Gold, The Fed And Where's The Beef?

by: Doug Eberhardt

- Follow the Fed? Does the Fed really know what's going on?

- The euro, dollar and gold.

- Trading the Ups and Downs of Gold.

- How should you be positioned today?

The question on everyone's mind now is, are we about to break out higher with the price of gold?
Follow the Fed?
We'll start with the Fed with my analysis because interest rates and the stock market have been driven the last 2 years in particular by what the Fed does and this in turn has affected the dollar and gold.
In the old days the markets and rates were driven by the size of Alan Greenspan's suitcase.
Then it was driven by QE on or QE off during Bernanke's tenure. And lately it has switched to the simple question "will they or won't they" raise rates? I guess Yellen's purse size is irrelevant. Valuations are a thing of the past for the most part when it comes to the market and what the Fed does or says they will do with interest rates is all that matters. "What is the Fed going to do?"... is the new mantra. But the Fed these last 2 years has a lot of egg on their face when it comes to their comments versus actions.
Janet Yellen's Fed said in December of 2015 that they will raise rates for the first time in nearly a decade as a "vote of confidence."
Our decision to raise rates should certainly be understood as a reflection of the confidence we have in the progress the economy has made and our judgment that progress will continue. 
It is a vote of confidence in the economy. Source 
The rate setting Federal Open Market Committee (FOMC) said it expected to raise short-term rates by another 0.75% percentage points next year - probably in three separate quarter-point moves - up from a previously predicted 2017 increase of 0.5%. Source
Flash forward a year to December 2016 after the Fed raised rates zero times during the preceding 11 months and we got a token rise and another 3 rate increase prediction for 2017.

What did we get for our GDP data for the last quarter of 2016? 1.9% was the GDP number for the last quarter and 1.6% for all of 2016, tied with 2011 for the lowest reading of the Obama administration. This leads us to ask a simple question of the Yellen-led Fed.
Where's the Beef?
This last Fed meeting we have seen the Fed once again not raise rates in a unanimous decision and they said the following; "Measures of consumer and business sentiment have improved of late." If you recall, the consumer sentiment leading up to the 2008/2009 financial crisis was also good. The consumer is not who I go to get a reading on the economy. The Fed said that growth is expanding at a "moderate" rate. Source Is 1.6% GDP for 2016 a moderate expansion?
What the Fed does is tell us what we want to hear, that everything is fine and the economy is good and we'll raise rates next time we meet. What it reminds me of though is a 1984 Wendy's comercial.
Can You Have Inflation Without GDP Rising?
The fact of the matter is, Real GDP has been contracting for decades as seen in the above chart and the only thing keeping us afloat is government spending to make up for the slack.
Keynesian economists will say the Fed needs to realize this and implement more QE to stimulate or they'll soon experience a deflationary contraction the likes of which they will be powerless to overcome with quick action monetary stimulus. The Fed will be reacting as usual.
I listened to CNBC during the Fed announcement and the Fed's change in language about inflation from their last meeting in December saying now inflation "will" rise to 2% over the medium term rather than "expected" to rise.
Bob Pisani came on and said "we're not talking about deflation anymore." Steven Liesman brushed off the fact that the Fed didn't talk about raising rates in March that other commentators brought up.
But what gives the Fed this confidence in saying inflation is on its way? Don't you need GDP growth to have inflation? The Fed meeting came after the GDP data came out below estimates.
You can't will inflation into the economy just because you say it's coming, the same way you can't will interest rate increases just because you predict them. Notice this last meeting they didn't say; "we will raise rates next meeting?" Why not?
The only thing the Fed has going for it is the unemployment data improving the last few years but what happened this last report? The unemployment rate increased from 4.7% to 4.8% and no one even mentioned the U-6 number going from 9.2% to 9.4%.
I simply think the Fed is clueless and has been for quite some time. They also said nothing that gave a hint about the unwinding of the $4.5-trillion balance sheet they need to unload and technically won't until rates rise more, so this is another clue that the Fed just talks the talk and isn't ready to implement any rate increases soon.
How Does All This Affect the Price of Gold?
There have been many dips in the price of metals the last 6 years where investors came in and bought the decline. But this last dip it seems the buyers have dried up. I have noticed it several times and so have my suppliers who I discuss this with. In fact, one supplier said they haven't seen it this slow in 6 years. The one thing that we seem to forget as buyers of gold, is that most of the buyers are Republicans. I can attest to this with my own clients and I have seen since Donald Trump was voted in office a shift in buying. It's simply not what it used to be. The Republicans won the Presidency, the Senate and the House and soon will have the Supreme Court majority. The VIX is at the lows, again. The fear is gone and this week we saw a resurgence in jobs data overall, despite the rise in the actual unemployment rate. Is the Republican takeover causing gold to fall in price or is this latest move higher a sign of investors waking up to an incompetent Fed that has pushed the dollar higher to where U.S. products are too expensive and thus GDP has floundered?

