Interest Rate Inertia: When Will Yellen Pull the Trigger?

Federal Reserve Board Chair Janet Yellen said today that the central bank’s monetary policy stance of gradually increasing the target for short-term interest rates is “appropriate,” notwithstanding the latest disappointing jobs report, which could signal deeper troubles, as well as drags on the U.S. economy from China’s slowdown and a possible U.K. exit from the European Union.

“My overall assessment is that the current stance of monetary policy is generally appropriate, in that it is providing support to the economy by encouraging further labor market improvement that will help return inflation to 2%,” Yellen said at a much-anticipated speech before the World Affairs Council in Philadelphia, a week before the June meeting of the Federal Open Market Committee (FOMC).

In her last public comments before entering the week-long blackout period in the lead up to the FMOC meeting, Yellen added, “The economic expansion following the Great Recession has now been under way for seven years. The recovery has not always been smooth, but overall, the gains have been impressive. In particular, the job market has strengthened substantially, and I believe we are now close to eliminating the slack that has weighed on the labor market since the recession.”

As such, Yellen said, “I continue to think that the federal funds rate will probably need to rise gradually over time to ensure price stability and maximum sustainable employment in the longer run.” But she refrained from giving away the timing of the next hike – the phrase ‘coming months’ was absent – instead reminding market observers that the Fed is not on a scheduled path of rate changes. “I will emphasize that monetary policy is not on a preset course, and significant shifts in the outlook for the economy would necessitate corresponding shifts in the appropriate path of policy,” she said.

Before Yellen’s Philadelphia speech, the markets were expecting the Fed to raise rates as early as the June meeting. However, the May jobs report released on June 3 dashed those hopes and surprised analysts. The labor market added just 38,000 jobs last month – the lowest since September 2010 and well below expectations. Meanwhile, the Labor Department said unemployment inched down to 4.7% — but it was due to people going uncounted because they left the workforce, according to the statistical methods used, and not from an increase in employment.

Recently, various members of the Federal Reserve, including Yellen, have signaled a readiness to hike rates because the economy has been strengthening. The last time the Fed raised its target for the Fed Funds rate was in December 2015, by 25 basis points. It was the first hike since June 2006, after which the Fed aggressively cut rates to mitigate the effects of the financial crisis.

Yellen said that although the recent labor market report was “concerning, let me emphasize that one should never attach too much significance to any single monthly report. Other timely indicators from the labor market have been more positive.” However, it remains an “important” indicator that the Fed will closely watch. The jobs report showed that weakness was fairly broad-based, even though a strike by 35,000 Verizon workers skewed the figure somewhat.

More generally, Yellen’s outlook on the economy is bullish: “Although the economy recently has been affected by a mix of countervailing forces, I see good reasons to expect that the positive forces supporting employment growth and higher inflation will continue to outweigh the negative ones. As a result, I expect the economic expansion to continue, with the labor market improving further and GDP growing moderately.” In addition to an increase in employment, rising equity and home prices have helped restore household wealth while lower oil prices boosted purchasing power.

Lael Brainard, one of the Federal Reserve’s governors, had signaled a willingness to delay a rate hike. “Recognizing the data we have on hand for the second quarter is quite mixed and still limited, and there is important near-term uncertainty, there would appear to be an advantage to waiting until developments provide greater confidence,” she said in a recent speech before the Council on Foreign Relations in Washington.

Brainard also cited overseas risks that would hamper U.S. growth, such as the June 23 referendum on whether the U.K. will stay in the European Union and pressures facing China and other emerging markets. “Because international financial markets are tightly linked, an adverse reaction in European financial markets could affect U.S. financial markets, and, through them, real activity in the United States.”

Yellen echoed those remarks. “Even though the financial stresses that had emanated from abroad at the start of this year have eased, global risks require continued attention. Much of the turmoil early this year appeared to be associated with concern over the outlook for Chinese growth, which in turn has broad implications for commodity prices and global economic growth.” She also said that a development that could shift investor sentiment is the upcoming referendum on a possible “Brexit.”

“A U.K. vote to exit the European Union could have significant economic repercussions,” she said.

Is a Fed Delay Risky?

Wharton finance professor Joao Gomes believes the Fed will hold off on a rate hike this month as well. “At this stage, markets attach a very low probability to a rate increase at the June meeting. Under the circumstances, the Fed is extremely unlikely to risk a surprise and it’s very likely that we will see them leave interest rates unchanged for the moment.” He adds that the markets do expect a rate hike at least once this year, possibly as early as July but more likely in the early fall. “I think this reflects both the perceived question [about timing] at the Fed and nervousness about the strength of the U.S. economy in the first two quarters of this year.”

