Gold Forecast: Stability Creates Instability

So we are now well within our long forecast downtrend. Having broken to five year lows, we are watching to see how we fall over the coming weeks…and how badly we end the month. We remain bearish in the short-term, but wouldn’t be surprised at a bounce over the coming days.

Hyman Philip Minsky (1919 –1996) saw the financial system as a fragile entity that constantly needed to swing between two extremes. He wrote "A fundamental characteristic of our economy is that the financial system swings between robustness and fragility and these swings are an integral part of the process that generates business cycles."

He saw the financial system like a pendulum moving from stability to fragility, followed by crisis …and then back to stability followed by growth. This is also a phenomenon of the natural world as well as human psychology itself. Nature rarely stands still instead days turn to night, summers to winters and empires rise and fall.

The chart below from the St Louis Fed is the yield on ten year Treasury Notes stretching back sixty years.

Interest rates have been falling for 35 years fuelling an epic credit boom, the nominal value of debt today is virtually ignored and only the affordability of servicing debt is important to the financial industry and political establishment as they attempt to push on a string. This reduction in the cost of servicing debt has lead to an explosion in the value of assets that produce a yield.

A constant fall in the cost of debt has created a false sense of stability to the financial and political systems of many countries around the world. It has also provided a sense of stability to the post war generations as they have watched their unearned wealth continue to rise to the point in any bubble where the beneficiaries of the boom become the victims of any risk re pricing event.

Since the early 1980’s stocks, and more recently bonds and real estate have been on a tear, as the demand for credit increased so interest rates fell, it became profitable to consistently borrow to buy as the demand for debt increased lenders fell over themselves to lend in to these assets booms they had helped to create.

Another issue is that these debt bubbles create a misallocation of capital away from productive enterprises like businesses that may create exports and employment and towards rising asset prices which only benefit the asset holders themselves. This creates a sense of wealth and security in some sections of society but leaves the whole of society worse off in the long run as these bubbles, subject to the laws of nature need to swing from excessive optimism to excessive pessimism.

The problem is as interest rates near zero lending and borrowing becomes more marginal, more money needs to be borrowed to chase a lower yielding asset. Time in an asset bubble slowly erodes the yield of the asset, as income streams increase more slowly than purchase prices. At some point this mispricing of risk is usually ended by an increase of defaulting loans somewhere in the economic chain, from the supplier of credit to the supplier of goods.

When looking at the long term trend of interest rates it’s surely impossible not to think about Minsky’s financial system swinging between robustness and fragility. If we think about financial markets being the product of human fear and greed we can accept that as a natural phenomenon they are subject to the rhythms of the natural world and the tendency of human nature to swing from optimism to pessimism.

Faith in assets that produce a yield has never been higher, whilst faith in physical objects with utility like commodities has almost never been worse. Assets requiring a yield depend upon the labours or ingenuity of others to pay the rent, dividend or coupon; they are essentially a form of IOU, they are an asset as long as the income stream remains.

Assets like commodities have a utility to man that has been accepted for millennia. From metals to hydrocarbons our modern economy is driven by our ability to exploit these assets for our benefit. But currently we appear to have an alarmingly deceasing demand for physical goods, this is likely a tell that the bubble economy is popping, the misallocation of capital for decades has seen a huge growth in marginal businesses that only exist in this false stability, any slowdown brings their viability in to question.  

This mispricing phenomenon we are witnessing right now may well be sowing the seeds for the defaults we would expect to see as the debt bubble bursts. But massive bubbles have massive blow out tops, the pendulum will swing from our current status of fragility towards the robustness that occurs once defaults have been accepted, but beforehand don’t be surprised to see even more extreme mispricing.

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Ken Ticehurst

To view one of the most accurate and unique gold price forecasts available visit us at: http://www.kenticehurst.com