Hard Times For Gold Stocks

Skot Kortje, in the Globe and Mail's "StockTrends" feature, relays some disappointing facts for gold-stock investors: the S&P/TSX Global Gold Index has been the worst-performing subindex of the Toronto Stock Exchange's over the last three months. A pure technical analyst would recommend avoiding the gold stocks, especialy since:

The U.S. Dollar Index turned Stock Trends Bullish last week, a trend category assigned when the 13-week moving average moves above the 40-week moving average. This signal of dollar recovery was last made in September of 2008, just as the financial crisis started to shake global markets. Coinciding with the U.S. Dollar Index's Bullish Crossover at the time was a new bearish trend in gold - the iShares Comex Gold ETF turned Stock Trends Bearish just when investors might have been most inclined to abandon paper currency for a shiny chunk of mineral.

As is so often the case, there's a difference of opinion between technically-driven analysis and fundamentally-driven. However, a fundamental case for the U.S. dollar is made just above: the greenback is still the world's panic money. People are not panicking into gold, but tend to go into the metal when panic turns into reflectiveness over the long-term effects of the current stimuluses. I don't know how much inflation is baked into the cake, nor do I know if the recent calls for a higher rate of U.S. inflation will influence future policy. I don't know to what extent those calls are proactive or are co-operative with the inevitable. What I do know is, for the nonce, the greenback is the place to be when the financial world seems doomed.


We're still in a shaky recovery, uncharacteristically sluggigh if governmental stimulus is factored out, that's being primed by a lot more easing than is usually the case. U.S. M3 has been awful, and M2 has been nothing to write home about. The case for inflation hinges upon M1, and the old Friedmanite monetarism. That interpretation points to stagflation.


In Friedmans's old monetarist framework, which he popularized back in the 1970s, M1 was the money supply measure best used to forecast future price rises. M2 was the better predictor of economic growth. This framework fell apart in the 1980s, because even more rapid M1 growth did not translate into renewed double-digit inflation.


Speaking of the 198os, these two graphs (from the St. Louis Fed's FRED system) show an interesting parallel between money supply growth now and growth back in 1986-7. The graphs are of M1 and M2's percent change from a year ago:





There are differences apparent to the eye, most noticeably in the greater rapidity of the fall-off of both measures. Of course, the underlying conditions are different: we've emerged from a serious recession, while there was none in the mid-'80s. I note, though, that the rapidity of money-supply growth back then helped cause a blow-out rally in the U.S. stock market that climaxed with the crash of 1987. There seems to be no asset bubble that hasn't been popped as of now; gold hasn't been popped, but it never got into nascent-bubble territory until after the crisis wreaked its wrath. As far as I know, the only poppable bubblesque theme around is the currently-unravelling greenback carry trade. In normal circumstances, bubbles in U.S. Treasury securities aren't poppable by a slowdown in money-supply growth.

The case for reviving the 1970s framework is this: if there are no asset bubbles to absorb the money growth, or an inflation-absorbing foreign sink like widespread use of the greenback as an alternate currency in the rest of the world, then money-supply growth spills over into regular price inflation. In such an environment, Friedman speaks again.

Granted that reliance upon a 1970s framework may seem fustian, but the conventional Keynesian excess-capacity framework was at its most groovy in the 1960s. Friedman's replaced it when it bummed out in 1973-4.