Gomes says small, measured increases in interest rates do not pose “any significant danger” to the U.S. or global economies. “I’m also fairly sure that the Fed will be extremely hesitant to raise rates until it is abundantly clear that the U.S. economy is strong enough to absorb such rate hikes.”

But he does have concerns. “From a U.S. standpoint, my main worry is that the Fed is delaying increasing rates until it’s too late. From a global standpoint, I think one could perhaps worry that a decoupling of economic growth between the U.S. and emerging economies would force the Fed to raise rates fairly quickly and spark a wave of capital outflows that would create significant headwinds for those countries,” Gomes says. “This is indeed a possibility, but I think people at the Fed have started to think very carefully about these implications and how they may in turn damage the strength of U.S. corporations and the U.S. financial sector through their exposures to the emerging economies.”

For emerging markets, there is a track record to underline the risks. Wharton finance professor Nikolai Roussanov points to the ‘taper tantrum’ of 2013 as proof. Back then, the Fed announced that it was going to slow down its monthly purchases of Treasurys and mortgage-backed securities, pushing Treasury yields higher. Global investors began selling off their emerging market holdings as the U.S. bond market looked more attractive.

However, keeping interest rates low for a long time carries its own risks. “We are beginning to see significant signs of dislocations in asset markets that may be very difficult to correct later on,” Gomes says. And even if the Fed does return to a “normalized” track soon, this dislocation in the markets might not see a smooth path back. “Much more important is whether such a correction will be smooth. History is full of such episodes where monetary policy stays loose for far too long, with disastrous consequences. The very nervousness in emerging markets about the U.S. interest rate decision is an example of the type of vulnerabilities induced by this massive dislocation in asset prices in the last few years. And many would argue the housing collapse of 2008 was a great example of the Fed letting credit run away and failing to raise interest rates early enough in the cycle to prevent them from getting out of hand.”

Current monetary policy is already “extremely loose by any conventional measure, and still would be if the policy rate was raised another quarter-point,” wrote Bloomberg News’s editorial board in a June 3 opinion piece. “Very low interest rates and a massively expanded central-bank balance sheet (thanks to a prolonged spell of quantitative easing) are distorting asset prices and creating problems for the future. What’s more, as a way to stimulate demand, they seem less and less effective.” That is why a Fed decision not to raise rates would be a “mistake.” Instead, the op-ed said, the government should step up and take more of the burden of stimulating economic growth off the Fed’s shoulders.  “The Fed doesn’t control fiscal policy, but it can and should signal that it’s no longer willing to carry the whole burden of reviving the economy.”

Op-Ed Contributor

Why French Workers Are So Mad


                                Credit João Fazenda       

PARIS — Last month, Emmanuel Macron, a onetime investment banker who is now the Socialist government’s young minister of the economy, visited Lunel, a small town in southern France. He was taken to task in the street for the “loi travail,” the labor law — recently pushed through by his government — that he was in Lunel to promote. A trade unionist wearing a T-shirt challenged him: “You, you’ve got lots of cash, you buy yourself nice suits.” Without missing a beat, Mr. Macron responded, “The best way to afford a nice suit is to work.”
A video of the interaction has been practically running on a loop on YouTube ever since. To most people in France, this exchange says it all about the gap between Mr. Macron and the working classes. In his eyes, if you don’t have a suit, it’s because you don’t work.
In France these days, not only is it getting harder and harder to find a job, but even those people who have one are unlikely to be able to afford a nice suit. Work pays less and less, except for the elites represented by Mr. Macron. As in the United States, income inequality in France is growing.
The new labor law aims to make employment in France more “flexible.” Its main provision follows a single guiding idea: to facilitate companies’ ability to fire people, which, proponents of the law promise, will make the labor market “more fluid” and in the long run create more jobs.
Unions have responded with major strikes at oil refineries, railroads and nuclear power plants, shaking the foundations of power. A sympathetic youth-led movement, Nuit Debout (Up All Night), has also sprung up — albeit disorganized and idealistic — calling into question the triumph of finance capitalism.
The overwhelming majority of the political class, big business, the news media and the intellectual elites have applauded the labor law. For them, the strikes offer yet more proof that France is “unreformable.”
Why is the law the subject of such debate? And how are two of the country’s main trade unions — both in a decades-long decline — managing to stay mobilized and carry out big strikes? Why have people gathered to discuss injustice in public plazas night after night since the end of March under Nuit Debout’s informal banner?
Even though no one knows precisely what effect the law will have, very few wage-earners in France, unionists or not, believe that making firing easier will create more jobs. Logically enough, they think it will create more firings. But more important, the French know recent history and can perceive trends.
Their protests are focused on the part of the law allowing companies to set their own terms for workers’ vacation allowances and other benefits, rather than adhering to a national standard.
The strikers fear that this measure will accelerate the disappearance of “bons boulots,” good jobs, and increase the number of precarious ones. Once again, nothing new there. The labor market in France has been offering less and less job security for decades. Today, 85 percent of new hires are temporary employees and the duration of their work contracts keeps shrinking — 70 percent of new contracts are for one month or less. How could a labor law that will encourage even more insecurity stimulate employment?
The government provides no satisfactory response to that question, except to point out that the current situation is not viable and that refusing to change is the worst possible option. For the last 30 years, the unemployment rate has typically fluctuated between 9 percent and 12 percent, with a brief dip in 2007 and 2008. The president, François Hollande, has said that persistent long-term unemployment has created a “social and economic emergency.” Overcoming a long-lasting structural crisis of this type is much more daunting than getting out of a cyclical one. 

