ZIRP & NIRP: Killing Retirement As We
Know It

By John Mauldin


“Baby boomers who are counting on the stock market are in trouble.”

– Robert Kiyosaki

“Pension and health care costs for our employees are going to bankrupt this city.”

– Michael Bloomberg

Over the last 150 years or so, numerous innovations have radically changed the way people live. You can tick off the list: electricity, the automobile, refrigeration, television, the Internet. Yet one innovation rarely makes those lists, even though it is just as significant if not more so: retirement.

The idea that people can stop working in their fifties or sixties and then enjoy 20+ years of relative leisure is actually quite new. For most of human history, the vast majority of people worked as long as they were physically able to – and died soon after. Retirement is possible now only because those other 20th-century innovations accelerated the division of labor and lifted us out of subsistence farming and living.

Our inventions often have a dark side that can come to haunt us. They may be applied to wage war… or to create reality TV. Are we going over to the dark side with retirement? Maybe not, but we’re certainly heading in that direction. And there’s nothing wrong with the idea of retirement, of course – the concept is a fabulous invention, helping to extend life and happiness. But retirement is made possible by a prior life of hard work and careful saving and investment. And the very funds that make retirement possible are dependent on growth of the economy. Without growth, retirement as we have come to know and love it will not work. Retirement will still be possible, of course – just not under the same conditions.

The zero interest rate and now negative interest rate policies of our central banks are gumming up the global retirement machinery. The Federal Reserve and other central banks have spent so many years subsidizing debt and punishing savings that it is now extremely difficult to guarantee future income streams at a reasonable present cost. And future income streams are the very heart and soul of retirement. Without adequate future income streams, retirement as we know it today is off the table.

Whether this sad fact is what the central bankers intended or not, it is indeed a fact, whether you are an individual saver or a trillion-dollar pension fund. Today we’ll examine how we have come to this unhappy point.

But first, let me mention that although my Strategic Investment Conference (May 24–27 in Dallas) is sold out, we’re trying hard to find a way to accommodate a few more people without compromising the experience for those who have already registered. We have created a waiting list, and you can click on this link and pay a small fee (which is refundable) to get on it. Seriously, we expanded the room this year and thought we were fine – then we sold out in less than a month! I have friends calling me up and asking to get in, as they have attended for many years. Not an unreasonable expectation. Believe me when I say we are trying, but there is a space issue. So even if we are BFF’s, get on that list! THEN call. The only way to be fair and to save my sanity is to do this on a first-come, first-served basis. The line is growing, so even though the conference is three months away, sign up NOW!

When Retirement Was Risk-Free

Saving money for retirement has never been easy for the average worker, but at least it was feasible if you started early and earned a middle-class living, especially if you had automatic deposits or a business or government guaranteeing you a pension. Plus, the bond market was on your side. Until the year 2000 or so, anyone could lock in risk-free 5% or higher yields in bank certificates of deposit.

Suppose you saved all through your career and accumulated a million dollars. It was a simple matter to put it all in CDs, Treasury bonds, or tax-free muni bonds and generate $50,000 a year in current income. Living costs were lower last century, too. Presumably, you also paid off your mortgage in the course of living the American Dream. Add in Social Security and you could enjoy a comfortable if not extravagant retirement. Your million-dollar principal would remain intact and could go to your children upon your death.

Again, this was relatively easy to do. It didn’t require any financial sophistication or even a brokerage account. The hardest part was saving the million dollars in the first place, but you could get by with much less if you drew down the principal over a 20- or 30-year period (and didn’t outlive the drawdown).

Better yet, you could do this with no risk, just by keeping your money in FDIC-insured banks. You might have to split it between a few different banks to stay within the limits. Some extra paperwork, but easily done. There were plenty of services that would help you distribute your assets over multiple FDIC-insured banks.

It was even simpler if you had an employer or union pension plan to do the work for you. Pension plans pooled people’s money, calculated how much cash they would need to pay benefits in future years, and built portfolios (mainly bonds) to match the liability projections. Government and corporate bonds yielded enough to make the process feasible.

Younger readers may think I just described a fantasy world. I assure you, it was very much a reality not so long ago. Ask your grandparents if you don’t believe me. However, you may find them in a state of shock today because they thought the fantasy would last forever. Indeed, their financial planner probably told them they could count on drawing down 5% of their portfolio per year to live on, because the income from the investments in their portfolio would more than make up for the drawdown.

None of this is possible today. Neither you nor a massive pension plan acting on your behalf can generate enough risk-free income to assure you a comfortable retirement.

Why not? Because our monetary overlords decreed that it should be so. Retirees and their pensions are being sacrificed for what now passes as “the greater good.” Because these very compassionate overlords understand that the most important prerequisite for successful future retirements is economic growth. And they think that an easy monetary environment is the necessary fertilizer for that growth. So, when they dropped rates to zero some years ago, they believed they would soon be able to raise them again – and get people’s retirements back on track – without risking future economic growth. The engine of growth would fire back up, and everything would return to normal.

So much for the brilliant plan. You and I, the expendable foot soldiers in the war to reignite growth, now gaze about, shell-shocked, as the economic battlefield morphs from the Plains of ZIRP to the Valley of NIRP.

Ultra-Low Rates

In fairness to our central banks, they must balance competing priorities. The Fed’s statutory mandate is to promote “maximum employment and stable prices.” Their primary tools to execute this mandate are the manipulation of the money supply and interest rates. Since 2008 they relied on near-zero interest rates to stimulate economic growth. As I wrote last week, the Fed (and much of the economics profession) sincerely believes that low interest rates will do the job they’re supposed to.

However, the hard evidence of the past few years is that ultra-low rates, combined with quantitative easing, haven’t stimulated much growth. Unemployment has fallen, which is good – but probably not as good as the numbers suggest, because people have gone back to work for lower pay and are now even deeper in debt. Personal income growth has stagnated, as we will see a little later in this letter. So, are we better off now than we were five years ago? The answer is a qualified yes. But it is not entirely clear, at least to your humble analyst, that the halting economic recovery is the result of low interest rates and not other less manipulable factors such as entrepreneurial initiative and good old muddling through. In fact, an ultra-easy monetary policy may be part of the reason we’ve been stuck with low growth. Witness Japan and Europe. Just saying…

Seriously, no one fully understands how all the moving parts influence each other. Years of ZIRP did help businesses and consumers reduce their debt burdens. ZIRP and multiple rounds of QE have also done wonders for stock prices … but not much for the kind of business expansion that creates jobs and GDP growth.

If year upon year of ultra-low rates were enough to create an economic boom, Japan would be the world’s strongest economy right now. It obviously isn’t – which says something about ZIRP’s efficacy as a stimulus tool.

