Looking Back

In my annual "Looking Forward" article: "Toward Normalization," posted here exactly one year ago, I began by stating:

"Since 2008 I have been forecasting an ’L’ shaped economy. Year after year, I've looked at the current economic and fiscal policies of the government, the condition of the financial system, the regulatory environment, taxes, and the Fed's monetary policy. And year after year I've been forced to conclude that we were in for ‘another year of L.’ And indeed, every year we have stayed in the 2% range, never achieving a typical economic recovery. For six years we have had sub-par growth and persistently high unemployment.

I think that is finally about to change.

The year 2014 should bring an improvement across the board, but with a joker in the deck. Although I think we have a good chance of seeing increased growth in the year, I think the 1st quarter of the year will be challenging. I’m concerned that dislocations can disrupt a natural recovery in the making."

And indeed that's what we saw. The GDP fell significantly in the first quarter but since then we have had a consistent rise. The average GDP is now running at around 3% absent the first quarter. I also predicted a turn in gold from down to up, and gold moved from 1180 when that prediction was made to near $1400.

As gold and commodities began to turn down I wrote the following article: http://seekingalpha.com/article/2503535-whats-caused-the-commodity-bull-market-to-derail

Here is an excerpt from that article which I think is worth looking at considering where we are now. Things were happening that should not have been happening at that time if we were going to continue the bull-run in gold that had begun.

"What we're seeing is serious. It either portends a new round of disinflation, deflation and/or recession, or it's a steep correction that has occurred due to a convergence of various factors. Earlier I wrote an article voicing my concern over what I was beginning to see. It was the beginning of my move to reduce my position in precious metals stocks and become a lot more cautious in my trading account.

All was going well until about ten days ago. Suddenly agricultural commodities, oil, and the CRB have all fallen. This means that gas and food prices will fall, and soon. As of today, inflation may have just peaked. It happened very abruptly."

That was July 2014. From that point on I began taking profits and reducing my position in gold and silver stocks. I reduced my exposure dramatically as precious metals fell. But as of 1140 gold I began adding to positions once again.

From my November 7th article "Why I'm Buying Gold Stocks"...

“No one is predicting today that the 1140 area we just hit is the low, but it might be...right now, precious metals stocks, and commodities in general, and most resource stocks are as oversold as they have ever been in market history. Either the world is heading for a devastating deflationary recession, or these markets will stabilize in here and we'll get a playable bounce. As of today, I'm a buyer of good low cost gold and silver producers."

Gold has since rallied even as commodities have continued to make new lows. I still believe this is a good time to accumulate low cost resource producers with good prospects going forward. But I might add, only with speculative money.

Looking Forward

I think the biggest surprise in 2015 will be how long interest rates stay low. I wouldn't be surprised if the Fed did not raise the fed funds rate all year. Falling commodity prices and the subsequent dislocations they can cause may prevent them from doing so. The vulnerability of Europe is another reason to delay. But even if they do I seriously doubt that will affect the long end of the interest rate curve which has much more of an economic impact on the economy than short rates. Long rates won’t move significantly higher until inflation or debt concerns reemerge. And at that point, gold will move up for the same reasons.

The biggest threats to both gold and economic growth in 2015, in my judgment, are a deflationary recession which looms in many parts of the world. The continuous fall in commodity prices are still signaling this vulnerability. And now we have the specter of nation states joining rogue hackers attacking our companies, institutions, and infrastructure. Cyberwar is now at our doorstep and won’t be leaving anytime soon. Both a deflationary recession and cyber-attacks have the capability of crippling the world economy.

While on the subject of predictions I should mention that for the first time in over three years I do see a scenario where gold could soar. This is a big change for me. There has been nothing in the last several years, including 2011, where predictions of $5000 dollar gold were rampant, that indicated anything of the sort. The best bull case I could muster up was my gold call at 1180 last year, and we did move up a quick 200 dollars. That was based on higher world growth and higher inflation which we did see temporarily in the first half of 2014.