This is where my brain went Friday after I began writing this article and asking where does gold go next, after locking in some good profit in the miners. First off, my number 2 rule after "always keep a stop if wrong" is take profit. So I don't think too many people complain about taking double-digit profits. But the one indicator that trumps all others is still one that can shed light on gold. It's the indicator that you have seen me write about in most of my articles the last year and it has allowed my timing overall in my articles, the few that I write, to give us some direction on how to play gold. That indicator is the U.S. dollar.
Gold has traded lock, stock and barrel with what the dollar does of late. So if you are going to convince someone of where you think gold is going, then you have to convince them where you think the dollar is going. And this is where we have to jump to some conclusions, which might be obvious to some, but oblivious to others.
With the chart below we can make the case for the inverse relationship of the dollar and gold of late. While it is not always a perfect inverse relationship, over time it can be relied upon for helping us forecast gold. When it goes away from this pattern, we simply keep a stop on our position (aka take profit).
I've made the case several times in my articles that most who sell gold don't understand what a dollar is when they continue to say it's going to crash. Yes, it is a "piece of paper" but it is the belief in the piece of paper that matters. That same belief goes for gold which is a metal. Both the paper and metal version of money are mocked by each other's opponent but only one of these has a history of maintaining purchasing power...over time - gold. And many who argue against gold try and compare it to stocks. Since when does gold become an asset to compare to stocks? It should be ONLY compared to currency as it is the original currency and the only currency that has a history of maintaining purchasing power. In fact, our government considers American Gold Eagles legal tender the same as Federal Reserve Notes and if that doesn't say that gold is a currency, I don't know what else does.