What isn’t a mystery, however, is that ZIRP has created a massive problem for retirement savers and pension fund managers. NIRP will make their problem worse – and they were already facing other challenges as well.

If we get negative interest rates for a sustained period, similar to Japan and Europe, it will be because the economy is stuck at no-growth or in contraction. Stock prices will head the other direction: down. It will be the mother of all bear markets. We are getting a little taste of it right now in bank stocks. Look for much worse as the growing impact of NIRP and the threat of NIRP reaches other sectors. 

Defined Failure

Employer-based retirement plans come in two flavors: defined benefit and defined contribution. A defined-benefit plan is what we usually think of as a pension. You work for employer X, who promises to let you retire at age 60 or 65 with a defined monthly pension payment – so many dollars per month, based on your salary, years of service, etc. You and your employer pay for this plan by contributing cash to it during your working years. (Unless you work for a government entity like a police force or fire department and can retire in your early 40s with full benefits after 20 years, then go to work for another government entity and retire with a second and sometimes even a third defined-benefit retirement plan. Yes, there are numerous instances of this. Not a bad gig if you can get it.)

But will the amount you and your employer contributed be enough to pay that defined benefit for all the years you survive after retirement? The answer necessarily involves guesswork and assumptions about events 20 or 30 years in the future. It also means someone has to be on the hook in case the guesswork is wrong. That’s usually the employer … or taxpayers.

Private-sector employers realized decades ago that carrying pension liabilities on their balance sheets left them at a competitive disadvantage. They removed those liabilities by switching newer workers to defined-contribution plans – the now-familiar 401(k) and similar programs. You and (if you’re lucky) your employer both deposit cash into your 401(k) account. You decide how to invest the money and hopefully do well. More to the point, a defined-contribution plan does not require your employer be on the hook for poor investment results. The one on the hook is you.

Defined-benefit plans now exist mainly in state and local governments, where unionized workers have more influence over management and elected leaders come and go. Politicians, by their nature, often think no further ahead than the next election. Their path of least resistance is to promise workers the moon and let their successors figure out how to pay for it.

Guess what? The future is here, and it turns out the guesswork and assumptions about the future were really, really bad. As in, if you are just about to retire or have only been retired a few years and have a pension, you may be seriously screwed.

Hot Potato Pensions

I get a creepy déjà vu feeling every time I write about public pensions. I’ve been preaching about them for more than a decade now, and the situation keeps getting worse. Obviously the politicians are ignoring me – and not without reason. Clearly, I underestimated their ability to postpone the inevitable. Nevertheless, I firmly believe a train wreck is coming. The math has never worked well, and now ZIRP/NIRP is making it much worse.

Fixed-income markets are tailor-made for funding future liabilities. Suppose you sign a contract in which you agree to pay your supplier $1 million exactly one year from now. How do you make sure you will have the cash on hand when the time comes?

The most conservative way would be to put $1 million in a lockbox right now, with instructions to open the box and disburse payment on the agreed date.

Back when CD and Treasury bill rates were 5%, you could just buy a series of $100,000 CDs for $1 million. When the time came, you handed over the principal and kept the interest accrued. You covered your obligation and still had $50,000 to use however you wanted.

That is roughly how defined-benefit pensions used to work, with longer time spans and much larger numbers. My example also has an advantage they don’t: certainty on how much cash you will need at maturity and the exact amount the investment will make in the meantime.

A pension plan that covers thousands of retirees can make educated guesstimates as to how long those pensioners will live. Professional actuaries are uncannily good at this when the population is large enough.

The far bigger challenge is to determine the expected rate of return on the pension’s assets.

That number is a hot potato, because it determines how much cash the employer must contribute each year to keep the plan “fully funded.” The laws require the sponsor of a pension plan to maintain a fully funded position. However, they allow a great deal of flexibility in how “fully funded” is defined. Assume higher returns in the future and you can get away with spending less money in the present. Furthermore, because we are dealing with large numbers over long time spans, small changes can make a huge difference.

The state and local officials responsible for these plans want to assume higher returns so they don’t have to raise taxes or cut other spending. So, as politicians often do, they shop around for someone who will give them the answer they want – along with plausible deniability should that answer turn out to be wrong. This is why we have a thriving “pension consultant” industry.

Almost without exception, public pension plans still assume very optimistic future returns. They base those projections on long-run past performance and assume the future will be like the past. CALPERS, the California public employee plan that is the nation’s largest pension, is in the process of reducing its base forecast from 7.75% to 7.5%. Even this tiny change was enormously controversial. Revenue-challenged local officials all over the state looked at the difference it made in their mandatory contributions and flipped out.

I have talked to numerous board members on multiple enormous public pension boards. Many of them would privately like to reduce their projected returns, but they know it is politically impossible to do so. Other simply say, This is what my consultants tell me, so I have to go with their expert opinion, don’t I?”

The return assumptions are a blend of past stock and bond market returns. This is where ZIRP starts to hurt. Bond returns have the advantage of being more predictable than stock returns, but now they are predictably low. Inflation-adjusted returns on Treasury and investment-grade corporate bonds are either zero, below zero, or not far above zero. They are certainly nowhere near the 5% or more that was once common.

If you can’t assume decent bond returns, can you make up the difference with higher stock returns? That’s not easy, either. Today’s behemoth pension funds don’t simply invest in the stock market; to a large extent, they are the stock market. It is mathematically impossible for all or even most of them to achieve above-market returns. They are just too big.

As I often say, long-run stock market returns are a function of economic, population, and productivity growth. Some companies always outperform others; but in the aggregate, stocks can’t outpace the economy in which they operate. If the economy grows slowly, then over the long run stock values will, too.

Growing slowly is exactly what the entire developed world has been doing and appears set to continue doing for years to come. If 2% is the best GDP growth we can hope for, then we are not going to see stock market returns over the next 20 to 30 years at anywhere near the 8% or 10% that many pension trustees assume.

If investment returns aren’t sufficient for pensions to pay the benefits they promised, all the consequences are bad. State and local governments must then implement some combination of higher taxes, spending cuts, or benefit reductions. All three hurt.

The same reality applied if you’re running your own pension. If you don’t save enough and/or fail to achieve your expected returns, you will face some unpleasant choices: work longer, live more frugally, or die sooner.

From Frying Pan to Fire

If ZIRP is bad, NIRP will be far worse for retirement planning. Bond-return assumptions will have to be even lower and potentially below zero. This situation would wreak havoc on every pension fund – but that’s not even the worst part.

Most asset allocations are generally in the ballpark of 60% equities and 40% bonds, so that is the standard portfolio we will be discussing. Other allocations will make some differences but not change the general direction. In other words, “your mileage may vary” – but probably not by much.

In an ideal world – which is the world that pension consultants live in – equities will return 10% nominal, and bonds will return 5%. A 60/40 portfolio blend will then yield an 8% overall return after fees, expenses, and management costs.

