and central banks understand that very well. Private banks and commercial bank economists might not understand this finer nuance well enough, especially during the QE reflation of asset prices period between 2011 and the end of 2017.

By the end of 2017, global QE (quantitative easing) was running at a $2.12 trillion annual run rate, according to Bloomberg data. Think about this amount of money as the equivalent of bailing out AIG every single month, and then some. But by October 2018, the European Central Bank had been tapering its QE program. The asset purchases were down to 15 billion euros per month. And by the end of this year's first quarter, the ECB is expected to stop expanding the size of its balance sheet, and globally, we will for the first time, once again, go net negative on liquidity.

Bloomberg data shows that over 95% of asset classes worldwide had negative returns for 2018, as liquidity and markets moved from QE to QT--quantitative tightening). Gold had underperformed during the QE years but might outperform during the QT regime.