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by Al Martin

Gold & Bonds on Disinflation Planet

(6-6-13) In an article called “Gold prices are heading towards $1,000. There are many reasons why the gold bubble is deflating, and why gold prices are likely to move much lower by 2015,” it appears that renowned economist Nouriel Roubini has changed his tune. (Gold prices are heading towards $1,000)

Roubini is no longer the “Super Bear” that he was, and he’s now long equities and short Gold. He has now joined the camp that the “Global Last Ditch Effort by the Central Banks,” as I call it, is going to be successful. And therefore, equity prices can continue to rise, according to Roubini, for another two years, and the Last Ditch Effort will be successful and inflation will continue to move lower, but we won’t return to an out and out deflation, and therefore it’s bearish for Gold.

But the debate now is whether the Fed will “taper off” QE (Quantitative Easing) purchases by the Fed of $85 billion of paper each month. Bernanke is in the midst of a very divided FOMC, where half of the members didn’t support QE to begin with, and he is being pressured to “taper off” the $85 billion a month purchases of US Treasury securities. You can see the effects in global and domestic equity prices in the very idea of the end of Quantitative Easing, noting the volatility that has been created certainly in the last three or four weeks. People are scared that central banks are going to withdraw pabulum from the Hopium Cloud. That’s the only thing supporting equity prices.

Now Bernanke is trying to hedge his bets because he’s under pressure. He’s got a more sharply divided board than ever existed in the Fed. The same can be said if the ECB, the Bank of England and the Bank of Japan. They’re all in the same situation where board members are sharply divided on continuing QE. This uncertainty then is being played out in the markets.

What this should be telling the Unwashed is how dependent equity and real estate prices have become on QE. PIMCO’s Mohammed El Arian calls it the “growth gap” and says it’s still significant enough that all asset prices, not only equities but real estate as well, become very dependent on QE. Why? Because the “growth gap” which is the gap between so-called real economic growth and the rise of asset prices continues to grow. This means that asset prices can only be sustained through continuing QE.

Another internet wag called David Rosenberg has called for “stagflation redux” writing that “the next major theme is stagflation — this will be the legacy of the Bernanke regime.”

It should be noted that stagflation is a completely made-up word by the media which is supposed to be a combination of stagnation and inflation. The correct terminology which nobody likes to use is disinflation. In other words, there are three economic states – inflation, disinflation and deflation. There is no such thing as stagflation.

A disinflationary economic environment is simply an environment in which inflation continues to fall but has not moved below zero. But it’s not a global phenomenon. Japan for instance is still in the grips of deflation because its inflation rate is in the red meaning it’s below zero. The United States and Britain on the other hand have the two highest inflation rates in the industrialized world but even the US is fallng. Why? Because the Fed and the Bank of England have been the most aggressive in terms of quantitative easing which has turned down the deflationary pressure that had existed both in the US and British economies.

These massive rounds of QE by all the central banks on the planet have effectively stemmed deflationary pressure resulting from the break of the 2004-2007 bubble. However it has not caused reinflation. The global central banks have not been successful in reinflating the planet’s economy which they have all been successful in doing in the past through some sort of quantitative easing measures which is nothing but another word for good old fashioned monetary stimulus.

Meanwhile the governments can not produce any fiscal stimulus which is necessary to go along with the monetary stimulus in order to reinflate the planet’s economy because all of the planet’s governments are hamstrung and can do nothing.

But to get back to Roubini’s forecast of Gold going to $1000, it should be noted that in a previous column we had written called “What’s Going on with Gold? (Part 2): Pent-Up Demand Spurs Gold Buyers” (4-24-13) -- “So where is the ultimate back-off in Gold here? It’s probably $1100 or $1200. That’s ultimately where we’re headed, which coincidentally is the average production cost of an ounce of Gold. This then will be equalized with the actual cost of production.”

Gold prices are going to decline to their production costs and that’s the only way you can take Gold off the market, so to speak. The only way you can reduce the supply is for Gold prices to fall to the point where it’s no longer profitable for the mines to produce it.

Gold has done well so far in the month of June. I’ve been trading it from the long side and we had numerous rally efforts in the June contract above $1400. It’s been a great trader on the long side because we’re consistently holding higher lows, which is a signal that the price wants to move higher.

However that’s not a function of any reduction or disruption of supply. That is a consequence of the action in the Dollar, in that the Dollar has been falling for the entire month of June. So far. As can be seen in the DX index.

The Dollar has been falling against the Euro and against the Pound and is now rising again against the Yen. However, net-net, the decline in the Dollar during the month of June so far is what is making the price of Gold to rise.