It doesn’t require a great deal of head scratching to realize that a negative interest rate environment is going to bring overall bond yields down below 2%. That paltry yield will drop the blended portfolio rate to 1.2%. How long can that low return last? Ask Japan. When we saw the advent of zero interest rates in the US seven years ago, no one thought they would be in place this long. No one.

The reality is that in our mega-debt world, long-term interest rates are going to be low for quite some time. One thing that could change that would be inflation’s charging back against consensus expectations. I don’t think the Fed really makes much of a move until inflation is over 3%. FOMC members would actually like to see 3% inflation for a while, though they will never say that. But then at some point they will have to make a move, and that is going to be exceedingly uncomfortable whenever it happens. But for the nonce, we are in a low interest rate environment.

Phantom Stock Market

Maybe we could just allocate more to equities? That is one possible solution, but the historical record suggests that might make our task even more challenging! When I start thinking about future possible returns, one of the first phone calls I make is to my friend Ed Easterling of Crestmont Research. He and I have collaborated on numerous papers on market cycles and future returns, most recently “It’s Not Over Until the Fat Lady Goes on a P/E/ Diet.” His website is a cornucopia of data and analysis. Let’s look at a few of his charts and conclusions.

One of the more reliable predictors of future returns is the current price-to-earnings (P/E) level. There are only three sources of stock market growth: EPS growth, dividend yield, and the change in P/E ratios (http://www.crestmontresearch.com/docs/Stock-Waiting-For-Avg.pdf). Where you start from gives you an excellent indication of the range of returns you can expect to get over the following 20 years. For most people, 20 years can be considered the long run.

Today the normalized P/E ratio is 23, which is right up there in the top 10% of historical rankings. Even if you want to quibble and drop the ratio a few notches, it’s still high. And by looking at the chart below, we find that historical returns 20 years on have ranged from 1.6% to 5.0%, with an average of 3.7%.

There is no historical instance of price-to-earnings multiples expanding from where we are today for any sustained length of time. In fact, levels like those we see today have generally indicated a brewing storm – a bear market. That doesn’t mean something new can’t happen this time. There are those who argue that because interest rates are so low, we can expect earnings multiples to continue to rise. Maybe, but for how long and how by how much?

If you take the highest historical return of 5% (from our current P/E) and marry that with the bond returns we discussed earlier, you find your 60/40 portfolio can now be expected to give you 4.2%. And the average historical equities return of 3.7% leaves you with only a 3.5% total return on your investment portfolio!

And the return level makes a huge difference to the eventual success of a pension. As in, a monster difference. Most people don’t realize that most of the money their pension will pay them in 20 or 30 years will come from the growth of the portfolio and not from their actual contributions. As we will see, your contributions might actually amount to as little as 20 or 25% of the total portfolio 20 years from now.

I’m going to start with a modest number, but you can add zeros to your heart’s content. Let’s say you save $1,000 a year for the next 30 years. Your pension consultant tells you that you can make 8%. And if you actually do, you find you have paid in $30,000, but your account has grown to $123,345.87, or over four times your contributions. Not a bad day at the office. You stick that into a 5% CD (bear in mind that we’re talking a fantasy outcome here), and you make $6,000 a year, or about $500 a month. Add a zero and save $10,000 a year for 30 years, and now you’re earning $5,000 a month, which, with a paid-for home and Social Security, provides you a comfortable, if somewhat frugal, lifestyle.

But what if you get only a 6% total return? Well, now you only have $84,801.68 after 30 years. Your 5% CD gets you only $4,000 a year. If you were able to save $10,000 a year, your monthly income would be roughly $3,500. Not bad, but much tighter. But that outcome depends on your being able to get 5% on your bonds or CDs. Do you want to bet your future that interest rates are going to be that much higher in 20 years? Maybe you need to save more.

Let’s turn to a little graph that my associate Patrick Watson whipped up for me in Excel. The top, gray line represents the 8% scenario; the middle, orange line is the 6% scenario; and the lower, blue line is the more pessimistic (but maybe realistic) 4% return.

What does that 4% return look like 30 years down the road? Your $30,000 in contributions have not even doubled, leaving you with just $59,328.34. That’s right, you don’t even get a double. And in our far distant future, that 5% CD is only going to give you $250 a month. Or if you save $10,000 a year for 30 years, you’ll be living on $2,500 a month.

But these numbers assume you don’t have to deal with that pesky inflation thing. A mere 2% inflation will guarantee that your money will be cut by about half after 30 years. (So even that $5,000 a month if you really make 8% won’t turn out to be that much of a lifestyle. And God forbid you make only 4%.)

Unicorn CDs

Well, that’s okay, many financial planners will say. You just dip into your principal, and when the market turns around you make it back up. I can’t tell you how many financial plans I’ve seen that assume the safe withdrawal rate (SWR) is 5%. As the table below (from one of Ed’s essays) demonstrates, a 5% withdrawal rate has historically (as in, since 1900) only been safe 47% of the time, and on average you are out of money after 21 years. Hardly safe!

The only way you can be “safe” is to find that magical 5% CD of the future when you’re ready to retire. If the world then happens to look like it does now, though, you’ll just have to keep right on working until things somehow magically recover. I hope that never happens to you, because you could find that your work experience is no longer relevant in an increasingly rapidly changing future.

I also wouldn’t assume that 30 years is a reasonable additional lifespan starting from age 65. With the advances being made in medicine and biotech, your “healthspan” as well as your lifespan are going to increase, and we are going to see many people live well into their hundreds. I think people would be well advised to plan to live a great deal longer than their parents and grandparents did and to budget for retirement accordingly. For most people that means continuing to work. If the thought of working an extra five years at your current job is somehow unpleasant, then my suggestion is that you switch jobs as soon as you can and find something you can tolerate for the longer term.

The same numbers that we applied to individual returns also apply to pension funds.

Pension funds are going to wake up in 10 or 15 years, find they are massively underfunded, and look to taxpayers and businesses to re-fund them. Your corporate pension plan that is guaranteed by the Pension Benefit Guarantee Corporation is not as guaranteed as you might think. If the PBGC has to take over your fund, you may be lucky to get 50% of the promised benefits. Before you get too fat and happy, I would read the fine print on that guarantee. Then I would ask the pension plan management exactly what expected return they are planning to get; and when you hear the typical “7½% for the long run (blah blah blah),” start trying to figure out how to work well past your expected retirement age so that you can supplement your pension when it fails. Then again, maybe your corporation will be there in 20 years when you need it. No need to worry – just assume it wil l all work out. Everybody else plans that way, and they all tell you everything’s going to be fine – just ask your brother-in-law.