There are 5.7 million unemployed (including the partly unemployed) workers in France today, the equivalent of some 28 million Americans. Action is urgently required. But the great absence from the debate over the labor law in the government is any reference to the reality of the jobs that will supposedly be created. Most people fill that void with dread.
The current round of strikes will probably come to an end soon. And Nuit Debout has already largely disintegrated. But its American cousin Occupy Wall Street left a legacy, the idea of the “1 percent” and of the noxiousness of ever-growing social inequalities. What’s going on in France now is similarly clarifying trends: To work in the future, you’ll have to settle for being less well paid, and for having worse health insurance and lower unemployment benefits. As for your children, they’ll live in a world with much greater inequality than yours. That’s the new rule. 

Why Investors Can’t be Complacent About Inflation Let Downs

Forecasters have consistently over-estimated inflation since the start of 2015

By Richard Barley

It isn’t news that global inflation is low. And yet just how low is apparently still a surprise to forecasters—at least to judge by Citigroup C 0.04 % ’s Inflation Surprise indexes, which track the performance of actual inflation against forecasts.

Only three times since the start of 2015 have the indexes for the U.S., U.K., eurozone and Japan entered positive territory, which implies inflation was higher than expected. Those occasions were in June and July 2015 for Japan and in April 2016 for the U.K. Otherwise, the indexes have shown inflation consistently undershooting expectations—even at extremely low levels.

Citigroup’s indexes don’t just look at headline consumer price inflation: they also look at wages and producer price inflation, where data and forecasts are available. That explains why the U.S. index, for instance, is still negative, despite forecasters having a better handle on headline CPI recently: wages have been the disappointment there. They are also calculated on a rolling basis, which means past forecast errors have some weight, although the latest data always have the biggest impact on the series.

Granted, economic forecasts are often unreliable. But, arguably, they should be just as likely to miss the outcome from both directions. The consistently negative readings on the Citigroup indexes implies that forecasters have been persistently over-optimistic on inflation. And that may help to explain why markets are refusing to price in predictions that inflation should pick up later this year as the effects of falling oil prices fade.

There have been false dawns before; the oil price plunge at the end of 2015 and start of 2016 pushed out a previous expectation of a rebound.

Even the European Central Bank last week appeared to err on the side of caution. It kept its forecasts for 2017 and 2018 inflation unchanged at 1.3% and 1.6% respectively, even though policy changes and oil prices were still expected to increase inflation.

Investors might be right to be cautious because inflation forecasters appear to have been crying wolf.

They need to be careful, however, because they could still suddenly find higher inflation at their door later this year. That would be a surprise markets wouldn’t take in their stride.

Getting Technical

Commodities Rally Looks Strong and Broad on the Charts

It’s not just gold and oil: Agricultural products are on the rise. Even Deere and DuPont are up.

Not many individual investors have experienced trading in the commodities pits, but they should pay attention to what is happening there right now. Commodities from sugar to soybeans look quite strong, and that is giving commodities-related stocks a boost, too.
You don’t have to have conviction on pork-belly futures to participate. The PowerShares DB Agriculture fund holds positions in a broad array of agricultural commodities, and after a choppy May it erupted higher two weeks ago (see Chart 1).

Chart 1

PowerShares DB Agriculture Fund

Sugar, corn and soybeans were already in strong rallies, then lean hogs and coffee joined the party in a big way. Of course, after such a big move in such a short period of time, the fund is a bit overbought.
It would not be a surprise to see it work off some of its excesses. Rather than wait for a conservative play in what is now a volatile item, however, investors should investigate how this newfound strength finds its way.

