INTERNATIONAL. Gold has been holding steady in the the US$1,600-US$1,800 band since early October. This could be attributed to consolidation after last summer's historic run up to $1,895, but I think this wait-and-see attitude reflects current market sentiment toward the US dollar.
In fact, the first few days of April have seen a sharp dollar rally and decline in gold. This is rooted in deflated expectations of a third round of Quantitative Easing (QE3) after the most recent Fed Open Market Committee (FOMC) meeting. Once again, the markets are responding to the headlines while losing sight of the fundamentals.
This is especially peculiar because the Fed did not explicitly take QE3 off the table. In fact, according to the minutes, if the recovery falters or if inflation is too low, the Fed is already prepared to launch QE3. While there is not much chance of low inflation, I'll explain below why the recovery is not only going to falter - it's going to evaporate like the mirage that it is!
The Obama Administration is touting recent job growth, and while this is a pleasant story to hear in an era of massive unemployment, it disintegrates when put in context. The 227,000 jobs gained - which merely kept the unemployment rate steady at 8.3% - were counterbalanced by a much worse trade deficit tally: $52.4 billion, the highest level since just before '08 crash.
The trade deficit is a real measure of whether our jobs are producing enough wealth to pay for our consumption. If we were adding productive jobs, I would expect the deficit to be shrinking. A look at the data shows that employment increased by only 16% in the primary and secondary sectors, where we need them the most. The majority of new jobs are still inflated sectors like healthcare (26%), temp work (20%), hospitality (19%), and consulting (16%), which will disappear as fast as they appeared when the bubble collapses. This is what we saw in finance and real estate when the housing bubble burst in '08.
Imagine the trade deficit is like a corporate balance sheet. You hire a bunch of new employees for your company, but instead of making bigger profits, you find yourself losing even more money than when you started. Are you going to hold on to those people?
While President Obama is focused on jobs, the Fed has been promoting a recent round of "stress tests" that show the financial system to be in good shape. Unfortunately, yet again, the headlines are not what they seem.
The recent tests were designed to measure big banks' ability to survive another significant drop in housing and stock prices; but those bubbles have already largely popped. What the tests failed to account for is what I consider the most likely scenario: rapidly rising interest rates amidst a dollar crisis.
Interest rates are the real risk. I think the Fed knew the banks would fail this test, so they simply ignored it. It wouldn't be the first time the Fed has turned a blind eye to a bubble market. For years, Chairman Bernanke and other Fed officials denied the housing bubble existed; and as late as 2008, well after it popped, they assured us the damage would be contained.
Supporters say the Fed knowingly didn't account for interest rates because the central bank has complete control over them. Many in Washington and on Wall Street honestly believe that the Fed can continue to print money to buy Treasuries without increasing inflation. A scenario in which the Fed is forced to choose between US government bankruptcy and US dollar collapse seems impossible.
In fact, higher interest rates are not only possible, but probable. The stress tests assume long-term Treasury note yields stay under 1.8%; but that figure is the current six-month low on the 10-year, which is already dragging along its historical floor. As I write, yields are already up to 2.2%. The post-war average is about 5.2% - high enough to crater today's banking system.
Remember, the rate needed to break the back of inflation in 1981 was a whopping 20%. At that level, there wouldn't be federal tax money left for the military, Medicare, Social Security, or even law enforcement - it would all be going to interest payments.
Even now, interest rates are a complete farce. In 2011, the Fed purchased 61% of new Treasury debt, compared to virtually none before the financial crisis started. This shows that at current rates, demand for US debt is already drying up.
Extended Interest Rates Pledge
It should be no surprise, then, that the Fed has paradoxically celebrated economic recovery while pledging to keep interest rates near zero through 2014.
First, even with an economic recovery, these low rates will continue to drive precious metals higher. Anyone who says this "recovery" will sink the gold market is misunderstanding what drives the gold prices - inflation.
Second, the Fed wouldn't be keeping rates so low if the recovery were genuine. If I say to you, "Yes, you can now ride a bike," but I refuse to take off the training wheels, would you believe me?
The truth is that Bernanke knows the recovery is phony and is using inflation to mask it. This bodes doubly well for gold.
Another fever notion is that inflation isn't really a threat, no matter what the Fed does. This is borne of the belief that "deflationary forces" are so strong that no amount of printing will overcome them. Core CPI figures are cited as proof.
Last quarter, Core CPI was up only .01% in February (the latest figure). This sounds low until you add in food and fuel - then it jumps to .04%, yielding an annualized figure of over 5%. This is well above the Fed's self-proclaimed target of 2% per annum, yet we hear no explanation or apology.
The reality is even worse, as the true rate of inflation as calculated by independent observers is closer to 10%. This means you can expect gold to rise 10% per year just to maintain your purchasing power.
Consider the price of gas which is almost $4 a gallon. President Obama is pledging to release oil from the strategic reserves to keep the price down - but it's not a supply problem. Those reserves are for a short-term crisis that disrupts the oil supply, but there is no disruption - oil is flowing. Oil production in the US is the highest it has been since 1993 and consumption is down below '97 levels due to the recession. After all, there's no reason to buy gas to commute if you're unemployed. The problem is inflation making the money we use to buy gas worthless.
Proof? A couple of pre-'65 silver dimes can still buy you a gallon of gas, while a couple of post-'65 base metal dimes won't even buy you a pack of gum in the convenience store.
The dollar has lost so much value that the government actually loses money on every penny it creates. Not because they're made of copper, that became too expensive long ago. They're actually made of zinc - a metal so cheap it's priced by the metric ton - and they're still too expensive.
So, where's the inflation? Everywhere!
Recovery Fever Will Be Broken
It's becoming very easy for a skeptical observer to poke through the veil of recovery. Unfortunately, most market participants still seem to hang on Uncle Sam's every word. This is a great danger for our economy and a great opportunity for the wise investor.
When an asset like gold moves sideways for a while, even those with good instincts get complacent. They start to view this as the "price level" rather than an extended dip below true valuation.
Recovery fever will wear off as Washington is forced to release propaganda that is more and more incongruous with facts on the ground. And gold will resume its climb in earnest.
Notes: Peter Schiff is CEO and Chief Global Strategist of Euro Pacific Precious Metals, a gold and silver coin and bullion dealer offering honest products at competitive prices.
This article first appeared on Peter Shiff's monthly Gold Report. To subscribe to the Gold Report please click here.
For more information about Euro Pacific Capital, please visit www.europac.net/
(c) Copyright Peter Schiff 2012.