Let’s step away from the unrestrained sarcasm to sum up the facts: Long before 20 years have passed and sometime after the onset of the next bear market, reality will set in, and pension fund managers will begin to plead for increased funding. And that is going to cause all sorts of repercussions. For a government plan, to obtain the needed funds, either taxes will have to go up, or other services and government expenditures will get cut. Either way, it appears that voters are in no mood to tolerate the status quo today. Imagine how much more fractious they’ll be in 20 years, when it’s clear that most people’s pensions are down the drain.

Governmental Bubbles

The biggest bubble in the world is the one we live in without being able to see it. It’s the bubble of government promises that government will not be able to fulfill. When it bursts, multiple generations will find their expectations destroyed. The politicians at ground zero had better be saying their prayers and putting their earthly affairs in order, because they aren’t going to last very long after that bubble bursts and reality sets in.

This is a mathematical certainty: hundreds of pensions are seriously underfunded, and many more will be endangered if we have another significant recession. Four percent returns for 10 years in a pension plan portfolio will result in massive future underfunding, even if things eventually get back to “normal.” There is going to have to be significant funding from corporations and taxpayers to make up the shortfall, at precisely the time when that money will be needed to rebuild infrastructure, retrain massive numbers of workers facing employment challenges from an ever-transforming environment, and deal with the fact that there will be more old people living than there are young people being born. This last fact is already the reality in Japan and much of Europe.

Next week we are going to look at what makes the pension challenge even more problematic: the difference between 2% GDP growth and 3% growth over the decades to come is every bit as dramatic as the difference between 4% and 8% portfolio returns. And if we don’t figure out how to get back to 3% GDP growth (and neither of the two leading presidential candidates are offering anything close to a plan that will get us there), the US is going to find itself even deeper in a hole, even as we continue to dig.

Chicago, Newport Beach, and New York

While the calendar looks relatively open (at least by past standards), the need for me to go to Chicago has arisen in the last 10 days, and suddenly it’s two days with about ten appointments. My staff decided that we might as well redeem the time while we’re there. Then after that whirlwind trip I’ll will be home for a few weeks before heading out at the end of month to Rob Arnott’s fabulous advisory council meetings, this time at Pelican Hill in Newport Beach. Those of you who know Rob and Research Affiliates know that his conference is a tad more academic than most, but he combines the intellectual heavy lifting with a fabulous food and party experience. It’s kind of like Adult Nerd Heaven. Then the following week I’ll be in New York, speaking and attending a conference.

I want to give a shout-out to my research associate Patrick Watson. Patrick went to work for me for the first time some 25 years ago, and we have worked on and off together for all the intervening time. About 10 years ago he struck out on his own and began to do research for other publishing firms, ghostwriting a lot of famous people’s newsletters and learning a great deal. With my research and writing schedule getting away from me after 15 years of Thoughts from the Frontline, I needed help. I have hired other research assistants over the years, and it has never really worked. But for whatever reason, Patrick and I really click and seem to bring out the best in each other. I know he has helped me be more productive; and given the pressure to write this next book, I don’t think I could keep all the balls in the air without him.

And speaking of the book, my research groups are beginning to put chapter outlines and research together, and most of the chapter groups are hitting their time targets. In my experience, that means we’ve come to the second most important part of the book-writing process: the no-more-excuses-not-to-begin-churning-out-copy part. The most important part, at least to my ADD brain, is when you get to the “oh-my-God-I’m-not-going-to-make-my-deadline” moment. It is actually useful when those two points coincide. In fact, now that I think about it, they almost always do. Nothing like a looming deadline and no excuses to get your derriere in gear. It helps that I am totally into the whole intellectual process of trying to figure out what the world will look like in 20 years.

Just for the record – and I’ve told my researchers this – I expect we will get a lot wrong. The future is by definition unknowable. I will be more than happy if we get the direction right. Lots of chapters will offer dual scenarios, but that’s okay. That’s not unlike what we do in business: you have your base plan, but you’re aware of all the other things that could happen that might change your operations. And hopefully the surprises are pleasant…

Before I hit the send button, I want to give you a link to Peggy Noonan’s latest essay. I think Peggy may be the finest, most powerful essayist of my generation. She thinks with clarity and writes in a fluid writing style that propels you along on her hurtling thought train, rarely ever pausing to give you a chance to get off, until you realize you’ve arrived at what should have always been your own conclusion. Young writers, if you want to know how to turn a phrase and see what writing should feel like after you’ve written it, you should study everything Peggy has penned.

If you want to write science fiction, you have to read J.R.R. Tolkien, Isaac Asimov, and Robert Heinlein. They are the masters. But if you want to write political essays and persuade people to a point of view – and do so in an aggressively literate yet polite manner, you read Peggy Noonan.

Her latest essay, “Trump and the Rise of the Unprotected,” talks about how Trump has managed to collect his diverse and burgeoning following. It is not within the experience of the establishment political class to comprehend what is happening. This phenomenon is more than just Tea Party.

I’ve been involved in the political wars for some 40 years. I’ve seen the back and forth between voters and politicians. This time around, I’ve talked to friends all over the country who do not fit the stereotypes the media has painted of Trump supporters. They are articulate, educated, and successful. They are also frustrated as hell with politics as usual. There are only a few times in American history that even vaguely rhyme with the time we’re in – I think what we’re seeing is unique. When you add the current frustrations of American voters to those of European voters, particularly around the issue of illegal immigration, you come up with real potential for profound change in the world geopolitical scene over the next five or ten years. It’s certainly something to think about, and Peggy sets a great thought table.

The political analyst in me looks at the record-high unfavorable rating for Donald Trump as a national candidate and then looks at Hillary Clinton and sees the same thing. I have a feeling this election cycle could be more negative and downright ugly than any I’ve seen in my lifetime – and that’s saying something. And given the mood of the country, it’s impossible to know what the outcome will be. We are truly in no man’s land here – but hey, it promises to be an adventure.

It really is time to hit the send button. You have a great week and find time to read something fun.

Your trying to wrap his head around the words President and Trump in the same sentence analyst,

John Mauldin

The Fed's Nightmare Scenario

by: Peter Schiff
- The Fed is collapsing markets with threats of rate hikes.

- If they continue, they will crash the whole economy.

- So instead they will capitulate and ease more.

Operating under the mistaken belief that a modest dose of inflation is either a prerequisite for, or a by-product of, economic growth, the nation's top economists have been assuring us for quite some time that inflation will stay very low until the currently mediocre economy finally catches fire. As a result, they believe that the low inflation of the past few months has frustrated Federal Reserve policy makers, who have been supposedly chomping at the bit to keep hiking rates in order to restore confidence in the present and to build the ability to cut rates in the future if the nation were to ever, god forbid, enter another recession.

