Gold QE3 Scares
Sellers hammered gold again this week on news from the Fed. The minutes from its latest FOMC meeting convinced traders the odds for a third round of quantitative easing are waning. This was the latest in a long line of QE3 scares that have become the bane of gold's existence. But they are merely a distraction from the Fed's ongoing massive monetary inflation behind the scenes, which is very bullish for gold.
Gold has suffered much from QE3 scares. This week's FOMC minutes drove it 3.4% lower in 2 trading days. On the last day of February, gold plummeted 5.1% after the Fed Chairman's testimony to Congress made QE3 look less likely. Gold hadn't seen such a huge down day since December 2008 during the epic stock panic! Surrounding an FOMC meeting in mid-December 2011, gold plunged 8.0% in 3 days.
This sad litany drones on, all the way back to before QE2 ended in June 2011. Most of the big gold selloffs in the past year have been driven by comments out of the Fed implying lower probabilities for any QE3 campaign. As vexing as this phenomenon has proven for long-side gold traders, the Fed isn't to blame. It has been clear all along that QE3 wasn't likely unless the US economy faltered dramatically.
I suspect the primary reason the Fed has been hesitant to launch QE3 was the firestorm of criticism surrounding the formal birth of QE2 in early November 2010. Immediately upon its announcement, governments and central banks around the world loudly condemned the Fed in a very public way. This was amazing, as usually any criticism is behind closed doors. I've never seen anything like it.
Even more problematic for the Fed was the anger the QE2 inflation ignited in Republican Senators and Representatives. The Fed serves at the pleasure of the US Congress, which has the full authority to do anything from cutting back its power to outright abolishing it. And like all other political entities, above all the Fed wants to survive. So heavily stung by QE2 outrage, QE3 was never really viable politically.
There is no doubt a QE3 would be very bullish for gold, as QE1 and QE2 were. Quantitative easing is the pleasant-sounding euphemism given to the disastrous practice of debt monetization. In QE the Fed buys US Treasuries, effectively "financing" Obama's record overspending and profligacy. The catch is the Fed creates the money used to purchase bonds out of thin air. QE is pure, unadulterated monetary inflation!
Gold has always thrived on fiat-currency inflation, for simple supply-and-demand reasons. Relatively more paper dollars are available to chase relatively less gold. While the dollar supply expands at double-digit annual rates, the global above-ground gold supply continues to gradually grow near its historical average of just 1% a year. So it takes more dollars to command an ounce of gold, bidding up its dollar price.
The problem over the past year is the QE3 hype has grown so deafening that traders wrongly assume it is the Fed's only form of monetary inflation. Therefore, they reason, if there is no QE3 then there is no inflation so we should sell gold. But nothing could be farther from the truth! As the Fed's own money-supply data shows, our profligate central bank continues to merrily inflate away like there's no tomorrow.
This first chart looks at year-over-year growth in the broad MZM money supply, superimposed over gold. The raw MZM data is weekly, while gold's is daily. These charts run back to 2006 for a couple reasons. February 2006 is when Ben Bernanke took the helm of the Fed, so this span encompasses his whole reign. It also provides a pre-panic baseline and shows the stock panic's impact on monetary inflation.
Before George Bush the Younger appointed Ben Bernanke to be Fed Chairman, he had the nickname "Helicopter Ben". This came from a 2002 speech where he said a central bank can always avoid deflation by simply printing more money ("helicopter dropping" it). In looking at the record of broad money-supply growth over his tenure, Bernanke has certainly lived up to this reputation. This guy is a monster inflationist on par with history's most notorious.
To get some sense of a baseline, around the world broad fiat-paper money supplies generally grow around 7% a year. With global mining only adding about 1% to the gold supply annually, you can see why gold generally tends to grow more valuable in paper-currency terms over time. Bernanke came into office after years of declining MZM growth had finally reined it back to very respectable sub-3% levels.
But the problem with central banks is there is only one thing they can do, inflate. When your only tool is creating paper money out of thin air, it looks like the solution for everything. A recession coming? Inflate. A stock panic spawning extreme fear? Inflate. Teenage pregnancies up? Inflate. Aliens invading Earth? Inflate. So when the subprime-mortgage crisis hit in 2007, Bernanke dutifully fired up his printing presses.
Within just over a year, the combination of the subprime crisis, a general credit crunch, and a global stock selloff had driven the Fed to more than triple its broad monetary inflation rate to an astounding 17%! Bernanke's crazy inflation naturally drove a massive rally in gold, catapulting it from $570 the day he took office to $1005 in March 2008 (when MZM growth peaked). This 77% gain in 25 months was driven by old-fashioned monetary expansion, the term "quantitative easing" hadn't even entered the popular lexicon yet.