The Materials Select Sector SPDR exchange-traded fund holds stocks from several parts of the basic materials groups from gold to steel to energy services. I wrote about gold and silver in Monday’s column, saying that gold stocks are surging and the mining sector had broken out on heavy demand.
The chart shows a strong rally this year as the ETF outpaces the broad market (see Chart 2). Money is flowing in at a fast clip as indicated by the on-balance volume technical indicator. We looked at this indicator for gold stocks Monday and saw huge inflows, presumably as demand swelled. The same is true, albeit more modestly, for basic materials.

Chart 2

SPDR Materials ETF

Of course, with gold miners — up 85% this year — being part of the basic materials group, this is not much of a surprise. However, it is chemicals, not gold, that holds the heavyweight position with all nine of the top holdings of the ETF. Giants Dow Chemical and DuPont have nice year-to-date gains.
Fertilizer maker Agrium ( AGU ), which is not a component of the ETF, looks even better.
Last month, this stock moved above and tested a two-year trendline with very strong on-balance volume readings (see Chart 3). Only a few days ago, it moved through short-term resistance as well as its 200-day moving average. It even reversed its trend of relative underperformance versus the market to outperformance.

Chart 3


Here, too, short-term momentum readings are a bit high, leaving the stock prone to a small correction. The trend is now clear to the upside, however, so Agrium has a good chance to reach even higher in the coming weeks.
Finally, there is an ETF that covers many different types of stocks involved in agriculture. The VanEck Vectors Agribusiness ETF is in a powerful rally this year and just broke through a strong resistance ceiling that had been in place since last summer (see Chart 4). The ETF contains such familiar names as the giant food processor Archer Daniels Midland) and farm equipment maker Deere. Both of these stocks are now in good technical shape, which is a positive change for the latter.

Chart 4

VanEck Vectors Agribusiness ETF

With commodities in general on the move higher, there is one notable exception — copper. This economically sensitive metal continues to trade near multiyear lows. It had a particularly bad Tuesday as rising stockpiles suggested that demand in China was not materially improved despite Beijing’s economic stimulus.
Unlike its fellow metals markets, Dr. Copper remains in a long bear market.
While recent changes in agricultural commodities were most dramatic, almost all widely followed markets look much better on their charts. In fact, the Bloomberg Commodity Index, which tracks a wide array of commodities and is nearly one-third weighted in energy, is already up more than 20% this year and looks ready to continue.
It is a tough pill for fundamental analysts to swallow given weaker economic numbers and an absence of inflation. The charts, however, do not give us the “why”; they only tell us what actually is happening.
To quote an old Indian proverb, “Eat the mangoes, do not count the trees.”