In the weeks leading up to the Fed's December 16 decision to raise rates by 25 basis points (their first increase in nearly a decade) the consensus expectations on Wall Street was that the Fed would deliver three or four additional interest rate hikes in 2016. But with the global markets now in turmoil, GDP slowing, and the stock market off to one of its worst starts in memory, a consensus began to emerge that the Fed is reluctantly out of the rate hiking business for the rest of the year.

With such thoughts firmly entrenched, many were largely caught off guard by the arrival last Friday (February 19th) of new inflation data from the Labor Department that showed that the core consumer price index (NYSEARCA:CPI) rose in January at a 2.2 % annualized rate, the highest in more than 4 years, well past the 2.0% benchmark that the Fed has supposedly been so desperately trying to reach. It was received as welcome news.

A Reuter's story that provided immediate reaction to the inflation data summed up the good feeling with a quote by Chris Rupkey, chief economist at MUFG Union Bank in New York, "It is a policymaker's dream come true. They wanted more inflation and they got it." The widely respected Jim Paulsen of Wells Capital Management said that the stronger inflation, combined with upticks in consumer spending and jobs data would force the Fed to get on with more rate hikes.

But higher inflation is not "a dream come true". In reality it is the Fed's worst possible nightmare. It will expose the error of their eight-year stimulus experiment and the Fed's impotence in restoring health to an economy that it has turned into a walking zombie addicted to cheap money.

While most economists still want to believe that the recent slowdown in economic growth (.7% annualized in the 4th quarter of 2015, which could be revised lower on Friday) was either caused by the weather, confined to manufacturing, oil related, or just some kind of statistical fluke that will likely reverse in the current quarter, and that the stock market declines of 2016 have resulted from distress imported from abroad, a much more likely trigger for all these developments can be found in the Fed's own policy.

The Chinese economic deceleration and market turmoil made little impact on U.S markets prior to the Fed's rate hike. And although U.S. markets rallied slightly in the days around the historic December rate hike, they began falling hard just a few days later. Stocks remained on the downward path until a recent rally inspired by dovish comments from various Fed officials which led many to conclude that future rate hikes may be fewer and farther between then was originally believed.

In truth, the markets and the economy have been walloped not just by December's quarter point increase, but from the hangover from the withdrawal of QE3, and the anticipation of higher rates in 2016, all of which contributed to a general tightening of monetary policy.

The correlation between monetary tightening and economic deceleration is not accidental. As it had been in Japan before us, the unprecedented stimulus that has been delivered by central banks, in the form of zero percent interest and trillions of dollars in quantitative easing bond purchases, failed to create a robust and healthy economy that could survive in its absence. Our stimulus, which was launched in the wake of the 2008 crash, may have prevented a deeper contraction in the short term, but it also prevented the economy from purging the excesses of artificial boom that preceded the crash. As a result, we are now carrying far more debt, and the nation is far more levered than it was prior to the Crisis of 2008. We have been able to muddle through with all this extra debt only because interest rates remained at zero and the Fed purchased so much of the longer-term debt.

In the past I argued that even a tiny, symbolic, quarter point increase would be sufficient to prick the enormous bubble that eight years of stimulus had inflated. Early results show that I was likely right on that point. The truth is that the economy may be entering a period of "stagflation" in which very low (or even negative) growth is accompanied by rising prices. This creates terrible conditions for consumers whereby prices rise but incomes don't. This leads to diminished living standards.

The recent uptick in inflation does not somehow invalidate all the other signs that have pointed to a rapidly decelerating economy. Just because inflation picks up does not mean that things are getting better. It actually means they are about to get a whole lot worse. Stagflation is in fact THE nightmare scenario for the Fed. If inflation catches fire now, the Fed will be completely incapable of controlling it. If a measly 25 basis point increase could inflict the kind of damage already experienced, imagine what would happen if the Fed made a real attempt to raise rates to get out in front of rising inflation?

With growth already close to zero, a monetary shock of 1% or 2% rates could send us into a recession that could end up putting Donald Trump into the White House. The Fed would prefer that fantasy never become reality.

But the real nightmare for the Fed is not the extra body blow higher prices will deliver to already bruised consumer, but the knockout punch that will be delivered to its own credibility.

The markets believe the Fed has a duel mandate, to promote employment and to maintain price stability. But it is currently operating like it has just a single unspoken mandate: to continue to shower markets with easy money until asset prices and incomes rise high enough to reduce the real value of our debts to the point where they can actually be serviced with higher rates, regardless of what happens to employment or consumer prices along the way.

If you recall back in 2009 and 2010, when unemployment was in the 8% to 10% range, former Fed Chair Ben Bernanke initially indicated that the fed would raise rates from zero once unemployment fell to 6.5%. At the time I wrote that it was a bluff, and that if those goalposts were ever reached, they would be moved. That is exactly what happened. But when 5% unemployment finally backed the Fed into a credibility corner it had to do something symbolic.

This resulted in the 25 basis points we got in December. Yet even as official unemployment is now 4.9%, the Fed can postpone future, more damaging rate hikes, so long as low-inflation provides the cover.

But can the Fed get away with moving its inflation goal post as easily as it had for unemployment? In fact, the Fed has already done so, with little backlash at all. When created by Congress the Federal Reserve was tasked with maintaining "price stability". The meaning of "stability" should be clear to anyone with a rudimentary grasp of the English language: it means not moving. In economic terms, this should mean a state where prices neither rise nor fall. Yet the Fed has been able to redefine price stability to mean prices that rise at a minimum of 2% per year. Nowhere does such a target appear in the founding documents of the Federal Reserve. But it seems as if Janet Yellen has borrowed a page from activist Supreme Court justices (unlike the late Antonin Scalia) who do not look to the original intent of the framers of the Constitution, but their own "interpretation" based on the changing political zeitgeist.

The Fed's new Orwellian mandate is to prevent price stability by forcing prices to rise 2% per year.

What has historically been seen as a ceiling on price stability, that would have forced tighter policy, is now generally accepted as being a floor to perpetuate ultra-loose monetary policy. The Fed has accomplished this self-serving goal with the help of naïve economists who have convinced most that 2% inflation is a necessary component of economic growth.

But as officially measured consumer prices surpass the 2% threshold by an ever-wider margin, (which could occur in earnest once oil prices find a bottom) how far up will the Fed be able to move that goal post before the markets question their resolve? Will the Fed allow 3% or 4% inflation to go unchallenged? President Nixon imposed wage and price controls when inflation reached 4%. It's amazing that 2% inflation is now considered perfection, yet 4% was so horrific that such a draconian approach was politically acceptable to rein it in.

Once markets figure out that the Fed is all hat and no cattle when it comes to fighting inflation, the bottom should drop out of the dollar, consumer price increases could accelerate even faster, and the biggest bubble of them all, the one in U.S. Treasuries may finally be pricked. That is when the Fed's nightmare scenario finally becomes everyone's reality.

