On October 2, 2017, Market Memo: Normalization, Tax Cuts, Geopolitical and Gold, I wrote:
What this means is that the price of gold (POG) will continue to adhere to the Kendall Rule. The initial steps of normalization, tax cuts, and trade issues will not disrupt this. Only serious geopolitical issues or another financial crisis may disrupt the POG’s continuation of tracking the duration of debt. Absent these concerns, a fall of the POG below $1250 becomes a buying opportunity.
Gold began a fall from $1350 on September 8, 2017. It hit $1240 on December 12, 2017. It has since risen back above $1350. I based my prescient call on understanding the gold signal as it relates to the operating mechanics of the Federal Reserve’s monopoly control of base money supply. Despite gold’s “barbarous relic” dismissal by economists, academia, and mainstream financial media, nothing has changed in the last 4000 years to diminish gold’s unique properties that have made it the monetary standard of reference.
Prior to the financial crisis of 2008, understanding the gold signal as it related to Fed control of the supply of base money was fairly straightforward. There was a direct correlation between Fed operating mechanics, regardless of constantly changing Fed theory and the supply of base money. It then became a matter of interpreting the various fiscal and geopolitical forces that impact dollar demand in relation to the Fed’s supply of base money.
The impetus for a change in the base money supply/demand relationship occurred with the Emergency Economic Stabilization Act of 2008. This act, effective October 1, 2008, enabled the Fed to pay interest on reserves (IOR) and altered the traditional relationship between base money supply and demand. With the Stabilization Act of 2008, the Fed began paying IOR for the first time in its history. Excess reserves that traditionally existed as a negligible amount of base money exploded from $1.9 billion to $2.7 trillion by August 2014. With massive excess reserves enabled by IOR, the Fed altered the direct relationship between base money supply and demand. This altered supply/demand relationship has confused the financial, investment, analysis, and forecasting world—regardless of which economic school defines one’s thought.
It became clear to me in July 2015 what was happening with the POG. I observed gold’s fall from its September 2011 high of $1900 and realized the POG would bottom out around the duration of debt level, then at $1100. Most analysts were predicting that gold would continue to fall to the $600 to $800 level. The minimum POG would then track the duration of debt level. I defined this new base money supply/demand relationship in a rule, The Kendall Rule. It has held for 2 1/2 years now. Understanding this new relationship is why I predicted in Oct 2017 that gold would not fall much below $1250.
The skewed supply/demand relationship caused by excess reserves, also affects how geopolitical and fiscal forces impact the POG. Geopolitical and fiscal changes no longer have the same direct impact on base money demand as they did prior to excess reserves. Excess reserves remove the Fed’s direct control over the supply of base money and in effect absorb base money supply. This new monetary paradigm requires a more nuanced interpretation of the impact of geopolitical and fiscal forces.
Due to 46 years of Fed incompetence in the management of the dollar, sovereign states and technologist cryptocurrency are threatening the dollar’s role as world reserve currency. The dollar has lost 97 percent of its value since 1971. China seems to understand gold’s monetary standard of reference and the importance of currency stability. After almost a decade of planning, China will finally open the Shanghai International Energy Exchange (INE) in March 2018. INE will execute oil contracts denominated in yuan. The petrodollar system began with the collapse of Bretton Woods. Since 1971 global oil trades have been transacted in dollars. To whatever extent the INE captures oil trading denominated in yuan, dollar demand will likewise decrease. A decrease in dollar demand without a corresponding decrease in dollar supply is signaled by a rise in the POG.
The U.S. has the power to stabilize the dollar and shepherd the rest of the world to a return to linked, stabilized currencies. Instead, the U.S. continues to manipulate the value of the dollar for perceived domestic advantages. This ongoing experiment with fiat dollar manipulation destabilizes the global financial system. It is no wonder that sovereign states and anarchist crypto movements are attempting to disrupt the dollar’s role as reserve currency. Global conflict, trade disputes, and beggar-thy-neighbor currency policy are a result of errant U.S. monetary policy. The POG, as always, signals this disruption.