IMF Go Home

Daniel Gross

BRUSSELS – The curtains are up on another act of the Greek debt drama. Eurozone finance ministers and the International Monetary Fund have agreed with Greece to begin, per the IMF’s demands, providing some debt relief to the country, and to release €10.3 billion ($11.6 billion) in bailout funds. Greece, for its part, has agreed to another round of austerity and structural reform.
Until recently, the IMF insisted that it would participate in the next Greek rescue program only if it deemed Greek debt to be sustainable. Based on the IMF’s most recent debt sustainability analysis, that is not the case. Germany, however, insisted that the IMF remain on board – and, with the latest deal, it seems to have prevailed, in exchange for agreeing to debt relief that it opposed.
The victory may well not have been worth the sacrifice. In fact, it would have been better to let the IMF pull out, for two reasons. First, the IMF’s assessments of debt sustainability in Greece are undermined by a deep conflict of interest. Second, and more important, IMF credits are too expensive.
In a normal bailout procedure, the IMF acts as an impartial judge of the troubled country’s debt sustainability; then, if it so chooses, it can step in as the lender of last resort. This is what happened in 2010, when the private sector wanted to flee from Greece and a systemic crisis loomed.
But today Greece has only a few private-sector obligations. Eurozone governments are the ones offering large amounts of funding. For its part, the IMF has a large volume of credits outstanding.
Of course, if Greece’s creditors accept a haircut, the IMF’s credits would become more secure – hence the conflict of interest. Indeed, the IMF’s debt sustainability analysis can hardly be considered neutral, and would surely be rejected by private-sector actors. A neutral judge – not one of the creditors – usually sets the terms in insolvency proceedings.
This is not to say that the IMF’s conclusion is necessarily wrong. In fact, one could debate the question of Greece’s debt sustainability endlessly. Some might suspect that Greece’s debt is sustainable, since the Greek government has to pay less in interest than Portugal or Italy, both of which have much lower debt levels.
The IMF, however, argues that, despite these low interest payments, the refinancing needs of Greece will surpass 15% of GDP (an arbitrary threshold, to be sure) at some point – perhaps as soon as 15 years. What the IMF fails to highlight is that, if that happens, it will be primarily because of the IMF itself – or, more precisely, the high cost of its loans.
The IMF is charging a much higher interest rate (up to 3.9%) than the Europeans (slightly above 1%, on average), largely because it has surcharges of up to 300 basis points on its own funding costs, compared to less than 50 basis points for the European lenders. Moreover, IMF loans are to be repaid in just 5-7 years, on average, compared to up to 50 years for the European funding.
The IMF assumes that its loans will be substituted by private-sector loans at even higher interest rates (over 6%). This would cause Greece’s debt to snowball, given that its GDP growth is highly unlikely to achieve such a rate in the foreseeable future.
The good news is that there is a simple way to avoid this outcome: replace the IMF’s expensive short-term funding with cheap long-term European loans. With that switch, Greek debt may well become sustainable, even by IMF standards.
Of course, this would require more funding from the European Stability Mechanism, the eurozone’s rescue fund. But the ESM would face lower risks, because the IMF has “super-senior status,” meaning that its loans are supposed to be repaid first, anyway. (It should be noted that the most senior creditor usually charges the lowest, not the highest, interest rate, as the IMF does.)
The savings for Greece would be huge. Given that the average surcharge on the IMF’s Greek loans is about 250 basis points, and the IMF has more than €14 billion in outstanding credits, the IMF is extracting huge profits from Greece – more than €800 million annually since 2013, nearly the equivalent of the Fund’s yearly operating costs. The IMF is a valuable global institution, but it should not be financed mainly by Greek taxpayers (and pre-financed by eurozone taxpayers).
By sending the IMF packing today, Greece might save several billion euros over the next decade, with a commensurate reduction in risk for European creditors. Add to that the IMF’s inability to provide impartial analysis of Greece’s debt sustainability, and it is hard to see how anyone can argue that the Fund can make a contribution to the Greek negotiations today.
There is a broader point as well. Greece is not the only country suffering from the high cost of IMF loans. The outstanding IMF loans held by Ireland and Portugal, which amount to another €23 billion, should also be re-financed. If IMF loans are replaced with ESM financing, eurozone taxpayers will save hundreds of millions of euros per year.
Eurozone IMF repayments
The IMF’s participation in the rescue programs for Greece, Ireland, and Portugal has already cost taxpayers in those countries nearly €9 billion in excess charges. While that mistake cannot be reversed, it can be rectified. If it is handled quickly enough, some €4 billion could still be saved.
A few years ago, European bodies may not have had the expertise to manage adjustment programs without the IMF’s guidance. That is no longer true. There is no good reason to keep the IMF around today – and there are billions of good reasons to send it home.

Massive Gold Investment Buying 2

By: Adam Hamilton

Gold's strong gains so far this year have been overwhelmingly fueled by one dominant driver, massive investment buying. After shunning prudent portfolio diversification with gold for years, investors are finally starting to reestablish those essential positions. And since their collective gold holdings were so incredibly low heading into 2016, reflecting hyper-bearish sentiment, gold's investment buying has only begun.

Nothing is more important for driving prevailing gold price levels than investment demand. This isn't as intuitive as it sounds, as gold's global supply-and-demand fundamentals imply otherwise. The best data available on this front comes from the venerable World Gold Council, which publishes outstanding Gold Demand Trends reports quarterly. They offer a valuable fundamental perspective which is unparalleled.

Per the WGC's data, in 2015 and 2014 jewelry accounted for 57.2% and 58.6% of gold's world demand. That's about 4/7ths, a typical proportion throughout most of modern history.

Meanwhile in those same recent years, investment demand was only responsible for 21.4% and 19.4% of total demand. Running at about 1/5th, far less than jewelry, it's hard to imagine investment demand dominating gold price levels.

Yet it does, and always has. The reason is investment demand is wildly variable, while jewelry demand is relatively stable. When investors flock to gold like we've seen in 2016, gold prices surge dramatically no matter what's going on in jewelry. Q1'16 again proved this, with gold rocketing 16.1% higher for its best quarterly performance since Q3'86! So jewelry demand at 4/7ths of the total had to be robust, right?

Rather shockingly, just the opposite was true. Q1'16's total gold jewelry demand per the WGC plunged by 19.3% year-over-year and 27.3% sequentially from Q4'15! That collapse was due to political turmoil in India, gold's second-largest jewelry market after China, after government proposals to raise taxes on the gold trade including jewelry manufacturing. But the point here is gold investment demand trumps all.

The best read on world gold investment demand absolutely comes from those quarterly GDT reports.

As a long-time gold investor and speculator, they are my most-highly-anticipated gold data by far.