Banks and money-laundering

Whoops apocalypse

American regulators wield a big stick, but not always fairly

LIKE politicians, financial regulators know that late on a Friday is a good time to slip out bad news.

The Financial Crimes Enforcement Network (FinCEN), part of America’s Treasury, chose February 19th to announce it had rescinded a devastating finding against a European bank suspected of facilitating money-laundering. The withdrawal, less than a year after the designation, looks like a climbdown.

In March 2015 FinCEN branded Banca Privada d’Andorra (BPA) as a “primary money-laundering concern”, saying its top managers had moved cash for criminal groups. This so-called “311” measure (after the relevant section of the Patriot Act of 2001) is usually crippling for the bank concerned, because in effect it cuts it off from the American financial system and any banks that participate in it.

BPA was no exception: the government of Andorra, a mountainous financial haven nestled between France and Spain, ended up taking over the bank despite objections from its majority shareholders, the Cierco family; its Madrid-based wealth-management arm was liquidated.

The Ciercos, insisting there was no legal basis for FinCEN’s move, sued in the American courts.

FinCEN’s explanation for its reversal was that Andorra had taken steps to protect BPA from money-laundering risks, and the bank therefore no longer poses a threat. The Ciercos are having none of this. They argue that it was instead a “blatant effort to avoid judicial scrutiny” of the 311 measure. They point to the timing: the court was to hear a motion to dismiss the case next month. That would have required much more detailed evidence to be aired in support of the 311 action.

The Americans wanted to avoid this because their case was flimsy, critics say. The Ciercos have argued from the start that it was based on cases of suspected money-laundering which the bank itself had reported to Andorran regulators and had brought in KPMG, an accounting firm, to investigate.

If BPA was already cleaning up its act, why go after it at all? Some suspect the bank was a pawn in a tussle between governments: miffed that Andorra was slow to adopt American-style anti-money-laundering rules, including limits on cash transactions, America decided to show who was boss by selecting a bank to pick on. There is some evidence to support this sacrificial-lamb theory. In unscripted comments last year, for instance, an American diplomat suggested that America chose to “use the hammer” on BPA as a way of resolving wider concerns about Andorra. (FinCEN referred questions from The Economist to the Department of Justice, which declined to comment on the ground that lawsuits are under way.)

The Treasury has been challenged in another 311-designation case. FBME Bank of Tanzania sued it after being accused of servicing all manner of bad guys. Last autumn an American court issued an injunction blocking the government’s action until the bank received more information about why it was deemed a threat to the financial system. The case continues.

Meanwhile, FBME’s operations have been severely disrupted: it has sought an injunction to stop the authorities closing an important subsidiary in Cyprus.

These cases highlight two problems with FinCEN’s money-laundering cudgel. The first is double-standards. It tends to go after only small banks in strategically unimportant countries; its use of 311 has been likened to using a sledgehammer to crack nuts. The second is its lack of openness. It faces no requirement to make detailed evidence public, or even available to a court, at the time of action.

By the time any challenge is heard, it may be too late for the bank in question.

BPA is not dead, but it is seriously wounded. Much of the value may have already vanished from a bank that was worth €600m ($680m) before the debacle—though there are substantial assets left thanks to a freezing order. The Ciercos want the Andorran authorities to halt the disposal of its assets and enter into “remedial negotiations”. They have hailed FinCEN’s about-face as a “momentous victory”. But will it be a hollow one?

Is Gold Making A Triumphant Comeback?

by: Bert Dohmen

- Analyzing the long-term economic and market cycles, the probability is very high that the stock market downturn may eventually be regarded as the worst since the Great Depression.

- Over the past several months, the bearish sentiment on gold was at an extreme high - no one wanted gold.

- I wrote in 1981 that after a 20-year bear market, gold would enter a 30-year bull market.

Analyzing the long-term economic and market cycles, the probability is very high that the stock market downturn may eventually be the worst since the Great Depression. Of course, there are many more safety nets now, and the central banks of the world will coordinate in order to soften a decline. But the Fed and other central bankers are not the solution. They are the problem.
All the 'safety nets' have to be paid for with money the governments don't have. Therefore, it will have to be financed with 'money creation' by their central banks.
That means the worse things get, the more money printing central banks will do. They will have to come up with better ways than the 'quantitative easing' of the last seven years. If they actually start throwing money from helicopters, as the Fed chair Ben Bernanke commented years ago, then central banks might be able to produce the elusive inflation that they have been trying to create. It will destroy paper currencies.
And that will eventually produce a rush to gold and silver and out of paper money. China has encouraged its citizens to hold gold, and probably has a plan to be the world's largest holder of the metal.
Below is the long-term chart of gold back to 2001 when the bull market started. In 1981, I had written in the Wellington Letter that my work showed that a 20-year bear market was ahead. It was right on target, but at the time, no one believed that gold would decline for 20 years.
Furthermore, I wrote in 1981, that after a 20-year bear market, gold would go into a 30-year bull market. In 1981, that seemed outlandish. I even wrote at the time, "I have no idea what would cause a 30-year bull market in gold." Now we know: all the central banks panicking and flooding the system, thus depreciating the purchasing power of our currency.

The year 2001 was the start of the bull market. Gold soared from about $250 to over $1900.
Then came a big market correction in 2011 to 2015. That retraced 50% of the prior rise, which is normal in a bull market. It's very possible that the long-term (secular) bull market has now resumed.
Let's go to the Market Vectors Gold Miners ETF (NYSEARCA:GDX). There are numerous reasons for calling this bullish. Here are two: look at the strong increase in volume as prices soared the past week.
Then look at the MACD indicator at the bottom, which is now on a nice 'buy' signal. Any pullback now would be another buying opportunity. Asians see the financial crisis ahead and are fleeing to the one asset that has prevailed against currency upheavals for centuries: Gold.
The preliminary evidence suggests that the secular (long term) bull market in gold is still intact and may be resuming now after a four-year correction. The big investment money of the world is now much smarter than before the last crisis. Now money is going to US Treasuries, and Asians are going to gold. For hundreds of years, gold has protected Asians against the inflationary policies of their own governments. They fear it may happen again.
The global banks are looking so bad, it suggests a major global banking crisis is ahead. On January 12, top officials in Japan were calling for an "emergency meeting" of top world financial figures to discuss what to do.

We have written that the central banks are out of ideas and out of ammunition. All they have left is talk about "we will do whatever needs to be done," and all their other clichés. When banks are in trouble, many investors around the world go for gold.
Whereas the last crisis was triggered by the subprime mortgage crisis in the US, we now have the debt around the world starting to implode. There is no area of the globe that can rescue the others. A crash is possible because the markets are so illiquid that they cannot absorb major selling.
The past several months, the bearish sentiment on gold was at an extreme high. No one wanted it.
When everyone is on one side of the fence, it's usually smart to go to the other side. This could be the big surprise of 2016.
A word of caution: The precious metals are extremely volatile. Don't be overexposed.

