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By Louis Golino for CoinWeek ………

Gold spot prices have been very volatile lately. During the weeks preceding the current Federal government partial shutdown, prices had been up, reaching almost $1400 an ounce, and gold posted its only quarterly gain for the year, though it remains down about 17% for the year to date.

Then we saw a sharp decline after the shutdown started and looked to be longer than many people had expected, and in roller-coaster fashion, an equally sharp rebound during the middle of the week. Equity markets were largely shrugging off the shutdown but continuing to trend downwards as greater pessimism set in about when the shutdown will be resolved.

us debt The Coin Analyst: Gold, the Government Shutdown, and the Coming Crisis Over the Debt CeilingThe decline in gold prices once the shutdown started was explained by Reuters  as a result of a large commodities fund selling gold and the fact that many investors bought gold in advance of the shutdown thinking prices would rally once it started, and they decided to sell because they believed that the crisis would be resolved quickly, a belief that is turning out to be incorrect so far.

With the Federal debt limit breach approaching in only two weeks on October 17, most investors are currently more focused on how that issue will impact markets rather than the shutdown. Of course it all depends on how long the shutdown continues, as an extended one will dampen economic growth, and feed into the Federal Reserve’s plans to possibly begin tapering its bond buying program known as quantitative easing. The longer the crisis lasts, the less likely the Fed will be to begin tapering.

We have had government shutdowns before, but the U.S. has never gone all the way over the debt ceiling cliff, an event whose consequences are impossible to estimate since it has never happened.

Some conservatives believe that it would not be that big a deal, especially if it was just for a few days. But it is important to remember what happened a little over two years ago in August of 2011. An impasse on government spending between President Obama and House Speaker Boehner resulted in a down-to-the-wire crisis over the debt limit that led to the first downgrade of the U.S.’s credit rating in history. That downgrade is estimated to have cost the American taxpayer somewhere between $100-200 billion in higher interest costs on the Federal debt. And of course gold reached its all-time nominal high of over $1900.

If we went over the debt limit and there appeared to be little prospect of a quick resolution of the political impasse, many people believe we could experience at the least the start of a serious economic downturn and a possible return to recession, as uncertainty among consumers and businesses rises sharply. Or if the markets really start to question the full faith and credit of the U.S. government, there is a chance we could see a credit crisis like the one that began in mid-2007, or even the start of a global economic collapse like the one that began in September 2008, depending on the level of economic instability and what happens in the bond markets.

ben gold 275x182 The Coin Analyst: Gold, the Government Shutdown, and the Coming Crisis Over the Debt CeilingIn the run-up to the current crisis, a lot of gold market analysts, including this columnist, have said that these scenarios would likely be bullish for gold and other precious metals. But it is time to reevaluate that view even though the long-term outlook for metals remains very positive.

  • First, we have not been in a bull market for metals since 2011, and the talk today is all about how the Fed’s tapering will affect metals. An extended impasse in Washington that bleeds into the economy’s performance will probably push back any tapering move by the Fed until they see how the crisis affects economic growth and other indicators. Tapering is widely seen as bearish for gold, so the longer it is put off, the longer gold prices should at least remain stable.
  • Second, most experts believe that debt crisis concerns are bullish for gold but that unless we face an extended debt crisis that leads to the kind of serious economic instability discussed above, we are not likely to see a repeat of 2011, according to media sources discussed in Gold Investing News.
  • Third, a shutdown will be deflationary, which is not positive for gold prices, but once the crisis is resolved, and the economy is allowed to continue its positive trajectory, interest rates will continue to rise as will prices, which will provide the catalyst for higher gold prices.

Don Coxe, a portfolio advisor to BMO Management, discussed in the Gold Report of Gold Investing News  how contrary to perceived wisdom, it is good economic news, not bad economic news, that will drive metals higher. I have made similar arguments previously in this column.

Mr. Coxe explains that a lot of investors have been waiting for years to see the Fed’s QE programs and massive multi-trillion dollar balance sheet result in the hyper-inflation that theorists like Milton Friedman long predicted, only to see inflation remain subdued in large part because the decline in the power of unions has removed a major source of the hyper-inflation of the 1970’s. This has a lot to do with the fact that back then unions were able to negotiate major cost-of-living increases for workers. Today everyone is cutting back benefits, and economists argue that wage pressure, which is very low today, is the main source of inflation.

But because he sees easy money as here for the long-term, and also because businesses will eventually have to increase inventories as consumer demand increases, prices and inflation will continue rise, and these dynamics will be bullish for gold and other precious metals.

The bottom line is that metal prices will remain especially volatile in the short-term and are not likely to see sharp increases unless there is a major, sustained debt crisis. Provided that Washington finds a way to get out of the way of the economic recovery, higher growth and interest rates will drive investors increasingly into precious metals as a hedge against rising inflation. And all that massive monetary liquidity will eventually pay off for metal investors. But as Mr. Coxe noted, it will take time and will continue to seem like “waiting for Godot.”

golino portrait thumb The Coin Analyst: Gold, the Government Shutdown, and the Coming Crisis Over the Debt CeilingLouis Golino is a coin collector and numismatic writer, whose articles on coins have appeared in Coin WorldNumismatic News, and a number of different coin web sites. His column for CoinWeek, “The Coin Analyst,” covers U.S. and world coins and precious metals. He collects U.S. and European coins and is a member of the ANAPCGSNGC, and CAC. He has also worked for the U.S. Library of Congress and has been a syndicated columnist and news analyst on international affairs for a wide variety of newspapers and web sites.

 

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4 Comments

  1. Hi Louis,

    Overall, an excellent article and it brings up a lot of points I hadn’t really considered in regards to short-term shutdown effects. The deflationary aspect of the shutdown was especially interesting.

    However, I noticed at the bottom of your article that you mentioned a sustained debt crisis would send prices higher. There is always the chance that if the government isn’t able to resolve this crisis by the time the debt-ceiling expiration rolls around, we may face further downgrades or even a true nightmare scenario of a debt default. That could send prices blasting off in a hurry.

    • Louis Golino says:

      Thanks, CO. I suspect that if we did miss any payments in two weeks because the debt limit is not extended, the reaction will be very strong in the equity and bond markets, and gold will probably go up a lot too. But I think those events will finally force the two sides to reach a resolution to the crisis. That is probably why one of the credit rating agencies recently said they do not plan to downgrade the U.S. this time. As I noted in several places, most analysts do see a debt limit breach as positive for gold, but to see a repeat of 2011, we would probably need to see a crisis that lasts weeks instead of days.

  2. Gordon Brown says:

    I believe that higher growth will eventually lead to higher inflation. Then the key would be what are real interest rate yields. If real interest rate yields do not keep up with higher inflation, then this will drive investors into precious metals as a hedge against rising inflation. However, if real interest rates do outpace inflation, then this will drive investors away from precious metals. If prices for precious metals fall to their lowest as happened during April 2001, then this would be the best opportunity to buy precious metals when they are cheapest. The Brown Bottom occurred from July 1999 to March 2002 when gold prices were at their lowest in 20 years, following an extended bear market.

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