Will Gold Glitter Or Fizzle In 2016? (Part 2)

Will Gold bottom in 2016?

I personally believe gold will bottom in 2016. The main reason is the Fed will probably not be able to raise rates four times in 2016 without causing panic in the financial markets.  For the Examiner I wrote a series on why the Fed couldn’t raise rates. Part one of the series was about the economy, part two was about the equity markets, and part 3 was about the bond markets. Since the end of QE, we have already seen two market bubbles pop. The first one was the shale oil bubble, and the second bubble was in the junk bond market.

Based on these events, it is safe to say that every time the Fed makes a move toward normalization, or begins tightening, a bubble pops. The popping of the shale-fracking bubble coincided with the end of QE. The current popping of the Junk bond bubble has coincided with the Fed’s first interest rate hike. At this pace, if the Fed were to increase interest rates by 25 basis points four more times in 2016, four more bubbles could possibly pop.  In my opinion there are presently bubbles in municipal debt, sovereign debt, auto loans, another housing bubble, student loans and one in technology. Currently, the popping of the shale bubble, and the junk bond bubble, haven’t triggered a decline in the stock market indices, as most of the junk bonds that were issued are tied to the energy sector. Consequently, this leads people to believe these are isolated incidents.  However, if four more of these bubbles were to pop in 2016, or even two more, I don’t think the equity markets will be able to ignore these problems…as they are ignoring the popping of the shale and junk bond markets currently.

I also believe that higher interest rates would cause companies to start raising cash, due to high debt levels that the American companies are carrying, as they are now possessing record amounts of debt. If this were to occur, there are only four ways that these companies will be able to generate cash as a means of paying down their debt. The first way is by increasing the company’s sales and profits. This would allow companies to allocate their increased profits as a means of paying down company debt. This strategy of paying down debt for corporate America is impossible, due to the fact that sales and profits have been on the decline this year, caused by a lack of consumer spending. This is why we are in the midst of an earnings recession.

The second way a company could generate cash would be by issuing new shares (i.e. equity). In this event the stock market would start declining precipitously, as the main buyers during this bull market were the companies that are being traded in the indexes. In 2015 alone, companies traded on the S&P500, have spent over 1 trillion dollars on share repurchase programs. If these repurchase programs were reversed, with shares being issued instead of purchased, a company’s earnings per share (EPS) would fall rapidly, thus causing the stock market to decline with it.       

The third way of issuing money would be to sell off company assets, as a means of generating cash. Considering that companies are almost stripped to bone with part-time employees, combined with the fact that vacancies are on the rise, there aren’t many assets that the average US Company can sell as a means of raising cash. Therefore, this method of raising cash would have very little effect on a company’s cash holdings. Also, if everyone were to sell assets around the same time period, the estimated price of an asset that a company thought they would receive would probably come up less then what they would have estimated to receive; as sellers would greatly outnumber the amount of bidders on the market, thus decreasing the price of the asset sold. This would in turn have companies looking for new ways of raising cash, once asset sales were completed. 

The last way of raising cash would be by providing inventory liquidation fire sales. This is a very feasible way of raising money considering that most of the recent GDP reports were only positive, due to a buildup of company inventories. If an inventory fire sale were to occur, the GDP numbers would start to decline rapidly, as inventories are being liquidated and written down. Consequently, the US would more than likely go back into an official recession. Moreover, the Fed would be forced to acknowledge that the recovery is over after reporting two negative GDP numbers in a row,. This would then make the Fed become more accommodative, allowing the Fed to bring back another round of QE at the very least.

This may not be the exact way it plays out in 2016, but I do believe something like this will occur this year, which ultimately may put a bottom in for the gold price, as fear creeps back into Wall Street, thus igniting fear and selling.