Despite stagnating prices in recent years, gold is set to explode as pessimism sets into the market. Excessive printing by the Federal Reserve has embedded fragility into financial markets, building a house of cards that will buckle under the pressure of an interest rate hike. The resulting stock market crash will send investors running back to safe haven assets.
Since 2008, the Fed has engaged in a range of “easy money” policies to foster economic expansion. There were two intended consequences of quantitative easing (QE): 1) to put a floor on asset prices, allowing them to stabilize in the short- to medium-term, and 2) to boost spending and investment with the hope that it translates into the creation of new jobs.
Before we evaluate the Fed’s relative success or failure, we should note that there were tons of unintended consequences. Precious metals, traditionally the market’s safe haven assets, became the collateral damage of monetary stimulus. Gold has fallen over 40% since the 2011 high of $1,900, and silver has dropped nearly 70%.
Why Gold Prices is Undervalued
The dramatic sell-off in commodities was, however, matched by a corresponding rise in equities. The stock market saw huge returns in recent years, with the S&P 500 and the NASDAQ gaining 61.6% and 84.6% respectively. In fact, growth in the Dow Jones Industrial Average perfectly mirrors increases in the money supply.
The Fed’s bond buying program was funded by printing more money. It’s as simple as that. The central bank’s liabilities grew from $1.0 trillion in 2007 to $4.0 trillion in 2015. By cycling toxic assets out from capital markets, the Fed was effectively sucking poison from the wound. (Source: Federal Reserve website, last accessed August 10, 2015.)
So when it comes to the first objective—putting a floor on asset prices—buying junk bonds was definitely a good move. Wall Street wanted to atone for their sins, minus the actual penance. They preferred that a higher power, in this case the central bank, swooped in and wiped the slate clean. This is exactly what happened.
With the Fed as a lender of last resort, Wall Street regained its reckless arrogance—sorry, I mean confidence. Money poured back into stocks as investors grew bullish on the economy, but reality was telling a different story.
Data on real wages shows that people simply aren’t earning much more than they were last year. The main takeaway from that is that spending in the economy is based on absurdly low interest rates, not increased wealth. The average American isn’t seeing an economic recovery, and it’s only a matter of time before reality catches up with the stock market run.
A Stock Market Crash Will Send Gold Soaring
To recap, the two objectives of QE were to prevent a deeper crisis and ultimately grow the economy. The first was a fairly quick and observable success, unless you were a gold or silver investor, in which case you got crushed.
But the second part about fostering an economic expansion; well, that part never came to fruition. The much-touted unemployment statistic of 5.3% is a misnomer. It’s really closer to 11.3%. That figure is calculated using all people who are out of work, working part time, or have lost hope of even finding a job. It means that over one in ten Americans is not gainfully employed. (Source: Bureau of Labor Statistics, last accessed on August 10, 2015.)
Knowing that, I find it hard to believe that the stock market rally will continue for much longer. It seems self-evident that a crash is on the horizon, but what’s less clear is where to put your money. U.S. Treasuries have eclipsed gold as the safe haven of choice, but look what happened to 30-year Treasuries when investors started expecting a rate hike:
Chart courtesy of www.StockCharts.com
The Fed had hinted at an interest rate hike in June of 2015, so investors grew jumpy as the date grew nearer. They began to demand a higher return from the U.S. government, reflecting pessimism on the country’s long-term prospects. Or maybe they just know the stock market recovery was hollow, because when the Fed kicked the can to later in the year, the yield receded.
Considering the inherent ties between T-bills and central banks, a Federal Reserve-fuelled stock market crash would certainly send investors to hard assets like gold and silver.