The Future of Gold, Oil & the Dollar

The ability of reflationary policy to mute the worst risks of debt deflation has been a source of enormous frustration for stock market bears ever since the 2008 collapse. Yes, the initial moderate rally out of the S&P500’s black hole was perhaps not so surprising in 2009. Bombed-out stock markets can always manage some sort of rally. But the ability of the rally to continue through 2010, and then 2011, and now 2012 has been quite vexing and painful for bearish investors.

Indeed, the entire post-2008 market phase has now produced an era of consistently poor performance for hedge funds. Recent data, for example, shows that an incredible 90% of hedge funds are underperforming the S&P500 through mid-September.

Will the pain continue?

Sentiment readings indicate that fears about the global economy dominated hedge fund thinking as early as 2005. And rightly so. It was clear early on that the first reflationary policy wave, which followed the technology bust of 2000, was doing nothing more than inflating a housing bubble. The return to reality in the 2007-2008 debt bust was a kind of victory for short-sellers -- but the nightmare started all over again in 2009. Incredibly, even the EU crisis of late 2011 was not enough to hold global stock markets down, as the policy of monetary rescue once again powered financial asset prices higher.

One of the more clever tactics of the U.S. Federal Reserve as it gingerly moved towards its third big reflationary program this year (QE3, the third round of quantitative easing), was to let other policymakers move first. Not only did the Fed hold its fire while Europe experimented for nearly twelve months with various forms of crisis intervention, but the Fed also let other policy solutions bubble up to the surface (e.g., nominal GDP targeting), which added thematic pressure at the margin. As each month passed since last Autumn, the Fed kept repeating its claim that it could do more if the data did not improve.

This left observers mystified, given that the economic data and especially employment numbers did not, in fact, improve. Certainly, as many skeptics believed, the Fed would not move right before the election, would it?

Bernanke may or may not be an avid chess player, but he certainly understands the concept of zugzwang (actually, Bernanke recounts trying to play chess against Ken Rogoff and regretting the experience.) As the next round of global reflationary policy moved into its endgame, Bernanke likely earned the biggest bang not by moving first, but by moving last.

This lent an element of surprise to the action, and the new policy is still being digested by markets. Various research houses, for example, continue to calculate the size of QE3, with Goldman’s most recent estimate coming in at $1.2 to $2.0 trillion. Moreover, other Fed members in their public remarks have followed up the QE3 announcement with aggressive dovish viewpoints. In particular Narayana Kocherlakota has insisted that the unemployment problem is a battle that must be won.

Now, however, just over a month from the Fed’s QE announcement, the mood has darkened in global markets. There’s a sense that the latest round of QE is already in position to fail (an issue I addressed in August: When Quantitative Easing Finally Fails). This conclusion seems premature.

Accordingly, let’s first take a look at three key markets, gold, oil, and the dollar, which have already had a chance to respond to QE3. And in Part II of this analysis, we will take a closer look at the stock market and some of the reasons why the pan-OECD reflationary policy, from Japan to the EU and the U.S., must have elevating stocks to new all-time (nominal) highs as its central aim over the next year.

More to the point: If OECD policy makers do in fact lose stock markets as the main transmission mechanism for reflationary policy, then trouble of a very serious nature will make itself known in the biggest way imaginable since the 2008 crisis began.


This summer bore witness to a rather tedious, politicized discussion about the resurrection of the gold standard. But one can argue now that the idea of a gold standard is outdated. Why? The reason is simple: gold, over the past ten years, has already handily and beautifully served its balancing function to the end of growth and the manic attempt of governments to fight industrial decline.

Moreover, “debate” of the kind seen recently between high profile investors such as Warren Buffet and Ray Dalio further illustrates that the discussion of gold remains trapped in identity politics. It is as though mere association with gold confers all sorts of meaning. But none of this actually pertains to gold’s new role, here in the 'era of no growth'.

Interestingly, Paul Krugman has done some of the best (and politics-free) commentary on gold in the past year; I highlighted his views in last Autumn’s essay Gold and Economic Decline. I remain in agreement that the poor prospect for economic growth, rather than inflation from ‘money-printing’, has been the primary driver of gold for the past decade. Gold has, accordingly, outperformed nearly every other asset – especially stocks and real estate – and for good reason. Krugman wrote:

For this is essentially a “real” story about gold, in which the price has risen because expected returns on other investments have fallen; it is not, repeat not, a story about inflation expectations. Not only are surging gold prices not a sign of severe inflation just around the corner, they’re actually the result of a persistently depressed economy stuck in a liquidity trap — an economy that basically faces the threat of Japanese-style deflation, not Weimar-style inflation.

