Gold Forecast in the White

But now what?

Our loyal readers know that back in April we forecasted gold would hit $2,500 an ounce in the second half of this year. Well, it’s the second half, and gold has officially closed above that mark.

Now, where are we going from here? Not just gold—what about other inflation hedges? Buckle up as we reevaluate if the end-of-year forecast still makes sense given all the volatility we’ve seen over the last 4 months.

First on the docket is a look at various forms of liquidity and Treasuries. We’ve been very critical of Yellen’s manipulation of the yield curve via overreliance on T-bills, including how this is costing taxpayers an extra $100 billion annually in additional interest on the federal debt.

But we have to remember that not all Treasuries are created equal. Or, at least they have different liquidity premiums. People are much more willing to treat T-bills like cash than they are with T-bonds.

What Yellen has done is flood the market with a near cash substitute. Now to be clear, your bank isn’t going to hand you a T-bill when you try to withdraw money from your checking account, but it’s darn close to that behind the scenes, and anywhere else the cash doesn’t need to be visible.

It’s been the Treasury’s version of Quantitative Easing, increasing liquidity by roughly the equivalent of $1 trillion in cash. And the buyback schedule is only adding to the effect from the new maturity schedule. They’ve managed to offset the Fed’s tightening—it is an election year, after all.

At the same time, Powell & Co. are getting ready to cut rates, which will cause the reverse repurchase agreement facility to effective collapse to or near zero. RRPs going away is not the catastrophe some people think. Alarmists for the most part are scared because they don’t understand how this complicated mechanism works.

You can get more details on RRPs from our previous posts (like this one) but suffice to say this facility soaks up excess liquidity to maintain a floor on interest rates. But dropping the interest rate means the old floor no longer has to be maintained.

That’ll dump about $300 billion of base money into the economy. And then there’s bank reserves. Once the Fed drops the target for the fed funds rate, it has to drop this interest rate too, and banks will pull over $700 billion from the Fed’s electronic vaults.

Even with continued asset sales (quantitative tightening), the Fed will still dump over $1 trillion into the economy if it cuts just 25bps.

And then there’s the deficit. We know, we know—we’ve beaten this dead horse a lot. Nevertheless, we have to reiterate that this is adding to inflationary pressure and driving price increases, including the bubble in financial assets.

At the same time, inflation has slowed significantly since April. We’re not so concerned about annual rates here as annualized rates: the month-over-month increase in prices has declined dramatically.

This is chiefly attributable to the plunge in demand across the economy. More and more indicators point to recession, as we explained here.

The question then becomes how much the Fed and Treasury will essentially pick up the slack via cash infusions. That will reinflate asset bubbles, à la the Japanese Yen carry trade, and put additional upward pressure on gold prices.