Remember that the blue line above is not the actual MZM (which looks parabolic), it is absolute annual growth in this measure of the US dollar supply. So Bernanke and his fellow inflationists didn't even attempt to remove some of their legions of new dollars from circulation. Instead the Fed kept right on growing MZM at a rate better than 10%. A healthy new cyclical stock bear in early 2008 concerned the Fed, so it predictably inflated.
Then the first true stock panic in 101 years erupted, a legendary fear superstorm unlike anything else we'll see in our lifetimes. It was in this terrifying time, November 2008, that the Fed started an unprecedented (in the US, but not in banana republics) bond-monetization program that would later be known as quantitative easing. Later in March 2009, the Fed greatly expanded QE1. If you want to learn about these campaigns in depth, I wrote another essay on them earlier.
Naturally gold rallied as the Fed created a staggering $1750b out of thin air to buy up mortgage-backed bonds and US Treasuries. Nothing like this had ever happened before in the century-long history of this central bank, it was radically unprecedented. But note that for most of QE1, the MZM growth rate was still high. Though it did fall briefly below 0% to actual contraction in mid-2010, this shrinkage didn't last long.
In that odd MZM trough, the Fed's second monetization campaign that would become known as QE2 was born. After starting it in August 2010, the Fed brought it to its full $900b strength a few months later in November. As QE2 unfolded, gold enjoyed an enormous rally. Around the world, traders began confusing the separate additional inflation of quantitative easing with the core underlying monetary inflation.
And the latter grew and grew. By the time QE2 formally wrapped up at the end of June 2011, MZM growth was back up near 8%. Since then, it has averaged 9.2% with plenty of spikes above 10%. The last time broad-money-supply inflation was this high in the pre-QE days in late 2007, gold soared. Bernanke's Fed has once again pegged its dollar-expansion up near the 2007 and 2008 crisis levels!
In addition, consider gold since the end of QE2. Today thanks to those periodic QE3-scare selloffs, everyone is convinced that no QE3 will be devastating for this metal. But history argues otherwise. Since QE2 ended, gold has consolidated near all-time record highs. The average gold price over the 9 months since is an incredible $1694! As recently as 2010, this would have seemed impossibly optimistic.
If the lack of QE3 was a big fundamental problem for gold, it should have sold off sharply when QE2 ended. Gold closed at $1501 that day. But instead this metal rocketed 26% higher in the next 7 weeks in a rare summer rally on growing fears of Obama's mind-boggling profligacy forcing the first-ever debt downgrade or maybe even default in our nation's history. Gold has done just fine in the post-QE era.
If gold hasn't fallen without more quantitative easing, if it has been able to consolidate near all-time record highs without giving back much at all, then why does QE3 matter? With MZM growth approaching 10% annually for the better part of a year now, Bernanke and his merry band of inflationists are happily providing torrents of new fiat dollars without QE. Why are traders so myopically fixated on QE3?
This is the real problem for gold, and it is purely psychological. Since the end of QE2, there have been 8 FOMC meetings. And 2 of these were unscheduled, what I consider "emergency" meetings. In how many of these meetings did the Fed launch QE3, or even imply a QE3 campaign was imminent? Zero. After this perfect post-QE2 track record of no QE3, why on earth are traders still eagerly expecting one? After the second FOMC meeting or so, no QE3 was no longer news. Yet silly traders still treat it as such.
The Fed's monetary inflation has been dramatic, up at crisis levels, in this post-QE world. With the annual supply of newly-created US dollars growing at 10x the rate the world's gold supply is expanding, there is more than enough inflation to continue pushing gold's secular bull higher. Quantitative easing is mere misdirection, smoke and mirrors hiding the fact that true monetary inflation remains explosive.
This next chart is similar, but looks at the narrowest measure of money. M0 (it's a zero) is also known as the monetary base. It is simply currency (paper dollars and coins) in circulation, currency in bank vaults, and reserves commercial banks have on deposit with the Fed. It is critical because it is the base of all money we use in daily transactions. It is also the base from which fractional-reserve banking multiplies.
Thus M0 has the most direct impact on inflation of all. Before Ben Bernanke came along, American central bankers were rightfully so scared of ramping this that its 48-year pre-panic average of annual growth ran at just 6.0%. But Bernanke, who history will remember as a crazy radical inflationist, decided to ramp the monetary base like nothing no one had ever imagined. And he is still doing it today!