But the quarterly resolution is far too sparse to support buying and selling decisions. Also these quarterly GDTs aren't released until about 6 weeks after quarter-ends, because of the intensive efforts getting this data.

But thankfully there's an excellent daily proxy available on investment capital flows into and out of gold. Every morning when I sit down at my desk, it's the first thing I check. It's the total gold bullion held in trust for the world's leading GLD SPDR Gold Shares gold ETF. Every trading day, GLD's managers publish comprehensive data on this ETF's entire gold holdings down to the individual-gold-bar level!

As of the middle of this week, this list of every bar's serial number, refiner, gross weight, fine weight, and assay purity was 1413 pages long. But it's the aggregate total gold held that is of supreme interest to anyone trying to game gold trends. The reason GLD's holdings are so important is this ETF effectively acts as a conduit for the vast pools of American stock-market capital to migrate into and out of physical gold.

GLD's mission is to track the gold price. But GLD's shares have their own separate supply and demand that is totally independent from gold's. Thus the GLD share price is always threatening to decouple from gold's. If the pace of GLD share demand exceeds gold's, GLD's price will break away to the upside and fail its mirroring mission. If GLD share supply exceeds gold's, this ETF will drift away from gold to the downside.

The only solution is to shunt excess GLD-share supply and demand directly into underlying physical gold bullion itself, equalizing those forces between the ETF and metal. GLD's managers accomplish this by issuing and redeeming shares. When GLD demand is outpacing gold's, they issue enough new GLD shares to offset that differential excess demand. The cash raised is then used to buy more gold bullion.

When GLD supply exceeds gold's, they buy back enough existing GLD shares to absorb that differential excess supply. These buybacks are paid for by selling a portion of GLD's gold-bullion holdings. Thus the fluctuations in GLD's daily holdings levels literally reveal stock-market capital flowing into or out of physical gold. GLD's bullion holdings rise on inflows from investment buying, and fall on outflows from selling.

Now GLD's holdings aren't just important because they are reported daily. As of the end of 2015, GLD's 642.4 metric tons of gold held in trust for its shareholders represented a dominant 40.0% of the total for all the world's gold ETFs! The second-place competitor merely held 9.5%, GLD's reign is unchallenged. Much to the chagrin of GLD conspiracy theorists, this WGC-created ETF has become the dominant gold force.

While nothing is more important for driving prevailing gold prices than investment demand, there is no more important source of investment demand than American stock investors buying GLD shares. It is these capital inflows into this single leading ETF that are responsible for much of the massive gold investment demand seen so far in 2016. GLD buying is the primary story behind this year's mighty new gold bull!

This first chart looks at GLD's daily gold-bullion holdings in tonnes superimposed over the gold price during the past several years or so. Each calendar quarter's GLD-holdings build or draw is noted in both percentage and tonnage terms, and compared to gold's same-quarter price action. GLD shares have been aggressively bought at a torrid pace by American stock investors prudently seeking portfolio gold exposure.

GLD and GLD Holdings 2013-2016

Gold's reversal of fortune over the past half-year has been epic. In mid-December, gold slumped to a major 6.1-year secular low after the Fed's first rate hike in 9.5 years. But that reaction was sentimental, it had no fundamental justification. Gold has actually thrived in past Fed-rate-hike cycles, with impressive average gains of 26.9% during the exact spans of all 11 since 1971! Rising rates boost investment demand.

Gold's late-2015 psychological woes proved to be the end game in a long mass exodus of stock-market capital from GLD shares, forcing huge gold-bullion sales. Between GLD's record gold-bullion-holdings peak of 1353.3t in early December 2012 and their 630.2t trough in mid-December 2015, huge differential selling forced this ETF to liquidate 53.4% of its holdings or a whopping 723.2t! This blasted gold 38.3% lower.

The catalyst for this extreme GLD liquidation far beyond anything ever witnessed before was the Fed launching and expanding its third quantitative-easing campaign in late 2012. QE3 was unprecedented in that it was open-ended. Unlike QE1 or QE2, there was no predetermined size or end date for these enormous new bond monetizations by the Fed. This fueled recent years' radically-distorted financial markets.

Fed officials deftly used QE3's ambiguity to their advantage to actively manipulate psychology among stock traders. Whenever the already-lofty stock markets threatened to roll over into a healthy pullback or correction, top Fed officials rushed to reassure that QE3 could be expanded if necessary. This led to a crazy stock-market levitation, stock markets that did nothing but rise on balance thanks to the implied Fed Put.