While many participants continue to use gold as a call option on future inflation risk – and from a resource and food standpoint, there is substantial inflation risk – the launch of QE3 more pointedly confirms the failure of Western economies to produce growth. It's for this reason that gold should prove to be more sensitive to reflationary policy than industrial commodities over the next year.


Did oil prices collapse this year due to the complex financialization of oil, as some predicted? No.

Oil prices don’t trend along price pathways simply because oil is the subject of financial speculation. Financial speculation can only take prices outside their fundamental price envelope for limited periods of time. And further, did QE3 cause gasoline to zoom to $5.00 a gallon, as many predicted? No, because quantitative easing doesn’t axiomatically cause oil prices to rise. Instead, it drip-feeds broken economies and mutes the devastating effects of debt deflation. QE dampens tail risk and allows the portions of the economy that are able to recover to muddle forward.

The two great forces currently acting on oil prices are, instead, the migration of demand from the OECD to the non-OECD, and the newly-significant higher cost to bring on marginal supply. That’s it. Neither is mysterious or complicated. As I explained in my recent piece, The Repricing of Oil, an odd stability has appeared in the global oil market that constrains oil prices to a range, defined at the lower bound by marginal costs and at the higher bound by exceptionally slow growth in aggregate oil demand.

Fresh QE from the EU, Japan, and the U.S, however, serves to place a harder floor under crude oil. QE and other reflationary policy from the OECD tends to flow more efficiently towards the non-OECD, either boosting or supporting much higher growth rates compared to developed world economies. This keeps annual growth rates of energy consumption plugging along for coal, natural gas, and, of course, oil. Much of this trajectory is not, in fact, dependent on robust world trade. Instead, the core trend in energy demand in the developing world simply comes from population expansion and the industrialization process that has yet to complete.

Do a reduction in world trade and less consumption of Asian goods from buyers in Europe and the U.S. mean that the non-OECD will grow more slowly? Of course. We can see the slowdown already, reflected in the soft pricing for global iron ore and metallurgical coal. But that doesn’t affect the ability of the 5 billion people in the developing world to slog forward with steady demand growth for oil. China and India, even in their slower-growth mode, are growing their oil demand by 4-5% per year. Should the global economy find its footing, oil prices will shoot substantially higher – though not because QE3 repriced oil; but because QE3 will have patched enough holes in the global economy to create new leg of growth.

The Dollar

The year-long rally in the U.S. Dollar Index must certainly have been a consideration for the Fed when deciding on new QE.

Why? Since the 2008/2009 low, U.S. exports have been one of the sturdiest sources of growth for the economy, with exports crossing the $2 trillion mark (in value) for the first time and taking up a larger proportion of GDP. As I explained in The Price of Growth, U.S. exports of coal, agricultural goods, and eventually natural gas represent a supertrend that offsets the portions of the U.S. economy that will have a difficult time recovering. Eventually, manufactured goods will also reappear as an export, owing to North America’s very cheap electricity rates, and U.S. labor costs will likely fall.

But the dollar’s rally on the Index, from 72.00 to 84.00, began to bite into export growth over the past year. It was inevitable that the Fed would eventually have to fight that trend. And fight it they have:

The market correctly anticipated the onset of QE3, of course, and started to break the dollar’s rally in late summer, as bourses positioned themselves for resolutions in Europe (which were positive for the euro currency) and began to react more confidently to weak U.S. data. For now, the year-long rally in the USD is decisively broken.

While it is certainly a stretch to claim that a weaker U.S. dollar will lead to job growth, the opposite, a strong dollar, would certainly lead to tighter monetary conditions. It is strange, moreover, that many of the same economists and financial writers who have for years decried the poor state of U.S. manufacturing and the super-elevated levels of U.S. consumption would either fear or criticize policies to weaken the dollar.

Do U.S. consumers not buy enough goods from abroad? Do U.S. consumers need to reverse the nearly decade-long trend of declining oil consumption via some policy that attempts to drive oil prices downward through a strong dollar? The fact is, the U.S. is already in the process of transitioning – like the rest of the world – to the powergrid. With its road and highway system in decline and with U.S. oil consumption down 15% from decade highs, the U.S. economy has rebounded, using not oil, but natural gas and coal. These are two commodities that, at current rates of economic growth in the U.S., are in fact quite abundant. The U.S. economy does not need a strong dollar.