And the erstwhile Bill Gross is also back in the news. Frankly you’d have a start a whole website to follow him because he flip-flops so frequently. Now you never know where Bill Gross and Company stand. Certainly it appears that they’re more bullish now on US Treasuries than they have been because US Treasury Bonds have sold off every day in the month of June. Gross and others are right to say that US Treasuries are now cheap relative to the risk of QE “tapering” -- which in practical reality isn’t going to happen. It’s just that the Unwashed don’t know that.

You have to look at what the central banks say – under pressure – and what the practical reality of the situation is – that global GDP continues to fall. And in such an environment, central banks are not going to withdraw or “taper off” quantitative easing because they know that in a falling GDP environment, quantitative easing, i.e. monetary stimulus, becomes the very last prop, propping up asset prices.

Gross wrote in his last missive that quantitative easing, have resulted in a global financial system that is "beginning to resemble a leukemia patient with New Age chemotherapy, desperately attempting to cure an economy that requires structural as opposed monetary solutions."

The long and short of it is that everyone is short Bonds now, which is probably about ¾ of fund managers, are essentially doing what they claim they are not doing – they’re fighting the Fed. If you’re short Bonds, you are fighting the Fed. They try to justify being short the Bonds by coming up with all this ancillary frummery. They say – the Fed could taper off at any time. The Bank of Japan could taper off at any time. And the Bank of England could taper off at any time. And therefore there’s an additional risk factor – so you should be short Bonds because the central banks can not artificially keep interest rates low. However the other side of that is that those who want to be long equities and short Bonds -- that’s the trade. That’s the prop trade, as it’s called because the central banks are propping up that trade.

Nevertheless to say that central banks are keeping interest rates artificially low is not correct – even though all of the pundits say that -- because they have to -- in order to support the idea of being long equities and short bonds. Central banks’ ability to control interest rates is in fact very limited.

The reason why interest rates continue to fall is because demand for money continues to fall.

It should also be noted that investors in PIMCO’s Total Return Fund pulled $1.32 billion from the $285 billion fund. That had to happen eventually because PIMCO has lost its luster This is what happened to the once great and almighty Fidelity Magellan Fund, which was once the flagship fund in the United States for decades. When Peter Lynch left in 1993, it began to get confused and began flip-flopping and the Fidelity Magellan Fund sank into obscurity.

The point is that when you start making flip-flops and making wrong call after wrong call and you start doing it every three or four weeks publicly – like Bill Gross has been doing, investors begin to lose faith. They lose their confidence.

In conclusion, Nouriel Roubini’s viewpoint does frame the picture pretty well. It is clear that the central banks do have a game plan for between now and the rest of the year, i.e. that they’re going to pull out all the stops in the last Desperate bid to create inflation, or to reinflate the planet’s economy.

And how they’re going to do that is to bring interest rates even lower. The BoE could cut another quarter point; the ECB cut another quarter point. Everybody is coming down to a quarter percent benchmark rate and everybody is going to announce fresh quantitative easing measures of some sort. This is a last desperate bid to reinflate the planet’s economy to try to spark “real” growth and not artificial growth

Nobody knows the outcome. However if you’re a well-known bear and suddenly you turn bullish on equities and bearish on Gold, it means you have joined the camp that believes that the global central banks will be successful in their last ditch effort in what they’re trying to accomplish, namely to reinflate the planet’s economy.

If what they are doing is unsuccessful, then there is no more the central banks can do because between now and the end of 2013, the central banks are signaling that they are going to burn up all the rest of the “tools in their toolbox” – to use Ben Bernanke’s words. This is a good way of putting it. All of the rest of the monetary tools that exist in the central banks’ monetary toolbox are now going to get used up. Stay tuned…

* AL MARTIN is an independent economic-political analyst with 25 years of experience as a trader on NYMEX, CME, CBOT and CFTC. As a former contributor to the Presidential Council of Economic Advisors, Al Martin is considered to be a source of independent analysis for financially sophisticated and market savvy investors.

After working as a broker on Wall Street, Al Martin was involved in the so-called "Iran Contra" Affair as a fundraiser for the Bush Cabal from the covert side of government aka the US Shadow Government.

His memoir, "The Conspirators: Secrets of an Iran Contra Insider," (http://www.almartinraw.com) provides an unprecedented look at the frauds of the Bush Cabal during the Iran Contra era. His weekly column, "Behind the Scenes in the Beltway," is published weekly on Al Martin Raw.com, which also publishes a bimonthly newsletter called "Whistleblower Gazette."

Al Martin's new website "Insider Intelligence" (http://www.insiderintelligence.com) will provide a long term macro-view of world markets and how they are affected by backroom realpolitik.

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