So what would cause gold to not just rise, but to soar? The answer is a continuation of governments demanding gold. In my 50 years of monitoring the international monetary system, I have never seen anything like the move by so many governments to take physical possession of their gold held in America. Why now is unclear. But the fact that they are is sufficient if continued, to create a run on gold by institutions, investors, the public, and speculators. That could push gold substantially higher very quickly. 

With all this said, I consider the above scenarios a low probability of playing out; but they are visible ones, and ones I will be watching closely.

More likely, we will see a continuation toward normalization with a slow increase in growth, inflation, and interest rates world-wide. Gold's stabilization is suggesting that this is the direction we are heading. If you step back and look at gold’s movement over the last year, you will notice it is virtually unchanged. This reflects monetary stability.

A sharp move higher or lower challenges this stability. It suggests the onslaught of inflation, deflation, or fear.

The reason I consider the negative economic potentials less probable than the positive ones, is that there is less leverage in the system: leverage has been reduced in the world because banks and corporations are holding greater amounts of capital – record amounts in fact. This lessens the probabilities of a credit event anything like what we saw in 2008. 

And the dramatic fall in oil is first and foremost a tax cut to most people of the world which increases liquidity. Low oil prices will benefit most of the major economies which are oil consuming nations -- the US, China, Japan, Europe, India – the largest, most developed nations of the world. And even if there are repercussions from the sharp fall, or a credit event, it is not likely to create structural damage to the American economy and will likely pass quickly. We are strong enough to withstand a shock or two.

And finally there is a lot less speculation in the world today. Consumers, home buyers, and investors have become very conservative since the financial crisis. Economic stagnation and disinflation has kept a lid on the system as a whole. The disinflationary recessionary bias weighing on the world for years is still with us today. However, the US has slowly pulled away from its influence. We are slowly returning to normal. The big question for 2015 is will the rest of the developed world follow.

I ended my last "Looking Forward: Toward Normalization" article saying that I thought we would end the year in the US with the economy looking much better at the end of the year than at the beginning. And indeed we see an economy on the mend. The last two quarters have seen an economy moving at 4 to 5% rates of growth. However, I think that 5% is the high watermark of the recovery. The return to normalization is a process that should continue in 2015. The greatest likelihood is that we continue to grow less than now, but more than before. I’m looking for a 2.5 to 3% GDP with inflation and interest rates remaining low in the first quarter but rising a bit for all of 2015. More importantly, world growth should increase a little and deflationary fears subside.

The net result on gold should be a gentle increase over the year leading gold back to the 1300 area. With oil falling, wages stagnant, and most other prices stable, costs to miners should stabilize or fall. The subsequent spread between stable to falling costs and rising metal prices should lead to a return to reasonable multiples and values of mining stocks. They should climb from ridiculously oversold levels to much higher levels as long as the perception is that the free fall is over and the trend of gold and silver is now up.

If this is the case, gold and silver stocks could be among the best performers in 2015.

Other possible surprises in 2015 include real tax reform, the reparation of the trillions of dollars held abroad back home and employed, and the beginning of what I call the “debamafication” of America. That amounts to a reduction of taxes, fees, regulations and mandates in healthcare. The Supreme Court will decide this March whether Obamacare, as structured, is in fact legal. A Supreme Court against subsidies provided by the federal government could pull the rug from under Obamacare as we know it.

And the reduction of regulations in Dodd-Frank legislation will undoubtedly be initiated by the new US Senate. Even now the Volker Rule passed by Dodd-Frank has been postponed for another two years due to the fact that no one can agree on what it means or how to implement it. That will most like be a recurring theme in 2015, as more regulations, taxes, fees, and mandates already passed and scheduled to go into effect next year, will be either killed, postponed, or replaced. These positive factors could add to growth, wages, and corporate profits in 2015.

However, I understand the list of things that could go wrong dwarf the list of things that might go right, so this years’ "Looking Forward", more than most, is simply an educated guess based on probabilities. Normally we can project the economy and monetary conditions which are based on actions already taken and extrapolate cause and effect. That is not true this year.

What will actually happen in 2015 will be dependent on political, economic, and monetary decisions not even made yet. As a trader and investor I will take reality as it comes -- one day at a time. In these markets I've learned lately to take them one hour at a time. Such is the world we live in today.

Paul Nathan

Paulnathan.biz