The Rational Case for $700 Gold

Gold has been a core trade for a lot of people throughout the crisis period. When Lehman failed in 2008, it shook the world, global credit froze, banks were on the verge of collapse, the global economy was on the brink of implosion – people ran into gold. Gold was a fear-of-the-unknown-outcome trade.

Then the global central banks responded with massive backstops, guarantees, and unprecedented QE programs. The world stabilized, but people ran faster into gold. Gold became a hyperinflation-fear trade.

Source: Billionaire’s Portfolio

In the chart above, you can see gold went on a tear from sub-$700 bucks to over $1,900 following the onset of global QE (led by the Fed).

Gold ran up as high as 180%. That was pricing in 41% annualized inflation at one point (as a dollar for dollar hedge). Of course, inflation didn’t comply. Still eight years after the Fed’s first round of QE (and massive global responses), we have just 13% cumulative inflation over the period.

So the gold bugs overshot in a big way.

Why? The next chart tells the story…

This chart above is the velocity of money. This is the rate at which money circulates through the economy. And you can see to the far right of the chart, it hasn’t been fast. In fact, it’s at historic lows. Banks used cheap/free money from the Fed to recapitalize, not to lend. Borrows had no appetite to borrow, because they were scarred by unemployment and overindebtedness. Bottom line: we get inflation when people are confident about their financial future, jobs, earning potential … and competing for things, buying today, thinking prices might be higher, or the widget might be gone tomorrow. It’s been the opposite for the past eight years.

So, no inflation – what does that mean for gold?

Source: Billionaire’s Portfolio

After three rounds of Fed QE, and now mass scale QE from the BOJ and the ECB, the world is still battling DE-flationary pressures. If gold surged from sub-$700 to $1,900 on Fed/QE-driven hyperinflation fears, and QE has produced little to no inflation, it’s fair to think we can return to pre-QE levels. That’s sub-$700.

We head into the weekend with stocks down 3% for the month. This follows a bad January. In fact, the stock market is working on a fifth consecutive negative month. The likelihood, however, of it finishing down for February is very low. It’s only happened 18 times since 1928. So the S&P 500 has five consecutive losing months just 1.7% of the time, historically.

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