Israel Is Beginning to Eat Its Own

An unrelenting wave of Palestinian violence has Israeli leaders at each other’s throats — and it’s going to get even uglier.

By Amos HarelAmos Harel is the senior military correspondent for the Israeli newspaper Haaretz.

Israel Is Beginning to Eat Its Own
After nearly five months of continuous violence, Israel finally seems to have lost its nerve.
Although Israelis have encountered far more serious periods of conflict with Palestinians in the past, the current era of stabbings and vehicle attacks has thrown them off balance. Even in the most horrific times of the Second Intifada, when suicide bombers blew themselves up twice a week on the streets of Tel Aviv and Jerusalem, a very Jewish version of the “stiff upper lip” persisted — everyday life continued apace, with businesses and schools remaining open.
This time, however, things have evolved differently. While the number of casualties remains significantly lower than the comparable period in the beginning of the Second Intifada in 2000 — 174 Palestinians and 31 Israelis have died so far, about 60 percent of the numbers last time — the Israeli reaction seems far more frantic and confused.
The government is now actively promoting a bill that would allow Knesset members to suspend their colleagues for supporting terrorism, as well as a “transparency bill” that would force left-wing NGOs receiving financial support from foreign governments to publicly report such assistance.
Prime Minister Benjamin Netanyahu led the campaign against Arab-Israeli members of the Knesset (MKs), after three such MKs attended a meeting with families of Palestinian attackers who were killed by Israeli police. He also threatened Arab-Israeli citizens after a shooting attack by an Arab-Israeli in Tel Aviv, vowing that Israel “will live forever by the sword.”

Months later, he promised to continue building fences along all of Israel’s borders in order to keep out “predators.”
Meanwhile, an ultra-right-wing grassroots organization, Im Tirtzu, initiated a public campaign against left-wing groups and human rights organizations, describing them as shtulim — Hebrew for “implants” or “moles,” carrying the implication that they are aiding Israel’s enemies. On Feb. 16, Jerusalem police even briefly detained two Washington Post journalists for suspected “incitement” of Palestinians after conducting interviews with residents outside the Old City.
In what might be perceived as a rare moment of comic relief, a Likud backbencher surprised fellow MKs earlier this month by revealing that, in fact, there’s no such place as Palestine. The reason? There is no letter “p” in Arabic. “Pa, pa,” she sputtered from the podium while Arab MKs watched in disbelief.

The response of Israel’s opposition to the current situation has also been beset by confusion. Opposition leader Isaac Herzog recently proclaimed that the two-state solution was currently unrealistic. His partner in the Zionist Union party, Tzipi Livni, slammed international media for being “hostile” toward Israel at a special session convened by a Knesset subcommittee.
Herzog and Livni’s main competitor for leadership of the anti-Netanyahu camp, Yesh Atid party leader Yair Lapid, has been busy attacking Breaking the Silence — an NGO made up of Israel Defense Forces (IDF) veterans that collects soldiers’ testimonies about the moral price of the ongoing occupation.

Nobody should be nostalgic for the Second Intifada. It was an ugly period, full of devastating incidents on both sides. Israel’s prime minister at the time, Ariel Sharon, used aggressive means to thwart Palestinian attacks. But Sharon, for better or worse, was constantly on the initiative: He ordered a military operation to reoccupy Palestinian towns in the West Bank after the Passover night massacre that killed 30 Israelis in March 2002; began construction of a barrier that separated Israel from the West Bank; and later on, fearing a loss of support for Israel in the West as well as growing rifts in Israeli society, ordered a unilateral disengagement from the Gaza Strip.
Netanyahu’s never-ending era as prime minister has been far less eventful. To the prime minister’s credit, there is always a significant gap between his tough rhetoric and actual cautiousness when applying military force. He has avoided unnecessary wars with Hezbollah, limited the scope of armed conflicts with Hamas, and showed much better recognition of the risks posed by the so-called Arab Spring than Western leaders, who were thrilled by events in Tahrir Square five years ago.
But the current mini-Intifada has caught Netanyahu, as well as Israeli security agencies, ill-prepared. Out of more than 280 attacks since Oct. 1, only one — the first — has been the work of an organized Hamas cell. Most others were “lone-wolf” attacks, initiated by young Palestinians with no prior record. The Israelis are now trying to develop a better way of monitoring Palestinian social media, hoping that this could provide them with clues for future attacks. But as Army Chief of Staff Gadi Eizenkot admitted last month, not even one attack has so far been foiled because of an early warning supplied by Israel’s massive intelligence-gathering apparatus.
It is, of course, much harder to identify in advance a 16-year-old armed with a knife he took from his mother’s kitchen than a suicide bomber sent on his way by a small network. But the series of attacks has eroded many Israelis’ sense of relative personal security, which has been Netanyahu’s main accomplishment — and the source of his electoral strength — during the last seven years. Some attacks initiated by Arab-Israeli citizens have also damaged the sensitive relationship between Jews and Arabs inside Israel, and there is a growing risk of a new round of violence in Gaza, where Hamas has successfully rebuilt its network of tunnels.
Faced with such challenges, Netanyahu’s rhetoric has become more bellicose, but little has changed in Israel’s actual military stance. The reason for the Israeli army’s rather restrained approach is the attitude of both Defense Minister Moshe Yaalon and Gen. Eizenkot. The conduct of these two leaders represents the only source for relative optimism in this rapidly darkening picture: Eizenkot, in particular, has been quite outspoken about lessons he learned from the Second Intifada and has insisted on the need to avoid collective punishment against Palestinians in the West Bank.
Eizenkot has also been wary of suggestions that the army conduct a massive incursion inside the Gaza Strip as a preemptive measure against the Hamas tunnels. The two officials support a rise in the number of work permits for Palestinians inside Israel; earlier this month, the security cabinet approved their proposal to increase the number by 50 percent, to 90,000 permits.
Nahum Barnea, a veteran political commentator in Israel and a critic of Netanyahu, wrote this month that in his unassuming way, Eizenkot is now filling Israel’s leadership vacuum.

A few more of these public compliments, and the IDF commander might find himself at odds with the prime minister’s office.