This last week, once again I was listening to a Peter Schiff podcast as I do enjoy his take on things, but his comparing the dollar to the German Reichsmark or the Zimbabwe dollar is not being intellectually honest. Germany was coming out of a war and Zimbabwe was going through a decade of contraction from 1998 to 2008, resulting in printing by the government to fund the budget deficit resulting in hyperinflation for both countries. Schiff's recent podcast talks about the dollar having its worst January in 30 years. This of course occurred just after a 14-year high in the dollar.
I have been one of the few gold bulls out there who is willing to look at both sides of gold and the dollar, and while I lean long gold for the long term, have at times challenged the short-term view simply because of my belief in the other side of the dollar; primarily the euro, having issues. If a bit over 50% of the dollar's value has issues, for a dollar crash to occur, the euro would have to move a lot higher. It's as simple as that.
But what most don't see is that it's not as black and white as some think where you choose to believe in the dollar crash, euro crash or what have you. In the long run, Schiff, me and any others who are bullish on gold will be proven right. Over time, it takes more of ALL currencies to buy gold. You can see that even in the 3rd chart with the major currencies. How is it that gold moved up in price in all currencies? This is another one of the illusions of what these currencies priced in each other represent.
For those who think I cherry pick times to make my point, I included the 5-year chart to show that gold wasn't a good buy at times. A 1964 quarter though could buy you about a gallon of gas in 1964.
It consisted of 90% silver. Today that same 1964 quarter is worth $3.16 of the current scrip.
The average price for a gallon of gas is $2.26, so technically the price of silver is getting you a lot more gas today. By comparison, a 1965 quarter could buy you 25 cents of gas in 1965 and 25 cents of gas in 2017. An apple-to-apple comparison of what money was versus what it is today is the issue, not what other assets have done compared to gold. In 1964 no one compared "currency" to stocks.
Remember, currency today is listed as the "safest" investment and metals at the top as the riskiest investment in the investment pyramid used by most financial advisors with clients. For those who want to argue that the dollar is safe, may I remind you that the Dollar Index had a 38% fall from January of 2002 to a low in 2008. Was that "the safest category of investment" that the pyramid suggests? Can there be times when one outshines the other? Of course. And a smart investor can know when to switch gears. But physical gold and silver investors really don't care about this risk.
They call precious metals insurance and you won't convince them otherwise.
I'll let the reader judge as to what one considers risky based on history since America went off the Gold standard. And I'm not a gold standard guy, but Warren Buffett's dad was and he was a U.S. Congressman when he warned in the 1940s about what the government can do to money in a system where printing can be abused.
The gold standard acted as a silent watchdog to prevent unlimited public spending.  
I have only briefly outlined the inability of Congress to resist spending pressures during periods of prosperity. What Congress would do when a depression comes is a question I leave to your imagination.
The Euro, Dollar and Gold
To complete this analysis on gold at present, we have to look at the European situation and make those judgment calls to see whether we are for the most part dollar bulls or bears and how that will affect gold and see if we are going to experience the same inverse pattern.
The euro has had a nice bounce off of the bottom as you can see from the following chart for the last month. The dollar has had a nice call during the same period. There has been some good data coming out of Europe as they try and peak through their latest deflationary episode (nothing moves straight down), but this move higher won't last. We'll see resistance in the euro bounce once we hit the level seen in the second cart around 1.14/1.15.
The euro simply has too many issues going on for it to have any sustained move higher. Whether it be their banks, countries like Greece, Italy or Spain, refugee crisis and terrorism or lack of tourism, this current move up on some good data will dissipate pushing the euro lower to the 1.00 parity with the dollar. This by default is dollar bullish. But for now we are going to enjoy the gold bull higher and a continued dollar pullback because of it. Yes, there can be some extensions to the 1.20 level in the euro that can push the dollar even lower which the chart shows is possible, but we'll address that when/if we get there.
Trading the Ups and Downs of Gold
I did some calculations on my JNUG NYSEARCA calls the last month for to see if a buy and hold approach would have been better than timing the market. As many of you know, I am not a buy and hold type of investor, except for physical gold and silver which I have recommended for years that investors have some and dollar cost average into a position and sit on it.
On 12/14/16 we bought our first shares of JNUG NYSEARCA, 1/2 position at 6.40. We cost averaged down and bought at 5.75 with a 1/4 position and 5.25 for the last 1/4 position. I clarified then that "This is a SWING trade till end of January and between now and then JNUG NYSEARCA will begin its rise."
We were long JNUG NYSEARCA then for an average of 5.95. I did so at a time admitting it was a mistake and a little early because it was actually JDST NYSEARCA that was green on my nightly report (which I made the mistake of ignoring), but we successfully hedged with some JDST NYSEARCA trades until JNUG NYSEARCA bottomed out. I am not counting those JDST NYSEARCA profits in my calculations here. We sold JNUG NYSEARCA at 8 for a 34.45% gain. We then scalped JDST NYSEARCA 5 out of 6 days for profit and re-entered JNUG NYSEARCA at 8 and sold 1/2 shares at 9.38 for 17.25% and the other half at 9.18 for 14.75%. We bought JNUG NYSEARCA again at 7.85 and sold 1/2 at 9.84 for a 25.35% return and the other 1/2 at 9.74 for a 24.08% return.
Over this time we did many trades long JDST NYSEARCA as I said, and a couple in JNUG NYSEARCA that didn't work but with quick stops; but all in all, the rise in JNUG NYSEARCA from 5.95 to its after hours price on Friday of 10.18 is a 71.09% return. Our in and out timing has given us a 75.16% return, not counting the many JDST NYSEARCA trades.
I'd say we came out on top quite well but we don't just trade JNUG NYSEARCA and JDST
NYSEARCA all the time and look at dozens of other leveraged ETFs too for profit. The point is, I think that one can time the market well with leveraged ETFs and not be affected by any deterioration in the pricing structure. While trading leveraged ETFs isn't for everyone, using a set of rules that control losses and lets your winners ride can get you some nice profit with little worry.
How You Should Be Positioned Today
You should be long gold (GLD) NYSEARCA, silver (SLV) NYSEARCA (or the physical equivalent) and (GDX) NYSEARCA if conservative at present. If willing to take on more risk, then JNUG NYSEARCA or (NUGT) NYSEARCA will give you some good leveraged moves higher in the coming months.

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