Yellow metal is now a mispriced hard asset

Yellow metal is now a mispriced hard asset
Wall Street will increase reflation risk and scramble to buy cheap inflation hedges, such as $1,250 gold. - KT file

Problems of European banking may extend, writes Matein Khalid



By Matein Khalid/ Commodities

Published: Sun 23 Oct 2016, 4:42 PM

Last updated: Sun 23 Oct 2016, 11:55 PM

King dollar, strong US economic data, a hawkish Fed and the failure of Deutsche Bank's $14 billion Justice fine to trigger international banking systemic risk all led to a 120 an ounce correction in the price of gold.
I am no goldbug but it seems to me that the yellow metal is now the most mispriced major asset class in the world and now offers a compelling risk reward calculus at $1,250 an ounce. After all, gold bull have been savaged since August even though 2016 is a bullish year for gold, despite the seven per cent post Brexit correction. The "hard Brexit" rhetoric of new Tory Prime Minister Teresa May led to another sterling crash and as amplified the rise in the US dollar index.
However, even if the Federal Reserve moves to hike interest rate in December, it is doubtful if the fragile global economy will allow the Fed to shift to a new aggressive monetary tightening cycle. In fact, 2017 could very well prove to be a "one and done" Fed call. If the Fed goes dovish, US economic data loses momentum or international banking risk rises, gold will find a strong bid at $1,250 an ounce.
While the Yellen Fed's own corporate spread index model implies only 12 per cent recession risk, anecdotal evidence suggests that the US economy could well soften while US equities are priced to perfection at 18 times earnings. The Federal Reserve may be forced to soften its rate hike language (and policies) to ensure negative US dollar interest rates continue in 2017.
The problems of European banking extend well beyond Deutsche Bank or even Germany. Spanish, Italian, Swiss and UK banks are at risk of failure. Does gold price systemic banking risk at its current levels? No. It is not just money market fund rules that have led to a rise in the three month London Interbank Bank Offer Rate (LIBOR), the benchmark for global bank funding cost. The global interbank market is nervous about something unexpected and ugly happening ahead, exactly as it was in the summer of 2008.
I expect Hilary Clinton to win in a near landslide on Election Day and the Democratic Party control the Senate, even if the Republicans retain control of the House of Representative. This makes deficit spending, fiscal stimulus and higher inflation in the US inevitable. If I read the political tea leaves right, Wall Street will increase reflation risk and scramble to buy cheap inflation hedges, such as $1,250 gold. World shipping freight rates, Chinese GDP growth, US retail sales all demonstrate that the US consumer's post crisis spending binge is almost over.
I had recommended a long gold trading position at $1,250 an ounce with a $1,241 stop a week ago. Gold has risen to $1,266 as I write, a two week high, after three successive days of gain last week. A major reason is rising inflows into the gold index fund (symbol GLD) and the fact that the Federal Reserve Beige Book indicates moderate economic expansion in most districts, reducing the risks of aggressive interest rate hikes.
I watch the performance of Treasury Inflation Protection Securities (TIPS) relative to Uncle Sam's debt as a proxy for Wall Street's inflation angst. When TIPS outperform Treasuries, Wall Street gets worried about inflation. This is happening now even as gold fell more than a $100 an ounce. Gold and TIPS should be positively, not negatively correlated since both benefit from inflation. The conclusion? Gold's fall was a position adjustment in the market and not a macro trend change, the reason I recommended investors accumulate gold at $1,250 an ounce.
Dr Janet Yellen could well allow the Federal Reserve to overshoot its inflation target without tightening the money supply as an antidote to the economy's aggregate demand deficit or post crisis "secular stagnation", to use Larry Summers's language.
After all, the $3.2 trillion debt in emerging markets could well plunge the world into recession if the Fed responds to a tight US labour market and inflation rates (PCE) above two per cent. The recent rise of the US Dollar Index to 98 is an ill omen for global growth. The message of the macro tea leaves is clear to me. The next $100 move in gold is up, not down. It is time to once again summon the ghost of Dr Auric Goldfinger.


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