These artificial one-way stock markets led investors to forget the wisdom of keeping their portfolios well-diversified with gold, which rather uniquely tends to move counter to stock markets. So they started to exit gold en masse, and GLD selling was the sharp end. All gold's endless sentimental woes of recent years originally sprung from an epic GLD liquidation in Q2'13, the most extreme GLD differential selling ever.

Understanding what happened in Q2'13 is necessary to understand what's happening in 2016.

That fateful quarter investors sold so many GLD shares that they forced a mind-boggling 251.8t holdings draw! That single quarter was responsible for 34.8% of GLD's total draw over recent years. And with GLD being forced to spew out 20.6% of its holdings to keep tracking gold, the gold price plummeted 22.8%.

That proved gold's worst quarter in an astounding 93 years! Fully 55.7% of gold's total loss between late 2012 and late 2015 came in that one awful quarter. And GLD was solely responsible. The WGC's Q2'13 GDT reported that total global gold demand plunged by 12.1% YoY or 118.3t. GLD's crazy-big 251.8t draw was more than double the overall global demand drop! Jewelry demand actually soared 36.8% YoY.

So there is powerful precedent of American GLD-share trading utterly dominating gold price action in past extreme quarters. This same phenomenon in reverse just happened in Q1'16, igniting gold's first new bull market since 2011. American stock investors flocked back to GLD to regain some critical gold portfolio exposure after the US stock markets suffered their worst selloff in 4.4 years. Their levitation was failing.

Q1'16's GLD-share buying was so extremely intense that this ETF's managers were forced to boost its physical-gold-bullion holdings by a staggering 176.9t or 27.5%! The gold investment buying via GLD was so massive that it had to shunt incredible amounts of excess demand into gold to keep GLD from decoupling sharply to the upside. Investors returning to gold after years of neglect is driving this new bull.

And much like Q2'13, GLD's role in Q1'16 was dominant. Remember jewelry demand dropped by 19.3% YoY in Q1 as the major Indian jewelry industry went on strike to protest proposed tax hikes on it. Yet overall gold demand still soared 20.5% YoY to 1289.8t. And traditional bar-and-coin investment didn't help at all, as it was only up 0.7% YoY to 253.9t. Q1'16's entire gold demand surge was driven by ETF buying.

The World Gold Council's elite researchers reported that global gold-ETF demand skyrocketed an epic 1320.7% higher YoY to 363.7t in Q1'16! That was the only significant gold-demand category that jumped. And of those 363.7t of gold purchased by ETFs on behalf of their shareholders, a dominant 48.6% came from GLD alone! This year's massive gold investment buying is from American stock investors returning to GLD.

And GLD's role in this year's new gold bull is even more dominant than that suggests. Total global gold demand climbed 219.4t in the first quarter, so the GLD holdings build alone was a whopping 80.6% of that! Without that huge GLD-share differential buying, world gold demand would've barely risen after that big jewelry plunge. So three cheers for American stock investors remembering portfolio diversification.

And bullishly for gold, that massive Q1'16 investment buying wasn't just a flash in the pan and remains far from over. So far in the second quarter, GLD's holdings are up another 61.9t or 7.6%.

That's a huge build, easily the second biggest in recent years. This continuing strong differential GLD-share demand from investors is pretty impressive considering the lackluster gold price action that has plagued much of Q2.

In its new bull run, gold first hit this week's low-$1260s levels in early March. So other than surging to new highs near $1294 briefly in late April, gold has essentially been consolidating in a sideways grind for 3.2 months. That's hardly likely to inspire confidence in an asset class that was universally despised just a few months before that. Yet after an April lull, stock investors resumed strongly buying GLD in May.

May's GLD holdings build of 64.5t wasn't far behind February's massive 108.0t, which was the biggest monthly build GLD had witnessed in exactly 7 years. So even though gold was really overbought on a short-term basis, even though American speculators were ramping their gold-futures long positions to record levels which is an ominous contrarian indicator, investors continued to aggressively add gold exposure.

And if gold investment demand remained so strong in recent months despite lackluster gold price action, it's almost certain to explode as gold's young bull market resumes. Nothing begets investment buying like rallying prices, investors love chasing winners! The fact gold investment demand remains massive as evidenced by GLD shares' differential buying proves that gold's new bull market has a long ways to run.

There are many reasons. Gold was hammered to secular lows late last year on epic bearish sentiment that was wildly unjustified fundamentally, so it needs to mean revert radically higher.

Before the Fed's extreme QE3 distortions slammed gold in early 2013, it averaged $1669 in 2012. And with the Fed's printing presses puking out freshly-conjured money like there's no tomorrow, gold thrives in inflationary times.

