… Something Wicked this Way Comes

Last week the price of gold went up $18, and that of silver 6 cents. Looking at the ongoing stock market drop, someone asked us if this is “it”. So far in Q4, the stock market (S&P 500) has now lost more points than in any quarter during the great financial crisis (though so far less as a percentage). Is this it, will gold hit $10,000?


S&P 500 Index, daily – an unseemly slipping on the banana peel. [PT]


There is certainly something more serious happening than at any time post-2009. We mean: after all this time of falling rates and zero (short-term) rates, the Fed presumes to hike rates. They are trying to head something off which is not occurring. Commodity prices aren’t rising (witness the big drop in oil, again).

Consumer prices, especially in some urban markets may be rising. Taxes, regulations, zoning, permitting, compliance, inspections, user fees, environmental impact studies, labor law, and litigation can push up retail prices. However, they are not a monetary phenomenon. The Fed cannot do anything about them, and should not try.

Meanwhile, everyone focuses on the effect of rising rates on the US government. They should instead look to the marginal debtor. The US government is not the marginal debtor. For a good list of candidates, one could start with all the firms that the Bank for International Settlements identified as zombies in 2015.


The global share of Zombie companies according to the BIS [PT]


A zombie is a corporation whose profits < interest expense. 2015 is before the Grand Interest Hike Gambit. If they were unable to service their debts even then (without borrowing more), just imagine what the change in 6-month LIBOR from 0.38% to 2.9% has done to them. Just think what it’s done to the firms that weren’t zombies then at 0.38%, but are now at 2.9%.


3-month LIBOR since 2015: from practically nothing (17 basis points) to 2.81% – that does make a difference. [PT]


And this is not counting the decline in revenue to, e.g. the home builders. At higher rates, people can afford less house (assuming they want to buy a house when they see the market dropping). And move upstream to manufacturers of building products, furniture, etc.

And cars. Ford and the others are still advertising 0% financing for 72 months. We wrote this May about the increase in the cost of this subsidy to Ford–$1.4 billion or 28% of its net profit. Since that article, the cost has risen by more than another quarter billion. Ford still isn’t letting off the gas pedal, out of fear of the even-greater loss they will suffer from the drop in sales that would cause.

Even if the Fed were inclined to reverse itself immediately (which we do not see any signs of), we expect there will be some big bankruptcies and lots of smaller ones. Investors will regret moving out on the risk curve in the reach for yield, as many junk bonds default and the even the survivors incur big capital losses. The spread between junk and Treasury bonds has widened, it can widen a lot further.


US high yield spreads – since breaking out from a sideways channel near multi-year lows, junk bond spreads have soared. [PT]


But $10,000 gold? Collapse of the dollar? We don’t see it in our macroeconomic analysis — and we don’t see it in the basis spread. There is no sign of backwardation (in the USD — there is permanent backwardation in the Swiss franc). We would expect to see serious gold backwardation before a banking system or currency crisis.


Fundamental Developments

Speaking of the gold basis, let’s look at the only true picture of the supply and demand fundamentals of gold and silver. But, first, here is the chart of the prices of gold and silver.


Gold and silver priced in USD as of last week


Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio (see here for an explanation of bid and offer prices for the ratio). It rose last week.


Gold-silver ratio


Here is the gold graph showing gold basis, co-basis and the price of the dollar in terms of gold price.


Gold basis, co-basis, and the USD priced in milligrams of gold


It is interesting to see a rise in scarcity (i.e., the co-basis) along with fall in the price of the dollar (i.e. rise in the gold price). At least in the February contract. However, it did not occur in the Gold Continuous Basis.

The Monetary Metals Gold Fundamental Price rose $19 to $1,307.

Now let’s look at silver.


Silver basis, co-basis, and the USD priced in grams of silver


In silver, we see the same pattern. And less. A small change in price. And a small change in scarcity.

And unlike in gold, the Monetary Metals Silver Fundamental Price fell 8 cents, to $15.11.

© 2018 Monetary Metals


Charts by: StockCharts, BIS, St. Louis Fed, Monetary Metals


Chart and image captions by PT


Dr. Keith Weiner is the president of the Gold Standard Institute USA, and CEO of Monetary Metals. Keith is a leading authority in the areas of gold, money, and credit and has made important contributions to the development of trading techniques founded upon the analysis of bid-ask spreads. Keith is a sought after speaker and regularly writes on economics. He is an Objectivist, and has his PhD from the New Austrian School of Economics. He lives with his wife near Phoenix, Arizona.




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