Once again the blue line is absolute annual M0 growth, the actual monetary base itself looks parabolic. Also note the vastly expanded right axis, which is 6x as large as the earlier MZM chart! Right during the stock panic, the Fed started expanding M0 at an unprecedented rate. In October 2008, its year-over-year growth soared from just under 10% to nearly 37%. And QE1 rapidly accelerated this record inflation vertically from there.
This monetary-base ramp continued to explode as QE1 was expanded, ultimately peaking near staggering 113% annual growth in mid-2009! And though this growth rate finally slowed dramatically in late 2009 and 2010, it only went below zero for a couple months late that year. This means that all the torrents of new money Bernanke's Fed injected into the system are still there. That inflation never left.
Now you'd think that with the end of quantitative easing the M0 growth profile must be back to normal, right? Not a chance under this crazy Fed. Since the end of QE2 last June, annual M0 growth has still averaged a breathtaking 33%. So on top of all the Fed's massive panic inflation, it is continuing to grow the monetary base by over 5x its half-century pre-panic average in this post-QE era! Wow.
In both broad and narrow money-supply terms, nearly every fiat-paper dollar Bernanke's Fed has ever created is still out there. And on top of that the Federal Reserve is still growing broad money almost 10% a year and narrow money over 30%! As I watch this new money-supply data come in every month, you can imagine my incredulity at today's ridiculous notion that no QE3 somehow means no more inflation.
And consider the gargantuan money supplies from which this current growth is derived. The day Bernanke took office, M0 and MZM ran $804b and $6805b. 6 years later at the end of February 2012, they were up to $2695b and $10,777b. So 30% and 10% growth rates now mean a heck of a lot more money being created than similar rates back then! The sheer quantity of monetary inflation is staggering.
While the Fed's giant pair of quantitative-easing campaigns was pure inflation that was great for gold, QE was never the whole inflation story. Before, during, and now after QE, the Fed has been aggressively growing the core underlying money supplies. And the money supplies are truly the most fundamental measure of real inflation. With it still running at crisis growth rates, gold has nothing at all to fear.
Almost without exception, all of gold's post-QE2 QE3-scare selloffs have erupted in the futures markets. Most of the time the GLD gold ETF doesn't show significant differential selling pressure, which means the stock investors who own gold through this vehicle aren't freaking out. The goofy futures traders have got to get it through their thick skulls sooner or later that no QE3 is no longer news, it is nothing new.
At some point I suspect is coming soon, this whole QE3 mania is going to quickly fade. Before QE1 was even a twinkle in Bernanke's eye, gold had already quadrupled in its secular bull. But during the whole QE1 and QE2 era, gold merely gained another 50% or so. The great majority of gold's bull happened without quantitative easing, and gold has continued higher even after the Fed quit monetizing new Treasuries.
While the lack of a QE3 is being used as an excuse for hot money to slosh out of gold periodically, it is certainly no fundamental justification. Paper-money supplies all over the world continue to explode, growing dramatically. This is naturally very bullish for gold since its own supply growth is so physically limited. Even the retarded futures traders are going to manage to figure this truth out sooner or later.
The gold QE3 scares we have weathered over the past year or so are a sideshow, misdirection from the serious real inflation happening in US money supplies. As long as the Ms continue surging at high rates relative to history, the monetary environment for gold remains super-bullish. And given this Fed's track record of doing nothing but inflating radically, I can't see this behavior changing anytime soon.
Provocatively gold is not even the biggest casualty of the QE3 scares. That dubious honor goes to the gold stocks. Whenever gold is driven lower on the latest "revelation" that QE3 isn't coming, gold stocks just get crushed. They have been hammered down to such insanely-oversold prices that they are now trading at panic levels relative to the gold price that drives their profits! Today the flagship HUI gold-stock index is trading as if gold was at $900, not $1600. This anomaly is ridiculous and unsustainable.
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The bottom line is quantitative easing is certainly not the only form of monetary inflation. Throughout and after its widely-followed QE campaigns, the Fed has continued to grow both narrow and broad US dollar supplies at very high rates. The magnitude of this core inflation is even more amazing considering the gargantuan bases it is coming from. Such incredible monetary inflation remains very bullish for gold.
So while the QE inflation was undoubtedly great for gold, the lack of QE3 doesn't mean the Fed has mended its inflationist ways. The QE3 scares that have pummeled gold are merely psychological, not fundamental. Whether QE3 happens or not, gold prices will eventually reflect the continuing mammoth printing of new US dollars. Traders who understand this now have a phenomenal buy-low opportunity.
Apr 06, 2012
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