Some key economic news was released last Thursday and Friday both from the ECB and the PBoC which is another sign of the woes that will drive gold prices higher against its G10 currency competitors. The following is my take on the big picture and how it will effect gold prices moving forwards.
ECB prepares to expand QE programme or even have negative deposit rate applied to depository banks:
On Thursday 22nd Oct the chairman of the European central bank indicated to markets that it will consider a range of momentary policies to fight against low imflation and to prop' up EU economic growth. The ECB only has a mandate for price stability, unlike the US FED which also has jobs growth as well.
Inflation or lack thereof is now a global reality that central bankers have been factoring in -so far-only as a tempory effect until. It is only now downing on them that this is not a temporary effect and may tern into a structural issue.
This global deflation has 3 key drivers.
1) lack of global demand
2) excess supply of key commodities such as energy and industrial metals
3) huge amounts of debt. The average debt to GDP ratio's (IMF data for 2015) for G10 countries are @90%. With Japan >200% and Sweden at the low end <%40%.
Demand and excessive debt levels are correlated since financing this debt is a drag on demand from both private and public sectors that are not purchase goods and services or invest but have to repay their debts.This is thus a source of demand side deflation.
Excess supply of raw commodities and finished products out of China is the supply side deflation. The combination is a deadly mix for economies which are trying to navigate this perfect storm.
The key countries that are of interest for Fx markets are the US, EU including UK, Japan and China, also Saudi Arabia and Iran but this is oil market related which then feeds into fx markets.
Currency wars:
For net exporters such as China and Japan their currency must be export competitive and thus devaluation is a key tool to prop up exports.
Japan has instigated "QE eternal" and is active in defending the yen to ensure it is not overvalued relative to other exporters.
China is also doing the same now that it has depegged the RMB from the USD. From economic reports the RMB had appreciated with the USD over the last few years by >10%. This had negative effects on its export industries.
China is apparently in a transition to the next phase of its economic development to a mixed economy rather than an export and infrastructure lead economy.
This shift has formed the gluts in finished manufactured goods and over capacity which need to be absorbed. This absorption is both an economic threat/risk for other countries and also an opportunity as well.
For the near to mid term this drives deflation on a global scale since China is exporting much cheaper goods and also commodities into global markets.
For example, last week, two leading UK steal works had to close, at a loss of @ 3000 jobs due to the dumping of Chinese AND EU steal into global markets. The UK pound has also strengthened on the back of expected interest rate rises.
China cuts key interest rates, reduces bank reserve ratios as stimulus package:
As per above the PBOC tries to inject slowing economy with more stimulus on Friday 23rd/Oct. This is part of the need to absorb excess capacity in China and increase consumption.
Hopefully it will not lead to increased manufacturing capacity and white elephant infrastructure projects and more property speculation and attempts to drive Chinese equity markets higher.
My suspicions are that it most likely will,since this is the path of least resistance and fosters the continued miss allocation of resources.
I think for China, this is becoming a game of diminishing returns since the fundamental restructuring of its economy and society is the only thing that can re-invigorate it; not more cheap money.
All the above leads to the inevitable debasement of currencies of the leading economies. Each will be trying to inflate their economies back to 'normal' but as they attempt to do so they just propetuate the problem since currencies operate on a relative strength basis. If one leading country cuts; all the others have to as well to re-ballance their relative initial positions.Thus a currency war unfolds.
Alot of analysts have been talking about 'policy divergence'. This was supposed to be the case when the US starts to raise interest rates whilst others still have a momentary easing stance in the form of cutting or QE.
Central bankers are now faced with the above tri-fectors od deflation and their solution is to cut and cut. This has the effect of strengthening the US dollar relative to its G10 currency peers.
In effect this is doing the job for the US FED, making it even harder for the US to raise rates directly in December.
This is the same for the UK which has been very hawkish and indicating its intent to raise rates in the first quarter of 2016. This will be less likely give China's action today and potentially the ECB in December.
Conclusion:
US FED and BoE are simply fucked !!!!.
If they start tightening they will kill exports since the dollar and sterling will explode higher against all their peers.
It will also put even more pressure on Emerging markets that are under a mountain of USDollar debt and also drive their inflation through the roof since all major commodities are dollar based. In reaction they will have to also increase their interest rates to strengthen their own currencies and stem inflation;but this will kill off their economic growth leading to possible recessions.
Thus low interest rates on a global scale is now the 'new norm' in my view until the above 3 horsemen of deflation have been removed.
This means many long years of working off debt, maybe a generation; so that average debt levels of industrialized nations falls from @ 90% to about 70% or less!!!.
GOLD OUTLOOK:
Gold does not bear any interest. Even the new Indian deposit scheme only bears @0.4% per annum.
Given the modus operandi of India jewelry buyers is not to purchase for immediate cash but as a store of value, this interest rate is not sufficient to entise gold hoarding Indians to get rid of their family heirlooms in exchange for interest bearing gold.
If interest rates on cash remain at record lowes for retail customers of banks and near zero for whoelsale customers then gold will be a competitive asset.
The above forces will drive gold price higher, if the ECB goes all out; then the s-h-i-t will hit the fan. The BoE and Fed will nominally have to stop interest rates from going higher and my have to suspend any future rise.
The US and UK are net importers so there will not be much fallout but there will be some, as per the UK steal industry.
The pressure will mount over time and exporters will have to outsource production overseas or close.....simple.
As the ranks of the unemployed grow the pressure will be too much and rate cuts will be on the table.....but there is no more room for cutting unless there is another bout of QE or negative interest rates at the wholesale level.
All the above is one way traffic for gold prices.
Currently gold has broken out of its bearish downwards trend; there should be some sideways consolidation to form a range bound market. Ranges being session highs @$1190 to session lows @$1100.
This range will hold until December.
Financial markets will be hyper sensitive given that the ECB and the US FED will be making key monetary policy decisions at approx the same time.
All makets, Fx, equities, bonds and commodities will be on standby. Either way expect extreme volatility; there are only a finite number of outcomes given that a central bank can either hold off, raise, cut or expend QE.
The most likely (if economic data gets worse) is that ECB cuts and US fed holds off. If economic date improves for EU and US and inflation rises ( and at this moment I can not see inflation rising unless wages go through the roof due to unemployment going to @3% in the US) is that both ECB and US go on hold and the markets have to wait a few more months.
Saudi Arabia + Iran; key drivers of energy deflation:
This is what will keep crude oil over supplied for the next 10 years in my view. There is simply NO way Iran and Saudi can go toe to toe and for oil prices to rise. There will have to be a new OPEC agreement to have a target price range and for production levels to be managed. This will play into the hands of US shale producers and other non-opec producers since prices would be higher than demand-supply dictate. Thus Saudi and other opec members will be losing market share as they have been over the last few years. It is a lose-lose for OPEC if they stabilize prices; they have to be relentless and drive US shale and non-OPEC produces into the floor. This is the only scenario where crude can be sustained above $50/bbl.
US shale and Iran's return to the oil and gas market will change the supply dynamics in a structural way, with oil and gas being in surplus on average. Only a strong global demand can bring balance back to the market.
As per above this will only happen when global dedt levels fall. So all are interlinked in a complex web which by its nature will play out over many years.
The above analysis puts gold in a very good position indeed. Unless the US bites the bullet and f-u-c-ks everyone by raising interest rates thus directly tighten US monetary policy; with the subsequent demolishing of gold price averages below $1000/oz.....which is not totally off the cards but is being pushed out further and further.
The above analysis indicates that until the 3 drivers of deflation have been removed low interest rates ARE NOW THE NEW NORM.
