The Gold Puzzle Explained

(December 19th, 2021 - Clem Chambers)

Inflation has been high for some time now, so gold should go up. It didn’t, it went down.

Tapering followed by tightening is firmly on the cards now the Fed has spoken this week (December 15, 2021), so gold should go down. It’s gone up:

So what is going on? Taper and rising interest rates are not bullish for gold and inflation can’t be bearish, unless we have entered a parallel universe where the rules are backwards. However, they are backwards and as Sherlock Holmes said, “When you have eliminated the impossible, whatever remains, however improbable, must be the truth.”

But discounting the possibility that we have landed in ‘Bizzarro world,’ what could be the cause?

Let’s build a thesis.

1. The market looks out one year and the price today reflects the status of affairs as the best guess of the aggregate of the market in 12 months. What does recent action say about that vision? It says we are going to get a deflationary recession. How could that happen

A hawkish polity or a hawkish Fed could slam out the anchors and do a “Volker” and smash the economy to purge it of inflation, zombie companies, ridiculous real estate prices, a bubble stock market and strip things back to the metal.

2. Too much more money printing would break economic stability and break everything.
3. Too little printing or an austerity tightening in the “Volker” style would break economic stability and break everything.

A goldilocks solution of monetary balance needs to be struck; a very tricky balance between too hot and not hot enough. Too much stimulus or active aggressive tightening causes everything to go haywire and that uncertainty alone devalues all assets.

So what the market said after Jay Powel spoke on December 15, 2021 is that we are going to get inflation but not too much, and it has taken the speech as a solid statement against fighting inflation by crushing the froth that is keeping it afloat against wave after wave of Covid pandemic.

In the old days, central banks used interest rates to heat up or cool down economies, but that is now obsolete. It is not the cost of money that is key, it is the availability. The cost used to modify the supply; supply and demand for money was adjusted by the rate of return on lending and the cost of borrowing. That linkage is gone because the lender will always make enough supply to be available for the demand with the adjustment coming from what that lender, in this case the Federal Reserve, will accept as collateral. The more difficult the times, the crummier the collateral that will be accepted in exchange for a freight car of cash. The interest rate is not the value any more as the availability of funds is now decoupled.

Every dodgy developing country lives in this regime but their problem is that they print and hand out the money to their cronies and either do it until the currency is destroyed or have an upper threshold they use as a ceiling for this operation. So the system is not new. Nor is it novel for the developed world. What the developed world is trying to do is to keep it within the bounds of a stable economy and that is about where we are now.

The Fed has in effect set the upper bound for inflation, for now, and that looks sustainable and therefore positive for gold and neutral for most stocks, and the horizon for that judgement is next Christmas.

As such, we should see gold rise on a slow but sure ascent and equities go sideways or perhaps down a little before entering such a neutral channel.

It is interesting that palladium has rocketed while gold, silver and platinum have ascended way less and this signals to me that palladium, a mainly industrial precious metal rather than a mainly investment asset like gold and silver, suggests that there are good economic times ahead especially in the sexy sector of high tech and sustainable power.

The palladium price has rocketed

If this a solution to the gold price puzzle, precious metals will go on a solid run because this will be a long term policy and the process of high but controlled inflation will get folded into the price of gold over time.