At Sprott, our investment thesis for gold is significantly long-term in scope. We believe gold’s methodical advance since 2000 has had more to do with the growing disconnect between productive output (GDP) and ever-inflating claims on that output (debt and equity valuations), than with short-term fluctuations in variables such as CPI-type inflation or interest rates. Because we view gold as a highly productive, portfolio-diversifying asset until such time as these gaping imbalances are finally resolved (through default or debasement or both), we are generally loath to focus on short-term projections for gold markets. However, the current alignment of fundamental, technical and quantitative factors underpinning gold markets has become so asymmetrical to the upside, we have developed high confidence for an imminent and potentially significant rally in precious-metal valuations.
Post-election advances in market-sentiment measures are now clashing head-on with intransigent U.S. realities of excessive debt, dismal productivity, structural under-employment and chronic economic stratification. In short, the Trump-induced reflation trade is dying a quick death amid epic (mis)positioning. In this report we provide a short precis of our updated reasoning for an allocation to gold, followed by a visual tour of our “top-ten” list of technical and quantitative factors we see powering gold’s developing advance.
In our 2017 Investment Outlook, we made the case that excessive U.S. debt levels all but preclude significant Fed tightening. We suggested that, with total U.S. credit-market debt of $66 trillion atop U.S. GDP of only $18.8 trillion, any sustained increase in fed funds target rates would catalyze immediate upticks in a wide array of financial-stress measures, as well as surging default rates in sketchier components of the U.S. debt pyramid. To us, the greatest shortcoming of consensus economic analysis has been failure to recognize the cumulative and corrosive damage which eight years of ZIRP and QE have inflicted on the market dynamics of nearly every global industry. By artificially depressing interest rates for so long, global central banks have destroyed time preferences, inflated sales by borrowing from the future, and completely distorted legacy sales practices and consumer buying habits. The U.S. has evolved into a “zero-down, zero-percent” society, for everything from cars to leaf-blowers, to jewelry to big-screen TV’s. Manufacturing supply chains have expanded across the globe, enabled by the reduced cost-of-time in a ZIRP world. The day of reckoning for trillions-of-dollars-worth of uncompetitive U.S. businesses (and credits) has been postponed by the palliative of illusory (ZIRP) financial conditions. As the Fed attempts to migrate from the zero bound, these profound economic changes will not be reversed without significant pain and dislocation.
We believe the three FOMC rate hikes since December 2015, (together with consequent U.S. dollar strength and curve-steepening), have already set in motion a cascading downward spiral in crucial sectors of the U.S. economy, such as retail and automobiles. Somewhat at odds with recent upticks in consumer sentiment, March retail sales (released 4/14) declined 0.2%. Together with February’s harsh downward revisions (from +0.1% to -0.3%), retail sales have now registered their steepest two-month tumble in over two years. During the same two months, the BLS reports payrolls shed 60,600 retail jobs (seasonally adjusted), the worst two-month drop since 2008. Ten U.S. retailers have already filed for bankruptcy during early 2017 (compared to only nine during all of 2016), with several industry heavyweights suddenly on the ropes (Sears, Gymboree, Nine West). Prominently featured in the current rash of retail insolvencies is a recurring theme of excessive corporate leverage. Morgan Stanley (3/29/17) reports major U.S. retailers shuttered 2,087 stores in Q1 2017, up nearly 70% from the Q1 2016 total. Bank of America (3/14/17) estimates that February U.S. department-store-spending collapsed at an historic 15% year-over-year pace.
We are not suggesting that weak retail sales and heightened stress among retail credits have arisen solely from recent Fed tightening. Obviously, there are monumental changes occurring in retail delivery channels. Our point is that eight years of ZIRP have delayed inevitable rationalization of hundreds-of-billions-of-dollars-worth of outdated retail formats and outmoded brick-and-mortar storefronts and malls. Three FOMC rate hikes have quickly ignited a painful reckoning process which will now crystalize significant capital losses throughout the retail sector. Each additional FOMC rate hike will only broaden and accelerate the writedowns.