TROUBLE LOOMING FOR THE U.S. BUT NOT GOLD / SEEKING ALPHA

Trouble Looming For The U.S. But Not Gold
              

Oct. 15, 2014 7:30 AM ET

 

by: Individual Trader       

       

Summary

• The Fed is caught in a bind. They can't raise rates nor can they increase taxes. If the equity markets fall more, they will have to re-launch QE.        
• QE was implemented to create a "wealth effect" in the economy. They can't let asset prices fall which will mean inflation in the long run.
• Once the markets see no end to all these central bank easing programs, gold will turn on a dime and rally hard from here.

The US and international equity markets have fallen sharply over the last few weeks and in my opinion there is more to this than meets the eye. I believe the Federal Reserve is running out of options as the US dollar gains strength against other international currencies. Let's discuss why the longer this global recession continues, the worse it is for the Fed as options month after month become more limited.

First of all the Fed can't raise interest rates with the main reason being the US's deficit spending. The US economy is nowhere near ready for a rate increase when you consider the deficit numbers.

Interest rates at zero mean the US is able to borrow at practically 0% to run their economy. A big portion of these borrowings finance the interest on the national debt. If interest rates were raised, borrowing costs would rise sharply.

Secondly, what is not helping the US at the moment is the strength of the dollar compared to other currencies. In the Fed minutes last week, Janet Yellen stated that the strong US dollar would keep inflation down which would hurt the domestic economy (The Fed is looking for higher inflation levels as they state this is a symptom of a healthy recovery).

Yes it is looking for higher inflation but not for the consumers' benefit. It is looking for more inflation because its debt becomes more expensive when the dollar is strong. The Fed wants to "inflate away" its debt which will be impossible if the dollar remains strong. So even though it is presently undergoing a "tapering process" of its QE programs, I don't expect this to last. It will either launch a new round of quantitative easing or will restart their present program.

Even though the Fed states consistently in its minutes that it wants consumer price inflation, what it really wants is asset price inflation (stocks and real estate). The whole purpose of QE was to increase asset prices through inflation. This "wealth effect" would enable the middle class and rich to spend more as they would feel they were richer. They can't raise taxes on the very people they want to spend more and they also can't let the stock markets fall. They know the middle class and rich have much of their wealth tied up in equities so domestic stock markets will be of utmost importance to them going forward. Again, having a weaker dollar would help equities rise in price easier.

From this standpoint, expect to see much bigger amounts of QE going forward. The Fed is running out of options and it definitely hasn't helped that foreign countries are not doing much better. US bonds are severely overbought reflecting the fear presently in equity markets. Something will have to give if we continue to have more downward pressure on US equity markets and I believe it will be another unprecedented easing program

What does all this mean for commodities and gold? Gold is having a tough time at present as the strong dollar is definitely affecting its price. Nevertheless, this pattern will change. Yes, gold may go to $1000 an ounce but it will not stay at these levels for long. The fundamentals with central banks vastly expanding their balance sheets will ultimately be bullish for gold. Precious metals will turn on a dime once the markets see the real intent of central banks. One can go long by investing in CEF or SPDR gold Trust ETF