Initial Conclusion

Contrary to popular belief, the Fed is much less concerned about the rise of gold as a challenge to their authority than many presume. Moreover, the Fed has come through a learning curve about oil. Bernanke understands (and has said) that there is a constraint on supply and that cheap oil is a thing of the past. Bernanke also understands that a price ceiling is largely operative in a time of weak economic growth, as economies will continue to balk at oil prices above $120. Accordingly, given that gold and oil already underwent spectacular price revolutions in the past decade, it can hardly be the concern of the Fed to “control” them now. No such control exists, and the Fed has essentially given up any pretense in this regard. Instead, it’s the U.S. dollar and the U.S. stock market that primarily concern the Fed.

In Part II: Where the Stock Prices are Headed Over the Next Year, we explain why the Fed – and its counterparts in the EU and Japan – cannot afford to lose control of stocks, especially as the global economy appears to be entering a synchronous slowdown. Moreover, just-released data on U.S. exports confirm that the encouraging three-year trend higher is faltering badly. Is it possible also that the Fed acted in anticipation of a new slowdown in the U.S. economy? Despite the controversy and elation over the latest jobs report, there is reason to believe that the U.S. economy may be seeing a four-year cyclical peak. In other words, the same concerns that are now the focus of stock market technicians and historians are also relevant to the U.S. economy.

Click here to read Part II of this report (free executive summary; paid enrollment required for full access).

This is a companion discussion topic for the original entry at

But I'm a bit disappointed that we haven't heard from CM in quite some time.  Anyone else in my boat?

It’s my understanding that Chris and Adam are in Europe, I suspect gathering info and insight up close and personal. I too miss them when they are gone and am looking forward to an analysis uopn their return. Be patient, everyone needs a change of scenery and perspective. We wish safe and enjoyable travels for them.
AK GrannyWGrit

Just spoke to Adam today and the're back.  It is really important though that the're out there to get the message to as many people as possible.  It is really heartening to see Chris popping up on more and more media venues. Climate change and peak oil are starting to become "main stream" issues and the sooner that they are dealt with at global level, the better the chance that we will all have a brighter future.  It's hard to estimate what impact Chris has had individually, but he certainly is making a great contribution. No mention of either of these issues in the presidential debate tonight (surprise, surprise)
I think that Gregor's analysis is interesting, a lot of the material I read in general inokes a definite and strong opnion, not so this time.  Interesting read, lacks the typical anti Bernanke vitriol, which is good (though I am no fan of Bernanke).  Things are continuing to bump along in there own way.  The probability of a catastophic event tipping things badly off the rails is certainly increasing, but a slow downward grind may be in the offing for the next 10 years as well.  We've got to get off the adrenaline for a while and plan for the long term.  It's not like Hollywood where a guy get's hit by a bullet and dies instantly, death comes slowly even to bad dysfunctional systems.

One thing that rarely seems to get mentioned that backs the US dollar is the US military. Its use to enforce the dollar system and the purchase and sale of oil in dollars goes a long way towards maintaining its international strength.  It does seem like we are hanging in this precarious balancing act between the slowing rate of energy demand increase, and increasing energy cost and production limitations.  How long will the additional reserves last that came on line as a result of the latest bump in prices last?  How long will people put up with a slowly declining standard of living to make up the difference in the availability in cheap energy?  What will we all resort to just to get by, that is the most frightening question of all to me.



Global level is exactly the problem.  Things need to be handled at the local level by individuals.  It's the large central planning view that has brought us to our current predicament.  Global solutions are not the answer - local, community solutions are.  Have you missed that part of the crash course?  Have you missed the message about building your local community?

Global solutions, just like federal solutions trample your rights and your ability to adapt and build for the future.  It brings you things like Monsanto, wars, fiat currencies, and institutions that pretend to act in your best interest but use government to steal from you and enrich those closest to power.


You missed my point entirely, global awareness does not in any way imply top down autocratic solutions, central planning or anything else of the sort. Local community solutions and individual responsibility is the only way forward.  I am already living what you advocate and don't need to be lectured about it.
However, if I'm sitting in my pasive solar house growing my own food with my precious metals and the rest of the world walks off a cliff from sheer stupidity that's going to have bad impact on me.  It's in my interest that the rest of the world wake up.

Isn't the whole point of this site and all of Chris's hard work about raising awareness on a global level so poeple can take individual actions to change there lives?