But perhaps most importantly of all, these artificial Fed-levitated stock markets remain way overdue to roll over into a major new cyclical bear that will at least cut stock prices in half. So investors desperately need to diversify their stock-heavy portfolios to prepare for the return of normal market cycles. And even now they remain radically underinvested in gold by recent standards, so their migration back is far from over.

This final chart expands on GLD's role as the dominant gold-investment proxy, looking at the ratio of the total capital invested in GLD to the total market capitalization of the flagship S&P 500 stock index. This metric effectively shows how much portfolio exposure American stock investors have to gold. Despite all their massive buying so far in 2016, their gold diversification still remains not far above major secular lows.

GLD/SPX Value 2005-2016

As of the end of May, the total value of GLD's physical gold bullion held in trust for its shareholders was just 0.175% of the S&P 500's total market cap. That actually wasn't much of an improvement from this ratio's 8.0-year secular low of 0.111% in mid-December. American stock investors' portfolio exposure to gold has merely climbed from just over 0.1% to well under 0.2% so far this year! That's still utterly trivial.

For many centuries if not millennia, the world's smartest and most-successful investors have advocated having at least 5% of every portfolio invested in gold. As the ultimate diversifier, owning gold is one of the best forms of portfolio insurance. When some major selling event hammers the rest of a portfolio, like an overdue cyclical stock bear artificially delayed by the Fed, gold surges to offset some of those losses.

While it's a big stretch to see American stock investors collectively put 5% of their capital into gold, there is plenty of precedent for them having much-higher portfolio exposure. Between 2009 and 2012, which were the last normal years before the Fed's QE3 greatly distorted everything, the ratio between the value of GLD to the S&P 500's market cap averaged 0.475%. There's no doubt it will mean revert back up there.

Those pre-QE3 levels of American stock investors' portfolio gold exposure per GLD still remain 2.7x higher than today's levels after that massive 2016 gold buying! Investors have much more gold buying left to do than they've already done merely to restore recent years' levels of normality in their portfolio gold exposure. And during a major stock bear, there's a good chance their gold exposure will dramatically overshoot.

The last bear market in stocks ran from October 2007 to March 2009, in which the flagship S&P 500 full of the biggest and best American companies plunged 56.8%. Over that exact span, GLD's holdings soared 75.7% higher which helped drive gold up 24.8%. Assuming a new stock bear started back at May 2015's all-time-record S&P 500 peak, a similar move today would catapult GLD's holdings to 1257.0t.

That's another 375.8t higher from this week's levels, and dwarfs GLD's massive 238.8t year-to-date build. Interestingly such GLD levels are close to its 1208.5t average holdings seen between those last normal years of 2009 to 2012. But I suspect that level of GLD holdings will be far exceeded during this next cyclical stock bear. GLD was only born in November 2004, so its reputation wasn't established in that last bear.

Since then, GLD has grown into a gold juggernaut that overwhelmingly drives this metal's biggest price moves seen in many decades. Most serious investors now know about GLD's ability to instantly and cheaply add portfolio gold exposure. So the number of investors and amount of capital likely to flood into GLD during this next stock bear is far greater than the relatively-modest inflows seen in the last one.

In addition, investors lulled into extreme complacency by the Fed's blatant manipulations of recent years are going to be totally shocked when normal market conditions inevitably resume.

Artificially-levitated stock markets are almost certain to fall faster than non-inflated ones. And the quicker the stock markets drop, the more investors will be motivated to lighten their stock-dominated portfolios and diversify into gold.

I've spent over 16 years now intensely studying and actively trading gold, silver, and the stocks of their miners. And there's no doubt that GLD's rise to gold dominance has made it impossible to understand and game the gold market without closely following this leading ETF's bullion holdings.

Investors who aren't paying attention to stock-market capital flowing into and out of gold via GLD are foolishly flying blind.

At Zeal we've long specialized in holistic analysis considering everything important to a given market. We dig up and crunch the raw data until we understand exactly what's moving markets. And in gold's case these days, it is stock-market capital flows via GLD and American futures speculators' collective bets. If you're not closely following these dominant gold drivers, your efforts to buy low and sell high will fail.

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The bottom line is gold's young new bull market was driven by massive investment buying.

Nearly all of that came from stock investors flooding into gold-ETF shares, led by the dominant American GLD. And investors' migration back into gold remains far from over. Heavy GLD buying continued in May despite gold's high consolidation of recent months. Investors still remain radically under-deployed in gold even today.

The American stock investors scrambling to diversify their stock-dominated portfolios with gold via GLD shares ahead of the coming bear have barely started. They have vast buying left to do merely to return their portfolio gold exposure to pre-QE3 normal-year levels. Thus the massive gold investment buying has only begun. It will likely take years to complete, driving gold's new bull higher on balance the entire time.