Gold Rise to Continue on Fed Manipulation

Jim Rickards - Gold Rise to Continue on Fed Manipulation

With extraordinary volatility in stock markets and continued strong accumulation of physical gold, Jim Rickards put together the following piece exclusively for King World News. One of the reasons Rickards has gained worldwide recognition is because of his ability to forecast ahead of time key moves by both the Fed and central planners. Jim Rickards clients include private investment funds and banks, government directorates around the globe in national security and defense and he has worked directly with the Fed and US Treasury. Jim is also a KWN resident expert and author of the extraordinary new book, “Currency Wars: The Making of the Next Global Crisis.”

King Vol 
by Jim Rickards, Sr. Managing Dir. Tangent Capital

September 11 (King World News) - Market commentators are never at a loss for reasons why stocks, bonds or currencies behaved in a certain way, especially on volatile days. From the European debt crisis to debt ceiling debates in the U.S. to natural disasters, there is always some phenomena that can be pointed to as a reason markets go up or down. In addition to these mini-themes, there are some mega-themes that have more explanatory power. From mid-2010 until mid-2011, the “risk on”/“risk off” explanation prevailed. The idea was that as U.S. growth emerged and the European crisis abated, traders would put on riskier trades such as stocks and gold but as growth faltered and Europe stumbled the risk-off paradigm would prevail and traders would move to Treasuries and the U.S. dollar. Lately all of the news seems bad and the risk-off mode dominates, although gold has advanced anyway as the perception of gold has morphed from risky bet to safe-haven where it should have been all along. A new mega-theme has emerged – call it the “conversation of volatility.” To understand it, begin with the three most important trading markets in the world – stocks, bonds and currencies. These markets have always affected each other although the interaction is greater at some times than others. Generally as interest rates in a country rise, the currency of that country strengthens. Likewise, as rates rise, stock prices go down because the discount rate applied to future earnings is greater and present values are lower. All three markets have certain historical volatilities but that volatility can shift as the influence of one market on the other becomes more pronounced. For example, if stock prices rise sharply, interest rates rise as credit demands increase and inflation takes off. This can cause the stock price rise to moderate shifting volatility from stocks to bonds. The same phenomena can play out between rates and currencies. The notion is that there is a quantity of potential volatility in the system at any one time based on the scale of the system and that volatility will move among stocks, bonds and currencies based on the credit cycle. Now consider the impact of Fed market manipulations. The Fed has set its short-term policy rate near zero and promised to keep it there until 2013. Through QE, QE2 and the new Operation Twist 2 the Fed has also squashed medium-to-long term rates. The result has been to take volatility out of the U.S. Treasury markets. Because currencies move largely based on interest rates, reduced volatility in interest rates also means reduced volatility in foreign exchange pairs except where governments dramatically intervene as in Switzerland recently. So we are living in a world where interest rate and foreign exchange volatility are greatly reduced due to Fed manipulation. Applying our notion of the conservation of volatility it quickly becomes apparent that if you take vol out of rates and FX then all of the volatility in trading markets must go toward stocks. For example, in prior periods, if stocks rose too far too fast, interest rate hikes might be expected that would cool off the action in stocks. Conversely, if stocks collapsed, rate cuts might stabilize the situation. Now as stocks gyrate wildly, there is no interest rate mechanism to absorb the shocks and stocks lunge deep into overbought and oversold situations. This is one explanation for the 200-plus point swings in the Dow Jones average that we have seen day after day. The stock market is like a racing car that has been fueled with nitroglycerine and had its brakes removed. For investors this is one more reason to avoid stocks. The removal of volatility from rates and currencies and the transfer of that volatility to stocks, combined with other destabilizing factors such as high-frequency trading and leveraged ETF’s, have detached stocks from fundamentals and resulted in the stock market being highly unstable and perhaps just one snowflake shy of an avalanche. In the short run, this will mean volatility in gold markets also as 400 point down days on the Dow cause forced selling of gold to meet margin calls. However, in the longer run the safe haven aspects of gold will become even more apparent as investors flee from stocks. The relentless push higher in gold will accelerate albeit with volatility along the way. Unless the Fed stops its manipulations and returns to a strong and stable dollar, the conditions for gold’s push to $5,000 per ounce or higher are still intact. 

James Rickards is a Senior Managing Director of Tangent Capital in New York and the author of “Currency Wars: The Making of the Next Global Crisis” Penguin/Portfolio Nov., 2011, to pre-order CLICK HERE.