Sorry I mistook your statement "sooner that they are dealt with at global level," which I took to imply global control and not global awareness.  I certainly agree with you and all of what you said in your response.  I totally agree with educating people, but the solutions being offered up by our politicians and media all seem to be centered around the idea that if we just had the right smart people with a little more power over the populace we would solve everything.
As far as the world waking up, no chance.  I have pointed many people to the Crash Course, only those that are already partially awake ever get the message.  Most of the populace will never have a clue until it smacks them in the face, and even then most will still not wake up, rather they will call for someone to save them instead of realizing they have to save themselves. crying  Perhaps I'm just a bit more pessimistic today after seeing brief portions of the political theater played last night.

[quote]Global solutions are not the answer - local, community solutions are.[/quote]I agree, local community solutions are required…on a global scale.  Climate change is a global problem.  I'm not going to make much difference in my little corner of the world.  It will require a world of "local communities" to fix it.  That is an enormous, perhaps insurmountable problem.

I agree that it is really difficult sometimes to deal with what is going on, that's why I enjoy posting here. It is a nice sanity check. That's also why I have turned off the radio and TV.  I did endure the debate last night, everybody else wanted to watch it (we streamed it over the internet).  The commentary before and after was no better.  It was covered like a sports event, discussions of strategy, as if we were a nation of campaign managers, no substance. It's gotten beyond ridiculous.
This is going to be a whole lot of hard work, there aren't going to any short cuts.  I have come to believe that learning the hard was is the only way from lots of personal experience.  And I would rather lead by personal example rather than haranguing people about personal reasponsibility and economic collapse.

Wow, it's seventy degrees in here and you don't have any heat on, you're doing this all by the sun? I didn't know you could do that.

Wow, you grew all this food yourself in your back yard, these peaches are really good.  Those raspberries look great.

You don't pay any utility bills, how did you do that.  How do you get all this hot water?

No interest payments to the bank, no debt, that must feel great…

Etc, etc.

The knocks will get as hard as they need to, not waking up is not an option.  In a way we are lucky to be alive now, when the rubber meets the road, when what needs doing gets done.  And we don't need to do the knocking, reality is working on that all by itself.

I do hope that Gregor is right and this thing does grind on for a while, more hard work to do!

Paul Krugman has been consistently wrong in is economic predictions for years. He is a leading Keynesian economists and all such economists usually are wrong. Mr. Macdonald quotes Krugman in this article in a favorable light and so I have to wonder about the sanity of Mr. Macdonald. Better for readers of this blog to take their advice on buying gold from Austrian School real world economists like Peter Schiff and leave Krugman and his followers to their silly economic debates in the Harvard faculty lounge.

Lewis Forro

Virginia Beach, VA

Gregor is brilliant. That simple.
He puts himself out there, works real hard, and I personally respect that very much. If he's wrong well, then he's wrong.

The point really is are we right. In the end that is all that will matter.

Gregor hustles, works hard, and that's all that be asked of any Man/Woman. Besides, he has shown that if the information changes he will too. That is a mind in control frankly.

Respectfully Given

Goooo Tigers


This is how I see the future of Gold. (With a lot of help from my friends)
China's wealth is tied up in USA script. On paper they are wealthy. If they try to realise this wealth it will go bad, turn rotten or whatever your prefered metaphore. They dare not step off the mine. What to do?

So they buy usefull comodities. Iron ore, copper, land, oil.  .  . They also buy monetary metal, Gold. Silver straddles the two commodity groups.

Is it in China's interest to buy cheap gold or expensive gold? So we see every trick in the book being used to lower the price. Just like buying fish at the local fish-market. "Gold? Nah. That stinks, is an ancient relic, useless" etc etc and so forth

And China is not the only player in town.

Goldman Sachs. Or is that sacks of Gold, man?

I agree with local communities and resiliency on a global scale as a the solution to the crushing global system that has developed.  My hope is that a plateau and reduction caused by peak FF will push us toward locality on a global scale.   
I don't see that there will be a global solution to AGW.  I think the energy inputs to put in place more global hierarchy will not be there.  I simply hope that we won't end up taking out enough of the really nasty fuels to keep the CO2/Methane trends heading upwards.

Mr. Robey, you look enough like the Dos Equis guy to have some credibility in here regardless of what you say!   In all seriousness, I always like reading what you have to say as it seems well thought out and balanced.  When you note above that silver straddles the two, I take it you think silver is a wise asset to own in preserving wealth?  Of the PMs in my portfolio right now, I have 55% gold and 44% silver and 1% platinum.  The folks at FOFOA think silver will go down as gold soars and I'm trying to think of my mix of PMs. 

I think the time is not far off when few people will accept even gold in exchange for food. I prefer collecting diverse skills, then hard steel especially as in needles, fishhooks, razors or blades (reused in arrowheads), then aluminum and some plastics which are very reuseable, then bullets, especially .22 caliber…