In La Tribune 10/06/2020
It’s fashionable for leading economists to think that gold investors are idiots. The yellow metal pays neither interest nor dividends. Ite missa est.
And yet, if we look closely at the yield curve of US Treasury bills since 1930, we can see a very nice bell curve: from less than 2% around 1942 to more than 15% in the mid-1980s, and then less than 1% today. What the same economists have never taught us on university benches is that this curve can sink irresistibly towards negative rates, which I more properly call disinterest rates since the lender pays instead of being paid.
There’s one thing to watch out. Now, as everyone knows, gold prices are less influenced by the fundamentals of the physical market – production, consumption, stocks – than by its financial constraints, the value of the dollar and the real interest rate (RIR). The latter, the RIR, is the cornerstone of gold prices. It results from the operation of subtracting interest rates from inflation. Negative RIR means gold prices go north, and vice versa.
Nowadays, the first part of the subtraction is atypical since it is a negative number, it is the rate of disinterest; the second part, real life inflation, is almost zero because it remains impervious to the inventive monetary creation of the monetary authorities. The problem is therefore that this subtraction no longer makes sense since the fall in rates is no longer balanced by a rise in inflation.
Accordingly the question everyone is asking is: where is inflation gone?
Since the crisis of 2008 and even more so in our post-Covid world19 , monetary creation by the authorities will have been inventive, of a historic, extraordinary and unprecedented volume. But this liquidity has remained confined to asset and capital markets, where it causes inflation without being transmitted to the real economy and, through dilution, could causes prices to rise.
Two simple examples illustrate this impermeability between capital market inflation and real life inflation. The first was the inexpensive debt incurred by companies to buy their own shares or pay dividends. In both cases the transaction supported share price inflation. The second is today’s situation. Three months after the start of the pandemic, while in real life states are indebted as never before to pay millions of unemployed workers, while companies are considering social plans and commentators talk of an economic and social crisis, as if nothing had happened, under the effect of the promises of future monetary creations by central banks, stock market indices are back to pre-Covid levels.
Far from being absent, inflation is enveloping the capital markets to such an extent that it becomes invisible and the tightness of the latter is such that they do not communicate price increases to the housewife’s basket.
How could they anyway? Inflation of the capital markets is transformed into earnings and wages for a fringe of the population without this manna flowing abundantly to other communities. The latter, for various reasons, have too few savings to finance their usual expenses and take the additional risk of investing. This is the evil of our times, the disconnectiion between the increases in income resulting from inflation on the financial markets and the decrease in income resulting from the sluggishness or even deflation of the goods and services markets. There is inflation on capital, but deflation on labour. Post Covid, this disconnection has rarely been so obvious.
What about gold anyway?
The inflation issue is therefore murky like a bad cataract, but it has a direct impact on gold prices, whose current situation is exceptional because it stems from this impermeability between capital markets and real life.
Gold prices do not need inflation to go north because with negative rates and zero inflation, or even deflation, RIR can only guide gold towards an irresistible rise. This is why, in the short term, the stability of this financial spiral logically projects a rise in gold prices from $1700/T.oz to around $2000/T.oz. Then, durably troubled by Covid-19, economy seems to be heading towards further interest rate cuts and deflationary spins, thus increasingly negative RIRs. An average 10 % annual increase of gold prices is expected.