Gold, Equity Valuations, and the Fed
Jeffrey Nichols, Senior Economic Advisor to Rosland Capital, had the following comments on the current gold market situation and outlook:
Over the past few years, as the broad equity-market averages moved from one high to the next, institutional investors – seeking higher quarter-to-quarter returns – moved out of physical gold and into stocks – at least, that is, until very recently.
Importantly, the global gold market remains tiny compared to world equity markets. As a result, the influx of institutional investors into gold had an extremely bullish price effect on the yellow metal, especially as gold ran up to its all-time high near $1,924 an ounce in September 2011 . . . and the subsequent exodus of institutional investors from the gold market had a very bearish impact.
Now, in early 2014, all that may be changing. Indeed, so far this year, U.S. and global equity markets have sold off sharply while gold has been a strong performer.
Equity Market Valuation
By my reckoning, U.S. stock-market valuations are pricey – and cannot be justified by past, current, or projected corporate earnings.
One popular indicator of stock-market valuation – the price-to-earnings ratio (the P/E) on the S&P 500 stock-market index – is currently near 16. This is well above the five-year and ten-year averages – and solidly in historical bubble territory.
Even if increased bubble-talk is premature or misplaced, it is hard to imagine an imminent return to economic prosperity and “boom” times sufficient to justify today’s lofty stock-market valuations.
Indeed, few stock-market strategists and business economists expect earnings growth in the next year or two sufficient to justify ever-higher equity prices – such that equities would continue to outperform gold, as they have in the past few years.
A Turning Point for the Fed
After its mid-December FOMC policy-setting meeting, Federal Reserve Chair Ben Bernanke announced the central bank would taper its program of bond purchases beginning this January – and odds are the Fed will continue shrinking its program of quantitative easing in the months ahead.
Fortunately, for gold investors, the Fed’s policy options present a win-win: If the economy falters a postponement of tapering would likely be greeted favorably by gold traders and investors.
On the other hand, if the economy shows signs of strengthening, a continuation or acceleration of tapering could be a plus for gold as inflation expectations begin to rise and increased credit demand boosts interest rates and short-circuits world equity markets. In fact, judging from recent stock-market and gold-price performance, this scenario may already be underway.
Moreover, even if the Fed further curtails its program of quantitative easing, reducing its bond purchases by an additional $10 billion each month, it will nevertheless have increased its balance sheet (which is the electronic version of printing money) by $900 billion during the 2014 calendar year – and, in the five years since the 2008 financial crisis, the Fed will have expanded its balance sheet by some 400 percent.
If this isn’t inflationary, I don’t know what is! Eventually, these birds will come home to roost.
About Rosland Capital
Rosland Capital LLC is a leading precious metal asset firm based in Santa Monica, California that buys, sells, and trades all the popular forms of gold, silver, platinum, palladium and other precious metals. Founded in 2008, Rosland Capital strives to educate the public on the benefits of investing in gold bullion, numismatic gold coins, silver, platinum, palladium, and other precious metals. Rosland also helps people who wish to protect their wealth by including a gold or precious metal-backed IRA in their asset portfolio. Click here for more information.
About Jeffrey Nichols
Jeffrey Nichols, Managing Director of American Precious Metals Advisors and Senior Economic Advisor to Rosland Capital, has been a leading precious metals economist for over 25 years. His clients have included central banks, mining companies, national mints, investment funds, trading firms, jewelry manufacturers and others with an interest in precious metals markets.