Meanwhile, the political discourse in Israel continues to deteriorate. On Feb. 18, two teenage Palestinian boys stabbed two Israelis at a supermarket in a settlement north of Jerusalem; one died from his wounds, and the other was severely injured. An Israeli citizen shot and wounded the two boys, who were evacuated to an Israeli hospital, along with the wounded Israelis.
The Israeli right quickly pinned blame for the attack on an unlikely source. “I hope that Eizenkot’s remarks yesterday [Wednesday] against the use of automatic weapons while dealing with attackers didn’t cause life-threatening hesitation,” Transportation Minister Yisrael Katz wrote on Facebook. “Terrorists who attack Jews should not come out of this alive.”
Katz, whose relationship with Netanyahu has recently soured, entered politics as a close supporter of former Prime Minister Sharon. It’s hard to imagine Sharon putting up with such behavior during the Second Intifada. But perhaps Sharon was luckier than Netanyahu — at least he didn’t have to deal with his ministers turning to social media in order to give advice about self-defense to soldiers and civilians. Not only is this new Intifada not going anywhere soon, it is already making Israelis lose all sense of proportion.

jueves, marzo 03, 2016



Gold Is Due For A Pullback

by: Vladimir Zernov

- Gold rallied from $1050 to $1250 without any pullback.

- This was a fear-induced trade.

- As markets calm down, gold will fall from current levels.

Gold's (NYSE: GLD) rally was spectacular. The precious metal reacted to the general market's downside and shot to highs that were last seen in the first half of 2015.
Some investors believe that this rally marks the end of the multi-year bear market for gold. Others argue that gold went too far too fast. In this article, I lay out my views on the topic and discuss what factors will have influence on gold in the near term and what factors will likely be ignored.
Let's look at the latest data by the World Gold Council.
Gold demand increased in the fourth quarter of 2015 compared to the fourth quarter of 2014, and this increase was attributed to the increase of investment purchases and central bank purchases. It looks like Central Banks took their chance to purchase more gold for diversification purposes while the gold prices were relatively low.
Source: World Gold Council
One could argue that Central Banks are the smartest guys in the room so you should closely follow their action. However, the World Gold Council's data suggests the opposite. As you can see from the graph above, Central Banks were actively buying gold since 2011.
So, Central Banks started buying gold when it was $1400 per ounce, bought gold all the way up to $1900 per ounce and continued their purchases while the gold fell under $1100 per ounce. Prior to 2010, Central Banks were net sellers of gold. This data suggests that you probably should not be replicating the behavior of Central Banks on the gold front.

I'd argue that it was just natural for Central Banks to buy some gold given the low interest rates around the world. Gold pays no interest, but its liquid competitors also pay little interest. Thus, buying gold as a means of diversification looked like a smart idea for Central Bankers around the world.
Also, one should not forget about the risk of negative interest rates. The gold's inherent weakness as a storage of value is the fact it pays you no interest. This weakness turns into strength once you have to pay to park your money. When I was a kid and did not know about the existence of interest rates, I thought that people pay the bank to look after their money.
Back then, I thought that money was safer in the bank than under the mattress, so it was logical for me to believe that people pay for safety. As it turned out, banks are not invincible and, generally, people will try to avoid paying the bank for using their money. The negative interest rate world is certainly bullish for gold.
The Central Bank purchases and possible inflows into ETFs look bullish for gold. The other contributors to gold demand, technology and jewelry, will likely be bearish contributors. Technology is moving away from gold, especially in the dentistry section.
I believe that the current trend will continue and technology's demand for gold will shrink year after year. The good news for gold is that technology is the smallest contributor to overall demand, so big percentage drops in technology demand will result in rather small physical decreases in demand.
I expect that jewelry will take a hit. India could be a bright spot, but others will likely suffer. Demand from Russia and Turkey will continue to fall. Given all the political and economic hardship in two countries, its consumers will take a serious hit.
Middle East markets also don't provide sources of optimism with oil near $30 per barrel. The demand in Europe remains anemic, and I think that you can't only blame economy for this.
In my opinion, cultural reasons also play a role in Europe's gold demand dynamics.

In my view, the situation on the demand side will ultimately depend on whether increased Central Bank purchases and flow of money into gold ETFs will be able to offset declines in jewelry and technology.
Not surprisingly, supply dropped due to lower gold prices. Both mine supply and recycled gold contributed to the drop. I would argue that we will not witness a similar supply drop this year. Judging from what we heard from gold miners during this earnings season, they adapted to the gold price environment and generally don't need further cuts to improve their cost profiles.
For big players, current costs are well below current gold prices so they will likely produce as much as the can while remaining cautious about new capital-intensive projects. It will take much more than a few months of gold upside before we see the return of serious risk appetite for new ventures in the gold mining space.
All in all, the supply side looks moderately bullish for gold. In my view, we cannot expect a flood of new gold into the market after years of the bear market. On the other hand, it looks like gold companies trimmed the excessive projects and will likely make minor changes to their portfolios going forward.
Do supply and demand matter now for the gold price?
I believe that it there was no sudden change in the supply/demand balance in the last few months that could cause the rally in gold. Gold is a financial asset, like stocks or bonds, and money constantly flows in and out of assets and asset classes.
Currently, it looks like gold was a part of a major "fear trade". As money exited from biotech (NYSE: XBI) or energy (NYSE: XLE), it had to find a place somewhere. The first part of the "fear trade" led to purchases in dividend stocks that, in theory, should protect investors in case of additional market downturn.

Look at the charts of AT&T (NYSE: T), Consolidated Edison (NYSE: ED) or Verizon (NYSE: VZ) - their new highs reflect the demand for safety in uncertain times. The second part was the gold trade that quickly pushed gold from $1050 to $1200.
In my view, demand and supply dynamics for physical gold had little to do with the recent surge in gold price. That's why I believe that investors' stance on gold must depend on their view of where the general market and interest rates will be heading and also on their view about the fate of the U.S. dollar.
What could cause the next leg of upside?
I see several catalysts that could propel the gold price higher. The first one is negative interest rates in the U.S. I don't see this coming and I expect that the Fed will be able to raise the rate at least once this year.
Apart from my view that negative interest rates are absurd and won't work for anyone, I just can't see what problems make cause the Fed to step into the negative interest rates territory in 2016 after they just made their first hike.
The second possible catalyst is sub - $25 oil. Currently, oil looks stuck in the wide range and it looks like the negotiations among producers and continuing cuts in U.S. rigs finally stopped the never-ending oil price downside.
I am a bit upset with this development as oil was so close to my December target of $25 per barrel, but I still see risks that oil could retest lows if production freezes lead to nothing and Iran ramps up its production ahead of expectations.
The third catalyst is the weakness of the U.S. dollar. I don't expect this. I believe that demand for U.S. currency will continue to grow amid problems in multiple parts of the world.
I don't think that the dollar is overvalued now, although it clearly creates some problems for multinationals who got accustomed to the artificially low dollar exchange rates.
I don't see any of these possible catalysts coming now. Hence, I'm in the "too far too fast" camp and I believe that the current rally is due to a pullback. I think that when the S&P 500 breaks 1950 we will see a massive sell-off in gold.