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Beverly Chandler

Van Eck’s gold specialist predicts gold may prosper if world goes into recession

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Van Eck Global’s gold specialist Joe Foster takes a moment to look ahead at the potential market outlook for gold. 

He comments that given the depth and duration of the gold bear market, many must wonder whether this is the beginning of a secular bear market measured in decades rather than a cyclical bear market that is measured in years.
 
“The last secular bear market lasted 21 years from 1980 to 2001. There were a number of cyclical bull markets after 1980, however the longer term trend was downward for gold. Several major macroeconomic drivers drove the secular bear market. In the early eighties, the Fed raised rates to combat inflation.”
 
He writes that while this initially caused a difficult recession, it set in motion a long period of disinflation and price stability in the economy. “The Reagan presidency further set the economy, in our view, on a positive trajectory with tax cuts and reforms that limited or reduced the regulatory burden on business. The US won the Cold War, with peace and commerce breaking out in many regions of the globe. With strong leadership and prescient policies, there was ample generation of wealth, tail risk diminished, and investment demand for gold remained weak.”
 
He continues: “In our opinion, the conditions that supported that secular bear market could not be more different than today’s. In fact, we would argue they are polar opposites. The stable disinflation that prevailed for over two decades ended with the credit crisis.”
 
Since 2008, deflationary concerns have dominated monetary policy decisions. “This has intensified with the slowdown in China and commodity weakness. Economic weakness has been met with policies of taxation and austerity. Increasing regulation of finance, health care, and energy capture the headlines, while insidious smaller scale regulations continue to accumulate across most industries.”
 
Foster comments that the ‘cold war’ has returned with proxy battles breaking out in the Middle East. “Failed states, refugees, and violence appear to be trending in the wrong direction. The US has seen very limited fallout from the weak global economy and
political strife; hence the US dollar and US assets are seen as possible safe havens for now.”
 
Foster believes that this is a cyclical occurrence for gold, not a secular trend. “The Fed’s chronic reluctance to raise rates suggests that  it sees the economy as so fragile that it cannot withstand a series of relatively miniscule 25 basis point increases.”
 
Quantitative easing and near-zero rate policies have failed to deliver the stronger GDP growth predicted by the Fed, Foster says. “We believe businesses do not want to invest when they do not know the impact of a promised rate hike that never seems to materialise. Yet, these failed policies have been copied by central banks around the world with no better results.”
 
Perpetually changing expectations and outlook risks losing market confidence, he writes. “After six years of economic expansion and a bull market that took the S&P 500
to new highs, it appears that rates could remain near zero into the next recession. The multi-generational low in interest rates has created misallocations of wealth that could bring a rash of unintended consequences that become apparent in the next economic downturn. Artificially low rates incentivise risk-taking, redistribute income to those with financial assets, and distort the allocation of credit.”
 
Examples of that include ballooning levels of student debt, auto loans, margin debt, high-yield debt, commercial real estate, and luxury residential construction.
 
The first significant economy to fall into recession in the current weak global economy is Brazil, he writes. “It is reminiscent of the US ‘dot-com bubble’ in 2000, when a fall in technical stocks and business activity brought a recession. Around the same time, accounting scandals were revealed and the Enron debacle was exposed. The US dollar embarked on a bear market and the gold bull market ensued. The contemporary Brazilian economy is driven more by commodities than technology, but the result is the same.”
 
Foster believes that the commodities bust triggered economic weakness and recession. “A massive graft scandal at state-run oil giant Petrobras has sent shock waves through the rest of the economy. S&P cut the nation’s debt rating to junk with a negative outlook. Since 2011, the Brazilian real has been in a bear market, and the market has worsened over the past year. The gold price in Brazilian real terms is at all-time highs, gaining 40.7 per cent so far this year.”
 
Foster concludes that perhaps the Fed’s trepidation with raising rates is justified. “Maybe Brazil is the first domino to fall. Is Japan or China next? Will the US economy be the last to topple? Brazilians have found gold to be a prudent store of wealth. Perhaps it is not too soon for those in many other countries to think about ways of preserving wealth should mainstream investments begin to falter.”

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